Effectively Representing the Client in a Voluntary Disclosure of a Foreign Account

Effectively Representing the Client in a Voluntary Disclosure of a Foreign Account
by Asher Rubinstein, Esq.

We have represented and advised many clients in the 2009 Offshore Voluntary Disclosure Program (OVDP), the 2011 Offshore Voluntary Disclosure Initiative (OVDI) and have already begun advising clients regarding the recently-announced 2012 revival of the OVDI.

From our involvement in many voluntary disclosures, we have heard a significant number of people reporting their their prior attorneys and advisors have not effectively represented the client’s interests before the IRS.  Many people have reported to us that their advisors have “pressured” them into making disclosures, instilling a fear of either making a voluntary disclosure or “going to jail”.  Other advisors were little more than paper-pushers, taking foreign banking statements and other documents, and simply turning them over to the IRS with little to no advocacy on behalf of the clients.  While practitioners may be correct that failing to bring an offshore account into compliance could result in criminal prosecution, we believe that the role of the client representative is not merely to scare, but to properly advise the client as to all options and all potential outcomes.  Please see our prior article, The Role of the Attorney in the Voluntary Disclosure Process, also published in Tax Notes Today.

Along these lines, we have fought hard on behalf of our clients and in some cases achieved notable successes with the IRS, including significant reduction of penalties.  Please see our article, A Few Voluntary Disclosure Successes.

We are also proud of our advocacy on behalf of taxpayers facing IRS “bait and switch” policies within the 2009 OVDP.  In our article, Offshore Voluntary Disclosure Penalties: The IRS Quietly Drops a Bombshell, we wrote about the IRS reversing its position, and no longer allowing taxpayers to argue “reasonable cause” for their non-compliance.  We took issue with the new IRS presumption that all foreign accounts were wilfully concealed, and the IRS refusal to consider evidence of non-willfulness.   In our article, Standing Up to IRS “Bait and Switch” Tactics, we noted how the Taxpayer Advocate Service (TAS), in its Fiscal Year 2012 Objectives Report to Congress (published in June, 2011), essentially agreed with our very concerns.

The TAS has once again sided with us against the IRS.  In its end-of-year 2011 Annual Report to Congress (December 31, 2011),  the TAS has once again criticized the IRS for its unfairness and inconsistent policy.  Among the TAS’ criticisms:

  • The IRS’s Offshore Voluntary Disclosure Program “Bait and Switch” May Undermine Trust for the IRS and Future Compliance Program;
  • The Potential for Strict Application of FBAR and Other Penalties Causes Unnecessary Stress and Fear Among Benign Actors Who Made Honest Mistakes;
  • U.S. Taxpayers Abroad Face Challenges in Understanding How the IRS Will Apply Penalties to Taxpayers Who Are Reasonably Trying to Comply or Return into Compliance.

The TAS noted that “the IRS Is perceived as having “reneged on” the terms of the 2009 OVDP that would benefit taxpayers whose violations were not willful.  Many felt that the IRS placed them in the unacceptable position of having to agree to pay amounts they did not owe or face the prospect the IRS would assert excessive civil and criminal penalties.  This perceived reversal burdened taxpayers, wasted resources, violated longstanding IRS policy, opened the IRS to potential legal challenges, and . . . damaged the IRS’s credibility.”

We are proud that the TAS once again echoed our concerns and advocacy of taxpayers’ rights against IRS unfairness and inconsistency.  As we wrote:

We are proud that the TAS has echoed our very concerns.  We will continue to argue on behalf of our clients in support of non-willful penalties where the facts allow it.  TAS has already issued at least one Taxpayer Assistance Order (TAO) to the IRS regarding offshore accounts. Our advocacy, coupled with TAS support, could compel the IRS to stick to the original terms that it announced.

As we note the increasing number of attorneys and non-attorneys who have in recent years entered the “offshore compliance” world and promote themselves as taxpayer representatives  (especially lately, as the IRS re-introduced its 2011 Offshore Voluntary Disclosure Initiative), we respectfully and humbly point out that we have long been on the vanguard of representing taxpayers before the IRS and fighting for taxpayer rights and lower penalties.  As our actual clients have witnessed, we have closed many voluntary disclosure cases with great success for our clients, and we continue to advocate on behalf of our clients against the IRS.

