IRS Streamlined Domestic Offshore Procedures (SDOP)

That sinking feeling when you realize you’ve failed to report foreign bank accounts or income to the IRS is unmistakable. Whether you’ve just learned about FBAR requirements or discovered your accountant missed important international tax forms, the fear of hefty penalties or potential legal consequences can be immense. The IRS Streamlined Domestic Offshore Procedures offers a lifeline for U.S. taxpayers who’ve made honest mistakes in their international tax reporting, providing a path to compliance with reduced penalties and greater peace of mind.

What Are the IRS Streamlined Domestic Offshore Procedures?

The Streamlined Domestic Offshore Procedures are an IRS procedure that allows U.S. resident taxpayers with unreported foreign income and assets to voluntarily correct past filing mistakes while facing substantially reduced penalties (a single 5% penalty instead of potentially numerous, higher penalties) if their failure to report was non-willful.

Understanding SDOP Eligibility Requirements

Before you begin the SDOP application process, you need to verify that you meet all the eligibility criteria. Not everyone with foreign account compliance issues qualifies for this procedure.

U.S. Residency Status

SDOP is specifically designed for U.S. taxpayers who are considered U.S. residents for tax purposes. If you’ve lived abroad and meet the foreign residency test, you may instead qualify for the Streamlined Foreign Offshore Procedures (SFOP), which offers even more favorable terms with no penalty.

Non-Willful Conduct

Perhaps the most important eligibility factor is that your failure to report foreign accounts or income must have been non-willful. The IRS defines non-willful conduct as conduct due to negligence, inadvertence, mistake, or a good-faith misunderstanding of legal requirements.

Common examples of non-willful conduct include:

  • Relying on a tax professional who provided erroneous guidance regarding the reporting obligation
  • Good-faith misunderstanding of which accounts are required to be reported

This certification of non-willfulness is made under penalty of perjury, making it necessary to evaluate your situation honestly. Your specific facts and circumstances will determine whether you are willful or non-willful in your non-compliance.

Tax Filing History

To qualify for SDOP, you must have filed U.S. tax returns for the previous three years if you were required to file. If you haven’t filed required returns, you may be ineligible to pursue the streamlined procedures.

No Active Investigations

You cannot use SDOP if you’re under civil examination or criminal investigation by the IRS, or if the IRS has already contacted you about your unfiled FBARs or international information returns.

Unreported Foreign Income

This procedure is specifically for taxpayers with unreported foreign income. If you reported all your foreign income but simply failed to file informational forms like the FBAR, you might instead qualify for the Delinquent FBAR Submission Procedures or the Delinquent International Information Return Submission Procedures.

How SDOP Differs from Other IRS Disclosure Programs

The IRS offers several programs or procedures for taxpayers with international compliance issues. Understanding how SDOP compares to these alternatives is key for making the right choice.

SDOP vs. Voluntary Disclosure Program (VDP)

The Voluntary Disclosure Program (formerly known as OVDP) is designed for taxpayers with potential criminal exposure—typically those who willfully failed to report foreign accounts or income. While SDOP carries a 5% penalty, the VDP involves a civil fraud penalty of 75% on the highest tax year, plus a 50% penalty on the highest aggregate balance of foreign assets.

Choose VDP if:

  • Your conduct was willful
  • You face potential criminal charges
  • You need some level of assurance against criminal prosecution

Choose SDOP if:

  • Your conduct was genuinely non-willful
  • You want to minimize penalties
  • You don’t have concerns about criminal exposure

SDOP vs. Streamlined Foreign Offshore Procedures (SFOP)

Both programs are for non-willful taxpayers, but SFOP is for those meeting the non-U.S. residency test. The key difference: SFOP waives all penalties, while SDOP includes the 5% miscellaneous offshore penalty.

