The panel of practitioners at the May meeting of the American Bar Association Section of Taxation have grappled with IRS's "one-size-fits-all" voluntary offshore disclosure program, finding that it was often ill-suited for some of their clients who may not have willfully evaded their tax obligations.
Background. On Feb. 8, 2011, the IRS announced a new 2011 Voluntary Disclosure Initiative (2011 OVDI) for taxpayers to disclose their unreported offshore accounts. To participate in the OVDI, taxpayers must file or amend their tax returns and Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts (FBAR)) and pay all delinquent taxes, interest and penalties by Aug. 31, 2011. The initiative covers tax years 2003 through 2010.
In exchange for participating in the OVDI, taxpayers with undisclosed offshore accounts can avoid criminal prosecution for their unpaid taxes and may be subject to significantly reduced penalties.
Under the OVDI, taxpayers will be subject to a 25% penalty on the highest aggregate account balance on their undisclosed accounts between 2003 and 2010. If the value of the undisclosed accounts was less than $75,000 at all times during the tax years in question, the penalty is reduced to 12.5%. Moreover, in limited situations, a penalty of 5% may be imposed.
Additionally, participants in the OVDI are required to pay an accuracy-related penalty equal to 20% of the underpayment of tax with interest for the tax years at issue and, if applicable, the failure to file and failure to pay penalties.
Voluntary disclosure vs. examination. Speaking at the May meeting of the American Bar Association Section of Taxation, John McDougal, Special Trial Attorney in the IRS Office of Chief Counsel explained that where taxpayers opted out of the IRS's voluntary offshore disclosure program in favor of a regular audit, the examiners were expected to look at all applicable tax years. Absent fraud, the statute of limitations is generally six years, although McDougal said that if there was an entity involved, and the entity failed to file information returns, "all bets were off" and IRS could go as far back as it liked.
McDougal noted that the 2011 OVDI covered eight years instead of six under the 2009 initiative. "The Commissioner decided that it would be unfair to give people that didn't come in last time a walk on the two other years (2003 and 2004) that were included in the first initiative," he said. Also mentioned was the fact that the penalty under the 2011 OVDI was 25%, as opposed to 20% under the 2009 OVDI.
With respect to the 5% penalty, McDougal said that taxpayers that did not open up the foreign account would be generally eligible for the reduced penalty, although if the bank required the taxpayer to open up the account to get it in their name, IRS wouldn't hold that against taxpayers.
McDougal said that agents weren't to make any factual determinations with respect to disclosures on matters pertaining to willfulness and reasonable cause. Once taxpayers participate in the OVDI, agents did not have the flexibility to mitigate the 25% penalty for reasons associated with reasonable cause or willfulness, McDougal said. Taxpayers seeking to have IRS consider their arguments on willfulness or reasonable cause were required to opt out of OVDI and ask for an examination. The caveat, however, was that all penalties and all tax years were on the table in a regular examination.
Mark Matthews of Morgan Lewis & Bockius LLP, said that practitioners felt that IRS was of the view that everybody coming into the program had significant criminal exposure. In his opinion, the problem lay with clients that were in a gray area, where there might be no criminal exposure. The opportunity presented through the OVDI had to be balanced against other civil penalties that might be faced if the taxpayer was detected on audit or otherwise.
"The perception is that the agents are leaning very hard to keep you in the program," Matthews said, finding that agents pressure taxpayers by telling them that they will look back at several tax years if they opt out of the OVDI.
Larry Campagna of Chamberlain Hrdlicka said that he believed that the OVDI makes a presumption of willfulness. "The FBAR penalty in particular, is the government's burden to prove willfulness," he said. "They can assess the penalty if they want to but they have to go to court and prove willfulness to collect the penalty."
In his practice, Campagna said he saw many clients that didn't fit the program very well because they were in some sort of gray area with respect to willfulness, but the client was also not willing to take a penalty hit of 25%. Quiet disclosures—i.e., where taxpayers file amended returns and pay any related tax and interest for previously unreported offshore income without otherwise notifying IRS—were also very problematic, he said.
Observation: In announcing the 2011 OVDI, IRS specifically discourages "quiet disclosure." IRS warned that taxpayers who don't come forward under the voluntary disclosure offer run the risk of being examined and potentially criminally prosecuted for all applicable years. IRS said it had identified, and would continue to identify and closely review, amended tax returns reporting increases in income.
References: For voluntary disclosure as defense in criminal tax case, see FTC 2d/FIN ¶V-3829; United States Tax Reporter ¶72,014.15; TaxDesk ¶871,019; TG ¶71869.