This article was orginally published July 25, 2015. It has been last updated August 16, 2017.
What you need to know before you make an offshore disclosure with the IRS.
Our work as OVDP attorneys is rewarding. Working with our dynamic clients, getting to know them, their families, all while doing our best to mitigate the risk and damage the IRS intend to cause — we feel great because the work we do is incredibly consequential.
My path to where I am now wasn't planned. In law school, I was intent on being a criminal defense appeals attorney. Thanks to a great externship program and the success and contacts I made with that, immediately after law school that is exactly what I was doing. Winning my earliest cases, overturning convictions, it appears as if I was made to be doing criminal defense.
Yet, there was still something even better waiting for me.
My father, who was my law school classmate (story about that here) had a career in fiscal management in the public sector. He understood how to successfully navigate bureaucracies better than most.
It was actually an easy sell to get me to join him and combine forces. For me, it seemed as if the marketplace suffered from a huge problem of tax attorneys who didn't understand and were intimidated by criminal law, and on the other end, criminal attorneys who didn't understand taxation. Closing this gap would be a huge boon to our clients.
This article is a summary of my experience as first a criminal law attorney, then a tax attorney, then as a managing parent of a law firm specializing in OVDP representation. I think it is a great place for those wondering about these programs should start. The story moves in chronological order so you can understand the evolution and context as to what particular phrases actually mean.
There were many surprises we discovered on the way to become the Number One IRS offshore disclosure firm.
Surprise #1: Prior to the first offshore disclosure initiative, voluntary disclosures were rare
Prior to 2009, if it was not a tax audit defense or a tax debt settlement case, most of the cases we would see were for people who had not filed their taxes for years but wanted to come clean with the IRS. At the time, the standard presumption by the IRS was for these taxpayers to file the last six years of tax returns, and pay the taxes they owed. If they couldn't pay the taxes, then they would enter into what we in the business call a "collection alternative."
Voluntary disclosure was reserved for those with criminal intent. The IRS really didn't want to waste their criminal resources if someone was simply paying their back taxes and some small penalties; they were after bigger fish. The pre-2009 voluntary disclosure domestic program (which still exists) was not just for those negligent in filing their returns, but rather for those who intentionally evaded taxes. In that case, the voluntary disclosure would go like this:
- The client comes in and discloses their tax problem.
- We amend their returns and gather all the money they owe (plus fines and interest).
- We contact a local criminal investigator in order to report a voluntary disclosure.
- If the investigator finds there was no on-going investigation, we're told that we are clear to file the previous six years of amended returns.
Surprise #2: People will ignore the IRS for years, even decades if they can
How does someone not file taxes for over six years? How does someone have a tax debt in the hundreds of thousands of dollars and not do anything about it? Well, the IRS moves slowly. So slow, that sometimes it appears as if they aren't moving at all. This snail pace causes a significant number of people to think that they just might avoid detection. Many of these people hold a fear that making any move towards resolution will make their problem worse.
The problem is that when the IRS hits, it hits like an avalanche and takes out everything below. From experience, I know that the majority of taxpayers that have a tax issue move just as slowly, if at all, when confronted with a serious tax problem.
Surprise #3: The First Offshore Voluntary Disclosure Initiative
First things first, OVDP stands for Offshore Voluntary Disclosure Program. Originally, it was called the OVDI (Offshore Voluntary Disclosure Initiative). Before 2009, there was no such thing as the OVDP. As a matter of fact, general awareness of foreign reporting wasn’t anywhere near as widespread as it is today.
It may be hard to believe, but at one point IRS voluntary disclosure practice was just for those with actual criminal intent. Mistakes and negligence were addressed with amended or original tax returns and we called it a day.
Cue 2009. The OVDI program was announced for those United States persons banking with the Union Bank of Switzerland (UBS). The IRS developed the OVDI as a way for those individuals, people with undisclosed foreign income, to come forward without fear of criminal prosecution. This rather quiet initiative was going to change everything surrounding international taxation. Seemingly overnight, we needed to make a clear distinction between international and domestic disclosures.
The OVDI surprised tax practitioners since it included those who didn't necessarily have criminal intent (tax evasion). Why did the IRS want to use its resources for people with non-criminal intent? Two reasons: First, they assumed most people with offshore accounts were intentionally evading taxes (something they still have a hard time admitting as true), and second… well, second is the next surprise.
