Scott Michel Comments on Voluntary Disclosure Penalty Issues

Excerpt taken from the article.

The Internal Revenue Service has persuaded U.S. taxpayers to disclose hidden offshore bank accounts but then sometimes failed to cap the penalties, as promised, an agency watchdog said on Wednesday, accusing the IRS of "bait and switch."

The Taxpayer Advocate Service, an oversight arm of the IRS, wrote in its annual report to Congress that a series of IRS voluntary disclosure programs allowing wealthy Americans to come forward and disclose their hidden accounts in exchange for reduced penalties had caused some taxpayers to pay more than they had been led to believe was required. Such taxpayers are typically those who have inherited accounts or work overseas.

"The IRS's offshore voluntary disclosure program bait and switch may undermine trust for the IRS and future compliance programs," Nina Olson, the national taxpayer advocate who heads the service, wrote in the report.

On Monday, the IRS said it was reopening a voluntary disclosure program for taxpayers hiding money in offshore bank accounts, many in Switzerland, the global capital of offshore wealth.

Previous IRS programs, in 2009 and 2011, brought in more than $4.4 billion in unpaid taxes and penalties from 33,000 taxpayers . Tax lawyers see the renewal of the program as a sign that the agency is again preparing to receive scores of names of wealthy Americans who are clients of Swiss banks, under a broad investigation of the Swiss banking industry.

Olson wrote that ordinarily the penalty on taxpayers for nonwillful, meaning accidental, failure to file a record of foreign bank and financial accounts, or Fbar, was capped at $10,000.

During the first voluntary disclosure program in 2009, the IRS offered a break, capping the maximum penalty at 20 percent. A program in 2011 raised the cap to 25 percent.

The problem, Olson wrote, is that in 2009, in a written comment known throughout the tax world as "FAQ 35," the IRS also said it would never assess a penalty greater than what the law would permit. Then in February 2011, the IRS said it would no longer entertain arguments from taxpayers that their compliance was not willful.

There was no immediate response from the IRS to the watchdog's report.

Scott Michel, a tax lawyer at Caplin & Drysdale, said many tax lawyers representing Americans with hidden accounts had interpreted the original comment to mean that if a taxpayer argued that he had not willfully, or intentionally, violated the law, he would not have to pay even the reduced penalties of 20 percent or, later, 25 percent but instead would pay the maximum of $10,000.

Scores of taxpayers, many with inherited Holocaust-era accounts, made the argument, he said. But the February 2011 provision halted that activity, he said.

"IRS agents would even tell you that if you raised the non-willfulness argument, you were in substance dropping out of the program, leaving them free to impose maximum penalties," Michel said. "So pretty much from the beginning, practitioners viewed FAQ35 as an empty promise."

To read the full article about voluntary disclosure penalty issues, please click here.