Wednesday, April 25, 2012

FBAR Penalty Administration: “Good Government” Or “Bad Government”?


Back in the day, when I held the privileged position of IRS District Counsel in Sacramento, California, my managers and the attorneys we supervised kept a running report card on how well we resolved the various problems served up to us by our clients-- the dozens of special agents, revenue officers, and revenue agents in the Sacramento District from the far north one-person post of duty in Yreka, down to Walnut Creek in the Bay Area. We were the in-house counsel for all the IRS posts of duty in the northern third of the State of California.  Our “clients” were troopers on the IRS front line, trying to decipher a statute so complex, Congress sometimes didn’t know what it was they were asking us to do.
With each settlement, concession, Tax Court victory or loss, refund granted, or prosecution recommended, we would ask ourselves whether the result was, “good government” or “bad government?” The answer was not always the same and if it was the latter, we honestly believed that at our level of the organization, we had the power to make the answer “good government” on the next case, by applying ourselves in good faith and always trying to do the right thing for both the taxpayer and our client, the IRS. 
As government attorneys, we saw ourselves as have a dual duty: one to vigorously and effectively represent our client, the IRS, and yet another duty of fairness and a sense of justice to the taxpaying public with whom we were dealing.
The current IRS international FBAR enforcement program is soon to present a major challenge to the leadership of the IRS.   There is a pipeline of IRS tax controversy matters starting to work its way through the system. These are taxpayer challenges to the way the IRS chooses to use its vast discretionary power granted to it by Congress, to administer FATCA, and the FBAR penalties. In so doing, the IRS has the power to impose anything from a “warning letter” to disproportionately massive confiscatory penalties which it can stack up so high, the taxpayer on the receiving end would be obliterated economically for life.
There are several threads which lay the foundation for the coming storm which will ultimately lead to a wave of new litigation in the Tax Court as well as the United States Districts courts on the issue of whether the IRS has abused its discretion with regard to the way it administers the FBAR penalties.  The IRS is in full-swing with its third offshore voluntary disclosure program in which taxpayers who have been out of compliance in the offshore area can come clean. In exchange for paying back taxes and interest from 2003 forward plus a whopping 27.5% FBAR penalty, the taxpayer can be virtually guaranteed there will be no IRS criminal investigation or federal prosecution.  When the program was announced first in 2009, it was a really good deal for people who had good cause to be worried, many of whom were enjoying their offshore accounts quite lavishly for many years before 2003.
In our practice, we helped many people through the first program who were quite happy to pay almost any amount to be able to sleep at night knowing that money was the only thing at risk as opposed to being a guest at a federal facility for a year or two making license plates and school furniture in addition to paying huge penalties. But we are not seeing those cases any more.  There is a new category of people coming forward now to make voluntary disclosures which will be squaring up against the IRS and from which future litigation is certain to arise.  In one form or another, the question for the courts will be whether the IRS can use common sense and good judgment in mitigating the penalties, especially the monster 27.5%, one-size-fits-all FBAR penalty.
 The hardest cases for the IRS will come from American ex-patriates, seven million strong, and recent immigrants to the United States with family back in their home countries and bank accounts as well, some of which they have held since childhood.
Background: As the only nation in the industrialized world to do so, the United States requires its citizens living abroad, regardless of how long, to file and pay U.S. income taxes. Under the Foreign Account Tax Compliance Act (FATCA), starting in 2014, all banks world-wide who want to continue to do business with Americans and American banks and institutions, will have to agree to become a withholding agent of the U.S. government and turn over to the IRS, the names of all their depositors whom they suspect are Americans.  This will be a huge challenge for the Service, which is having trouble keeping up with the treasure trove of American names the Swiss bankers have reluctantly agreed to turn over to the IRS after an embarrassing and bloody fight over so-called Swiss bank secrecy.
Becoming compliant is not easy to do: Knowing full-well that the IRS is likely to learn their names sooner or later, many ex-patriates abroad and recent immigrants are trying to get ahead of the curve and come forward under the current voluntary disclosure program.  The problem is a voluntary disclosure under the current IRS program is known as a “noisy” disclosure where total cooperation is a precondition and the IRS has a right to inquire about whatever they want before they agree to anything before they close the case. The IRS has also made it very clear that it does not like “quiet” disclosures, where a taxpayer just decides to comply with reporting prospectively or simply files a few years of back returns. That leaves the taxpayers few choices. Either do a “full ostrich” which is to do nothing and keep your head in the sand as deeply as it can go, or jump in and get with the program. But here is the hitch: the program is essentially “one size fits all.” Under the program the very same outcome is dictated by terms which were designed to apply to the American high roller who jets all over the world in his private plane visiting his secret accounts in Monaco and Switzerland, as well as a third generation Canadian family struggling to support a family on a middle class income working in a lumber mill whose grandparents immigrated from Wisconsin sixty years ago.
The IRS has no discretion unless a taxpayer opts out:  Under the program, the IRS agents working the OVDI cases have no authority to compromise the penalties and work out some reasonable settlement.  Wisely, the program provides that an “opt out” option is available where the voluntary disclosure is treated like an ordinary audit which means the taxpayer has a chance to settle the case with an agent, an IRS Appeals Officer, or take the IRS to Tax Court or the US District Court. It is at this point in the process where the IRS has a chance to prove to the whole world that it can be reasonable, fulfill its mission and at the same time do the right thing.
In her 2011 annual report to Congress, the National Taxpayer Advocate leveled  scathing charge against the IRS arguing that the IRS was guilty of a “bait and switch” tactic in its administration of the OVDI program which has caused extreme anxiety in the professional tax community over the question of whether the IRS has, or will honor a prior pledge that under the program a taxpayer will not be required to pay a penalty greater than he would otherwise be required to pay under existing statutes.  The NTA is not a reckless person. Her report is well-documented. The Commissioner’s black eye over this has yet to fade and he has yet to issue a satisfactory response.
My thirty years with the Office of Chief Counsel has made me believe that the professionals at the helm of the IRS are honorable, good people who sincerely want to do the right thing and make the IRS synonymous with "good government." Now is the time for the IRS to prove me right as it navigates this difficult path.

