The National Taxpayer Advocate (NTA) Nina Olson has released her 2012 Annual Report to Congress. In it, among other issues of concern, she criticized IRS practices in the Offshore Voluntary Disclosure Program (OVDP), which in NTA’s opinion, hinder voluntary compliance by penalizing taxpayers who are entitled to a reasonable cause exception from willfulness.
The 2012 OVDP was announced in January of 2012, encouraging taxpayers with undisclosed offshore (non-US) accounts to come forward and get into compliance. In comparison to prior offshore amnesty programs, the maximum penalty was raised to 27.5% of the highest account balance during the eight-year period preceding the disclosure. One of the major complaints of the program was that penalty presumed willfulness. Many taxpayers and practitioners viewed the penalty as too harsh because willfulness, especially in the case of FBARs, is the government’s burden to prove. The 2012 OVDP attempted to address the criticism by providing taxpayers who have reasonable cause for their failure to file certain tax returns an opportunity to subsequently opt out of the civil settlement structure. According to the FAQ announced by the IRS, 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.
The NTA’s criticisms of IRS’s handling of offshore voluntary disclosures include the following:
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. The NTA stated that IRS was not doing enough to educate U.S. citizens abroad about their FBAR filing obligations. The report noted that 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 IRS will spend resources to punish, but not to educate, U.S. citizens abroad,” the NTA said.
Additionally, the report found that IRS had discontinued an initiative to send letters to taxpayers 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). 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 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 due to limited resources.
The NTA recommended that 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.
In response to criticisms, 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. IRS said the chart had been publicized abroad through IRS Twitter account, overseas IRS tax attaches, and 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 IRS issued conflicting guidance about how to make a late election to exclude undistributed income from those plans.
Under Rev Proc 2002-23, 2002-1 CB 744, if a taxpayer does not make an election to exclude undistributed income from an RRSP by attaching it to a timely-filed U.S. income tax return, the election will be considered late. To rectify the situation, these 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 IRM 220.127.116.11.9.1 (August 4, 2009) indicated that late elections would be processed without a ruling.
Under the 2012 OVDP, FAQ#54, 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; and 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 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.