On January 9, 2014, Nina Olsen, National Taxpayer (TA) Advocate Delivered her annual report to congress. The report severely criticized the current version (2012) of IRS’s OVDP for unfairly and disproportionately penalizing benign non-filers and non-filers with small offshore balances.
The TA analyzed results from the 2009 OVDP.
Based on the 2009 program analysis, the TA report highlights several perceived deficiencies in the present program that retains most of the 2009 program guidelines and procedures:
- The program imposes excessive penalties on taxpayers whose failure to file was due to reasonable cause or not “willful.”
- Taxpayers with smaller non-reported foreign account balances are disproportionately penalized compared to those with larger balances. The 2009 OVDP median offshore penalty was about 381 percent of the additional tax assessed for taxpayers with median-sized account balances, and 580 percent of the tax assessed for taxpayers with the smallest account balances (i.e., the bottom 10 percent, with an average $44,855 account balance).
- Taxpayers who “opted out” of the OVDP program and agreed to subject themselves to audits fared better but still faced penalties of nearly 70 percent of the tax and interest.
- The sole remedy offered by IRS for benign non-filers is to enter the program and then “opt-out” and be audited. Those electing this route, however, face uncertainty as to the amount of FBAR penalty and whether other income tax issues and penalties will be imposed (e.g., civil fraud penalty)
- The so-called “Streamlined Program” for non-resident U.S. citizens is excessively burdensome and unfair to non-willful non-filers in that:
- It still requires a voluminous submission (questionnaire, three years of Forms 1040 and six years of FBARS).
- Is closed to U.S. residents, and,
- Fails to provide certainty as to which taxpayers will be deemed “high risk” not eligible for streamlined treatment versus “low risk” and eligible. Thus, those making a streamlined disclosure may still be subject to the most severe penalties.
- While the government has imposed new complicated and confusing duplicate reporting requirements (Form 8938 and FBAR), IRS has cut-back its educational programs to inform taxpayers of these responsibilities.
- The new electronically filed FBAR form lacks sufficient space for submitting detailed “reasonable cause” or “non-willful” explanations, allowing only 750 characters of text to be transmitted.
While FBAR penalties are computed as a percentage of account balances rather than tax liabilities, the report offers the comparison to illustrate that the penalties are often Draconian and may deter other taxpayers from coming into compliance.
The TA proposes a three category approach to replace the IRS one-size-fits-all process:
- Category I would include taxpayers with unreported offshore income less than a threshold of $5,000 (The penalty threshold for substantial understatement under IRC Sec. 6662(d)): Category 1 taxpayers would pay no FBAR or other information reporting penalties.
- Category 2 would include taxpayers who under-reported income of more than $5,000 but who believe they acted non-willfully or with reasonable cause: Category 2 taxpayers would submit the delinquent returns with the tax, interest and income tax penalties along with the non-willful FBAR penalty ($10,000 per violation) or no penalty payment if reasonable cause is believed to exist, together with an explanation. IRS would audit a small number of these returns.
- IRS would provide more concrete guidelines when and whether “reasonable cause” will be found.
- Category 3 would include taxpayers not fitting into Categories 1 or 2. These willful violators would follow the current OVDP process.
- Category 1 is a good idea because a threshold would be clear and allow taxpayers to come into compliance without the great uncertainty that presently exists or the feeling that they are being bullied into paying exorbitant penalties.
- Category 2, as suggested by the TA, will still present problems for taxpayers in determining whether the facts support a “reasonable cause” finding and whether “willful blindness” will apply to color non-overt behavior as willful. That is, what facts will be required to overcome the presumption that one is charged with knowledge of the content of a tax return signed voluntarily?
- Perhaps instead a second threshold of higher amount could be included in the program that would treat taxpayers coming within its parameters as non-willful violators but require of them a more voluminous disclosure.
- Category 3 again requires a professional advisor to determine if the non-filing was due to “reasonable cause “or was non-willful.
- All in all, apart from non-resident non-willful violators, the OVDP is beneficial to those whose actions raise a concern of criminal violations or who desire certainty as to FBAR penalties or wish to more expeditiously conclude their case.
- Others, filing quietly or opting in and out are unfairly threatened with draconian civil penalties under the Bank Secrecy Act regardless of the amount of income tax evaded.
- The IRS under the BSA has wide latitude in determining the amount of the willful or non-willful penalty which can run from zero to the maximum amounts. The mitigations provisions in the IRM are not very helpful to many because they are based on account balances, not income evaded, and because IRS has not clearly indicated how and when mitigation will apply.
- IRS should publish clearer rules and examples to indicate how it intends to administer the FBAR penalty scheme and key the willful penalty (calculated as a percentage of the account balance on the date of violation) to the amount of income not reported on Form 1040 not the value of the account not reported on the FBAR
© 2014 by Robert S. Steinberg, Esquire
All rights reserved.