This article was originally written on January 24, 2014. While there still there is a 5% OVDP penalty, its nature has changed so much, this original article is best used to demonstrate the evolution of the IRS OVDI/OVDP procedures. Click here for up to date information on the 5% Streamlined OVDP penalty.
To summarize, the 5% offshore penalty used to be very hard to qualify for. But now the opposite is generally true as long as you did not act intentionally. Even better, instead of a 5% penalty for those living overseas, the penalty has been reduced to 0%.
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Here is the original article for those interested in OVDP history:
With the standard 2012 Offshore Voluntary Disclosure Penalty at 27.5%, many people in the program and those considering the program, look longingly at the OVDP 5% penalty wondering if it can apply to them.
This article will discuss why the OVDP 5% penalty only applies in very specific situations, and why, that if the OVDP 5% penalty does apply, it may make more sense to opt-out of even the 5% penalty to argue for no penalty and simply a warning letter.
Is the OVDP 5% penalty even available to you?
If we take a look at OVDP FAQ 52, the first thing you need to understand is that the 5% penalty is not something you can simply negotiate down to if you have facts favorable to your side. Rather you must specifically qualify for the 5% penalty. If you made an innocent mistake and you don't qualify for the 5% penalty, the only way to reduce your offshore penalty is by opting-out.
If you opt-out, the penalty structure is not based on a percentage of your account value, unless you have been deemed willful in your non-filing of your FBARs and/or record-keeping requirements.
To whom does the OVDP 5% penalty apply ?
Number one: taxpayers who meet all four of the following conditions:
- Did not open or cause the account to be opened – that is, you inherited the accounts or someone put you on the account without your knowledge.
- Have exercised very little contact with the account.
- Have not withdrawn more than $1000 from the account in any year for which the taxpayer was non-compliant with the exception of withdrawing the funds to close the account.
- Can establish that all US taxes have been paid on funds deposited to the account. If you are unable to establish that the funds were properly deposited before January 1, 1991, it will be presumed that they were.
Number two: taxpayers who are foreign residents and were unaware that they were US citizens. A common example is when a taxpayer's parents were working in the United States when the taxpayer was born and moved back to their country of origin.
Number three: taxpayers who are foreign residents and meet all three of the following conditions for all the years of their voluntary disclosure period:
- Taxpayer resides in a foreign country.
- Taxpayer has complied with all or has tried to comply with all of the tax reporting and payment requirements in the country of residency seat.
- Taxpayer has $10,000 or less of US sourced income each year. That means for any interest earned in the United States it's less than $10,000 (Note: for these taxpayers there is good news as the penalty will not apply to non-financial assets such as real property; that is for commercial purposes business interests or artwork. This exemption only applies if the income tax returns filed with the foreign tax authority included the offshore related taxable income that was not reported on the taxpayer's US tax return).
But — If you qualify for one of the three above 5% categories, aren't those grounds for an opt-out?
If you closely examine the requirements to meet one of these OVDP 5% penalty options, you would see how, implicitly, all of them are powerful arguments that the taxpayer had reasonable cause not to know about the FBARs and not to file any. This is the precise reasoning that will allow for a 0% "no penalty at all", and ask that simply a warning letter be issued instead.
So the relevant inquiry is whether or not it is worth the taxpayer's time and expense to opt-out when presented with a 5% penalty. While there is some risk, when a taxpayer's accounts start exceeding $200,000, in highest account value, that's when we think a taxpayer should start considering opting-out of even having a 5% offshore penalty assessed against them.
