Going Quietly Into The Night May Not Be The Best Idea For U.S. Citizens Living Abroad

Apparently, there are a large number of U.S. citizens living outside the United States as well as a large number of individuals who are dual citizens of the United States and their country of residence (estimated to be in the millions).  Judging from the phone calls that I have been receiving from my contacts at foreign law and accounting firms, a large number of them have recently become aware of the IRS Offshore Voluntary Disclosure Initiative (“OVDI”) providing reduced penalties for U.S. citizens who come forward to report previously undisclosed foreign financial accounts.

The deadline for participating in the program – August 31, 2011 – is rapidly approaching so U.S. citizens living abroad, including dual U.S. citizens, must decide immediately whether to participate in the program.  Many of these individuals have not filed U.S. income tax returns and have not filed Treasury Forms TDF 90-22.1, more commonly knows as the FBAR, to report interests in foreign financial accounts.

A significant number of these individuals appear to be getting advice to make so-called “quiet disclosures.”  An individual making a quiet disclosure does not participate in the IRS’s OVDI, but merely files delinquent or amended income tax returns and delinquent FBARs.  The hope is that the IRS will not discover and audit the taxpayer, or if the IRS does audit the taxpayer, that the taxpayer will qualify for lesser penalties that apply to non-willful violations of the applicable income tax and FBAR provisions.1

For many, following the advice to make quiet disclosures may not be the best approach.  The IRS has created a special reduced penalty regime applicable to U.S. citizens living abroad who have complied with their tax obligations and filings in their country of residence.   For individuals that qualify, the IRS will apply a special 5 percent penalty for failing to report the foreign financial accounts if the individuals make a voluntary disclosure under the OVDI.  The penalty applies to the highest balances in the individual’s foreign financial accounts for the period from 2003 through 2010 so the penalty, although reduced, may still be quite substantial for some.  Nevertheless, the 5 percent penalty pales in comparison to the penalties that might otherwise apply.

The IRS has indicated that it will be looking for individuals who make quiet disclosures and will audit those individuals.  Also, the IRS has stated that it will consider criminal prosecution of those individuals when appropriate.  If criminal prosecution is not warranted, the IRS said that it will impose the maximum penalties that apply, including the penalty for willfully failing to file an FBAR — the greater of $100,000 or 50 percent of the amount in the foreign financial account for each violation.

U.S. citizens living abroad (including dual citizens) are taking a significant risk in filing quiet disclosures, particularly if they would otherwise qualify for the reduced 5 percent penalty under the IRS’s OVDI.  They may find out that their quiet disclosures will not be “quiet” after all and they may face much harsher penalties when the IRS discovers and audits them.

Going quietly into the night may not be the best choice.

1 The individuals may also have been advised that the FBAR penalty can be waived if that taxpayer had reasonable cause for failing to file the FBARs and all income from the foreign financial accounts was reported.  For those individuals living abroad who have not filed U.S. tax returns, the waiver of the penalty would not apply.  The penalty for a non-willful failure to file an FBAR is $10,000 per violation.

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