The standard Offshore Voluntary Disclosure Program (OVDP) offshore penalty on unreported foreign account is 27.5% of account values. Meanwhile, the Streamlined Domestic Offshore Procedures (SDOP) is 5% of the penalty base. So, it follows that the SDOP penalty should always be a better deal than the Standard OVDP, right? 5% should always be less than 27.5%?
The answer is, it depends. The reason why is that sometimes the 5% SDOP penalty can actually have a larger penalty base than the Standard OVDP 27.5% penalty. This is confusing: SDOP is not always better than Standard OVDP! Let see if some some examples can shed some light on this. Or you can watch this video:
Let's imagine you have Account A. There is $100,000 USD equivalent in it. Let's suppose that with Account A you've always reported the income over the years, but you've never put this account on Form 8938 or filed an FBAR for it. And let's say you are worried about FBAR penalties and Form 8938 penalties. So, what offshore program do you need to enter into in order to avoid penalties? The answer is you only need to file delinquent FBARs and Form 8938s. And that's it. You actually don't need to going into a Full OVDP or Streamlined Program.
Now let's imagine that you have Account A and the facts are exactly the same. But in addition, you also have Account B. Account B has $100,000 USD equivalent. But for whatever reason, you did not put down the income this account earned on your tax return, did not file FBARs or Form 8938s. Now, assuming you wanted to avoid future FBAR penalties, Form 8938 penalties, and assuming you are not an expat, what program can you enter into? The answer is either Full OVDP or SDOP. If you enter into Full OVDP, your penalty base would be Account B, as it is related to tax non-compliance and Account A can be cured with filing missing FBARs and Form 8938s. In that case your offshore penalty would be $27,500, that is 27.5% of the $100,000 of Account B's high value.
Now let us suppose that your were non-willful in your failing to report the income for Account B, and were able to enter into the SDOP instead of the Full OVDP. What would be your offshore penalty? If you are thinking it would be $5,000 or 5% of $100,000, good, you are thinking logically about this IRS. Which as you shall see, could lead you to say with regret "I've made a huge mistake."
The true answer, believe it or not, is $100,000. Why does this happen? Because SDOP is concerned with the Form 8938 non-compliance as well. That is, the unreported income of Account B "springs" the reported income of Account A into the penalty base. In both cases, Form 8938 and FBARs were not filed. Reporting income in Account A does not remove it from the SDOP penalty base.
Yes, this is a rather an unexpected outcome.
Yet still, in this case, it would probably still make a lot of sense to enter into the SDOP as the total offshore penalty of $10,000 is far less than $27,500 of the Full OVDP (also in SDOP we only have three years of unpaid taxes to pay compared to the 8 years of Full OVDP). But can we imagine a situations where it would be cheaper to enter into the Full OVDP and pay a 27.5% offshore penalty rather than the 5% SDOP offshore penalty? It's not too hard actually, we see facts like these all the time.
Let us assume that Account A doesn't have $100,000 in it, but rather $10,000,000. And let us suppose you reported the income but did not file FBARs or Form 8938. And now you just learned about Account B which you inherited years ago but didn't know it. And again in Account B, its high value was $100,000, you never reported in the income or field FBARs or Forms 8938s.
Let's look at the outcomes. With full OVDP, only Account B would be in the penalty base, as Account A can be cured with delinquent FBARs and Form 8938s. You penalty base is $100,000, so your offshore penalty is $27,500. So what happens with SDOP? In that case, your offshore penalty base is not $100,000. It is actually $10,100,000 because both Accounts A & B are put into the penalty base due to the FBAR and Form 8938 non-compliance. Meaning your SDOP penalty is $505,000! 5% can be more than 27.5%!
Unreported Specified Foreign Assets
In these hypotheticals, I used interest bearing bank accounts for ease of understanding. However, with FATCA Form 8938, there is a whole host of items required to be reported that do not need to be reported on on an FBAR. We will be discussing those in an upcoming article. The important issue to consider is that you could have a small unreported specified foreign asset that can spring a much larger foreign asset into the SDOP penalty base, even though it would be excluded from the OVDP penalty base. And the results can be dramatic.
This is why we say that even simple offshore disclosures may not be as simple as you think. And trying to do this by yourself using a low-rent tax outfit can be the far more expensive route in the long run.
Note 1: The Streamlined Foreign Offshore Procedures (SFOP) has no penalty base so we didn't discuss that. SFOP is nearly always going to be the best deal, if you qualify.
Note 2: We did not discuss OVDP opt-out. As those FBAR penalties are based on entirely different criteria and not based upon any particular penalty rate.
If you have unreported foreign accounts and are concerned, or if you're unsure which program would be best for you, contact us to set up a confidential, complimentary consultation. Call us at 888-727-8796 or email firstname.lastname@example.org.