SDOP vs. Delinquent FBAR Submission Procedures

The Delinquent FBAR Submission Procedures are for taxpayers who reported all income but failed to file FBARs. These procedures don’t impose penalties if you file the missing FBARs and include a reasonable cause statement. However, if you had unreported income, SDOP or SFOP may be the appropriate choice.

The SDOP Application Process: Step-by-Step

Initial Assessment

Before proceeding, carefully evaluate your situation to confirm that SDOP is appropriate. This includes determining non-willfulness, confirming U.S. residency, and calculating potential unreported income and penalties. Take action now to review your financial history.

Gathering Documentation

You’ll need to assemble extensive financial records, including:

  • Bank statements for all foreign accounts
  • Income statements for foreign investments
  • Documentation of foreign retirement accounts
  • Records of foreign entity ownership
  • Prior tax returns

For accounts that no longer exist, you may need to contact financial institutions for historical records or reconstruct information from other sources. The thoroughness of your documentation will help support your non-willfulness claim and ensure accurate reporting on amended returns.

Amending Tax Returns

The SDOP requires you to file amended tax returns (Form 1040X) for the most recent three tax years for which the tax return due date has passed, reporting all previously unreported foreign income. You must also include any required international information returns, such as:

  • Form 8938 (FATCA)
  • Form 3520 (foreign trusts and foreign gifts and inheritance)
  • Form 5471 (foreign corporations)
  • Form 8865 (foreign partnerships)
  • Form 8858 (foreign disregarded entities)

Each amended return should be clearly marked “Streamlined Domestic Offshore” in red at the top of the first page. Ensure all forms are properly completed and submitted together to prevent processing delays and additional IRS inquiries. Carefully follow the very specific IRS instructions ot ensure proper processing.

Filing Delinquent FBARs

You must file FBARs (FinCEN Form 114) for the most recent six years for which the FBAR due date has passed. These are filed electronically through the Financial Crimes Enforcement Network’s BSA E-Filing System, with a statement explaining that they’re being filed as part of the SDOP. Act promptly to file missing FBARs.

Calculating Tax, Interest, and Penalties

You’ll need to calculate:

  • The additional tax due from unreported income
  • Interest on unpaid tax
  • The 5% miscellaneous offshore penalty

Completing Form 14654

Form 14654, “Certification by U.S. Person Residing in the U.S.,” is a vital component of your SDOP submission. This form:

  • Certifies your eligibility for the program
  • Includes your narrative statement explaining non-willfulness
  • Provides the calculation of your 5% miscellaneous offshore penalty

The non-willfulness statement must be specific enough to be credible but concise enough to avoid creating unnecessary issues. Be precise and truthful.

Submitting Your Package

Once all documents are prepared, you’ll submit your complete package to the IRS at the address specified in the SDOP instructions, following the very specific assembly instructions. Keep copies of everything submitted for your records.

SDOP Penalty Structure and Financial Implications

The SDOP’s main benefit is replacing potentially multiple, severe penalties with a single, reduced penalty framework.

The 5% Miscellaneous Offshore Penalty Explained

Under SDOP, you pay a 5% penalty on the highest aggregate balance of certain foreign financial assets during the six-year period covered by your FBAR filings. This is calculated based on the year-end balance/value for each year, then taking the highest of those six figures. The computation can be complex when foreign assets other than foreign bank accounts are present.

For example, if you only have foreign bank accounts, and if your highest aggregate foreign account year-end balance was $500,000 during the six-year period, your miscellaneous offshore penalty would be $25,000 (5% of $500,000).

