The IRS Offshore Voluntary Disclosure Initiative

In February, the IRS announced the 2011 Offshore Voluntary Disclosure Initiative (OVDI). The purpose of OVDI is to bring taxpayers that used undisclosed foreign assets to avoid tax into compliance with U.S. tax laws. OVDI, which is similar to the 2009 Offshore Voluntary Disclosure Program, ends on August 31, 2011.   OVDI provides taxpayers with a safe harbor from criminal prosecution and streamlines civil penalties provided that taxpayers fully disclose offshore assets and income. Participants will be required to pay back taxes and penalties on the unreported amounts of income and sometimes the assets generating that income. Lastly, participants will not incur criminal penalties.

Chuck Rubin provided an overview of OVDI at his blog when the initiative was first announced. Since the initial announcement of OVDI, the IRS released detailed procedural guidance in a lengthy Q & A bulletin posted at the IRS OVDI website.

Despite the benefits of OVDI, participation in the program may not be appropriate for all taxpayers. Participants in OVDI are subject to fixed penalties. For example, the 20% accuracy related penalty may be abated when the taxpayer can show reasonable cause for its omission. That reasonable cause abatement is not allowed to OVDI participants. Furthermore, penalties may be imposed on a greater income amount or asset base than otherwise would apply if the taxpayer had filed a return and was audited. Therefore, the taxpayer should analyze their unreported income and assets with their tax advisors and determine whether they should participate in the OVDI, or file a return and resolve the unreported income items during an audit.

The Q & A bulletin from the IRS provides the process for which taxpayers may participate in the OVDI. First, a taxpayer must submit an Offshore Voluntary Disclosure letter to the Criminal Investigation Division (CID). A complete copy of this letter can be found at the IRS OVDI website. In this letter, the taxpayer will describe the unreported income and the assets generating that income, the value of such assets, the location of assets, the related unreported income and other applicable information such as account numbers and bank representatives. If CID accepts the Offshore Voluntary Disclosure letter, then CID will request a full OVDI disclosure package, which includes all prior returns, amended returns, and payment for the amount due.

Taxpayers that are unsure of their eligibility for OVDI (for example, taxpayers under investigation by CID), may request pre-clearance from CID before submitting their Official Voluntary Disclosure letter. This pre-clearance procedure, detailed in the Q & A, involves submitting an inquiry letter to CID, who will respond within thirty (30) days.

OVDI is applicable to the taxpayers who have not reported offshore assets or income and gives them a clear path to avoid criminal prosecution.