IRS Again Revises its Offshore Voluntary Disclosure Program

The Federal government is continuing to use its power to catch taxpayers who did not report their foreign financial accounts and/or pay income tax on the income derived in those accounts.  The U.S. taxes worldwide income of its citizens and residents and requires the disclosure of certain foreign financial accounts and assets.  The rules for determining who must report and what must be reported are exceedingly complex.  Many taxpayers have been blissfully ignorant of the rules.  The government is using the threat of large penalties to encourage taxpayers to catch up on accounts that haven’t been reported in the past.  In the past these threats have not distinguished between taxpayers who ignorantly omitted their foreign disclosures and taxpayers who have willfully concealed their accounts.  Responding to some criticism of their approach, the IRS has revised some of the rules pertaining to the offshore voluntary compliance program.  See their statement dated June 18, 2014.  There appear to be four programs currently in place as described on the IRS website.  Various financial penalties apply.

1.     The Offshore Voluntary Disclosure Program (OVDP) is a voluntary disclosure program specifically designed for taxpayers with exposure to potential criminal liability and/or substantial civil penalties due to a willful failure to report foreign financial assets and pay all tax due in respect of those assets.  OVDP is designed to provide to taxpayers with such exposure (1) protection from criminal liability and (2) terms for resolving their civil tax and penalty obligations.  A special rule under this program requires taxpayers to comply with an August 3, 2014 deadline.  This is the date that FBAR non-filers  who have foreign bank accounts with a foreign financial institution that has been publicly identified as being under investigation, or is cooperating with a government investigation.  See the list here.  If such individuals voluntarily come forward by the deadline, their penalty is reduced to 27.5% of the account balance instead of the 50% penalty that will be imposed if they voluntarily come forward after this date.

2.     “Streamlined” filing compliance procedures are available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part.  The streamlined procedures are designed to provide to taxpayers in such situations (1) a streamlined procedure for filing amended or delinquent returns and (2) terms for resolving their tax and penalty obligations.  These procedures will be available for an indefinite period until otherwise announced.  The IRS definition of “streamlined” does not mean that a lot of work isn’t necessary to comply with the requirements.

3.     Delinquent FBAR Submission Procedures.  Taxpayers who do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:  (1) have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114, previously Form TD F 90-22.1), (2) are not under a civil examination or a criminal investigation by the IRS, and (3) have not already been contacted by the IRS about the delinquent FBARs should file the delinquent FBARs according to the FBAR instructions and include a statement explaining why the FBARs are filed late.

4.     Delinquent International Information Return Submission Procedures.  This program pertains to foreign reporting for forms other than the FBAR.  Taxpayers who do not need to use the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:  (1) have not filed one or more required international information returns, (2) have reasonable cause for not timely filing the information returns, (3) are not under a civil examination or a criminal investigation by the IRS, and (4) have not already been contacted by the IRS about the delinquent information returns should file the delinquent information returns with a statement of all facts establishing reasonable cause for the failure to file.  As part of the reasonable cause statement, taxpayers must also certify that any entity for which the information returns are being filed was not engaged in tax evasion.

The IRS states that simply filing amended tax returns to correct past problems won’t protect taxpayers from penalties and possible criminal prosecution.  The IRS wants taxpayers to come in under one of the above programs and pay the financial penalty associated with the program.  This type of threat is not normally associated with amended tax returns filed to correct mistakes, and it shows the attitude of the government towards taxpayers who have not timely reported foreign financial accounts.

U.S. Supreme Court Rules that Inherited IRAs are not Protected from the Claims of Creditors

On June 12, 2014, the U.S. Supreme Court unanimously held in Clark v. Rameker that the protection afforded individual retirement accounts under the Bankruptcy Code is lost once such accounts are inherited.  The reason given is that the account loses its traditional character as “retirement funds.”  While it seems clear that an IRA inherited by a non-spouse is now no longer protected, it is unclear whether the protection is also lost if a spouse inherits the IRA.

The Court concluded that an inherited IRA did not constitute “retirement funds” in the hands of the beneficiary by citing the following limitations imposed on inherited IRAs.  Such limitations do not exist for IRAs that are owned and not inherited.

1.     The beneficiary cannot contribute money into the inherited IRA.

2.     The beneficiary must begin minimum required distributions from the inherited IRA and cannot wait until the beneficiary’s own retirement.

3.     The beneficiary may withdraw the entire inherited IRA balance without an early withdrawal penalty if under age 59 ½.

A spouse beneficiary has the ability to roll over the inherited IRA to his or her own personal IRA, whereas non-spouse beneficiaries are unable to do so.  This fact brings up a few important questions: Will this rollover allow the inherited funds to be protected under the Bankruptcy Act?  Or, will the protection not be permitted because the spouse did not set aside such money him or herself?  We may not know the answer to these questions without future litigation.

IRA owners should now consider naming a discretionary trust as beneficiary.  Giving the trustee discretion on how and when to make distributions to beneficiaries may enhance creditor protection.  The trust must be properly drafted to qualify as a designated beneficiary to avoid unfavorable income tax results upon the IRA owner’s death.

This case deals with Federal bankruptcy law.  State law may nevertheless provide some protection to an inherited IRA.  Individuals with large IRA balances who are concerned about asset protection should consult with their attorney.