IRS Commissioner Ignores Taxpayer Advocate’s Recommendations Seeking to Address Unduly Harsh Penalties Faced by Participants of the Offshore Voluntary Disclosure Program
As we previously reported here, in August of 2011 the Internal Revenue Service (IRS) Taxpayer Advocate Service released Taxpayer Advocate Directive 2011-1 (TAD) which addressed the IRSs failure to treat certain participants of the 2009 Offshore Voluntary Disclosure Program (OVDP) fairly and demanding that the IRS change the way it administered the OVDP.
The OVDP was a program under which taxpayers could voluntary disclose the existence of their offshore financial accounts in exchange for the IRSs leniency in the imposition of penalties arising from the taxpayers failure to disclose these accounts in a timely fashion. As stated by the IRS:
Recent IRS enforcement efforts in the offshore area have led to an increased number of voluntary disclosures. Additional taxpayers are considering making voluntary disclosures but are reportedly reluctant to come forward because of uncertainty about the amount of their liability for potentially onerous civil penalties. In order to resolve these cases in an organized, coordinated manner and to make exposure to civil penalties more predictable, the IRS has decided to centralize the civil processing of offshore voluntary disclosures and to offer a uniform penalty structure for taxpayers who voluntarily come forward. These steps were taken to ensure that taxpayers are treated consistently and predictably.
Voluntary Disclosure. Questions and Answers, Question 20. (May 6, 2009). (emphasis added).
Taxpayers who fail to report their offshore accounts on a Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”) face onerous penalties. United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year on the FBAR. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account. See 31 U.S.C. § 5321(a)(5). As discussed by the IRS, however, nonwillful violations are subject to a civil penalty of not more than $10,000. Voluntary Disclosure. Questions and Answers, Question 15. (May 6, 2009). (emphasis added).
As discussed by the Taxpayer Advocate in the TAD, the IRS lured participants in this program with promises of leniency, consistency, and predictability.
With significant FBAR penalties as leverage, the IRS “strongly encouraged” people who failed to file these and similar returns and report income from foreign accounts to participate in the 2009 Offshore Voluntary Disclosure Program (OVDP), rather than quietly filing amended returns and paying any taxes due. It warned that taxpayers making “quiet” corrections could be “criminally prosecuted,” while OVDP participants would generally be subject to a 20 percent “offshore” penalty in lieu of various other penalties, including the FBAR penalty. While the OVDP appeared to be a great deal for those involved in criminal tax evasion, it was a terrible deal for many whose violations were not willful or who would be eligible for reasonable cause exceptions.
Taxpayer Advocate Directive 2011-1, 4. (August 16, 2011). (emphasis added).
Accordingly, taxpayers who entered the OVDP having committed nonwillfull violations of the FBAR obligations could be required to pay penalties amounting to 20 percent of the assets in their foreign account, which in most cases exceeded the $10,000 cap under the ordinary regime for nonwillfull violations of the FBAR. Notably, Question 35 of the original OVDP Frequently Asked Questions and Answers addressed this situation by providing that under no circumstances would a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes for failing to file a FBAR. Thus, under the original terms of the OVDP, the IRS promised to compare the 20 percent offshore penalty to the total penalties that would otherwise apply to a particular taxpayer and impose the lesser of the two.
In March 2011, however, the IRS issued a Memorandum to all OVDP Examiners which retroactively changed the terms of the 2009 OVDP two years after the implementation of the program. The memo directed IRS examiners to stop accepting less than 20 percent penalties and assume that all violations are willful unless proven otherwise.
Due to the change in practices, the TAD explained that the IRS harmed taxpayers seeking to correct honest mistakes, and thus requested the IRS revoke its March 2011 memorandum.
On August 30, 2011, the IRS appealed the TAD, arguing that under the program, “an agent could make a comparison that determine the taxpayers liability under OVDP was higher than that under existing statutes and could give the taxpayer the benefit of a lower tax liability.” It also found that the Taxpayer Advocates assertion that certain “taxpayers [are] worse off than if he or she had not entered the OVDP” was not based in fact and “contrary to guidance issued by the Deputy Commissioner Services and Enforcement.” Appeal of Taxpayer Advocate Directive 2011-1. Memorandum for Steven T. Miller, Deputy Commissioner for Services and Enforcement. (August 30, 2011).
In response to the IRSs Appeal, the Taxpayer Advocate issued recommendations regarding TAD 2011-1 on October 26, 2011, indicating that the IRSs OVDP guidance documents have “created confusion and consternation” in large part because “the IRS has remained silent about the seemingly reasonable way . . . that it will apply FBAR penalties.” Recommendations Regarding Taxpayer Advocate Directive 2011-1. Memorandum for Douglas Shulman, Commissioner of Internal Revenue Service. (October 26, 2011).
