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New Practice Update: The IRS Voluntary Disclosure Program (VDP) was updated in 2019 and continues to evolve. Voluntary Disclosure is an IRS program that pre-dates the streamlined procedures. VDP is designed for taxpayers as an alternative to the streamlined program.

A common misconception perpetuated by inexperienced offshore tax attorneys is that Voluntary Disclosure is only for people who were willful, but this is absolutely false. And, with the Internal Revenue Service making foreign accounts compliance a key enforcement priority, IRS voluntary disclosure may be the best option for certain taxpayers, especially those unable to certify non-willfulness under penalty of perjury.

IRS Voluntary Disclosure (Program)

The IRS voluntary disclosure program has been around for many years. While OVDP was terminated in 2018, the traditional voluntary disclosure was then updated and revamped. Alternatively, if the taxpayer has no foreign accounts or unreported income, but has previous years' unreported international information returns (but taxpayer does not qualify for delinquency procedures) – the IRS may waive all penalties under IRS Voluntary Disclosure.

Updated Voluntary Disclosure Practice

In 2019, IRS Voluntary Disclosure Program was updated and OVDP was ended. The submission process has changed significantly, especially for offshore related issues. In the prior year version of the offshore program, the taxpayer was not required to submit a preclearance letter – it was optional. In addition, the preclearance was not a pre-printed form.

Eligibility for the New IRS Voluntary Disclosure Program

Eligibility for IRS Voluntary Disclosure Program is different than the streamlined program. Unlike the streamlined program, there is no non-willfulness element.

Three (3) important aspects of making a submission, are:

Legally sourced funds
No Placeholder submission
Full disclosure
Legally Sourced Funds

Essentially, a person must have legally earned the money that was not previously disclosed. This is to avoid the taxpayer from using IRS voluntary disclosure to launder money. For example: let’s say Peter sold illegal drugs in Peru and left the money in a Peruvian bank account that was never reported. Peter cannot use the IRS Voluntary Disclosure Program to report the money. Why? Because once the money is reported, then it would have been “cleaned” through the disclosure process.

No Placeholder Submissions

A placeholder is used to hold a spot open for the taxpayer. The IRS does not allow that for IRS Voluntary Disclosure. In other words, a person must make a full submission during the process.

Full Disclosure

When it comes time to submit to IRS voluntary disclosure, the person must make a full submission. In other words, all unreported foreign accounts, assets, investments and income must be reported. This is true, even if the chance of the IRS finding a particular offshore account or income stream is slim, and/or the account was dormant or sleeping.

Tax Treatment 

The tax treatment under IRS voluntary disclosure is essentially the same as it would be if a tax return was filed timely (with penalties and interest tacked on). For example, if a type of income is categorized as employment income if the income had been reported timely, it would be categorized as employment income when it is finally reported. The same with interest income, dividend and capital gain.

If a person has unreported PFIC income, they may lose the opportunity to make a QEF or MTM election (Under prior OVDP, the taxpayer could use the MTM instead of sec 1291 excess distribution calculation).

Offshore Penalties

Unlike OVDP, the penalties under the new updated IRS Voluntary Disclosure are different, and less firm. Some of the penalties, include:

Taxes Due

Under the prior OVDP, the taxpayer paid a 20% penalty on the outstanding taxes due for each year of the compliance period. Under the updated procedures, the IRS voluntary disclosure compliance period was reduced from 8-years to 6-years.

And, instead of an annual 20% penalty, the taxpayer pays a single 75% on the highest year’s amount of tax liability. Under the revised procedures, the taxpayer can try to negotiate that penalty to a lesser penalty.

Offshore Penalties

With OVDP, the taxpayer paid a 27.5% or 50% penalty on the highest year’s unreported balance of accounts and assets for the compliance period. Under the updated IRS Voluntary Disclosure procedures the taxpayer does not have a set penalty. Rather, the IRS agent will follow the rules of the IRM (Internal Revenue Manual).

Under the IRM, a person is (generally) subject to a 50% penalty on the highest year’s unreported balance. Under the revised procedures, the taxpayer can also try to negotiate the FBAR penalty to a lesser penalty.

International Information Returns

Under the revised procedures, a taxpayer may be able to avoid all fines and penalties for international information returns.

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