It should be obvious to practitioners and taxpayers alike that the IRS offshore voluntary disclosure program first announced in 2009, is not for everyone. It is expensive, time consuming and sometimes nerve-wracking. But for those taxpayers and practitioners who still consider it an option, here are some miscellaneous comments and observations.
Even without the program, in this area of law enforcement one thing is pretty clear: for criminal purposes, the IRS is so overwhelmed and delighted with all the low hanging fruit it can choose from, CID and the U.S. Department of Justice have been very picky about choosing only cases with very egregious facts to make sure every prosecution is a "slam dunk" e.g., a very high probability of conviction. For CID to work an offshore case these days the conduct has to be pretty bad and almost always disclose overt acts to conceal or mislead the government about foreign assets and accounts.
How much risk is the client willing to take?At the outset, a taxpayer with offshore compliance issues will make the decision to enter the program based in part on her tolerance for risk and uncertainty. Clearly, with its promise of no criminal investigation or prosecution, no civil fraud penalty, "only" an eight year look back period, the ability to predict the exact amount of the "in lieu of" penalty and the 20% accuracy penalty, the IRS Program provides the most amount of certainty and predictability. For many, the certainty of knowing in advance exactly what the IRS is likely to do is worth paying a 27.5% tribute and the reward of being able to sleep at night and plan financially for the future.
At the opposite end of the spectrum, a very large group of "catch-me-if-you-can," "what,-me-worry?" taxpayers (and a fair amount of tax lawyers at home and abroad) are simply willing to oll the dice. This group believes the odds of the IRS finding out about their offshore shenanigans is worth the risk. For them, a good night’s sleep has never been a problem. This view persists even though it is common knowledge that once FATCA really kicks in, (it will probably take another five years) the IRS is going to start receiving the names and Socials of offshore depositors automatically through the virtual international banking data base now in its formative stages.
But once a decision has been made to apply to the Program, there are problems for the taxpayer and practitioners. We get a few days’ turn around for our requests for Preliminary Clearance and liberally granted extensions to file the complete package. That said, once that package is fully submitted, there can be a long wait before an agent is assigned to actually work the case, request additional information, and prepare the final closing agreement setting forth the terms of the settlement and amount of the Monster Penalty.
IRS gets a barely passing grade:The current OVDI program was a great idea when it was first announced in 2009 because it brought forth thousands of people who were gladly willing to pay a then, 20% penalty on the value of the assets, and almost a guarantee of no civil fraud penalty. Those folks were happy to get away with clearly criminal conduct at whatever the cost.
The problem in 2013 is that the process is bogged down with so many applicants and a lack of IRS staffing.
In the beginning our office was serving clients who really needed to do something fast because in some cases, had the IRS come to them first, they could have easily been the subject of a two to three year criminal investigation followed by a negotiated plea bargain with the possibility of sometime "at camp."
Today, many of the cases do not show the overt criminal conduct of concealed assets and income. Often, the challenge now is to analyze the facts sufficiently to see if there is any way to avoid the onerous, expensive and time consuming OVDI process while at the same time exercise due diligence and follow all the rules under Circular 230 and other standards by which tax practitioners are measured.
Handling of current OVDI cases by IRS:
These cases are assigned all over the country without regard to the practitioner’s place of business but that’s ok because they do not want to meet with you if they can help it.
Exercise of discretion by first line agents:
The IRS FAQ’s and the agents assigned make it clear that they are not permitted to deviate from the one-size-fits-all approach of the OVDI procedures. Any wrinkles that arise in the processing of a case are supposed to be worked out after invoking the "opt out procedures" which clients and practitioners are loathe to invoke. After waiting for months to get to the front of the line, many people do not want to invest another six months of attorney’s fees and delay to test the waters. Next it is widely known that under opt out, both the IRS and the practitioner are swimming in uncharted waters. The IRS has intimated that they could "throw the book" at people who dare to knock this chip off its shoulder but so far, there is no anecdotal evidence that they have carried out that threat.
Interestingly, I learned from an IRS manager in Mississippi that whether or not a new and different opt out agent is assigned depends in part on the discretion of the local manager who may elect to have the original agent assigned work the opt out.
Minority discounts on valuations of fractional interests of foreign financial assets:
In one scenario which is not uncommon, the taxpayer owns a fractional interest in foreign real estate and the issue is whether the agent is willing to allow a minority interest or lack of marketability discount for purposes of the penalty base. At 27.5%, the consequences can be expressed in six figures. We believe the initially assigned agent should have the discretion to allow the discount and that we should not have to opt out to get it. The taxpayer is paying the 27.5% tribute on the value of the assets he owns. To compute the penalty on a full one fourth of a piece of real estate the client owns with his three brothers is overreaching because his share is not worth that much. If the original agent without any opt out is comfortable allowing the client to submit a proper real estate appraisal for the entire property, it should not take another level of review (opt out) to determine its correct value considering a proper minority discount.
Owners in name only:
Another issue, common with many applicants from India and the subcontinent is where the client’s family back home put their names on accounts, sometimes not even advising the son or daughter that they have done so. In India, because of the difficulty of navigating their version of probate, a common practice is for the parents, early on, to put their childrens’ names on all their accounts including their business accounts to avoid Indian probate. We recently had a very capable international agent in San Francisco where we were able to prove with excruciating detail, that despite the US kids’ obligation to file an FBAR under such circumstances, they were even less than mere nominees and the agent allowed us to fully exclude those accounts from the penalty base. In effect in that case, we were able to have the OVDI agent apply the mitigation provisions of the FBAR Manual, something presumably reserved for strictly opt out cases.
The choice to enter the program must be made by the client and we often hear from potential clients that all they want to do is to just start filing prospectively and take their chances simply because they cannot afford the cost and time of the lengthy OVDI process. It is pretty clear that practitioners cannot simply advise a client to just go ahead and do that. That said, those that choose to disclose their off shore shenanigans by simply starting to file are relying on their perceived risk of criminal prosecution. They figure if the IRS had the choice to go criminally on someone who just started filing vs. someone who continues to do nothing, they will probably choose the latter.
With last week’s announcement of a six month extension of time for compliance with some of the FATCA Regs., one can easily imagine that the automatic exchange of information agreements the Treasury is currently negotiating with dozens of countries all over the world will be further delayed much beyond the announced implementation dates. Nevertheless, the FATCA train has already left the station. Banks and foreign financial institutions are spending billions of dollars to get FATCA Friendly.
FATCA is not going to happen on schedule but it is coming. Clients have to make up their minds. It’s always better to voluntarily disclose compliance irregularities before the IRS comes knocking. The trick is exactly how to do it.
While FATCA creeps toward the starting gate, there appears to be scant progress on two fronts sorely in need of attention: (1) the plight of Americans abroad whose local bank is no more a "foreign financial institution" to them than the corner McDonalds is an English fish and chips joint to us, and (2) the hapless recent immigrant who was never told in citizenship class that as American taxpayers, they now had to register their worldwide assets with Uncle Sam in addition to report the income. The collateral damage of these two unintended FATCA consequences, particularly the former, account for the bulk of the internet chatter on this example of the gross tax injustice FATCA on Americans abroad.
The problem seems to be that of the five to seven million estimated Americans living abroad, few seem to vote. Add that to a Congress which for all practical purposes is frozen in place with no effective direction and leadership and the result is a broad based sense of frustration and disdain. Unfortunately there appears to be little hope any time soon of any attention to this problem.
Next blog: FATCA Reform or Repeal: Wishful Thinking or a Likely Prospect.