Taxpayer Advocate Service Criticizes IRS’s Offshore Voluntary Disclosure Programs in 2014 Congressional Report
By: Heather L. Schmidt
To combat money laundering and evasion of U.S. income obligations through the use of offshore accounts, Congress imposed a requirement on all United States taxpayers to annually file a Report of Foreign Bank and Financial Accounts (“FBAR”) disclosing interests in accounts held outside of the U.S. where the aggregate balances exceed $10,000. However, in 2002 the IRS estimated that less than 20 percent of U.S. taxpayers complied with their reporting obligations. In response, Congress significantly increased the maximum penalty for willfully failing to report offshore accounts and established a penalty for non-willful violations.
To entice taxpayers to come into compliance on their own accord, the IRS offered mitigated penalties to those who participated in their newly-established amnesty program. Beginning with the Offshore Voluntary Compliance Initiative in 2003, this amnesty program has been modified with various penalty regimes and information requirements to transform it into the current 2014 Offshore Voluntary Disclosure Program (“OVDP”). Recognizing the complexity of these programs and the length of time it takes to process the voluntary disclosure submissions, the IRS established Streamlined programs in 2012 and 2014 to complement the OVDP and accommodate “low risk” taxpayers with little to no unreported income in a more timely and efficient manner.
Despite their numerous modifications and purported efforts to improve IRS disclosure programs, many uncertainties and ambiguities remain. On January 14, 2015, the Taxpayer Advocate Service released their 2014 Annual Report to Congress, commenting on litigated issues, case advocacy and administrative problems and providing legislative recommendations to mitigate or rectify these issues. Once again, Offshore Voluntary Disclosure programs and related civil penalties made the list of “Most Serious Problems.”
In their analysis, the Taxpayer Advocate found that the disclosure regimes generally over-penalize “benign actors” who inadvertently failed to report their foreign interests but have little to no tax outstanding, lack the consistent and transparent guidance necessary to provide certainty to taxpayers, and, in regards to the 2014 Streamlined program, fail to provide closure. For example, under the 2011 Offshore Voluntary Disclosure Initiative, taxpayers with only $268 tax owed on a median account balance of $17,368 paid a median offshore penalty of $2,202 – penalties that constituted 821% of the tax due. Although a taxpayer owing $268 in back tax clearly should not fall within the realm of devious taxpayers targeted by Congress’s Bank Secrecy Act, for many, paying an 821% penalty in exchange for closure was preferable to the “prolonged uncertainty, the expense and stress of an examination, potential appeals, and the risk of even more severe penalties” associated with opting out. While the 2014 Streamlined program lessens the penalty to a more reasonable amount for those who are willing to certify non-willfulness, the IRS will not provide a closing agreement to those taxpayers, meaning the IRS can reopen the case at any time until the statute of limitation expires. The 2014 Streamlined program also constitutes a departure from IRS’s historic practice of allowing taxpayers with closing agreements under previous programs to benefit from smaller penalties under subsequent guidance, effectively penalizing those who came forward early.
To alleviate these issues, the Taxpayer Advocate made a number of legislative recommendations to provide certainty and fairness to taxpayers, including, among others:
(1) Raising the FBAR threshold from $10,000 to $50,000 to account for inflation after 1970 – when FBAR reporting obligation originally became law – and to be consistent with the triggering threshold for Form 8938 Statement of Specified Foreign Financial Assets, which is part of an individual’s tax return;
(2) Cap the civil FBAR penalty to reflect a reasonable amount and eliminate penalty stacking that impairs proportionality of the penalty to the tax due;
(3) Eliminate or waive the civil penalty if there is no evidence the account was used in connection with a crime and the account information was already provided to the IRS (i.e. through Form 8938) or the taxpayer resides in the same jurisdiction as the account; and
(4) Release guidance clarifying the government’s position with respect to the distinction between willful and non-willful violations to provide taxpayer certainty and place the burden of proving actual willfulness on the government prior to asserting the willful penalty; and
(5) Authorize and direct the IRS to amend offshore disclosure closing agreements to make them “consistent with the terms of agreements publicly offered to similarly-situated taxpayers in subsequent IRS programs.”
Both taxpayers and tax practitioners are eagerly awaiting for IRS and Congressional responses to these issues and recommendations.
U.S. taxpayers with offshore accounts should seek legal counsel to ensure they are fully compliant with their U.S. filing obligations. The voluntary disclosure initiatives offered by the IRS can provide protection against criminal prosecution and mitigation of certain civil penalties. Andreozzi Bluestein LLP can counsel taxpayers by recommending a disclosure method appropriate for each taxpayer’s unique set of facts and circumstances and can guide them through the disclosure process.
 31 U.S.C. §§ 5314, 5321 dictate when a taxpayer has a FBAR filing requirement and the civil penalties associated with the failure to file FinCEN Form 114.
 Foreign Account Reporting: Legislative Recommendations to Reduce the Burden of Filing a Report of Foreign Bank and Financial Accounts (FBAR) and Improve the Civil Penalty Structure, Taxpayer Advocate Service 2014 Annual Report to Congress 331, 332 (Jan. 14, 2015).
 The Offshore Voluntary Compliance Initiative was modified into the Last Chance Compliance Initiative from 2003-2009, the Voluntary Disclosure Program from 2009-2011, the Offshore Voluntary Disclosure Initiative from 2011-2012, the Offshore Voluntary Disclosure Program from 2012-2014, and finally, the current Offshore Voluntary Disclosure Program.
 Offshore Disclosure Programs are no stranger to the Taxpayer Advocate’s Annual Reports’ “Most Serious Issue” list. In their 2011 Report, the Taxpayer Advocate Service authored The IRS’s Offshore Voluntary Disclosure Program “Bait and Switch” May Undermine Trust for the IRS and Future Compliance Programs, followed by The IRS’s Offshore Voluntary Disclosure Programs Discourage Voluntary Compliance by Those Who Inadvertently Failed to Report Foreign Accounts in 2012 and Offshore Voluntary Disclosure: The IRS Offshore Voluntary Disclosure Program Disproportionately Burdens Those Who Made Honest Mistakes in 2013.
 The Taxpayer Advocate directed her critiques and recommendations to the OVDP and 2012 Streamlined programs, opining that uncertainty surrounding potential treatment outside the programs coerces taxpayers to pay unfair penalties under the program to avoid facing the ambiguity associated with opting out. See n.6, infra, at 85. Currently, taxpayers can come forward under either the 2014 Offshore Voluntary Disclosure Program, the 2014 Streamlined Program, or can elect to opt out of the OVDP and proceed under a general voluntary disclosure under Internal Revenue Manual guidelines.
 Offshore Voluntary Disclosure (OVD): The OVD Programs Initially Undermined the Law and Still Violates Taxpayers Rights, Taxpayer Advocate Service 2014 Annual Report to Congress 79-93 (Jan. 14, 2015).
 Id. at 87.
 Id. at 85.
 Id. at 90-91.
 Foreign Account Reporting: Legislative Recommendations to Reduce the Burden of Filing a Report of Foreign Bank and Financial Accounts (FBAR) and Improve the Civil Penalty Structure, Taxpayer Advocate Service 2014 Annual Report to Congress 331-45 (Jan. 14, 2015).
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