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Sunday, November 18, 2012
Taxpayer Advocate - FBAR penalties
National Taxpayer Advocate suggests changes to Offshore Voluntary Disclosure Initiative
Speaking at a recent international tax enforcement conference, National Taxpayer Advocate Nina Olson suggested that IRS implement an approach to its Offshore Voluntary Disclosure Initiative (OVDI) that would only penalize taxpayers based on their level of non-compliance.
Background. Generally, a U.S. citizen is required to report his worldwide income on his federal income tax return—that is, all income, regardless of which country is the source of the income. (Reg. § 1.1-1(b))
Each U.S. person who has a financial interest in or signature or other authority over any foreign financial accounts, including bank, securities, or other types of financial accounts in a foreign country, if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year, must report that relationship each calendar year by filing TD F 90-22.1, Report of Foreign Bank and Foreign Accounts (FBAR) with the Department of the Treasury on or before June 30 of the succeeding year.
The civil and criminal penalties for noncompliance with the FBAR filing requirements are significant. Civil penalties for a non-willful violation can range up to $10,000 per violation, and civil penalties for a willful violation can range up to the greater of $100,000 or 50% of the amount in the account at the time of the violation. Criminal penalties for violating the FBAR requirements while also violating certain other laws can range up to a $500,000 fine or 10 years imprisonment or both. Civil and criminal penalties may be imposed together. The authority to enforce these assessments has been delegated to IRS.
Under its OVDI initiative, IRS won't impose certain penalties on taxpayers who voluntarily and timely disclosed unreported offshore income, if the applicable requirements are met. IRS announced the 2012 OVDI in January of 2012. The 2012 OVDI is substantially similar to its 2011 disclosure initiative (2011 OVDI), but with several key differences. Notably, the maximum penalty is raised from 25% to 27.5%, and unlike the 2011 OVDI, there is no set deadline under the new program to apply. IRS cautioned, however, that it can change the terms of the program at any time. For example, it could increase penalties for all or some taxpayers or defined classes of taxpayers. In addition, it may end the program entirely at any point.
Compliance problem. As Olsen noted at a conference sponsored by the Tax Section of the American Bar Association, there may be as many as 5 to 7 million U.S. resident taxpayers and perhaps tens of millions of nonresident U.S. taxpayers who are subject to the FBAR rules this year. Only 741,000 taxpayers filed FBAR returns in 2011. So far there have been approximately 28,000 OVDI filings for 2012.
Category-specific approach to FBAR non-compliance. Olsen reasons that, given the number of taxpayers who are subject to the FBAR rules, there may be many different reasons for taxpayer non-compliance. But instead of taking this diversity into account, Olson argued that IRS's approach in this area has been driven solely by the view that all non-compliance stems from a willful disregard to the FBAR rules.
A considerable shortcoming with the OVDI is its “one-size-fits-all” solution to taxpayer non-compliance. Taxpayers who fall into some gray area with respect to non-compliance are nevertheless subject to the same applicable penalty that is imposed under the OVDI as if they had willfully disregarded their FBAR filing obligations. Because many potential OVDI participants do not fit the program very well, they often choose to remain out of compliance. Olson suggested a four-category solution to improve the OVDI experience and encourage additional taxpayer compliance.
Category 1: Resident and nonresident taxpayers who properly declared their income, but failed to file their FBARs or other information returns. Olson suggested that such persons be permitted to enter the OVDI and clean up their affairs without being subject to the 27.5% penalty imputing willfulness. Such treatment is currently only afforded to nonresidents who come in under IRS's streamlined procedures, but Olson suggested expanding the group to residents as well.
Category 2: Taxpayers who failed to properly report their taxable income but whose tax liability is under a certain dollar threshold amount. Olson opined that taxpayers in this group should be treated more liberally than under current IRS practice. She suggested looking at Code Sec. 6662(d) for a threshold dollar amount for the imposition of accuracy-related, but not FBAR, penalties. Code Sec. 6662(d) provides that an individual's understatment is “substantial” for purposes of the 20% substantial understatement penalty if it exceeds the greater of $5,000 or 10% of the tax required to be shown on the return.
Category 3: Taxpayers with a valid reasonable cause exception to willfulness for their failure to file their FBARs. Olson suggested that taxpayers in this category should not be required to opt in to OVDI but subsequently opt out of the program's civil penalty structure. Instead, such taxpayers should have a special program available, and their advisors would have to make the judgment call as to whether their client fits into this category.
Category 4: Taxpayers with fact patterns that suggest a willful disregard of the FBAR rules. Olson suggested that taxpayers in the fourth group continue to be subject to the current OVDI rules.
With regard to Category 3, in order to determine whether there are valid arguments to claim a reasonable cause exception, the facts and circumstances involving non-compliance would have to be carefully reviewed by practitioners. Olson suggested practitioners rely on the standard of willfulness as established in Ratzlaf v. U.S., (Sup Ct 1994) 510 U.S. 135. In Ratzlaf, the Supreme Court addressed the standard for willfulness in the context of violation of the bank secrecy laws. The standard applied in the case was “a voluntary intentional violation of a known legal duty”—in other words, knowledge of the requirement and the specific intent to disobey the law should be the standard here.
If the Ratzlaf standard for willfulness isn't satisfied, then Olson said that the taxpayer should be given a break and permitted to only pay the accuracy-related penalties. “Such an approach would increase voluntary compliance and would stop terrorizing the entire country of Canada,” Olson observed.