Wednesday, April 18, 2012

It's Time For Common Sense And Fairness For American Expatriates !

Finally, the main stream media is waking up to the coming train wreck of FATCA’s impact on Americans living abroad. On April 15, 2012, in the New York Times and on the 16th in the International Herald Tribune, reporter David Jolly published articles which bring to the fore, what is probably the most knuckle headed legal conundrum facing Americans abroad of recent memory.

FATCA was enacted in March of 2010. Implementation comes in stages: for those expats who file US tax returns, preparing for their June 15, 2012, filing for the 2011 year tax, this is their contact with new form 8938. This form essentially requires American taxpayers to disclose all of their foreign assets over a threshold amount in addition to disclosing foreign bank accounts to the IRS on FBAR forms.

By January 1, 2013, all banks wishing to comply with FATCA will be expected to make application to the IRS to have the privilege of becoming a withholding agent on behalf of the Unites States government and to file annual reports with the IRS detailing all their American depositors’ annual banking activities. During this time, all participating foreign banks must conduct a detailed search of their records to find any depositors who may be suspected of being Americans. By 2014, all participating foreign banks will be expected to  have already asked their US depositors to waive any rights they may have had under their foreign country’s  privacy laws to keep their banking records private or risk the closure of  their accounts.

Also in 2014, the names of all depositors suspected of being American citizens (or US Persons) and their account information must be turned over to the IRS for scrutiny.  Once the IRS has the list of suspected Americans, it will begin a process of information matching. They will check any treaty information it may have as well as prior filed returns to see if there are any obvious lies or inconsistencies, and  determine  who might need a little chat, who requires  special scrutiny or a  full blown  audits, or worst of all, who should be picked for a  criminal investigation which may lead to a public trial, nationally distributed Department of Justice press releases, and  an appropriate  stay in a federal facility where they can think about their sinful behavior while they are making license plates. The latter of course assumes the government can get its hands on these tax miscreants and hold them still long enough to receive the full treatment.

In my 43 years of experience in and out of the IRS, I have never seen a more controversial compliance issue.  But to say that American ex pats have been specially targeted by Congress for rough treatment is not entirely true. The legislative history of FATCA and even FBARs makes no mention whatsoever of targeting Americans living abroad. Clearly Congress only had in mind, American residents who were using offshore financial institutions to hide money from Uncle Sam. It appears as though no one in Washington was even thinking about the ex-pat community when FATCA was enacted.

