In the Spotlight: IRS Abuse of FBAR Penalties in Voluntary Disclosure Programs

The non-partisan volunteer group, American Citizens Abroad (ACA), based in Geneva, Switzerland has alerted Congress to some questionable practices of the IRS in its Offshore Voluntary Disclosure Programs (OVDP), especially with regard to the 2009 initiative.

 By way of short background — the maximum penalty for a “willful” failure to report foreign accounts on an FBAR is extremely harsh, but taxpayers who voluntarily correct unintentional violations are generally not subject to a significant penalty.   IRS had strongly encouraged all US persons with an FBAR violation to participate in its first offshore voluntary disclosure initiative (the 2009 OVDP) or face potentially excessive civil and criminal sanctions.  One year after the 2009 OVDP had ended, the IRS changed key terms of the program by rescinding what was known as “FAQ 35”, the result of which was detrimental to persons with inadvertent FBAR violations, including persons who were already in the 2009 program. 

FAQ 35 and the “Bait and Switch”

 FAQ 35 generally provided that under no condition would a taxpayer pay OVDP penalties that were greater than the applicable penalties outside the program. Thus, if a taxpayer’s failure to disclose a foreign account was “non-willful”, the maximum applicable penalty would be a maximum of $10,000 per violation. This sounds high, but in reality, in many cases, this penalty could be far less than the penalties that would otherwise apply under the set-penalty framework of the OVDP (in 2009, the offshore or “in lieu” penalty was typically 20% of the highest aggregate balance of the foreign accounts and foreign assets that related in any way to tax noncompliance).  By rescinding FAQ 35, taxpayers could no longer have FBAR or other tax penalties abated or dismissed entirely by making such arguments as having “reasonable cause” for the violation.

This abusive “bait and switch” tactic was well-documented in a Taxpayer Advocate Service (TAS) Report.  The 2011 report was aptly titled, The IRS’s OVDP ‘Bait and Switch’ May Undermine Trust for the IRS and Future Compliance Programs.” 

According to TAS, the IRS said “it would no longer consider whether taxpayers in the 2009 OVDP would pay less under existing statutes on the basis of non- willfulness or reasonable cause. Such taxpayers could either agree to pay more than they believed they owed or withdraw from the 2009 OVDP and face the possibility the IRS would assert massive civil penalties and seek criminal prosecution. Both options were problematic. Withdrawal would waste all of the resources already expended on the 2009 OVDP application and would not bring the taxpayer closure or certainty, as advertised. Moreover, in any future examination the IRS might have to request and review the items that were before the examiner processing the 2009 OVDP submission.”

The TAS officially requested the IRS not to seek aggressive penalties for inadvertent FBAR violations, to revoke the “bait and switch” position and to respond within three months. To date, public interest groups have noted they are unaware of the receipt of any response by IRS to this TAS directive.   

 Earlier this month, with all eyes on the IRS due to the numerous troubles the agency is facing (think “tea parties” and Star Wars skits), the ACA called on Congress to take note of the agency’s abuse in application of FBAR penalties generally and in particular, in the OVDP.  ACA presented evidence to Congress of IRS’ unfair targeting of US citizens living and working abroad and used the “bait and switch” as a prime example of the lack of transparency and fairness in IRS’s dealings with many Americans in the OVDP.

ACA Takes a Stand

 “There is no question that the IRS targeted Americans living overseas,” said ACA Director Jackie Bugnion. “By luring them into the OVDP in a form of entrapment then hitting them with ruinous penalties based on the overseas assets, instead of using the discretion which was within IRS purview for benign actors, the IRS treated ordinary, hard-working Americans like criminals. Most of the unreported accounts were pension funds and basic financial accounts used for living expenses and were not being used to hide assets.”

ACA Executive Director Marylouise Serrato stated: “Now that Congress is finally taking a hard look at some of the questionable practices of the IRS over the last several years, we urge them to include the 2009 OVDP and the general use of FBAR penalties against Americans living overseas in their ongoing investigation. Some Americans overseas are losing their life savings due to IRS targeting and this kind of discrimination must end.”

You can read the ACA’s letter to Congress here

 Hopefully, Congress will take a long hard look at the IRS’ activity in the OVDP and FBAR arena and mandate what can only be described as much needed corrections.

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