Surprise #4: The IRS finds a way to penalize wealth
In the history of surprises, this might be the least surprising. The IRS loves money, who would have guessed? What’s surprising is how they decided to get money from those engaged in willful and non-willful noncompliance. Instead of charging a small penalty as they had for voluntary disclosures, the IRS decided to require the previous six years of unfiled returns and a penalty based on account value. Just like that, the cost of a voluntary disclosure could be way more expensive than it had been just a year earlier. Never before had the IRS imposed a penalty based on value. Instead, penalties had been dependent on the tax amounts originally unreported or unpaid. This was uncharted territory.
Not only did the IRS start basing their penalties on the value of accounts, but they also decided to rope a lot more people into the program. Instead of only encouraging those with a criminal motive to come forward, the IRS opened their net and said that they wanted everyone — whether willful or non-willful — to join the program. Not only did they start making more money from the new rules, but now they were bringing in an extra group of people for more disclosures!
The IRS wanted as many people to enter into the 2009 OVDI as possible, regardless of criminal intent, because there was a 20% offshore penalty ("In Lieu of FBAR penalty") they could assess and collect for every case! So, it's a given that non-criminals should use the program, right?
Well, the IRS was about to learn a lot about their own program. A significant majority of the people entering into OVDI had no idea they were supposed to be paying taxes on their foreign accounts. While you hear a lot more about “the bad guys” who are trying to avoid paying their taxes, the IRS was learning what I’ve known for years – a huge number of people have tax problems because they just don’t know. They’re not willful, they’re not going in with criminal intent, they’re just worried and confused because no one ever told them what they were supposed to do. So now there’s a flood of people flocking to submit themselves to the program before the deadline. Well, on October 15th, the IRS shut the gates to the OVDI.
With the conclusion of the 2009 OVDI, there was no official offshore voluntary disclosure program. So, with more and more people starting to realize that they needed to file on their foreign accounts, we had no choice but to go back to the pre-2009 process of doing things. It turns out that the IRS had absolutely no plans in place for helping those people who missed the deadline. For almost three years, from 2009-2011, the IRS just sat on the cases we submitted. To say this was aggravating would be a disservice to the choice words and fiery frustration we shared with our clients towards the IRS.
Surprise #5: The IRS closes the OVDI with no contingency plan in place
After October 15, 2009, no one could make an Offshore Voluntary Disclosure. Even though people were still learning about the FBAR and requirements for reporting worldwide income, the IRS didn't plan on individuals not banking with UBS (formerly the Union Bank of Switzerland) to come clean. There was no plan in place to take care of them. Instead, so many of them were left high and dry until the next program rolled around.
Surprise #6: The 2011 OVDI gets aggressive
In 2011, the IRS decided to recreate the much-needed 2009 program with some updated guidelines. The 2011 OVDI program expanded the required years of disclosure from six to eight, which was not the best news. At all. And, for the voluntary disclosures we made after October 15, 2009, the IRS sandbagged the processing on those submissions and then told our clients that we could only use the 2011 initiative. Again, this changed the look-back period from the standard six years to the newly mandated eight years.
Surprise #7: The eight-year look back period is problematic
When entering into an OVDI/OVDP, accurately amended returns can be the fine line between success and failure. The Enrolled Agent, CPA, or attorney amending your returns should be aware that their work does not end after they’ve completed the eight years of previous returns. Instead, they need to go back to the very beginning of the noncompliance to find the proper basis in a given asset. The IRS may decide it’s in their best interest to kick you out of the OVDP even if you want to stay. At this point, they’ll look for any discrepancy that gives them the authority to kick you out and give you a hard time.
Surprise #8: The 2011 OVDI brings the opt-out
However, in some really "great news," the IRS also found a way to deal with the influx of disclosures coming from non-willful noncompliance – they started separating them from those with criminal intent. By opting out and negotiating the penalty, non-willful disclosures could whittle down their fines. There was a caveat, however, seeing as the opt-out process was difficult and time-consuming. Added to that was the fact that the IRS does not necessarily value fairness above all else. For many of our clients, the opt-out provided a huge victory. Instead of looking at penalties that would destroy their wealth (many portfolios were down from their highs of 2007-2008), they either paid no penalties at all or much lower non-willful FBAR penalties.
Surprise #9: The IRS closes the 2011 OVDI and leaves nothing in its place
Apparently not learning their lesson, the IRS decided to close the 2011 OVDI with no program left in its place. They failed, yet again, to realize that every single day more and more people are learning about the necessity of filing reports for their foreign accounts and income.
