IRS National Taxpayer Advocate yesterday released her 2020 annual report to Congress yesterday. Federal law…
National Taxpayer Advocate calls IRS Penalties Draconian and Inefficient
National Taxpayer Advocate Erin Collins recently issued her 2023 Annual Report to Congress. By law, the Advocate’s report is required to identify the 10 most serious problems taxpayers are experiencing in their dealings with the IRS and to make administrative and legislative recommendations to address those problems.
Most Serious Problem #8 is that “The IRS’s Approach to International Information Return Penalties Is Draconian and Inefficient.” Our clients have been subjected to numerous large International Information Return penalties over the years, and reform is badly needed. I applaud the National Taxpayer Advocate’s comments and hope her recommendations are heard and implemented ASAP.
Her comments are below.
U.S. persons who receive money from abroad or who have certain foreign financial interests and crossborder business activities are potentially subject to a wide range of U.S. reporting requirements. Many of these requirements come with significant penalty exposure when a filing is late, incomplete, or inaccurate. Although Congress intended these requirements to prevent wealthy taxpayers and corporations from hiding income and assets abroad, the international information return (IIR) regime also harms unsuspecting lowerincome taxpayers, small businesses, and immigrants. Most of these penalties are automatically assessed, broadly applied, needlessly harsh, and often unexpected.
Rather than promoting compliance with IIR requirements through taxpayer education and support, the IRS has opted to flex its administrative muscle and bring down the enforcement hammer on good-faith taxpayers and bad actors alike. As a result of this approach, many taxpayers are exposed to potentially life-changing penalties for failure to meet information filing requirements that are obscure and complex. For example, a U.S. taxpayer who receives a $500,000 inheritance from a foreign relative might think that inheritance, since it is excludable from income, requires no information reporting. However, under IRC § 6039F, failure to report a foreign gift, inheritance, or bequest carries a penalty of five percent of the total amount of the gift, up to a maximum of 25 percent. For IRC § 6039F penalties assessed in calendar years 2018-2021, the average IRC § 6039F penalty for taxpayers was $426,000, and the IRS assessed 36 percent of these penalties against individuals reporting $50,000 or less in income. Many of these IIR penalties are systemically assessed when taxpayers attempt to become compliant by submitting late returns. When taxpayers provide a reasonable cause statement for their late filing, the IRS routinely ignores the statement until after it assesses the penalty. Although the IRS furnishes taxpayers with the right to go to the IRS Independent Office of Appeals, which often concedes these penalties, taxpayers do not have access to prepayment review in the U.S. Tax Court, leaving taxpayers subject to penalties that are often disproportionate and extraordinarily harsh when compared with the underlying tax liabilities involved.
The National Taxpayer Advocate recommends that the IRS: 1) stop automatic assessment and collection of Chapter 61 IIR penalties prior to considering the taxpayer’s specific facts and circumstances, including providing the taxpayer their appeal rights with the Independent Office of Appeals; 2) update the Internal Revenue Manual to require review of any reasonable cause relief requests before assessing penalties when these requests are submitted in conjunction with IIRs potentially giving rise to penalties; 3) extend eligibility for first-time abatement to all IIR penalties regardless of whether the underlying return was filed late; 4) revise Notice 97-34 or issue guidance to make the administrative $100,000 threshold subject to the same inflation adjustments as the $10,000 threshold set forth in IRC § 6039F; and 5) update Schedule B and the related instructions to include foreign gifts as potentially reportable transfers.
The National Taxpayer Advocate recommends that Congress: 1) amend IRC § 6212 to require the Secretary establish procedures to send a notice of IIR penalties to the taxpayer by certified mail or registered mail for adjudication with the U.S. Tax Court prior to assessing any “assessable penalty” or other IIR penalty listed in Chapter 61, Subchapter A, Part III, Subpart A; 2) clarify that the government has the burden to establish willfulness by clear and convincing evidence before asserting a civil willful Report of Foreign Bank and Financial Accounts (FBAR) penalty and that the government cannot meet this burden by relying on the Schedule B attached to a return; 3) eliminate 31 U.S.C. § 5321(a)(5)(C)(i)(I), which would have the effect of narrowing the statutory maximum civil penalty for a willful FBAR violation to no greater than 50 percent of the balance in the account at the time of the violation so that a $100,000 penalty is not imposed with respect to low-balance accounts; and 4) amend IRC § 6038D and 31 U.S.C. § 5314 to eliminate duplicative reporting of assets on Form 8938 where a foreign financial account is correctly reported or reflected on an FBAR while ensuring continued IRS access to foreign financial asset data for both tax compliance and financial crime enforcement purposes.
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