Broadly speaking, the IRS had a good idea in trying to bring U.S. citizens and tax residents with unreported offshore financial accounts back into compliance with the tax reporting system. The number of applicants, almost 15,000, who clamored into the 2009 program, mostly holding Swiss accounts, indicates how wide-spread non-compliance had become. The 2011 OVDI is an extension by IRS of its “bring into compliance” philosophy with some added requirements and more severe penalty, 25% instead of 20%, on the foreign accounts’ highest aggregate value measured by an 8 year instead of a 6 year period. Like many bureaucratic agencies, however, IRS takes a good idea and begins to negate the good idea with its implementation. Specifically, with regard to the 2011 OVDI, IRS on June 2 IRS issued an updated set of Frequently Asked Questions (FAQS) which answer some concerns of professionals. Some aspects of the IRS program, however, that could use further rethinking are:
- August 31 deadline. IRS has now recognized that many will be unable to comply with this requirement and will grant a 90 day extension to those who need more time and can demonstrate a good faith attempt to fully comply with FAQ 25 by August 31, 2011. What seems clear to this writer is the 2011 OVDI deadline and extension announcement, following the 2009 program with its deadline, illustrate that deadlines only lead to dead ends. When this program finally closes, IRS will have backed itself into a corner of having no inducement other than threatened discovery to bring others into the fold. Perhaps a better approach would have been to invite all offshore account non-filers to come in from the cold, with no deadline, under one simple and unified penalty regime but require the applicants to include all completed years beginning with 2003. Thus, one owning up in 2012 would have to file from 2003-2011 under the simplified penalty regime. Going forward all returns would have to fully comply with all provisions of the tax law.
- Following the thread of keeping the penalty calculation relatively straightforward, some aspects of the present implementation scheme are hard to understand, given that the penalty structure is an arbitrarily determined percentage in any event, namely:
1. Application of PFIC rules: The PFIC rules are in fact themselves a penalty regime on those who keep certain passive income producing assets offshore. The elective alternative method in FAQ 10 is still daunting. Applying these complex accounting rules to an already difficult to obtain data environment serves no purpose but to make more arduous the process of reporting. It also imposes a penalty on a penalty. If that’s the goal, why not simply apply a higher tax rate on net gains and avert the need to go through any mark to market accounting machinations? Going forward, of course, the normal PFIC rules would apply.
2. Value of private business interests acquired with offshore funds: FAQ 50 indicates that the maximum penalty one would pay outside of the OVDI is the ceiling on the penalty amount one will be asked to pay by participating in the program. Yet, FAQ 51.1 Example 3 suggests that one must opt out in such a situation. In any event, one must value offshore business assets to determine if the OVDI penalty will exceed the ceiling. Business valuation is a subjective time-consuming operation, even when data is readily available. A foreign location adds more subjectivity in evaluating risks and rate of return if an income method is employed. To a great extent every business valuation based on future expectations is speculative. Why not specify that value will be based on the higher of offshore funds invested in the business or value derived from actual distributions utilizing a recognized local benchmark equity yield ?
The updated FAQ do add certainty by clarifying that those who opt out of the OVDI will not automatically be viewed as potential tax criminals but will be included in CI’s traditional voluntary disclosure program outside of the OVDI. Those opting out will not be financially punished simply for having opted out of the special penalty regime; but, will be examined under the standard IRS audit process and subject to the full array of civil tax and FBAR penalties. Moreover, should facts not disclosed to IRS in the original OVDI submission be discovered, a criminal investigation could ensue. Thus, those opting out are almost certainly subjecting their records and statements to closer scrutiny than what occurs under the examination review in the OVDI program. Careful consideration should precede any decision to opt out of the OVDI submission.
I also question the advisability of the 5% and 12% penalty imposition. If the goal is to bring taxpayers into compliance, perhaps a wiser tact would be to forgive the penalty entirely for these nominal omissions. It seems that the IRS is torn between an open arms welcome back into the system and an institutional need to punish perceived wrongdoing. Perhaps a more forgiving paternal approach would bring more nominal wrongdoers into the tax system and free up IRS personnel to the review of the more egregious and monetarily significant cases?
Copyright 2011 by Robert S. Steinberg
All rights reserved.