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Thursday, January 10, 2013
National Taxpayer Advocate report slams IRS over handling of offshore voluntary disclosures
The 2012 National Taxpayer Advocate (NTA) Annual Report to Congress criticized current IRS practices in the Offshore Voluntary Disclosure Program (OVDP) that hinder voluntary compliance by penalizing taxpayers who are entitled to a reasonable cause exception from willfulness.
Background. The IRS announced the 2012 OVDP in January 2012. The 2012 OVDP is substantially similar to the 2011 Offshore Voluntary 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. The 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. (See International Taxes Weekly, 01/10/12; see also International Taxes Weekly, 07/04/12)
One of the major complaints of the 2011 OVDI was that penalty presumed willfulness. (See International Taxes Weekly, 05/17/11) Many taxpayers and practitioners viewed the penalty as harsh because willfulness, especially in the case of FBARs, is the government's burden to prove.
The 2012 OVDP attempted to address the criticism received from the 2011 OVDI. Specifically, FAQ 51.1 (of the 2012 OVDP) provides that benign taxpayers who have reasonable cause for their failure to file certain tax returns may be better off by first applying to the OVDP program and subsequently opting out of the civil settlement structure.
According to the FAQ, opting out of the civil settlement structure does not affect the status of a taxpayer's voluntary disclosure under Criminal Investigation's Voluntary Disclosure Practice, so long as the taxpayer is fully cooperative in the examination process, by providing all requested foreign records and submitting to interviews, as requested, and as long as no new issues are uncovered that were previously not disclosed.
OVDP participants who "opt in -- opt out" disadvantaged
Taxpayers who follow an "opt in -- opt out" path in offshore voluntary disclosures (i.e. taxpayers who opt in to OVDP but subsequently opt out of the program's civil penalty structure) are generally subject to extended resolution times over smaller amounts when compared to traditional offshore voluntary disclosure participants, the report said.
The average time to resolve OVDP submissions for taxpayers who elected to remain within the program's civil settlement structure was about 300 days. For participants who opted for the path envisaged under FAQ 51.1, however, the average resolution time (if the case has been closed at all) was approximately 550 days.
Therefore, the OVDP process burdens taxpayers eligible for a reasonable cause exception (e.g. more compliant taxpayers) by processing participants not eligible for the exception (e.g. presumably less compliant taxpayers) through the program more quickly, the report said.
Participants eligible for FAQ 51.1 relief usually involved smaller amounts (compared to participants who did not qualify for such relief), usually averaging about $15,000. The prolonged time for settlement generally meant that such participants incurred significantly higher representation fees compared to those who did not seek to opt out of the civil penalty structure.
IRS will spend money to punish but not educate FBAR violators, NTA says
The NTA said that the IRS was not doing enough to educate U.S. citizens abroad about their FBAR filing obligations. The report noted that the IRS had not conducted an in-person presentation about the FBAR filing requirements in foreign countries, even if the foreign country had a tax attache and a significant number of U.S. persons with filing requirements.
"This approach sends the message that the IRS will spend resources to punish, but not to educate, U.S. citizens abroad," the NTA said.
Additionally, the report found that the IRS had discontinued an initiative to send letters to tapxyaers who had filed an FBAR in a prior year but not in the current year to remind them that they may still have a filing requirement (FBAR Stop Filer Program). The IRS also halted its FBAR Compliance Initiative Program that sought to educate individuals with offshore accounts who are most likely to have FBAR violations.
The NTA said that despite the fact that the IRS has information regarding potential FBAR non-filers at its disposal, including from new Form 8939, it is unlikely that it will expand its self-correction options available to benign actors as it is unlikely that it will not have additional resources.
The NTA recommended that the IRS send "soft" notices to educate individuals with foreign accounts about their FBAR and Form 8938 reporting requirements and encourage them to self-correct their inadvertent violations.
But the IRS said that it has educated persons with foreign accounts about their FBAR and Form 8938 reporting requirements by posting a comparison chart on IRS.gov that distinguishes between the requirements for the two forms. The IRS said the chart had been publicized abroad through the IRS Twitter account, overseas IRS tax attaches, and the IRS National Public Liason's practitioner email distribution list.
Contradictory treatment of Canadian RRSPs
The NTA said that persons with Canadian retirement accounts (commonly referred to as registered retirement savings plans or RRSPs) faced additional compliance burdens as the IRS issued conflicting guidance.
Under Rev Proc 2002-23, if a taxpayer does not make an election to exclude undistributed income from an RRSP by attaching them to a timely-filed U.S. income tax return they will be considered late. To rectify the situation, taxpayers are required to obtain a private letter ruling to make a late election. According to the report, such rulings can cost anywhere between $728 to $4,500 and take as long as 149 days, on average, to process. The NTA noted, however, that under IRM 22.214.171.124.9.1 (August 4, 2009), late elections would be processed without a ruling.
Under the 2012 OVDP, FAQ#54, the IRS provided entirely different instructions for making the late election. Under FAQ #54, a taxpayer is required to provide a statement requesting an extension of time to make an election to defer income tax; Forms 8891 for each of the tax years and type of plan covered under the voluntary disclosure; a dated statement signed by the taxpayer under penalties of perjury describing events that led to the failure to make the election and events that led to the discovery of the failure.
The NTA also suggested that the IRS clarify how beneficiaries of Canadian retirement plans can file late or amended returns that elect to exclude undistributed income from those plans by issuing formal guidance to consolidate the seemingly inconsistent guidance.
Rep. Dave Camp (R-MI), Chairman of the House Ways and Means said the NTA's report highlighted the need for comprehensive tax reform.