Surprise #10: The IRS tells professionals and taxpayers not to make soft-disclosures, thousands make them anyway
Again, prior to the 2009 OVDI, the voluntary disclosure was only for people with actual criminal exposure. Many practitioners felt these OVDIs were not fair to those who were innocent, or at very worst negligent. Consequentially, they had their clients simply file amended returns, pay the taxes they owed, and complete missing FBARs. They then advised them to not enter the entire OVDI, therefore keeping them from being subjected to the 25% offshore penalty put in place by the 2011 OVDI.
Were we tempted to do the same thing for our clients? Yeah, for about a minute. Then we took an inventory of reality.
(1) The IRS loves other people's money
(2) The courts essentially rubber stamp whatever the IRS does
(3) Therefore, we are subjects of the IRS, due process be damned
We had quite a few potential clients ask us to make a soft disclosure for them; we appreciated their motivation to solve their tax problem, but this wasn't the right way. Even though we love to help people, helping someone in a way that can come back to haunt them isn't our style. I had to tell quite a few people that they would have to find other representation if they were determined to pursue a soft disclosure. My only advice was if you are going to make a soft disclosure, do it yourself, and not to involve a tax preparer. Why? Becuase if you are audited, the IRS will interview your tax preparer. I learned from my criminal law experience, tax professionals will say anything, and will even invent stories when they feel they are threatened.
As it turns out, while the IRS said they were going to be incredibly aggressive in audited soft disclosure, the truth is they haven't…yet. Right now, this seems an empty threat. What I don't like is that the IRS has many ways though to extend that statute of limitations. People who think they are safe, actually might not be.
Surprise #11: 2012 Offshore Voluntary Disclosure announced with no deadline
Finally, the IRS realized a number of people with undisclosed foreign accounts was larger than they had thought and getting word out about their initiatives was taking too long. It was decided that the initiative should be made permanent. So, in 2012, the Offshore Voluntary Disclosure Program (note OVDP not OVDI) was put into place and raised the offshore penalty to 27.5%, where it stands today (unless your bank is on the OVDP FAQ 7.2 list).
Surprise #12: The IRS creates a program for those without any criminal intent
In June of 2014, the IRS finally came to the realization that most people with unreported foreign income or accounts were not criminals. In order to adjust for this understanding, they separated disclosures into categories depending on whether or not you lived in or outside of the US. US expats got the best deal, the Streamlined Foreign Offshore Procedures (SDOP), seeing as there was no longer an offshore penalty to pay. The same deal had the option of paying a 5% penalty on the highest year-end value of unreported assets (again under the Streamlined Domestic Offshore Procedures (SDOP)).
Surprise #13: Most tax lawyers shouldn’t be allowed within a 100-mile radius of an OVDP case
There are way too many lawyers claiming that they know how to work foreign taxation cases. The surprising (or horrifying) reality is that many of these attorneys have done little more than dabble in OVDP. Domestic taxes are incredibly complicated, but foreign taxes are even more intricate and detailed. So when an attorney doesn’t have a grasp on how complex these cases are, things aren’t going to end well.
OVDP is tough, and if you’re not up to date on every little rule change, and don't' constantly test the boundaries, then you’re going to be unprepared. When an attorney holds their client’s future in their hands, being unprepared is inexcusable. Working with OVDP cases has to be a full-time pursuit, not a side-project.
My firm has inherited a number of cases from OVDP “experts.” Either these “experts” were lawyers dabbling in a program they knew nothing about or they were scam companies set up to take advantage of people in trouble. Either way, it’s unacceptable. If you see someone charging an extraordinarily low fee for OVDP work, be careful. Proper representation isn’t cheap and you often get what you pay for; a tax problem is not the time to save a few dollars. With quality representation, you’re paying as much for the expertise of knowing what not to do as you are for direction in what to do. There are numerous pitfalls lining the way, and avoiding them at all costs is a necessity.
Surprise #14: Some attorneys don’t fight for their clients
When you’re paying someone a substantial sum of money, it’s not unreasonable that you would expect to see a high return on your investment. In the previous paragraph I mentioned that you should be wary of fees that seem abnormally low. At the same time, sometimes you can pay huge legal bills and not see any results. Not all attorneys are interested in fighting the IRS to get you a better resolution. I might get some grief for saying this, but there are an increasingly large number of attorneys who are little more than high-paid paper pushers.
Would you believe that some attorneys steal content from others to make themselves appear as OVDP experts, even when they're not? I've seen my own articles and OVDP success stories copy and pasted onto another lawyer's blog.Don't get the wrong idea, though.