Standing Up to IRS "Bait and Switch" Tactics

Standing Up to IRS “Bait and Switch” Tactics
By Asher Rubinstein, Esq.

In a recent article, “Offshore Voluntary Disclosure Penalties: The IRS Quietly Drops a Bombshell“, I took issue with the IRS’ rescission of FAQ 35 of the 2009 Voluntary Disclosure Program (OVDP) and the IRS’ retroactive application of that rescission to pre-existing program participants.

Why Is FAQ 35 Important?  Because The IRS Promised Lower Penalties

FAQ 35 provided that under no condition would a taxpayer pay OVDP penalties that were greater than the applicable penalties outside the program.  Thus, if a taxpayer’s failure to disclose a foreign account was “non-willful”, the maximum applicable penalty would be a maximum of $10,000 per year.  While a $10,000 penalty sounds quite high, especially for each of the six years of the OVDP (’03-’08), these non-willful penalties, in many cases, may be less than the penalties that would otherwise apply under the OVDP (typically 20% of the highest aggregate balance of the foreign account).

In rescinding FAQ 35, the IRS changed its position and summarily now presumes that all OVDP participants willfully failed to declare the foreign accounts.  “Willful” penalties are the greater of 50% of the account value each year, or $100,000 per year.  These penalties are therefore much greater than the maximum $10,000 yearly non-willful penalty.   Rather than applying these higher “willful” penalties, the IRS suggests that its 20% OVDP penalty is a more lenient, more charitable penalty.  However, the best result for the taxpayer might have been the non-willful $10,000 yearly penalty, which the IRS has now rescinded.

The IRS “Bait and Switch”

Suddenly, two years into the OVDP process, the IRS changed the very terms by which it attracted taxpayers to come forward and disclose their foreign accounts and declared that change to be retroactive.  The unilateral change in terms will result in significantly higher penalties.  If taxpayers disagree with the OVDP penalties, their only recourse is to exit the OVDP, submit to a full audit and potentially far higher penalties and criminal prosecution.

About the IRS changing the terms and rescinding FAQ 35, I wrote:

We take issue with the IRS changing the terms of the OVDP that have been in place for over two years.  Taxpayers who disclosed under the 2009 OVDP did so with an understanding of its terms, including FAQ #35, as well as other guidance issued by the IRS with respect to the 2009 OVDP.  We must question whether subsequently, and retroactively, denying such taxpayers the opportunity to benefit from FAQ 35 is a “bait and switch” maneuver that violates basic and fundamental concepts of fairness.  Such a policy change is also questionable from a legal standpoint in light of historical precedent which prohibits the IRS from issuing rules and setting policy on a retroactive basis.

     To stop the IRS from unfairly mistreating taxpayers, we have appealed rigorously to the IRS, individually on behalf of every applicable client, and demanded that the IRS lower its unjust penalty assessments in accordance with the IRS’ very own guidelines.  We are now getting support from official channels.

The Taxpayer Advocate Service Endorses Our Position That The IRS Is Being Unfair

The IRS has come under fire from within its own organization, the Taxpayer Advocate Service (TAS).  TAS is an independent organization within the IRS, tasked with “help[ing] taxpayers … who believe an IRS system or procedure is not working as it should.”  And this watchdog actually has teeth.  Pursuant to Federal law, “the National Taxpayer Advocate (“NTA”) may issue a Taxpayer Assistance Order if the [NTA] determines that the taxpayer is suffering or about to suffer a significant hardship as a result of the manner in which the internal revenue laws are being administered by the Secretary [of the Treasury].” In such an order, the NTA has the authority to “require the Secretary … to cease any action, take any action as permitted by law, or refrain from taking any action, with respect to the taxpayer under … any [] provision of law which is specifically described by the NTA in such order.”  We have already requested that the IRS stick to its original terms of the OVDP and refrain from taking any action that would result in unfair treatment of our clients.  As it turns out, it may soon be TAS who may require the IRS to stick to its terms and refrain from taking any unfair action.

