Nary a day goes by that I don’t talk to a client who is confused about one or more aspects of the OVDP program. Most of the time, it’s not the client’s fault. Usually, the confusion lies in the fact that the rules themselves are like a tangled web or labyrinth on the scale of what Harry Potter had to endure in the triwizard competition. So grab your broom. It’s time to navigate the labyrinth of overlapping rules within OVDP. The only difference is that your tour guide on this journey is not a famous teenage wizard who wears glasses, is an ace Quidditch player, has an impenetrable patronus, and speaks Parseltongue. Instead, it’s a very ordinary tax attorney who can no more get a snake to listen to him than he can his dog, Fido.

For as tedious as the rules can be, surprisingly that is not the primary source of confusion. Instead, the primary source of confusion (or should I say frustration) lies in juxtaposing the conditions that are needed to satisfy eligibility for one aspect of the program with the conditions that are needed to satisfy eligibility for a different aspect of the program. This confusion is only exacerbated when both aspects tend to overlap. Admittedly, I would be less than sincere if I didn’t acknowledge the existence of another factor that contributes to this shortcoming – that when this level of confusion exists, and the taxpayer is in greatest need of guidance, the IRS is nowhere to be found.

Some critics go so far as to attribute a sinister motive to the IRS for not providing guidance – i.e., that it has intentionally planted a trap to ensnare as many taxpayers as possible in the thicket of exorbitant penalties. While I don’t subscribe to this conspiracy theory, I do acknowledge the fact that the IRS could be more assertive in issuing notices, updating “questions and answers,” issuing technical advice memoranda, and/or issuing revenue rulings in order to inject uniformity into areas of the program that are susceptible to more than one interpretation. Perhaps the IRS should take guidance from the Wizengamot, the wizarding world’s high court of law, that has issued rulings time and time again forbidding the use of magic in the Muggle world. Of course, Harry might object, as he was formally accused of performing underage magic when he was forced to conjure a Patronus charm to save himself and his cousin, Dudley, from Dementors in the Muggle town of Little Whinging. Harry was subsequently expelled from Hogwarts, but the expulsion was later retracted.

While rules do help create uniformity, the following disclaimer applies: “Be careful what you wish for, you just might get it …” In other words, if the IRS were to weigh in, the guidance it provides may have unforeseen and unpleasant consequences, kind of like when Harry and Ron took a flying car to catch up with the Hogwarts Express, which behaved so erratically that it crashed into a Whomping Willow tree before ejecting the boys out.

There is no better example of confusion these days than in the case of taxpayers who are juxtaposing the requirements that trigger an increase in the offshore penalty from 27.5% to 50% with the requirements that disqualify a taxpayer from participating in OVDP. Contrary to popular belief, they are not one and the same.

Let’s set the stage. You have an undisclosed offshore account and want to disclose that account so that you can come into compliance with your U.S. tax obligations. Certainly, that is a worthy goal and one which is consistent with the IRS’s stated mission of encouraging voluntary compliance and self-policing. After evaluating your options, you decide to apply to the OVDP. However, because of some procrastination, August 4, 2014 has come and gone without you submitting your request for pre-clearance. It’s now August 10, 2014. However, you still want to apply.

Beginning on August 4, 2014, the offshore penalty within the OVDP program will increase from 27.5% to 50% for taxpayers whose foreign accounts are held with financial institutions that the IRS has relegated to a list. If you’re wondering what this list is, all you need to know is that it’s not a list of financial institutions that the IRS plans to take out to dinner. If that wasn’t enough of a clue, it’s not the type of list that any financial institution would aspire to be on.

Taxpayers who have already filed a pre-clearance letter or who expect to do so before August 3, 2014 remain unaffected. Therefore, they are not at risk and need not worry.

For all others, read on. Taxpayers who fail to submit their pre-clearance letter before August 3, 2014 will be subject to a 50-percent offshore penalty if any one of the following events has occurred that constitutes a public disclosure:

Your foreign financial institution has become a target of investigation by the IRS or the Department of Justice; or
Your foreign financial institution is cooperating with the IRS or the Department of Justice to help them locate tax evaders; or
Your foreign financial institution has been identified in a court-approved summons seeking information about U.S. taxpayers who may hold financial accounts at that institution.

