IRS Voluntary Disclosure for Foreign Assets and Crypto

The IRS provides three compliance options for taxpayers with undisclosed foreign financial assets:

(i) IRS Criminal Investigation Voluntary Disclosure Practice;

(ii) Streamlined Filing Compliance Procedures;

(iii) Delinquent International Information Return Submission Procedures (IRS, Options available for U.S. taxpayers with undisclosed foreign financial assets).

The IRS first asks a threshold question: was the failure to disclose willful?

The answer determines which compliance option is available to a client an overseas company, foundation, bank account, or cryptocurrency exchange account (or other crypto holding structure).

Who must report what

A U.S. person, including a trust or other entity, must file an FBAR (FinCEN Form 114).

The filing requirement applies when the aggregate value of the person’s foreign financial accounts exceeds $10,000 at any time during the calendar year (IRS, Report of Foreign Bank and Financial Accounts).

Foreign holdings also trigger income-tax information returns:

(i) Form 8938 for specified foreign financial assets;

(ii) Form 5471 for foreign corporations; and

(iii) Forms 3520 and 3520-A for foreign trusts and large foreign gifts (IRS, International information reporting penalties).

Crypto follow a different rule set. FinCEN’s position is that “Currently, the Report of Foreign Bank and Financial Accounts (FBAR) regulations do not define foreign account holding virtual currency.” (FinCEN Notice 2020-2).

However, “FinCEN intends to propose to amend the regulations implementing the Bank Secrecy Act (BSA) regarding reports of foreign financial accounts (FBAR) to include virtual currency as a type of reportable account under 31 CFR 10110.350.” Id.

Income derived from crypto is subject to federal income tax. Form 1040 requires taxpayers to indicate whether they received, sold, exchanged, or otherwise disposed of a digital asset during the tax year.

Income from digital assets is taxable, Form 1040 asks whether the filer received or disposed of a digital asset, and brokers report dispositions on Form 1099-DA beginning with 2025 transactions (IRS, Digital assets).

The voluntary disclosure form includes a separate “Digital Asset Issues” section.

It requires taxpayers to disclose “ALL domestic and foreign digital asset transactions related to tax noncompliance.”

The form also requires taxpayers to identify “all aliases, usernames, monikers, mobile phone numbers, and email accounts” used to acquire or dispose of digital assets. (IRS, Form 14457 Instructions (Rev. 7-2025)).

The programs at a glance

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Panel A compares the four IRS disclosure options. Panel B is an illustrative hypothetical for a single $1,000,000 foreign account; VDP and examination bars show ceilings under the cited rules, not typical results. Sources are printed on the image and listed below.

How the penalties are computed

Streamlined Foreign Offshore. A qualifying taxpayer “will not be subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties” (IRS, U.S. taxpayers residing outside the United States).

Streamlined Domestic Offshore. “The Title 26 miscellaneous offshore penalty is equal to 5 percent of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period.” (IRS, U.S. taxpayers residing in the United States). [emphasis added]

“A foreign financial asset is subject to the 5-percent miscellaneous offshore penalty in a given year in the covered tax return period if the asset should have been, but was not, reported on a Form 8938 for that year.” (IRS, U.S. taxpayers residing in the United States). For example, a foreign financial asset with a $1 million peak balance would result in a $50,000 penalty.

Voluntary Disclosure Practice. “If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.” (26 U.S.C. § 6663).

Under the current terms it applies to the one year with the highest tax liability in the six-year Disclosure Period, in lieu of accuracy and late-filing penalties on the other years (IRS, Form 14457 Instructions (Rev. 7-2025)).

Separately, “Willful FBAR penalties will apply to all cases involving FBAR noncompliance where facts and law support” them, computed under the Internal Revenue Manual (IRS, Form 14457 Instructions (Rev. 7-2025)).

For example, if a taxpayer had a $1,000,000 foreign account and underreported $40,000 of tax annually, the potential civil fraud penalty could reach approximately $30,000. In addition, the willful FBAR penalty could be as high as $500,000. The IRS emphasizes that “[n]o penalty deviations will be permitted” (IRS, Voluntary Disclosure Practice, FAQ 18).

Choosing the program: five steps

1. Disclosure timing. A voluntary disclosure is timely only if it is submitted before the IRS initiates a civil examination or criminal investigation. It must also be submitted before the IRS receives information from a third party or acquires information through an enforcement action. (IRS, Voluntary Disclosure Practice).
2. Was your conduct willful? Willfulness includes knowing violations, reckless violations, and “willful blindness” through “a conscious effort to avoid learning about a legal duty” (IRS, IRM 4.26.16.5.5.1). Non-willful conduct is “negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding” (IRS, Streamlined filing compliance procedures).
3. Is the source of income legal? The Voluntary Disclosure Practice “does not apply to taxpayers with illegal sources of income.” Eligibility is determined under federal law. As a result, conduct that is legal under state law but illegal under federal law is treated as illegal for purposes of the program. (IRS, Voluntary Disclosure Practice).
4. Inventory every entity. Form 14457 requires identification of related entities, defined to include “corporations, partnerships, associations, limited liability companies, trusts, estates, escrows, charitable foundations, insurance companies, international business companies.” This test applies to both foreign or domestic entities (IRS, Form 14457 Instructions (Rev. 7-2025)).
5. Model the tax & penalty consequences under each program before filing anything.

Common misconceptions and mistakes

“A Quiet Disclosure Is Safer.” Not necessarily. Taxpayers who previously filed amended returns or delinquent information returns outside the IRS’s approved disclosure procedures “must pay previous penalty assessments,” and those penalties generally will not be abated (IRS, Streamlined filing compliance procedures).

“Streamlined ends criminal exposure.” The streamlined procedures “do not absolve taxpayers of criminal liability if IRS Criminal Investigation determines their conduct was willful.” (IRS, Voluntary Disclosure Practice, FAQ 17; IRS, Streamlined filing compliance procedures).

“The VDP guarantees immunity.” It “will not automatically guarantee immunity from prosecution,” and CI’s timeliness and completeness determinations “are not subject to any administrative or judicial review or appeal process” (IRS, Voluntary Disclosure Practice; IRS, IRM 9.5.11.9).

“The narrative can hedge.” The IRS states: “You will be required to provide a statement acknowledging your willful failure to comply with tax or tax related obligations” (IRS, Voluntary Disclosure Practice). If the narrative “states they were merely negligent or careless and does not fully describe willful non-compliance, the clearance request will be denied” (IRS, Voluntary Disclosure Practice, FAQ 12).

Procedural slips. Part II is due 45 days after the preclearance letter, with “no more than one 45-day extension,” and a separate Form 2848 is required for each taxpayer and entity (IRS, Voluntary Disclosure Practice).

This article is for general informational purposes only and does not constitute legal advice. Reading it does not create an attorney-client relationship with Dilendorf Law Firm. Attorney Advertising.