Since 2009, about 38,000 American taxpayers with undeclared offshore bank accounts have come forward and paid $5.5 billion in back taxes, fines and penalties under three voluntary disclosure initiatives. Most were motivated by the prospect of reduced fines and penalties and the potential avoidance of prosecution.
However, congressionally appointed watchdog Nina E. Olson criticized the Inland Revenue Service’s amnesty programs in a report released last week for “disproportionately burdening those who make honest mistakes.”
Each year, Americans have to disclose their foreign accounts that hold more than $10,000 to the U.S. Treasury by filing a Report of Foreign Bank and Financial Accounts, or FBAR.
Although 7.6 million Americans live abroad, in addition to a large number of U.S. residents with offshore accounts, the IRS received only 807,000 FBAR submissions in 2012, the report noted. As a result nearly 7 million U.S. taxpayers could face potentially draconian fines and penalties for FBAR violations.
The offshore voluntary disclosure programs not only failed to bring offshore account holders into compliance, but the programs that were designed for “bad actors” now burden “benign actors” who inadvertently violated the rules, the IRS ombudsman said.
According to the report, most need to opt into a voluntary disclosure program, then opt out again and get audited to get a fair result.
Those who opted out on average were subject to IRS-assessed penalties of nearly 70 percent of the unpaid tax and interest.
Taxpayers who remained in the disclosure programs, in contrast, were charged average penalties of more than double the unpaid tax and interest associated with the unreported accounts.
“Because those opting out faced prolonged uncertainty and a risk of even more severe penalties, some agreed to pay more than they should,” the report concluded.
The IRS ombudsman noted that education and burden reduction could bring millions of benign actors into compliance. She recommended that the IRS adopt a three-category approach distinguishing “taxpayers who under-reported offshore income by less than a reasonable threshold amount,” taxpayers who have reasonable cause for not reporting or who acted non-willfully, and others who do not fall into the first two categories but come forward.
The first category should be allowed to file delinquent returns without the risk of maximum penalties as they are currently applied. For those in category 2, the IRS could provide more comprehensive guidance whether a reasonable cause applies to reduce anxiety, uncertainty and controversy, the ombudsman recommended. “This three-category approach could prevent the IRS from being viewed as extorting or bullying unjustified penalties from taxpayers – particularly unrepresented taxpayers with small accounts – and ultimately improve voluntary compliance,” the report said.
Ms. Olsen’s report also found the IRS’s tax evasion penalties to be “extraordinarily high” compared with other penalties the IRS administers.
Taxpayers with smaller unreported accounts, especially the ones without legal representation, were disproportionately hit harder by the penalties, and had to pay nearly eight times the unpaid tax under the 2009 program. Unreported large account holders, in turn, paid penalties of three times the unpaid tax. “By this measure, the 2009 program was unfair,” the report noted.
Taxpayers who entered the last of the disclosure programs paid on average penalties nearly four times the amount owed in taxes.