Do you have unfiled freelance taxes involving foreign accounts? If so, it is important to be aware that the IRS is ramping up its enforcement in regard to taxpayers with outstanding taxes in these areas.
In fact, there are two key IRS programs which may offer you some relief from your unfiled foreign taxes in any of these categories: income tax, corporate tax, or sales tax. These two programs are the IRS Offshore Voluntary Disclosure Program (OVDP) and the IRS Streamlined Foreign Offshore Filing Procedures (Streamlined Procedures).
These programs have some similarities, however there are some key differences, too, as outlined below.
IRS Offshore Voluntary Disclosure Program vs Streamlined Foreign Offshore Procedures
Choosing to follow the OVDP versus the IRS Streamlined Procedures is a complex decision. If you are considering disclosure of foreign assets that are part of your delinquent tax situation, then the OVDP vs streamlined filing procedures comparison is critical to understand.
Keep in mind that if you opt for the streamlined compliance procedures, you will not be eligible for the OVDP.
The requirements and eligibility for the new IRS Voluntary Disclosure Program are different from those for the streamlined program. One of the key differences is there is no willfulness component to the judgment of whether a penalty should be assessed.
You may need to contact a tax professional familiar with these programs to ensure you understand which one best fits your unique situation and how you can get back into compliance with your unfiled foreign tax returns.
This is because the IRS is aggressively enforcing rules on foreign accounts compliance to ensure that back taxes are paid in full. The Internal Revenue Service’s Offshore Voluntary Disclosure Practice (OVDP) is run by the IRS Criminal Investigation (CI) with the goal of facilitating Offshore and Domestic Tax compliance for taxpayers who are not willfully disobeying the law.
How does the OVDP apply to freelancers who have not filed their foreign taxes? Essentially, it provides a measure of grace. If you have not filed your taxes and they are late, you can opt to make a timely and complete submission to the Offshore Voluntary Disclosure Program.
From there, the IRS will evaluate your case and determine which penalties should apply to you. You will generally receive a closing letter (Form 906) and as a result, the U.S.
Government will usually refrain from pursuing criminal prosecution and special agent investigations against you.
To be clear, this does not guarantee you as a freelance professional any “immunity,” however, you can often avoid any criminal prosecution for prior year noncompliance. The IRS’s VDP also applies to foreign accounts.
There are three key aspects that need to be considered prior to making a submission including 1) whether the funds are legally sourced, 2) if there is not a placeholder submission, and 3) if there is full disclosure. These include:
- Legally sourced means that you must have legally earned the money that was not previously disclosed.
- Not having an IRS Voluntary Disclosure Program placeholder means that you aren’t holding a spot open (or having one held open for you) as a delinquent
- Full disclosure of all assets, accounts, and previous tax issues must be made in order to qualify for the IRS Voluntary Disclosure Program. This applies, even if an offshore account or income stream is negligible or if it is dormant.
Here are some additional frequently asked questions about the IRS Offshore Voluntary Disclosure Program versus the Streamlined Offshore Compliance Program:
How are freelance taxes treated under the IRS Voluntary Disclosure Program?
The tax treatment under IRS voluntary disclosure for freelance taxes is the same as if a tax return is filed timely (with penalties and interest added). If you have unreported passive foreign investment income, you may lose the option to file IRS Form 8621, an information return which must be filed by as a Shareholder of a Passive Foreign Investment Company (PITC) or a Qualified Electing Fund or a Market-to-Market (MTM) election of the same.
You must also submit a preclearance letter. A preclearance letter is used in OVDP Voluntary Disclosure but not streamlined. Testing the IRS waters by intentionally submitting a preclearance letter and then going streamlined is a highly flawed strategy.
While in previous years, the preclearance was “optional,” that is no longer the case. A preclearance letter is submitted on standardized Form 14457.
Also required are six years of unfiled tax returns and FBARs (this is in comparison to three years for unfiled tax returns under the streamlined program). The Streamlined Procedure also requires six years of FBARs in alignment with the statute of limitations for FBARs.
How are freelance taxes treated under the IRS Streamlined Foreign Procedures
Program? Another program for delinquent foreign tax filings is the IRS Streamlined Filing Procedures Program which was created in 2012 to encourage U.S. expats to catch up on their delinquent taxes. The program was initially considered an alternative to the IRS’s other disclosure programs such as the VDP outlined above.
The Streamlined Filing Compliance Procedures were designed to help low-risk individuals become tax compliant. They are also designed to be a less burdensome way to get caught up on your taxes. Streamlined filing requires only your most recent 3 years of late tax returns and six years of FBAR filings in addition to Form 14653 which is required to qualify for the streamlined filing program. Form 14653 certifies that your lack of compliance was not willful or intentional.
How are penalties assessed with the OVDP vs. Streamlined Foreign Offshore Procedures
The penalties under the new updated IRS Voluntary Disclosure encompass the following:
Taxes due: The IRS voluntary disclosure compliance period is now six years. There is an annual 20% penalty of which a taxpayer pays a single 75% on the highest year’s amount of tax liability.You can try to negotiate that penalty to a lesser penalty.
Offshore penalties: The IRS Voluntary Disclosure Procedures do not have a set penalty, however, the IRS agent will follow the rules of the IRM (Internal Revenue Manual) which states that each taxpayer is subject to a 50% penalty on the highest year’s unreported balance. You can also try to negotiate the FBAR (offshore account) penalty to a lesser penalty.
International Information Returns. Under the revised procedures, a taxpayer may be able to avoid all fines and penalties for international information returns. In other words, there is no set penalty for unfiled information returns.
Penalties on Freelance Taxes Due with Streamlined Procedures
Under the Streamlined Foreign Offshore Procedures, there is no penalty (full-penalty waiver). Under Streamlined Domestic Offshore Procedures, the penalty is limited to a single 5% penalty. Under OVDP Voluntary Disclosure, the IRS may determine that no penalty applies for international information returns. It all depends on the specific facts of the applicant (overall, this will be a good-thing for taxpayers).
Do Penalties for Unfiled FBAR & FATCA Still Apply with OVDP and Streamlined Procedures?
Under the Streamlined Procedures, the FBAR penalties are combined with FATCA and other asset penalties, and limited to a single 5% penalty.Form 3520 gift penalty is not included (but if the money is deposited into an unreported foreign account, the penalty on the unreported account(s) would apply).
The FBAR penalty under OVDP is a baseline of 50% minimum value of $100,000 — whichever is greater. There is also interest on the tax liability under either program, at the standard rate of interest.
Have unfiled foreign tax returns or FBARs? Now is the time to act!
As you may have seen or read in the news, the Internal Revenue Service is making foreign account compliance a key enforcement priority.
Tax returns submitted under either the OVDP or Streamlined Foreign Offshore Procedures are processed like any other return submitted to the IRS. They will not be subject to an IRS audit automatically, but they may be selected for audit under the existing audit selection processes applicable to any U.S. tax return and may also be subject to verification procedures against information received from banks, financial advisors, and other sources. Thus, returns submitted under the streamlined procedures may be subject to IRS examination, additional civil penalties, and criminal liability.
If you are considering whether to apply to the IRS’s Streamlined Program or IRS Voluntary Disclosure, you should be careful to evaluate all the options as there are many issues to consider, including non-willful vs. willful non-compliance since willfulness does not always require knowledge (willful blindness) or intent (reckless disregard). Even if you are non-willful, you may still benefit from the OVDP instead of the streamlined procedures. This is why checking with a qualified tax professional is the best course of action so you have peace of mind that your delinquent foreign taxes are being handled correctly.