Assets Included in the Penalty Base

The 5% penalty applies to the following non-exhaustive list:

  • Foreign financial accounts 
  • Foreign financial assets reported on Form 8938
  • Foreign partnership interests
  • Foreign mutual funds
  • Foreign life insurance with cash value
  • Foreign annuities

Assets Excluded from the Penalty Calculation

Certain assets are excluded from the penalty calculation, including:

  • Foreign real estate held directly (not through an entity)
  • Non-financial assets not held in a financial account
  • Other assets depending on your specific facts and circumstances

Additional Tax and Interest

In addition to the 5% penalty, you must pay:

  • The full amount of additional tax due on unreported income for the three tax years covered
  • Interest on the unpaid tax, calculated from the original due date

Penalty Comparison Example

Consider a taxpayer with a highest aggregate balance of $500,000 in foreign accounts who failed to file FBARs for six years:

  • Under standard non-willful FBAR penalties: Up to $60,000 for non-willful violations ($10,000 per year for six years)
  • Under SDOP: $25,000 (5% of $500,000)

The savings of $35,000 in this example demonstrates why SDOP is an attractive option for eligible taxpayers.

Common Pitfalls and Best Practices When Using SDOP

The SDOP process contains several potential pitfalls that could jeopardize your application.

Incomplete Disclosures

The IRS expects complete disclosure of all foreign accounts and income. Partial disclosures can lead to rejection from the program and potentially worse penalties than if you hadn’t applied in the first place.

Inadequate Non-Willfulness Narrative

Your non-willfulness narrative must be truthful and comprehensive. It should explain why you didn’t comply with reporting requirements without being overly defensive or providing unnecessary details.

Incorrect Penalty Calculations

Calculating the 5% penalty incorrectly could result in underpayment (leading to further issues with the IRS) or overpayment (costing you money unnecessarily).

Missing Deadlines

Once you become aware of your filing obligations, timely compliance is important. Delaying your SDOP application after learning about requirements could jeopardize your claim of non-willfulness.

Best Practices

  • Consult with an experienced international tax attorney before proceeding
  • Gather complete records for all foreign accounts and assets
  • Be thorough but concise in your non-willfulness statement
  • File as soon as possible after discovering non-compliance
  • Ensure all required forms are included and properly completed

For additional guidance, consider reaching out to an international tax lawyer who specializes in streamlined offshore procedures.

Life After SDOP: Maintaining Future Compliance

Successfully completing the SDOP is just the beginning of your ongoing tax compliance obligations.

Post-Submission Timeline

After submitting your SDOP package, the IRS will process your submission. You may not receive explicit confirmation of acceptance, and the IRS typically only contacts taxpayers if there are issues with the submission. Processing times can be lengthy, though it can vary based on IRS workload.

Ongoing FBAR and FATCA Reporting

After completing SDOP, you must continue to file annual FBARs by the due date (currently April 15, with an automatic extension to October 15). You must also report foreign financial assets on Form 8938 if you meet the filing thresholds.

Record Keeping

Maintain detailed records of your foreign accounts and assets, including:

  • Account statements showing all activity
  • Documentation of account opening and closing dates
  • Records of foreign income
  • Proof of compliance with FBAR and other reporting requirements

Good record keeping makes annual filing easier and provides protection in case of future IRS questions.

Warning Signs of Further Review

While most SDOP submissions are processed without incident, be alert to signs that the IRS may be conducting further review:

  • Formal notices requesting additional information
  • Requests for interviews or meetings
  • Notification of an examination or audit

If you receive any such communications, consult with a tax professional immediately.

Facing a Tax Problem? We’re Here to Help.

At Hughes Noff Tax Law, we know how overwhelming it can feel when the IRS or state tax authorities get involved. Whether you’re dealing with an IRS audit or tax disputeinternational tax non-compliance, or tax debt resolution, we’re here to give you relief and bring down that anxiety. Let us deal with the federal government—so you don’t have to.

We approach every client with empathy and provide the advocacy, direction, service, and resolution they deserve. We have over 25 years of experience resolving complex tax controversies and understand the unique and sensitive nature of these matters. As both attorneys and CPAs, we understand the law and the numbers. Our clients appreciate the clarity and peace of mind we help restore—read their stories here.

Contact us today or call 410-694-7758 to schedule your consultation.