The Taxpayer Advocate asked the IRS Commissioner to respond to the recommendations by January 26, 2012 and specifically cited to IRC §7803(c)(3), which provides that the “Commissioner shall establish procedures requiring a formal response to all recommendations submitted to the Commissioner by the National Taxpayer Advocate within 3 months after submission to the Commissioner.” However, the Commissioner failed to do so.
The Taxpayer Advocate reinforced her concerns in the Taxpayer Advocate Service 2011 Report to Congress as follows:
While the maximum penalty for a “willful” failure to report foreign accounts on Form td F 90“22.1, Report of Foreign Bank and Financial Accounts (FBAR) is severe, people who voluntarily correct inadvertent violations are generally not subject to a significant penalty. Nonetheless, the IRS “strongly encouraged” nearly everyone with a violation to participate in the 2009 offshore voluntary disclosure program (OVDP) or face potentially excessive civil and criminal penalties. More than a year after the 2009 OVDP ended, the IRS changed key terms of the program to the detriment of those with inadvertent violations, damaging the IRSs credibility. The IRSs statements also leave the public confused and concerned that excessive FBAR penalties may apply to inadvertent violations.
The Most Serious Problems Encountered by Taxpayers. Taxpayer Advocate Service 2011 Report to Congress, p. 21. (December 31, 2011).
In light of these issues, the Taxpayer Advocate expressly recommended that “the IRS issue public guidance committing not to seek excessive penalties for the inadvertent violations, revoke the March 1 memorandum, and clarify that participants of the 2009 OVDP will not be required to pay more than they would be liable for outside the program.” Id. She also recommended that the IRS “amend signed agreements for those who would pay less outside the program.” Id. Under IRC §7803(c)(3), the recommendations contained within the Taxpayer Advocate Service 2011 Report to Congress required a response by March 31, 2012.
Subsequently, the American Citizens Abroad (ACA), an advocacy group of U.S. citizens living overseas, wrote to IRS Commissioner Doug Shulman expressing concern regarding the IRSs utilization of the OVDP to camouflage a policy of taxing assets of Americans abroad by imposing large penalties for simple FBAR filing omissions. The ACA thus requested that IRS examiners account for the individual circumstances of taxpayers abroad who were previously unaware of the FBAR filing requirements, pursuant to the U.S. system of citizenship-based taxation. Further, the ACA requested the Commissioner to comply with the measures recommended in the TAD and the 2011 Report to Congress and revoke the memo. Pursuant to IRC §7803(c)(3), the Commissioner had 90 days to formally respond to the Taxpayer Advocates recommendations contained within the 2011 Report to Congress. This deadline expired on March 31, 2012 without any response from the Commissioner.
Rather than responding to the TAD or any of the concerns raised by the ACA, Commissioner Shulman expressed pride in the revenues resulting from penalties paid by OVDP participants during a speech at the National Press Club.
As we increased our enforcement efforts and gained significant momentum, we gave taxpayers a chance to come in voluntarily and avoid going to jail. In a typical year, we used to get 100 or so taxpayers who used our voluntary disclosure program. For this program, we thought that figure would rise to maybe 1,000. So, we are very pleased that through the end of 2011, weve had approximately 33,000 voluntary disclosures from individuals who came in under several special programs we started in 2009. To date, these individuals have paid back taxes and stiff penalties amounting to more than $4.4 billion, and the number continues to grow. We are now mining the information we have received to date and have launched our next wave of investigations on banks, bankers, intermediaries and taxpayers.
Prepared Remarks Commissioner of Internal Revenue Douglas H. Shulman before the National Press Club. IR-2012-42 (April 5, 2012).
The purpose of the Taxpayer Advocate Service is to mandate administrative or procedural changes which violate Taxpayers rights. In the history of the Tax Advocate Service, the office has only issued six TADs aimed to force IRS compliance on issues that the advocate deems abusive or inequitable to Taxpayers. Thus, it is clear that such directives are only issued in response to matters of utmost significance.
The inclusion of a specific deadline in IRC §7803(c)(3) by which the Commissioner must respond to the recommendations of the Taxpayer Advocate reveals Congresss intention that the concerns expressed by the Taxpayer Advocate must be taken seriously and addressed in a timely manner. This deadline is not unlike other deadlines enacted by Congress throughout the Internal Revenue Code which, when missed by taxpayers, are predictably dealt with much more harshly by the Commissioner.
The Commissioners failure to adhere to his statutory duty to respond to the recommendations by the Taxpayer Advocate coupled with his remarks during his speech before the National Press Club reflect that his objectives are focused solely on generating revenue, without any regard to taxpayers rights or whether such revenue is properly collected.
Fuerst Ittleman will continue to monitor the exchange between the IRS and the Office of the Taxpayer Advocate for more developments. You may also monitor these exchanges here on the IRS website. If you have any questions regarding the OVDP, FBAR penalties, or offshore voluntary disclosure generally, please contact us at email@example.com.