On June 30, 2011, TAS issued its Fiscal Year 2012 Objectives Report to Congress.  In this report (“TAS Report”), NTA Nina E. Olson strongly criticized the IRS’ recent conduct towards 2009 OVDP participants in rescinding FAQ 35:

The IRS announced [in its original FAQ 35] … that “[U]nder no  circumstances will a taxpayer be required to pay a penalty greater than  what he would otherwise be liable for under existing statutes.”  Taxpayers  who would not be subject to significant penalties because their violations  were not willful, or because they qualified for the “reasonable cause”  exception, believed this statement applied to them.

On March 1, 2011 . . . the IRS “clarified” its seemingly unambiguous  statement.  It would no longer consider whether taxpayers in the 2009  OVDP would pay less under existing statutes on the basis of non- willfulness or reasonable cause.  Such taxpayers could either agree to pay  more than they believed they owed or withdraw from the 2009 OVDP and  face the possibility the IRS would assert massive civil penalties and seek  criminal prosecution.  Both options were problematic.  Withdrawal would  waste all of the resources already expended on the 2009 OVDP  application and would not bring the taxpayer closure or certainty, as  advertised.  Moreover, in any future examination the IRS might have to  request and review the items that were before the examiner processing  the 2009 OVDP submission.

Pressuring taxpayers who would pay less under existing statutes to  remain in the program and pay more than they believe they owed was  even worse. It violated longstanding IRS policy along with most  conceptions of fairness and due process.  The IRS’s inconsistency  and failure to follow its published guidance damaged its credibility  with practitioners and could be subject to legal challenge.  In 2011,  TAS will continue to communicate with taxpayers and practitioners to  determine the impact of the IRS’s apparent reversal, advocate for the  IRS to abide by the plain language of the original terms of the OVDP (as  reasonably interpreted by the public and many of the IRS’s examiners),  and document our findings in the National Taxpayer Advocate’s 2011  Annual Report to Congress.  (Emphasis added and footnotes omitted).

     The TAS has essentially endorsed the arguments raised in my article  regarding the IRS’ “apparent reversal” regarding penalties to be imposed on OVDP participants.  The result of the TAS Report may be that Congress instructs the IRS to stop its “bait and switch” with respect to the “IRS’s inconsistency and failure to follow its published guidance.”

Taxpayer Options for the IRS “Bait and Switch”

It is important to note that, “TAS will monitor the IRS’s implementation of its voluntary disclosure initiatives to ensure fairness and protection of taxpayers’ rights.”  It is possible that if TAS ultimately determines that the IRS continues to “violate …  most conceptions of fairness and due process,” TAS might provide taxpayers with the means to achieve retroactive relief from a penalty assessment on the basis of clear IRS misconduct.

The TAS Report gives taxpayers in the 2009 OVDP a third option with respect to penalties.  The prior options were: (a) pay the penalty and close the matter, or (b) opt-out of the OVDP and be subjected to full audit, potentially higher penalties and possible criminal prosecution.  Now taxpayers might pay the penalty under protest, then file for a taxpayer assistance order (TAO) and if successful pursue a refund of penalties.

We are proud that the TAS has echoed our very concerns.  We will continue to argue on behalf of our clients in support of non-willful penalties where the facts allow it.  TAS has already issued at least one Taxpayer Assistance Order (TAO) to the IRS regarding offshore accounts. Our advocacy, coupled with TAS support, could compel the IRS to stick to the original terms that it announced.

