Tens of thousands of taxpayers, and tax professionals decided to ignore warnings by the IRS and created a reporting scheme often called soft or quiet disclosure. This is done by amending past tax returns and filing delinquent tax FBARs without participating in the Offshore Voluntary Disclosure Program (OVDP). These crafty taxpayers looked at the FBAR-equivalent penalties (5-27.5% of highest account value), thought they were too high and ignored IRS warnings. They hoped that when they put all their foreign account information on an IRS form, they could cross their fingers and the IRS might leave them alone.
The IRS policy is that if a citizen or resident has any previously unreported overseas income, they have to participate in the OVDP (sometimes referred to as OVDI), or risk the full brunt of an IRS FBAR auditor (criminal charges a far lesser risk). The government recently flagged 9,884 individuals and 711 businesses who amended their tax returns and FBARs in 2009 or 2010 as potential soft disclosures. The IRS has invested millions of dollars and assigned thousands of agents to audit FBAR returns to identify soft disclosures.
Why? The IRS lost out on collecting revenue and decided to crack down on Quiet/Soft Disclosures. This problem has the potential to hurt tens of thousands of citizens and new residents who may have accounts overseas and made the mistake of believing a soft disclosure would shield them from further IRS scrutiny. Soft disclosures needlessly put taxpayers at risk for civil and criminal penalties.
We've seen how and why a normal person can get caught up in the IRS’s soft disclosure trap, and can tell those who have made a soft disclosure what to do.
A true-life Quiet/Soft Disclosure problem of a couple in Hong Kong
John worked in Hong Kong for a number of years. While in Hong Kong, John met Mary. Mary is a citizen of Hong Kong. She has lived in Hong Kong for her entire life and has worked hard to put away a small nest egg in Hong Kong. John realized that Mary is the love of his life and asks her to marry him. She accepts.
John moved back home to Houston to start a family and brought Mary with him. For years John and Mary filed their income tax returns and paid their taxes on income they made in the United States. At some point John and Mary realized that the nest egg account that Mary saved up had generated interest or investment income, or the accounts that Mary set up to send money back to help her aging parents had her name listed on it. In an effort to avoid further IRS FBAR penalties, John and Mary consulted with one IRS FBAR attorney who told them that they must use the OVDP to get this matter behind them.
John and Mary thought the cost was too high, so they listened to a CPA a friend referred them. The CPA told them what they wanted to hear. And John and Mary made the mistake of amending their past tax returns and filing their old FBARs. On these returns, they were required to put down account numbers and bank information.
John and Mary fell into the IRS’s trap. Now the IRS has all the information it needs and if audited, the burden of proof is on John and Mary that they did not commit a willful violation of FBAR. A willful FBAR penalty is 50% of account value. And this can be assessed for multiple years.
If John and Mary amended their tax returns and filed delinquent FBARs, they have provided the IRS with all the information they need to identify their tax accounts for a possible soft disclosure. Essentially John and Mary have raised their hands and said “WE ARE TAX EVADERS, HERE IS ALL OUR INFORMATION. PLEASE COME AND PENALIZE US AS MUCH AS YOU CAN.”
What John and Mary must do right now about their Quiet/Soft Disclosure
Get into the OVDP — now!
We’ve been warning taxpayers of the perils of filing Quiet/Soft Disclosures for more than a year now. We have been criticized for being scaremongers. But everything we've been saying has turned out to be true.
The new IRS crackdown on soft disclosure threatens thousands of individuals and business as they have already provided all the information the IRS needs to catch them. When John or Mary get caught, the burden of proof falls on them to show that they did not know that they were in violation of FBAR rules. Again, this means that if they do not participate in the OVDP program they could end up with a 50% penalty of the highest annual value for every year John and Mary did not file an FBAR.
Fortunately, John and Mary still can participate in the OVDP program even if they made a soft disclosure as long as they enter the program before they get caught. And for those who have lost money, not being able to pay the entire fines from the OVDP is not an excuse — there are ways to negotiate payments. Get it down before an auditor is assuming the worst about you. If you need help understsanding what disclosure program, if any, would be best for you then contact us for a complimentary, confidential consultation.
Thanks to summer Intern Andrew Feng (UConn Law '14) for his help on this article
