Taxpayer Advocate Criticizes IRS Offshore Compliance Efforts

In her annual report to Congress, National Taxpayer Advocate Nina Olson sharply criticized the IRS for its unfair application of FBAR penalties, as well as its treatment of innocent taxpayers who were unaware of the FBAR filing requirements. The report also recommends that the threshold for filing an FBAR, which has been set at $10,000 since 1970, be raised to $50,000.

Olson calls for reform of the FBAR penalties which are often disproportionately high. Innocent taxpayers with smaller foreign accounts often end up paying penalties that are eight times the amount of unreported tax. This is ten times the civil fraud penalty assessed against taxpayers who fraudulently underreport their tax liability, which is 75 percent.

Willful penalties can be much more draconian. Several recent high-profile cases have resulted in the assessment of multiple willful FBAR penalties, often adding up to 150 percent of the total balance in the undeclared accounts. FBAR penalties must be paid in addition to any taxes, penalties and interest that are owed.

The report also indicates that less wealthy individuals who are not represented by an attorney tend to pay larger penalties than those who are represented. Such individuals generally do not take advantage of their right to Opt Out of the OVDI penalty because doing so without a qualified attorney is a risky proposition.

Another problem cited in the report is the inconsistent treatment of different taxpayers. Taxpayers and their counsel often rely on the FAQs published by the IRS. When a taxpayer disagrees with a Revenue Agent’s interpretation of the FAQ, the Agent is not required to explain their interpretation or allow the taxpayer to speak with a technical advisor. Since these interpretations are not published, the way a taxpayer is treated often hinges on which Revenue Agent they are assigned to.

The newly announced Streamlined Compliance Procedures address some of these concerns, prescribing much less onerous requirements – and a much smaller penalty of 5 percent – for individuals whose failure to file FBARs was non-willful. For individuals who were non-residents for at least one of the three most recent tax years, there is no penalty. The timeline for completing a disclosure under these new procedures is much shorter. Unfortunately, these new procedures do not benefit individuals who have already completed voluntary disclosures and signed a Closing Agreement.

Since these new procedures do not provide immunity from criminal prosecution, like the Offshore Voluntary Disclosure Program does, it is important to consult with a qualified tax attorney before making a submission, to ensure that there is no risk of criminal liability. If there is a risk that the IRS will interpret the conduct as being willful, then the taxpayer should utilize the Offshore Voluntary Disclosure Program instead.