National Taxpayer Advocate criticizes IRS over treatment of OVDP participants who qualify for reasonable cause exception
National Taxpayer Advocate Nina Olson, November 9, 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.
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, Olson said at an international tax enforcement conference sponsored by the Tax Section of the American Bar Association in New York.
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 alsoInternational 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 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 do not qualify for reasonable cause exception subtly advantaged
According to Olson, 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, Olson concluded.
She also noted that 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.
The NTA's findings suggest that more compliant taxpayers could be discouraged from participating in the OVDP. Year-to-date voluntary disclosure filings in 2012 are 28,000 and Olson opined that the number was low in comparison to the estimated 4 to 6 million U.S. taxpayers who are non-compliant with their FBAR obligations.
“There is something wrong with this picture,” Olson observed. “If the point of civil penalties is to increase voluntary compliance then punishing the people who are eligible for reasonable cause for non-willfulness is not the way to promote future compliance.”
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