These requirements stand in stark contrast to the requirements that must exist in order for a taxpayer to become ineligible to participate in the OVDP. Taxpayers will be deemed ineligible to participate in OVDP if at least one of the following events occurs before a request for pre-clearance is made:

• The IRS commences a civil or criminal examination or investigation of the taxpayer;
• The IRS receives information from a third-party – as the result of a John Doe summons or treaty request – that provides evidence of the taxpayer’s non-compliance;
• The IRS commences a civil or criminal investigation that is directly related to the taxpayer’s liability; or
• The IRS acquires information related to the taxpayer’s liability from a criminal enforcement action such as a search warrant or grand jury subpoena.

A simple comparison of the requirements for triggering the 50% offshore penalty with the requirements that preclude a taxpayer from participating in the OVDP program reveals that they are different. For example, the mere fact that the IRS receives information relating to the taxpayer from a financial institution complying with its FATCA requirements – prior to the taxpayer making a pre-clearance request – does not render the taxpayer ineligible from participating in the OVDP, so long as no investigation has been commenced of the taxpayer based on that information. What this does mean is that the taxpayer now faces a 50% offshore penalty instead of 27.5%.

Similarly, the mere fact that the IRS served a John Doe Summons or made a treaty request does not make every member of the John Doe class or group identified in the treaty request ineligible to participate in the OVDP.

But why tempt fate? If you know that your financial institution has received a John Doe summons by the U.S. government for the names and accountholder information of its U.S. customers and you are concerned that it will provide the information requested, there is no sense sitting back and waiting to see what happens – no matter how much the bank has reassured you that it will safeguard your privacy. Faced with the choice between divulging accountholder information or paying exorbitant criminal and/or civil penalties, most financial institutions will choose the former, thus sacrificing you and the rest of its U.S. clients in order to save its own hide.

Viewed through this lens, sitting back to wait and see what happens is the equivalent of playing Russian Roulette. If you lose, you are no longer eligible to participate in OVDP. And if you are ineligible to participate in OVDP, you lose any possibility of being cloaked with immunity from criminal prosecution. Of course, if you were a teenage wizard in your second or third year at Hogwarts School of Wizardry, losing your invisibility cloak might be even more devastating than a Muggle who loses his cloak of immunity from prosecution. After all, how would a curious teenage wizard be able to navigate (or should I say, snoop) around Hogwarts after dark without his invisibility cloak?

While the risk of criminal prosecution may be ever so slight, if the recent case of Zwerner is any indication, assertion of the willful FBAR penalty isn’t. Indeed, outside of the program looms the 800-pound gorilla (or what might be referred to in the Harry Potter universe as a Basilisk — a monstrous serpentine creature) of IRS civil penalties – the willful FBAR penalty.

If you thought that the offshore penalty was bad, then wait until you hear about the dreaded willful FBAR penalty. The maximum willful FBAR penalty is the greater of $100,000 or 50% of the balance in the account at the time of the violation. And if you thought that this penalty applies only per unfiled FBAR, you’d be mistaken. FBAR penalties are determined per account and for each year of each violation.

For example, assume that a taxpayer has four undisclosed offshore accounts with a maximum aggregate value that exceeds $ 10,000 (USD), the threshold amount that triggers the FBAR filing requirement. That taxpayer could theoretically be liable for the maximum willful FBAR penalty – not just once, but four times over. And that would be the FBAR penalty for only a single tax year. To the extent that these accounts remained undisclosed in subsequent tax years, willful FBAR penalties could be asserted for each additional year just like they were in the first year – four times over. Because the statute of limitations for asserting FBAR penalties is six years, you can begin to see how the cumulative effect of multiple FBAR penalties over a period of years is nothing short of staggering.

Of course, FBAR penalties are just the tip of the iceberg (or perhaps the tip of the very long nose on one Argus Filch, the caretaker of Hogwarts). The potential for other penalties also exists, including failure to file and failure to pay penalties, accuracy-related penalties, and information-related penalties. If there is a lesson to be learned in all of this, it’s this: get off the fence, pick up your broom, and get into the Quidditch game before it’s too late. You don’t have to have a standoff with a dark wizard in order to avoid the onerous 50% penalty. You don’t even have to impress a pretty young redhead girl with the last name of “Weasley.”

Instead, your owl merely has to deliver an important letter to the Ministry of Magic before August 4, 2014 — your pre-clearance letter. And if that happens, then you have accomplished something even more miraculous than conquering the dark lord — you have stopped the IRS from taking all of your hard earned money. And your wallet might just thank you for it.

Original Post By:  Michael DeBlis