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FBAR Penalty Administration: “Good Government” Or “Bad Government”?

On Behalf of | Apr 25, 2012 | Firm News


Back in the day, when I held the privileged position of IRS District Counsel in Sacramento, California, my managers and the attorneys we supervised kept a running report card on how well we resolved the various problems served up to us by our clients– the dozens of special agents, revenue officers, and revenue agents in the Sacramento District from the far north one-person post of duty in Yreka, down to Walnut Creek in the Bay Area. We were the in-house counsel for all the IRS posts of duty in the northern third of the State of California.  Our “clients” were troopers on the IRS front line, trying to decipher a statute so complex, Congress sometimes didn’t know what it was they were asking us to do.

With each settlement, concession, Tax Court victory or loss, refund granted, or prosecution recommended, we would ask ourselves whether the result was, “good government” or “bad government?” The answer was not always the same and if it was the latter, we honestly believed that at our level of the organization, we had the power to make the answer “good government” on the next case, by applying ourselves in good faith and always trying to do the right thing for both the taxpayer and our client, the IRS.

As government attorneys, we saw ourselves as have a dual duty: one to vigorously and effectively represent our client, the IRS, and yet another duty of fairness and a sense of justice to the taxpaying public with whom we were dealing.

The current IRS international FBAR enforcement program is soon to present a major challenge to the leadership of the IRS.   There is a pipeline of IRS tax controversy matters starting to work its way through the system. These are taxpayer challenges to the way the IRS chooses to use its vast discretionary power granted to it by Congress, to administer FATCA, and the FBAR penalties. In so doing, the IRS has the power to impose anything from a “warning letter” to disproportionately massive confiscatory penalties which it can stack up so high, the taxpayer on the receiving end would be obliterated economically for life. There are several threads which lay the foundation for the coming storm which will ultimately lead to a wave of new litigation in the Tax Court as well as the United States Districts courts on the issue of whether the IRS has abused its discretion with regard to the way it administers the FBAR penalties.  The IRS is in full-swing with its third offshore voluntary disclosure program in which taxpayers who have been out of compliance in the offshore area can come clean. In exchange for paying back taxes and interest from 2003 forward plus a whopping 27.5% FBAR penalty, the taxpayer can be virtually guaranteed there will be no IRS criminal investigation or federal prosecution. When the program was announced first in 2009, it was a really good deal for people who had good cause to be worried, many of whom were enjoying their offshore accounts quite lavishly for many years before 2003.

In our practice, we helped many people through the first program who were quite happy to pay almost any amount to be able to sleep at night knowing that money was the only thing at risk as opposed to being a guest at a federal facility for a year or two making license plates and school furniture in addition to paying huge penalties. But we are not seeing those cases any more.  There is a new category of people coming forward now to make voluntary disclosures which will be squaring up against the IRS and from which future litigation is certain to arise.  In one form or another, the question for the courts will be whether the IRS can use common sense and good judgment in mitigating the penalties, especially the monster 27.5%, one-size-fits-all FBAR penalty.

The hardest cases for the IRS will come from American ex-patriates, seven million strong, and recent immigrants to the United States with family back in their home countries and bank accounts as well, some of which they have held since childhood.

Background: As the only nation in the industrialized world to do so, the United States requires its citizens living abroad, regardless of how long, to file and pay U.S. income taxes. Under the Foreign Account Tax Compliance Act (FATCA), starting in 2014, all banks world-wide who want to continue to do business with Americans and American banks and institutions, will have to agree to become a withholding agent of the U.S. government and turn over to the IRS, the names of all their depositors whom they suspect are Americans.  This will be a huge challenge for the Service, which is having trouble keeping up with the treasure trove of American names the Swiss bankers have reluctantly agreed to turn over to the IRS after an embarrassing and bloody fight over so-called Swiss bank secrecy.

Becoming compliant is not easy to do: Knowing full-well that the IRS is likely to learn their names sooner or later, many ex-patriates abroad and recent immigrants are trying to get ahead of the curve and come forward under the current voluntary disclosure program. The problem is a voluntary disclosure under the current IRS program is known as a “noisy” disclosure where total cooperation is a precondition and the IRS has a right to inquire about whatever they want before they agree to anything before they close the case. The IRS has also made it very clear that it does not like “quiet” disclosures, where a taxpayer just decides to comply with reporting prospectively or simply files a few years of back returns. That leaves the taxpayers few choices. Either do a “full ostrich” which is to do nothing and keep your head in the sand as deeply as it can go, or jump in and get with the program. But here is the hitch: the program is essentially “one size fits all.” Under the program the very same outcome is dictated by terms which were designed to apply to the American high roller who jets all over the world in his private plane visiting his secret accounts in Monaco and Switzerland, as well as a third generation Canadian family struggling to support a family on a middle class income working in a lumber mill whose grandparents immigrated from Wisconsin sixty years ago.

The IRS has no discretion unless a taxpayer opts out:  Under the program, the IRS agents working the OVDI cases have no authority to compromise the penalties and work out some reasonable settlement.  Wisely, the program provides that an “opt out” option is available where the voluntary disclosure is treated like an ordinary audit which means the taxpayer has a chance to settle the case with an agent, an IRS Appeals Officer, or take the IRS to Tax Court or the US District Court. It is at this point in the process where the IRS has a chance to prove to the whole world that it can be reasonable, fulfill its mission and at the same time do the right thing.

In her 2011 annual report to Congress, the National Taxpayer Advocate leveled  scathing charge against the IRS arguing that the IRS was guilty of a “bait and switch” tactic in its administration of the OVDI program which has caused extreme anxiety in the professional tax community over the question of whether the IRS has, or will honor a prior pledge that under the program a taxpayer will not be required to pay a penalty greater than he would otherwise be required to pay under existing statutes.  The NTA is not a reckless person. Her report is well-documented. The Commissioner’s black eye over this has yet to fade and he has yet to issue a satisfactory response.

My thirty years with the Office of Chief Counsel has made me believe that the professionals at the helm of the IRS are honorable, good people who sincerely want to do the right thing and make the IRS synonymous with “good government.” Now is the time for the IRS to prove me right as it navigates this difficult path.

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