What is the “OVDP” and what does it mean if you use this option?
The IRS has now had several versions of what is called the Offshore Voluntary Disclosure Program (ODVP). Each version of the OVDP has required the filing of 8 years’ of back tax returns and 6 years of FBARs. In addition, volumes of supporting documentation are required. Choosing this option is very time-consuming and generally is very expensive, both in terms of professional fees and penalties. These programs, however, are a welcome relief for taxpayers who face a real likelihood of criminal penalty sanctions. More information on the most recent program, can be accessed here.
Generally, taxpayers entering the OVDP, are those taxpayers who have criminal tax exposure with respect to their tax noncompliance; that is, their tax noncompliance was willfully done. By entering the OVDP, the risk of criminal prosecution basically disappears. In “exchange” for the IRS not recommending such criminal prosecution to the US Department of Justice, a taxpayer is subject to various penalties. Such a taxpayer must make full payment of tax deficiencies and interest on the back taxes due for the OVDP Time Period, which is generally 8 years. Interest is compounded daily.
For each year in the OVDP Time Period, if applicable, the taxpayer is subject to the normal “failure to file” and “failure to pay” penalties (which are basically 50% of the tax due each year) and/or the accuracy-related penalty which is 20% of the tax due for the particular year. Furthermore, in place of all other tax or information return penalties that may otherwise be applicable, a 27.5% “in lieu” penalty will be assessed under the OVDP. The penalty is assessed on the highest aggregate offshore account / asset value in any year covered by the OVDP. A person must determine the highest aggregate offshore account / asset value in each of the 8 years covered by the OVDP. Then choose the year which has the highest total (only one year will yield the highest total value). The 27.5% penalty will be applied only to that “highest” year. In certain cases, the 27.5% penalty will be increased to 50%. See IRS OVDP FAQ 7.3.
Not all offshore assets are necessarily added into the OVDP penalty base. The offshore penalty is intended to apply to all offshore holdings that are related in any way to “tax noncompliance”. Thus, the value of artwork purchased with undeclared investment income would be included in the penalty base. Similarly, the value of a home purchased abroad with untaxed salary would be dragged into the penalty base; as would the value of an overseas apartment on which rental income had not been reported by the taxpayer. However, if the taxpayer purchased the house with previously taxed funds and never rented out his home, but only resided in it, there would be no “tax noncompliance” associated with the house and its value would not be included in the penalty base.