IRS OVDI Procedure: Holding the IRS to Proper Payment Application

Jack Townsend is a tax attorney and law school professor and hosts what is likely the best blog on the Internet with a focus on federal tax crimes. I am honored that Mr. Townsend invited me to be a guest blog author on the issue of the IRS misapplying payments made by taxpayers in the Offshore Voluntary Disclosure Initiative (OVDI). My blog post can be found here, and is also posted below. The numerous comments following my post on Mr. Townsend’s blog may also be of interest.

IRS OVDI: Holding the IRS to Proper Payment Application
by Asher Rubinstein, Esq.

It has been said that the 2011 Offshore Voluntary Disclosure Initiative (OVDI) corrected many of the hiccups of the 2009 Offshore Voluntary Disclosure Program (OVDP).  For instance, midway during the 2009 program, the IRS began to enforce PFIC tax methodology, required taxpayers to sign new and revised Powers of Attorney, required taxpayers to sign statute of limitations waivers, and transferred and re-transferred case files to IRS agents across the country, all of which caused confusion and delay in the resolution of OVDP cases.  In addition, the IRS revoked OVDP FAQ 35 to the detriment of many taxpayers who entered the OVDP in reliance upon FAQ 35.  By the time the 2011 OVDI program was introduced, the IRS seemed to have standardized and centralized its voluntary disclosure procedure, building upon the lessons learned during the OVDP.

However, as more OVDI cases now head toward resolution, it appears that the IRS is again wavering in certain policy decisions, again to the detriment of taxpayers.

Under the 2009 program, there were months of back-and-forth communications between IRS agents and taxpayers, as the IRS issued multiple Information Document Requests (IDRs) for the same case.  Once the taxpayer answered the questions in the IDR and provided the documents requested, the IRS would process the answers and documents, and then issue a new IDR, with additional questions and requests for documents.  This pattern was often repeated again and again, causing months of delays in the case.

Thus, under the 2011 OVDI, all documents were due in the initial submission, reducing the likelihood of a back-and-forth.  Along with the complete OVDI package (consisting of amended returns, FBARs, OVDI forms, etc.) taxpayers had to include payment of back taxes, interest and accuracy penalties.

Accordingly, for our OVDI clients, we submitted payment for each year on a separate check, noting the applicable year on each check.  Our cover letter also included a year-by-year itemization of tax, interest and penalties being paid, and corresponding check numbers.  We addressed tax liability, interest and accuracy penalty on a year-by-year basis and requested that the IRS apply the payments as we specified.

Reminiscent of the mistakes of the 2009 OVDP, the IRS now appears to be applying all of the separate annual payments to the 2007 tax year alone.  This means that interest continues to accrue for all other years, even though the tax liability, accuracy penalty and interest for each year had been paid with the initial OVDI submission, many months ago.  In addition, taxpayers have gotten “refunds” for 2007, because of the application of multi-year payments to that single year, and the IRS is issuing demands for payment for all other years of the voluntary disclosure.  The demands include interest, notwithstanding that interest has already been paid.  Moreover, in some cases, the IRS is assessing failure to pay penalties, notwithstanding that full payment has in fact been made months ago.  In one case, the “refund” for 2007, which should never have been issued in the first place, resulted in a new demand for the amount “refunded”.

When we raise these issues with the IRS agent assigned to the voluntary disclosure, the agent advises that the application of payments is made at the IRS campus, and the OVDI agent is powerless to alter them.  The agent then advises us (orally) that “it will all reconcile at the end”.

We are not persuaded by the agents’ assurances.

The IRS’ failure to apply taxpayer’s payment to taxpayer’s entire tax liability, including penalties and interest, on a year-by-year basis, will result in more delays, additional interest and penalty assessments, additional back-and-forth between the IRS and the taxpayer, and additional professional fees to resolve what should otherwise be a straightforward application of payment.

In addition, disregarding the taxpayer’s instructions as to application of payments is in violation of taxpayer’s rights, because “[w]here a taxpayer makes voluntary payments to the IRS, he does have the right to direct the application of payments to whatever type of liability he chooses.” Salazar v. CIR, T.C. Memo 2008-28, *34 (February 25, 2008); Estate of Wilson v. CIR, T.C. Memo 199-221, *14 (July 6, 1999); Muntwyler v. U.S., 703 F.2d 1030, 1032 (7th Cir. 1983).

We are therefore requesting that the IRS recalculate taxpayer payments in a manner consistent with the taxpayer’s instructions as made in the OVDI submission.  We are also arguing that any interest or penalties which may have accrued as a result of the misapplication of taxpayer payments be cancelled.

While we were optimistic that the procedural mistakes of the OVDP had been addressed and corrected in the OVDI, recent developments suggest otherwise.