US Expat Taxes Explained: Offshore Voluntary Disclosure Initiative

This article was first published on August 17, 2011. It was updated on June 16, 2014, with information relevant to the 2013 and 2014 tax years.

US citizens are taxed on their worldwide income and are required to file US expat taxes if their income exceeds the federal filing threshold, even with income from anywhere in the world. However, there have been numerous US citizens who have moved abroad and assumed that their lack of US-source income meant that they didn’t have to report or pay US expat taxes to the US government. This couldn’t be more wrong. Because of the many US citizens who have made this costly assumption, the US government has made various attempts to help expatriates become compliant with their US expat taxes and FBAR reports. The effort currently in place is called the 2011 Offshore Voluntary Disclosure Initiative (OVDI) and is available until August 31, 2011, or later with an approved extension.

What Is The Offshore Voluntary Disclosure Initiative?

US citizens who have authority over foreign financial accounts whose cumulative balances exceed $10,000 USD at any one point in the tax year must file a Report of Foreign Bank and Financial Accounts (FBAR), Treasury Department FinCEN Form 114. Failing to file this form properly can result in stiff penalties and even criminal prosecution!

The 2011 OVDI provides US Expat Taxpayers who have failed to comply with FBAR filing requirements the opportunity to do so with reduced penalties. The IRS offered a similar program in 2009, with great success. Although the 2011 program has more rigid requirements and less of a penalty reduction, it still provides a “way out” for US citizens who want to become compliant, but fear the consequences. More information about FBAR filing requirements can be found in our ”US Expat Taxes Explained” series.

Who Is the Offshore Voluntary Disclosure Initiative For?

The 2011 OVDI is for any US taxpayer who is out of compliance with their FBAR filing requirements. Of course, as with nearly every piece of US expat tax law, there are exceptions to this. The 2011 OVDI is not for:

  • Taxpayers whose returns are currently under examination by the IRS,
  • Taxpayers who have already been notified by the IRS that they are not in compliance, or
  • Taxpayers who have reported and paid all of their US expat tax, unaware of their FBAR filing requirements (these taxpayers can simply file the outstanding FBAR reports, attaching a statement explaining their reasons for not filing),

The 2011 is for:

  • US expat taxpayers who have knowingly failed to file an FBAR,
  • Taxpayers who want to voluntarily want to become compliant with IRS tax reporting requirements

Many taxpayers facing compliance issues are concerned about the hefty US expat tax liabilities requiring immediate payment. While this concern will not go away, it’s important to note that the IRS can and will establish installment agreements and other forms of debt settlement for taxpayers. Being proactive and voluntarily disclosing your US expat tax liability will work in your favor when attempting to establish payment arrangements with the IRS. If you are unable to pay at this time, and can prove this situation to the IRS, you may even be eligible for debt forgiveness or penalty relief.

How Does the Offshore Voluntary Disclosure Initiative work?

Without a Voluntary Disclosure Initiative in place, the penalties for failing to timely file an FBAR include:
  • FBAR penalty (50% of the total aggregate value of all of your foreign accounts)
  • Failure to File and Failure to Pay penalties (approximately 25% of the unpaid income tax — read more about these penalties in our ”US Expat Taxes Explained” series)
  • Accuracy Related penalty (20% of the income tax associated with the foreign accounts)

It’s important to note that the IRS takes the reporting requirements for FBARs and other informational returns (5471, 5472, 3520, etc) very seriously. If a US expat taxpayer is found to have fraudulently and intentionally failed to file their FBAR, the IRS can assess a 75% fraud penalty as well as pursue criminal prosecution. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.

For example, in 2007, Edward Expat has $5,000 in a Swiss bank account, $6,000 in a British bank account and $2,000 in a German bank account. The cumulative balances of these accounts total $13,000, so he is required to file an FBAR by June 30, 2008. By failing to do so, he incurs a 50% FBAR penalty of $6,500 ($13,000 * 50%). These accounts also earned $500 in interest income, and can incur an additional $225 in Accuracy Related, Failure to File and Failure to Pay penalties. Failing to report these bank accounts and their associated income can cost Edward $6,825!!

If we assume that Edward held the same account balances in 2008 and 2009, yet failed to report this information to the IRS via his US Expat Taxes, he could be faced with a significant balance due to the IRS. However, by taking advantage of the 2011 OVDI before August 31, 2011, he can become compliant on all of his reporting requirements with significantly reduced penalties. The IRS has also recently announced the opportunity to extend this deadline by 90 days with proper communication.

Under the 2011 OVDI, the penalties are calculated at either 5%, 12.5% or 25% of the highest year’s cumulative account balance. Taxpayers eligible for a 5% penalty must have not opened the account themselves, had “minimal” interaction with the account, and never withdrew more than $1,000 in one year. If the highest cumulative balance is less than $75,000, the US Expat Taxpayer will be eligible for the 12.5% penalty rate. All other taxpayers are subject to the 25% penalty. In Edward’s case, the highest year’s cumulative account balance was $14,500 in 2009, putting him at the 12.5% penalty rate.

Rather than paying an FBAR penalty of 50% for each year, under the 2011 OVDI, Edward will only pay 12.5% on the highest year, which is $1,813 ($14,500 * 12.5%). He will also owe the accuracy related, failure to file and failure to pay penalties on the under-reported interest income for each year.

What Do I Need to Do?

To take advantage of the 2011 OVDI, taxpayers need to file their US expat taxes and pay all tax associated with their under-reported income by August 31, 2011. This entails:
  • Preparing and filing amended US expat tax returns for any years between 2003 and 2010 covered under the 2011 OVDI. The returns should be amended to include any income previously omitted, particularly the foreign earned income.
  • Filing all information returns (FBAR, 5471, 3520, etc) not previously reported.
  • Paying all penalties associated with under-reported income (including accuracy related, failure to file, and failure to pay).
  • Paying the 5%, 12.5% or 25% FBAR penalty on the covered tax year with the highest cumulative balance.

If the taxpayer cannot afford to pay all of his or her US expat tax liability, he or she should make a good faith arrangement with the IRS to commit to paying these taxes in the near future. Taxpayers participating in the 2011 OVDI will also be asked to cooperate with the IRS, if requested, to provide information on offshore financial accounts, institutions and facilitators.

Why Should I Get Compliant with My US Expat Taxes and FBAR?

“Tax secrecy continues to erode,” IRS Commissioner Doug Shulman said. “We are not letting up on international tax issues, and more is in the works. For those hiding cash or assets offshore, the time to come in is now. The risk of being caught will only increase.”

By voluntarily reporting offshore accounts under the 2011 OVDI, US Expat Taxpayers have an opportunity to pay substantially less in penalties than if they were discovered through IRS examination. Taxpayers participating in the 2011 OVDI can become compliant with US Expat Tax requirements, avoid potential prison time and resolve any outstanding tax concerns. After the 2009 disclosure initiative, the IRS received a great deal of information regarding offshore accounts and institutions. The 2011 initiative is proving to be equally fruitful for the IRS, and the chances of undisclosed financial accounts being discovered increases with each year. Becoming compliant with US Expat Tax filing requirements now is highly recommended. More information about the 2011 OVDI and its impact on US Expat Taxes can be found on the IRS website.

Have More Questions About Your FBAR?

If you have further FBAR questions or would like to learn about our expat tax services, please contact us.

UPDATE II: The 2012 Offshore Voluntary Disclosure Program was launched in early 2012 and as of the writing of this article does not have a closing date. For more information on this program please visit here.