While yes, there are some lawyers well worth avoiding, there a number of fine attorneys — many who I am proud to call my friends — ready to solve your tax problem. Similar to medical professionals, there are different skill levels all across the board. Be careful that you're represented by a proper tax practitioner, not a tax pretender.
Surprise #15: OVDP requires a lot of paper
There is a shockingly large amount of paperwork involved in OVDP. If we ever run out of trees in the United States, you better believe I’ll be pointing at the IRS as the cause. A single OVDP case can contain several reams of paper in order to get a proper resolution. One recently concluded case had us sending the IRS 15 lbs. of paperwork. That's actually pretty average.
This OVDP submission actually tipped the scales at 14 lbs 8 ounces.
Filing an OVDP is about 20% legal work and 80% processing (a.k.a. busy work). Having an attorney take care of that entire workload will not only rack up your bill, but it is also terribly inefficient. At our firm, we have had cases where more than six members of our team have come together to expedite the process. Seeing as certain individuals have more experience putting everything together, speaking with the IRS, or making sure everything goes out on time, we’re able to keep cases cost-effective for our clients. Too often we’ve had clients come to us because their attorney missed some important deadline. The truth of the matter is that you can’t ask one person to do it all.
Surprise #16: The IRS can be your best resource
I am not a fan of the IRS. Cue gasps of shock and horror. After seeing how many lives have been ruined by their frustrating rules and guidelines, I don’t think I ever will be. But that doesn’t mean I don’t appreciate some of the incredible people they have working for them. Some of the IRS staff I’ve worked with have been nothing but professional, kind, and helpful. The IRS is wildly underemployed and their workers are criminally overworked. But the good apples, the people who actually care about the lives they are affecting, are an incredible resource for getting results.
One of the most important things an IRS agent ever told me was that the majority of individuals with foreign bank accounts didn’t have those accounts under their name. The IRS is able to find these people, and without the account being under their name, it sets them up for potential criminal intent. Information like this has helped me understand how to better move cases in a quick and efficient manner. It’s an interesting situation: as an OVDP attorney, you have to work with IRS employees while maintaining a stance against the IRS as a whole. Treating IRS staff with respect can lead to new understandings about how to work within the system and get fantastic results.
But this is not to say that everyone at the IRS understands their own rules or even has a grasp on how the law works.
The IRS continues to make changes to the OVDP program. With the creation of the OVDP streamlined process – which is pretty solid if there is no criminal exposure – those accidentally in noncompliance have a way to better sort their tax problem. For those with any signs of criminal intent, the full OVDP is still the best option for a positive resolution. The OVDP continues to evolve, albeit slowly, with the shifting landscape of foreign taxation. What is important is keeping up-to-date and never feeling like you’re behind the new rules and guidelines.
Surprise #17: There is a shortage of offshore tax competence all around
There is something called competency bias. Competency bias means that if you are a doctor, you assume that people know what their blood pressure measurements mean; if you are an arborist, you assume people can tell a white oak from a red; and if you are a professional guitarist, you tend to assume that everyone will know E flat minor as the coolest sounding chord. While these are assumptions you make, most of the public has no idea what you're talking about. As your competency goes up, the more competency you will assume others possess. But they haven't changed. No one else has changed, just you.
As I became a better tax attorney, as I figured out tough issues and cases, I assumed others were doing the same thing. Working with a bigger team and finding even more difficult issues to tackle, I assumed the rest of the world was doing the same. Sadly, this is not true. Working with OVDP cases is NOT for everyone. There is a small elite set of the population that can actually do the work. This is as true of OVDP tax law firms as it is of the IRS. The IRS is frantically trying to find enough qualified people to fill in their offshore examiner positions and it's not enough.
Luckily for us, we haven't had to grow overnight like IRS OVDP departments were forced to. We've been able to be much more selective in who joins us our team. We've been able to pick and choose among the best attorneys, CPAs, enrolled agents, and support staff to make IRSMedic the force it is today.
Surprise #18: Don't hire an OVDP attorney.
That's right. You don't want to hire an OVDP lawyer. You need a full team!. The fact is, no attorney can do this all by himself/herself, or even with a handful of help. I learned quickly that the only way to out-power the administrative avalanche of the IRS is with a full team of dedicated specialists handling particular stages of an OVDP. An OVDP requires full project management, utilizing Gantt charts and PERT charts, and intense secure document management and reconstruction.
The IRS's communication between departments is abysmal, and you need to have people on your team who understand and anticipate that.
Don't hesitate to contact us if you need assistance.