Offshore Voluntary Disclosure Penalties: The IRS Quietly Drops a Bombshell

Offshore Voluntary Disclosure Penalties: The IRS Quietly Drops a Bombshell
by Asher Rubinstein, Esq

Under the 2009 Offshore Voluntary Disclosure Program (OVDP), the penalty applicable to a voluntary disclosure is 20% of the highest aggregate balance in the foreign account(s).  Pursuant to IRS OVDP FAQ #35, IRS “examiners will compare the 20 percent offshore penalty to the total penalties that would otherwise apply to a particular taxpayer.  Under no circumstances will a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes.”  Penalties for non-willful failure to file the FBAR are $10,000 per year.  Thus, the IRS examiner could compare, on one hand, the 20% OVDP penalty with, on the other hand, the $10,000 per year non-willful penalties (usually $60,000, since the OVDP covered the six tax years between 2003 and 2008).  The lower amount would be the measure of penalties, $60,000 or 20% of the aggregate account balance.

This calculation assumes facts that would support a non-willful failure to file the FBARs.  If the offshore account was especially large, or if the taxpayer used foreign entities such as trusts, foundations or corporations to hide the true beneficial ownership, or if the taxpayer was aware of but ignored the FBAR requirements, then non-willful penalties would not apply.  Instead, the penalties for willful failure to file the FBAR are $100,000 per year.

Under the 2011 Offshore Voluntary Disclosure Initiative (OVDI), the possibility of lower penalties based on non-willful failure to file the FBAR no longer applies.  Instead, the presumption is that the taxpayer willfully failed to file the FBAR.  Thus, for taxpayers who voluntarily disclose foreign accounts under the 2011 OVDI, the comparison is between $800,000 ($100,000 per year, over the eight rather than the six years at issue in the 2011 OVDI), versus 25% of the aggregate account balance (the 20% penalty from the 2009 OVDP was increased to 25% under the 2011 OVDI).

We expected the 2011 OVDI to impose higher penalties than those under the 2009 OVDP, so the 25% penalty amount is not surprising.  However, the new presumption of willfulness does seem to us to be particularly punitive and, in many cases, not supported by the particular facts of the case.  Many taxpayers, for instance, inherited accounts established decades ago and were simply unaware of the FBAR requirement applicable to an account that they never even set up.  To presume that such a taxpayer willfully disregarded his FBAR obligation is wrong and unfair.

What is also unfair is that the IRS recently set forth a new policy that FAQ #35 no longer applies to taxpayers who voluntarily disclosed their foreign accounts under the 2009 OVDP.  This new policy was not publicly announced.  It was e-mailed to IRS field examiners by higher-ups within the IRS.

First, we take issue with the IRS changing the terms of the OVDP that have been in place for over two years.  Taxpayers who disclosed under the 2009 OVDP did so with an understanding of its terms, including FAQ #35, as well as other guidance issued by the IRS with respect to the 2009 OVDP.  We must question whether subsequently, and retroactively, denying such taxpayers the opportunity to benefit from FAQ 35 is a “bait and switch” maneuver that violates basic and fundamental concepts of fairness.  Such a policy change is also questionable from a legal standpoint in light of historical precedent which prohibits the IRS from issuing rules and setting policy on a retroactive basis.

Second, given the substantial delays that taxpayers faced – – it was announced that, two years into the OVDP, approximately ten percent of cases have been concluded – – including delays between passing the Criminal Investigations Division and assignment to a civil IRS agent (in some cases this took one year), IRS examiners’ long delays in reviewing documents, application of PFIC methodologies over a year into the OVDP, and re-assignment from IRS agent to IRS agent, we can’t help but note that if the IRS had processed OVDP cases faster, more cases would have been concluded before the 2011 OVDI and taxpayers would have had the benefit of FAQ #35.

The counter argument is that the IRS simply “clarified” FAQ #35, which never explicitly referred to non-willful FBAR penalties, to now refer to willful penalties of $100,000 (rather than non-willful penalties of $10,000) that would “otherwise apply”.  Thus, FAQ 35 leads to a comparison between 20% of the highest aggregate balance and $600,000 rather than $60,000.  However, it appears to us that “clarified” is simply a way to avoid saying “changed the terms”.

The change in policy does not instill much confidence in taxpayers who are presently considering whether or not to come forward and disclose foreign assets under the OVDI.

We will continue to argue on behalf of our clients, in support of non-willful penalties as the proper measure of penalties, if the facts allow it.

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