Practitioners Debate Fairness Of Lack of OVDP Retroactivity
By Andrew Velarde — firstname.lastname@example.org
The lack of access to new streamlined procedures for previously closed cases in the IRS offshore voluntary disclosure program may seem inequitable at first glance, but practitioners disagree over whether the lack of retroactive relief is actually unfair.
"While it would have sounded fairer to apply this retroactively and let people reconsider the results they achieved, from the time opt-outs became available people were always on notice that if they thought they were non-willful, they had a way to express it,’’ Larry A. Campagna of Chamberlain, Hrdlicka, White, Williams & Aughtry said. ‘‘I think it’s a small universe of taxpayers who have a legitimate position that they were non-willful and didn’t choose to opt out.’’
'I think it’s a small universe of taxpayers who have a legitimate position that they were non-willful and didn’t choose to opt out,’ said Campagna.
However, Josh O. Ungerman of Meadows, Collier, Reed, Cousins, Crouch & Ungerman LLP disagreed. ‘‘The OVDP has many taxpayers with closing agreements who were non-willful but who were scared to opt out,’’ Ungerman said. ‘‘If those same taxpayers had the choice to participate in the streamlined program as it is today back then, they would have never gone into OVDP.’’ Ungerman said that with the changes, the new streamlined program has expanded exponentially.
Among the changes the IRS made to the OVDP and streamlined filing compliance program in June, the agency is now permitting resident U.S. taxpayers to use the streamlined program if they certify that previous compliance failures were not willful. All penalties will be waived for nonresident U.S. taxpayers, and resident taxpayers will be subject only to a miscellaneous offshore penalty equal to 5 percent of the foreign financial assets that gave rise to the tax compliance issue. Eligibility for the streamlined process had previously been limited to nonresident taxpayers who could demonstrate a low level of compliance risk and who did not owe more than $1,500 of tax for each of the three years covered by the program. (Prior coverage: Tax Notes, June 23, 2014, p. 1357.)
Under the opt-out system, taxpayers who were arguably non-willful could take such a position with the IRS and be subject only to small penalties if they were successful in their assertion. Last year an IRS official said the average foreign bank account report penalty in opt-out cases was only between $10,000 and $15,000. (Prior coverage: Tax Notes, Nov. 4, 2013, p. 470.)
Not Black and White
Campagna questioned how much better most opt-out cases would fare under the newly expanded streamlined filing compliance program. "Where the taxpayer had a good non-willful position, most of the [opt-out] cases have been resolved fairly reasonably,’’ Campagna said. ‘‘My guess is they came out about as well or better than the 5 percent," he added, alluding to his relevant client experiences.
Campagna acknowledged that some taxpayers may have been reluctant to enter into the opt-out process because of doubts about the likelihood of success or the fees required in arguing such a position, but he said he was skeptical that a taxpayer could claim that barring closed cases from access to the newly reduced penalty structure was unfair.
Ungerman, however, saw the decision not to make the program retroactive as unfair. "The government thinks that you are either willful or not, it’s black and white. It’s just not the case. In my experience, many clients talked about opting out, but when it came down to it, they were scared. You have many non-willful [taxpayers] in that group,’’ Ungerman said.
Ungerman said the IRS is pursuing taxpayers in civil FBAR willful violations for what could be considered a low level of willfulness. The penalty could be 300 percent of the account in those cases, he noted. ‘‘If a taxpayer opts out, I can’t guarantee that taxpayer the IRS isn’t going to go after 100 percent of the account, or even 300 percent,’’ he said.
Some practitioners have previously criticized the opt-out program for moving too slowly, lacking agent discretion, or causing problems for taxpayers with holdings in passive foreign investment companies. (Prior analysis: Tax Notes, Mar. 3, 2014, p. 900.)
In her annual report to Congress, released before the program was modified, National Taxpayer Advocate Nina Olson decried the unfairness of the OVDP. The report criticizes how the IRS implemented the OVDP, arguing that it disproportionately harmed benign actors and taxpayers who possessed the smallest offshore accounts. It describes the opt-in/opt-out process as burdensome and inflexible. (Prior coverage: Tax Notes, Jan. 13, 2014, p. 150.)
‘‘Those who opt out are subjected to audits. Because those opting out face prolonged uncertainty and the risk of even more severe penalties, some agree to pay more than they should. Moreover, IRS resources devoted to auditing and disproportionately penalizing those who come forward to correct honest mistakes are not available to address noncompliance by others who do not come forward,’’ the report says.
Retroactivity Not Unprecedented
The frequently asked questions on the transition rules explain that a taxpayer who, as of July 1, 2014, has completed the OVDP certification process with the full execution of a Form 906 closing agreement will be ineligible for transitional treatment under the modified OVDP rules. Transitional treatment under the OVDP generally allows taxpayers who are currently participating in the program and who meet the eligibility requirements to take advantage of the more favorable penalty structure of the expanded streamlined procedures.
Retroactivity within the OVDP and its predecessors is not unprecedented. In 2011 the IRS reduced the penalties for some taxpayers and made the modified penalty structure available for those who had participated in the 2009 OVDP. Taxpayers under the 2011 offshore voluntary disclosure initiative (OVDI) were eligible for a more lenient 5 percent penalty, outlined in FAQ 52, if they did not open the account (unless the bank required them to open a new account), had minimal contact with the account, did not withdraw more than $1,000 in any year covered by the OVDI, and could establish that taxes were paid on funds deposited in the account. The FAQ also provided for imposition of the 5 percent penalty on foreign residents who did not know they were U.S. citizens. (Prior coverage: Tax Notes, Feb. 14, 2011, p. 735.)
At New York University’s Tax Controversy Forum in June, Jennifer Best, senior attorney-adviser (services and enforcement), IRS Large Business and International Division, said the IRS would not pay refunds on the difference between the OVDP penalty and the 5 percent streamlined penalty for closed cases to those taxpayers who may now wish to argue they were non-willful. (Prior coverage: Tax Notes, June 30, 2014, p. 1480.)
Addressing the retroactivity of reduced penalties in 2011, Best was quick to dismiss application of that precedent to the newest changes. ‘‘We made the decision [for retroactivity in 2011] for a narrowly tailored group of OVDP participants when we changed the terms of OVDP,’’ Best said at the forum. ‘‘The OVDP penalty is different from the streamlined penalty. The penalty base is lower in streamlined.’’
The two programs ‘‘are designed for different taxpayers,’’ Best said, adding, ‘‘OVDP is designed for willful evaders — it always has been. The streamlined procedures are designed for the non- willful.’’
Nevertheless, it seems counterintuitive that taxpayers who came forward earlier under the program should be met with harsher consequences than similarly situated taxpayers who may come forward later.
The IRS’s decision not to revisit previously closed cases could be a practical one involving resource allocation.
The two programs ‘are designed for different taxpayers,’ Best said, adding, ‘OVDP is designed for willful evaders— it always has been. The streamlined procedures are designed for the non-willful.’
‘‘You generally would think the later [taxpayers] should get the worse deal, and that has been the basic theme of this program,’’ one practitioner told Tax Analysts, speaking on condition of anonymity. He pointed to the penalty structures of previous offshore disclosure programs, which featured consistent penalty rate increases in the programs rolled out between 2009 and 2012, from 20 percent to 25 percent to 27.5 percent. ‘‘But every now and then, you look back and realize you have been too harsh on a group of taxpayers....I suspect [the IRS] really doesn’t have a way out of it, and it would involve a massive effort to revisit all the cases,’’ he said.
TAX NOTES, August 11, 2014
Copyright 2014 Tax Analysts. Reprinted with permission.