In our article that appeared in The Jerusalem Post on February 22, we described
the 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI). This is intended
by the US Internal Revenue Service (IRS) to allow US citizens, green-card
holders and US tax residents to come forward and report previously undisclosed
foreign financial accounts and unreported income from said accounts.
What is the OVDI about?
June 6 the IRS announced it was making changes to the 2011 OVDI, which would be
more favorable to certain individuals living outside the US and that it is
giving a limited 90-day extension to the original August 31
First, a recap. The major thrust of the
2011 OVDI is that the taxpayer, in addition to paying any previously unpaid tax
plus a 20 percent accuracy-related penalty and interest on the tax, may choose
to pay an “offshore penalty” that was, in most cases, equivalent to 25% of the
highest aggregate value of the undisclosed offshore accounts in any of the years
2003 through 2009. The 25% “offshore penalty” is in lieu of a range of other
possible penalties in the US tax law.
However, the 25% penalty could also
be applied to nonfinancial offshore assets acquired with funds on which no US
tax was paid, even though the assets themselves do not produce any income. The
2011 OVDI made provisions for two reduced offshore penalties, one for 12.5% and
one for 5%, but the conditions to meet these reduced penalties were so
restricted, they were limited to a small class.
The major problem was
that the IRS lumped together into the same box the US citizen residing in
Boston, who was intentionally not disclosing his ill-gotten gains deposited in
an offshore account, together with the US citizen, who has been residing in a
foreign country (such as Israel) for many years, or was even born in a foreign
country and had foreign bank accounts and other foreign financial assets just
because he was resident of a foreign country.New 5% offshore penalty
Under pressure from tax professionals, the IRS is now recognizing that the US
citizen or green-card holder living in a foreign country should be classified
differently than the US person residing in the United States. There is a new
reduced 5% offshore penalty for US persons (citizens, green-card holders) living
outside the US. The conditions under which it can be claimed are as follows:
Taxpayer is a foreign resident.
2. Meets all three of the following
conditions for all of the years of his voluntary disclosure: a) taxpayer resides
in a foreign country; b) taxpayer has made a good-faith showing that he or she
has timely complied with all tax-reporting and -paying requirements in the
country of residency; and c) taxpayer has $10,000 or less of US source income
The IRS also declared that for “these taxpayers only, the
offshore penalty will not apply to nonfinancial assets, such as real property,
business interests, or artworks, purchased with funds for which the taxpayer can
establish that all applicable taxes have been paid, either in the US or in the
country of residence.”
Therefore, if you are resident of Israel and have
been paying Israeli tax on all your foreign-source income (e.g., Israeli salary,
rental income from Israeli real estate, pensions, etc.) and have $10,000 or less
of US source income in each year, you should meet the conditions for the 5%
The fact that many Israeli residents are not required to file
income-tax returns should not disqualify you, providing you have been paying the
taxes through withholding at source or payment vouchers (e.g., 10% tax on
residential rental income).
Taxpayers, who participated in the 2009 OVDI
are entitled to have the new reduced 5% offshore penalty applied if they
qualify.A possible scenario
Here is an example of the new 5% penalty
from the IRS: A taxpayer is a US citizen who has lived and worked as a corporate
executive in Country X (such as Israel, apparently) since 1995. His income has
included earnings in excess of $250,000 in each year, as well as bank interest
and investment income on financial accounts that had a high aggregate balance of
$1.2 million in 2009. He has paid all required taxes on his earnings and
investment income in Country X in every year, but he has filed no US income-tax
returns since moving out of the United States.
In addition to his
financial accounts, the taxpayer has acquired a personal residence in Country X
with an equity of $900,000 and an automobile worth $85,000, both financed with
previously taxed savings from the US, as well as his salary and investment
earnings in Country X.
If the taxpayer was fully tax compliant in Country
X, he will be eligible for a reduced offshore penalty of 5% of the value of the
financial accounts, or $60,000. The residence and automobile will not be
included in the penalty base because the funds used to acquire them were fully
taxed in the Country X.Why should I voluntarily disclose?
While the 5%
offshore penalty may still seem to be a bitter pill to swallow for many US
persons living in Israel for many decades, or even those born here, it should be
seriously considered as a means of getting back into the US tax system in the
least restrictive way.
If accepted into the program and you meet the
conditions for the lower penalty, you have the certainty to know exactly what it
will cost you in the end. If you do not enter the 2011 OVDI with the lower
penalty, you will have to be willing to live with the uncertainty of potential
civil and criminal penalties.
Additionally, it is going to become
increasingly more difficult for anyone who has any previously undisclosed income
from overseas assets and/or has not disclosed these financial assets on FBARs
(Foreign Bank Account Reports).
For example, starting with the 2011 US
income-tax return, in addition to having to file FBARs, one will have to
disclose on a new Form 8938, attached to the tax return, the aggregate balance
of all “foreign financial assets” of more than $50,000. There will be
substantial penalties for failing to make this disclosure.
starting with 2013, every foreign bank in the world will have to have a signed
agreement with the IRS to disclose all of its US account holders, or suffer
consequences that these financial institutions may not want to incur. Therefore
it will become increasingly difficult to hide foreign financial accounts from
the IRS.Extension to file documents
To qualify for the 2011 OVDI, all
documentation must be submitted by August 31, 2011. The package of documentation
includes original or amended US income-tax returns for 2003-2010, FBARs for the
same years and copies of offshore financial-account statements for all years in
which the aggregate highest balance exceeded $500,000. If you have not already
started the process with a tax professional, there is not much time left to
prepare the documentation.
The IRS announced that it will grant a 90-day
extension, providing you can demonstrate a good-faith attempt to fully comply
with the IRS requirements.Opting out
As we reported in our February 22
article, you can always elect to withdraw from the 2011 OVDI if you do not like
the offer made to you. In its revised FAQs issued on June 6, the IRS now
recognizes that there might actually be circumstances in which it would be
better for the taxpayer to opt out of the program. It discusses several
examples.Israeli tax implications
If you reside in Israel, you can only
qualify for the new US 5% offshore penalty if your Israeli tax affairs are in
order. If they are not, consider applying to the IRS and the Israel Tax
Authority; each country has programs for this.
To sum up, we strongly
suggest that if you qualify for the reduced 5% penalty, discuss your situation
as soon as possible with professional advisers in each
country.[email protected] [email protected]Don Shrensky is a qualified
US and Israeli CPA. Leon Harris is an Israeli CPA and international tax