Our firm represents a number of American families who are in their third and fourth generations of living and working in foreign jurisdictions who now want to comply ahead of the 2014 foreign bank computer dump on the IRS.   This is to only to find that they and their children not only have to file delinquent returns back to 2003 under OVDI and register their foreign accounts and assets with the IRS, but also may have to hire forensic accountants in their adopted countries to do a net worth analysis of their assets and businesses in order to properly determine the “value of foreign assets during the period covered by the voluntary disclosure.” See FAQ # 7.

The law which requires U.S. Persons to submit worldwide income to US taxation must be changed. It is unfair, it makes no sense, and it has a chilling effect on commerce, jobs creation, and free trade. Perhaps more importantly, our world image has suffered enough over the last few decades. People from all over the world who have been on the fence about whether America has lost its mind, can only be convinced that we have with this new compliance initiative.

Tuesday, April 10, 2012

Who Said The IRS Doesn’t Give a Hoot About Providing Guidance to American Expats?!

Last week, the IRS announced a new compliance initiative aimed at the estimated seven million Americans who reside outside the United States. The IRS has launched a new International Compliance Project under which the IRS will match up forms 1099-R with “a selection of individuals with foreign addresses,” pull those returns for a “look see” to ascertain whether the expat correctly reported an early distribution from a retirement account  on his form 5329 (Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts) .  If the IRS concludes from its preliminary check that a little chat might be in order,  the expat will receive a “compliance contact letter” asking for additional information. A reference on the announcement to “other resources” reassures us that receipt of a compliance check letter is not an audit or investigation.  Rather, the IRS is “just checking” to see what’s up and warns that if the taxpayer blows the letter off and refuses to provide the information requested, it may just decide that a full blown examination or investigation is warranted.

Lessons to be learned: (1) the IRS has gotten very good at matching up 1099’s and other information returns with 1040’s. (2) the IRS continues to be very serious about tax compliance amongst Americans living abroad, and (3) playing fast and loose with your IRA or other retirement account is not the way you want to go if you just want to see if the IRS can take a joke.,,id=223461,00.html

Thursday, April 5, 2012

Panama Report Part II: Panamanian Bankers React to FATCA

A few weeks ago I wrote about my trip to Panama and particularly my interaction with some of the American expat community in Boquete and in Panama City. Another part of my trip was a number of meetings with the compliance and executive officers of some of Panama’s largest banks to learn how they were dealing with FATCA and whether Panama’s banking elite were resisting FATCA or whether they were ready to “get with the program.”

Panama used to get a black eye every time U.S. and Western European leaders wanted to take a swing at banking havens and Panama was usually lumped in with the bad boys in the Cayman Islands, Jersey and Guernsey, and Andorra. Recently the President of France slipped and bad mouthed the Panamanians seemingly not aware that in recent years Panama has gotten with the program.

 Panama used to be called the "Switzerland of the Americas" for its banking privacy and secrecy. In August 2009, Panama was put on the OECD's "gray list" of countries deemed uncooperative with global tax standards. To get off the list, Panama entered into a number of international tax agreements. Panamanian President Martinelli recently signed a 2011 agreement with the US which requires Panamanian authorities to cooperate with US investigations even when the charges are not criminal in nature or violate Panamanian law.

Despite these changes, the reaction I received from some of the bankers I met from some very large banks ranged from incredulity as to what was expected of them to comply with FATCA, to outrage yet again, as American hegemony over Latin America reared its head once more.

I had the good fortune to be able to address my new friends in Spanish which generated a spirited debate amongst the principals and staff assembled at the meetings.  I’ll save for another time, the many ways a US law can be excoriated in Spanish but at least they had the decency to make it clear to me that they did not intend to kill the messenger!

In explaining FATCA to my new banking friends, I tried my best to be as diplomatic as possible but it was uncomfortable at the least to go into a foreign country, sit down with some of its captains of industry and tell them the IRS was expecting their FATCA compliance applications no later than January 1, 2013, and that the following year, they are expected to have conducted detailed searches for every American in their data bases and be ready to turn over their names, rank and serial number to the IRS forthwith. 

FATCA continues to cause an uproar all over the world but it is clear that this train has left the station. Just look at the number of international conferences and programs on everything from the multibillion dollar world of FATCA Information Technology how to make sure your Anti-Money Laundering and Know-Your-Customer rules and regulations will pass muster under IRS government inspection.