How Did We Get Here?

For the last 7 years, the IRS maintained a consistent, robust program for taxpayers with exposure to potential criminal liability or substantial civil penalties due to a willful failure to report foreign financial assets. Taxpayers could come forward, pay back taxes with interest and a penalty, and avoid criminal prosecution. However, that arrangement appeared to change on September 28, 2018, when the IRS ended the latest iteration of its OVDP. Disclosure options remain available for taxpayers with non-willful compliance issues under the Streamlined Foreign Offshore and Streamlined Domestic Offshore Procedures. However, for taxpayers that intentionally violated a known legal duty, the path remained uncertain after the closing of the OVDP. By releasing the CI memo, the IRS has removed the uncertainty and clarified that willful taxpayers still have a framework with which to voluntarily disclose. However, the penalty regime under the new framework is far less favorable than under prior programs.

Penalties That Hurt

Under the new framework announced in the CI memo, taxpayers must pay all applicable taxes and interest for six prior tax years, as well as penalties. The CI memo states that the penalty generally will be "the civil penalty under IRC § 6663 for fraud or the civil penalty under IRC § 6651(f) for the fraudulent failure to file income tax returns" applied to the one tax year that generates the highest tax liability (and highest penalty). The civil penalty under IRC § 6663 for fraud is a 75% penalty on unpaid tax. In the alternative, the IRC § 6651(f) penalty for the fraudulent failure to file is also 75%. Hence, the standard penalty under these procedures will be at least 75% of the highest year tax liability. By comparison, the miscellaneous offshore penalty under the 2014 OVDP was typically 27.5% of the value of undeclared assets.

In addition, the CI memo states that the IRS may assess willful FBAR penalties across the same six-year period. Those penalties can be up to 50% of the highest undeclared foreign account balance during that period.

Mitigation and Examination

The CI memo states that civil penalties may be mitigated under existing Internal Revenue Manual procedures. Taxpayers should be cautious in relying on the phrase "may be mitigated;" the CI memo also states that "the imposition of lesser penalties is expected to be exceptional." In other words, waivers are likely to be uncommon.

Furthermore, experience has shown the IRS has not always restricted itself to program rules. For example, the Streamlined Domestic Offshore Procedures state that even "if returns properly filed under these procedures are subsequently selected for audit...the taxpayer will not be subject to accuracy-related penalties...or to information return penalties or FBAR penalties..." Nevertheless, the IRS has audited many Streamlined participants and sought to impose these additional penalties. In the CI memo, the IRS makes clear that if a taxpayer proceeds with voluntary disclosure under the new method, it will be assigned to an examiner for civil examination. In addition, if "a taxpayer fails to cooperate with the civil examination, the examiner may request that CI revoke preliminary acceptance." In other words, unless a taxpayer is prepared to cooperate fully with an examination, criminal liability remains a distinct possibility.

Don't Try This At Home

What is clear from the CI memo is that taxpayers will need a skilled advocate when making a voluntary disclosure. Whereas in prior programs a full examination did not result automatically from a voluntary disclosure, now every taxpayer that voluntarily discloses will be subject to such examination. Taxpayers will require professional assistance in remaining "cooperative" with the IRS and translating information requests in to responsive answers. Otherwise, the specter of criminal prosecution looms.