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National Taxpayer Advocate Delivers Annual Report to Congress that Criticizes Offshore Voluntary Disclosure Programs

National Taxpayer Advocate Nina E. Olson today released her 2014 annual report to Congress, which expresses concern that taxpayers this year are likely to receive the worst levels of taxpayer service since at least 2001 when the IRS implemented its current performance measures.

Federal law requires the Annual Report to Congress to identify at least 20 of the “most serious problems” encountered by taxpayers and to make administrative and legislative recommendations to mitigate those problems.  Overall, this year’s report identifies 23 problems, makes dozens of recommendations for administrative change, makes 19 recommendations for legislative change, and analyzes the 10 tax issues most frequently litigated in the federal courts.

Among the “most serious problems” addressed is the Offshore Voluntary Disclosure (OVD) Program Inequities.  The report describes the evolution of the OVD program and the disproportionate penalties it says were often imposed, particularly with respect to unrepresented taxpayers.  The IRS changed the streamlined program in 2014 in ways that allow many taxpayers to pay lower penalties.  However, the new rules do not allow taxpayers who already had entered into closing agreements with the IRS at higher penalty rates to amend those agreements.  Therefore, taxpayers who are the most deserving of leniency because they were the first to acknowledge they had failed to comply with foreign account reporting requirements ultimately are paying substantially greater penalties than taxpayers who waited until later to acknowledge their noncompliance.  Among other things, the report recommends that the IRS revisit this decision.

The summary of the report is below:

OFFSHORE VOLUNTARY DISCLOSURE (OVD): The OVD Programs Initially Undermined the Law and Still Violate Taxpayer Rights

Problem

Before it updated the “streamlined” program in 2014, the IRS generally required those who failed to report offshore income and file a related information return (e.g., a Report of Foreign Bank and Financial Accounts (FBAR)) to enter into an offshore voluntary disclosure (OVD) settlement program and pay an

“offshore penalty” designed for bad actors. “Benign actors” with inadvertent violations generally had to “opt out” and be audited to obtain a lesser penalty.  Uncertainty about what penalty might apply in the audit, the IRS’s one-sided interpretation of the program terms, processing delays, and the cost of representation in an audit prompted some to pay a disproportionate offshore penalty. Inside the 2011 OVD programs, taxpayers with small accounts paid over eight times the unreported tax—over ten times the 75 percent penalty for civil tax fraud—and those who were unrepresented generally paid even more.

Analysis

Because violations by taxpayers who have small accounts or are unrepresented are more likely to have been inadvertent, the OVD programs undermined the statutory scheme, which applies a higher penalty to “willful” than non-willful violations or those due to “reasonable cause.” The IRS’s one-sided interpretations of its OVD FAQs, which were not explained, appealable, or published, eroded confidence that the IRS would be reasonable in a post-opt-out examination. The IRS now allows benign actors to pay a smaller penalty under the 2014 streamlined program. However, unlike the last time it made taxpayer favorable changes to an OVD program, the IRS will not allow those with signed closing agreements to benefit from the most recent changes, thereby punishing taxpayers who came in early. Thus, the IRS’ OVD programs eroded taxpayer rights, such as the rights to pay no more than the correct amount of tax, challenge the IRS’s position and be heard, appeal an IRS decision in an independent forum, to be informed, and to a fair and just tax system.

Recommendations

The IRS should improve the transparency of OVD program guidance (e.g., FAQ interpretations); allow taxpayers to discuss OVD and streamlined program guidance interpretations with the IRS employee interpreting the guidance and to appeal the interpretations; and allow taxpayers to amend closing agreements to benefit from recent program changes.

The full report of this problem is quite negative.

Unfortunately the IRS is not mandated to accept the above recommendations. However, in the past, such recommendations were taken “into consideration” for future changes.  So stay tuned.