For many years, the IRS has had a general voluntary disclosure policy whereby if a taxpayer came forward with information about a tax irregularity (e.g., excessive deductions taken, income omitted from a tax return), and the taxpayer was not already under audit or investigation, the IRS would accept the voluntary disclosure. The taxpayer would have to pay back taxes, penalties and interest, but the taxpayer could generally avoid criminal prosecution. In 2009 and again in 2011, the IRS announced specific programs for voluntary disclosure of foreign accounts and assets that were not tax compliant.
An important question is whether a taxpayer who is voluntarily disclosing offshore accounts via the 2011 Offshore Voluntary Disclosure Initiative (OVDI) should also include domestic tax issues that may need to be “cleaned up”. Somewhat surprisingly, the OVDI FAQs are silent on this issue.
It is our conclusion that a taxpayer should not take the position that an offshore disclosure under the OVDI should only be limited to the offshore noncompliance. As part of the OVDI process, the taxpayer will have to submit amended tax returns. A taxpayer should not sign amended returns that he or she knows to be incorrect or incomplete, i.e., compliant as to foreign income but non-compliant as to domestic issues. Moreover, one of the conditions for participation in the OVDI is that the disclosure be truthful and complete. Therefore, we do not advise taking the position that the offshore disclosure was truthful and complete, and that the condition of truthful and complete is only limited to the offshore context and not the domestic issues.
However, it is also important to keep in mind that disclosing the domestic issues will allow the IRS a greater look back period than usual. Normally, the IRS can go back three years in an audit. Within the context of the OVDI, however, domestic issues as far back as 2003 are now, like the offshore issues, subject to IRS scrutiny.
As part of the OVDI, taxpayers are required to sign IRS Form 872 which extends the Statute of Limitations back to 2003. This Form 872 extension is a “general” waiver and is not limited to the offshore issues alone. In addition, the Form 906 which is the Closing Agreement that completes the voluntary disclosure, includes the following language: “this closing agreement does not prevent the IRS from auditing taxpayer for the years 2003 through 2008 and proposing adjustments unrelated to offshore financial arrangements”.
The bottom line is that if you are cleaning up offshore noncompliance via the OVDI, you should also clean up any domestic tax noncompliance as well.