In its annual congressional report, the head of the Taxpayer Advocate Service, Nina Olson, accuses the Internal Revenue Service of pulling a “bait and switch” on taxpayers. The IRS, she says, persuaded U.S. taxpayers to disclose hidden offshore bank accounts in exchange for reduced penalties, but then, in some instances, failed to cap penalties as promised. Not all of these taxpayers maintained these accounts in an attempt to avoid tax. The report lists several examples of taxpayers who maintained foreign accounts for non-tax reasons:

• Residents of Canada or other foreign jurisdictions who were born in the U.S. while their parents were temporarily working or vacationing here and have dual citizenship, but who have never lived here and never filed tax returns here;

• People who inherited an overseas account or opened one to send money to friends or relatives abroad;

• Refugees from Iran when the Shah fell, or from other countries, who have felt compelled to conceal their assets out of concern that the countries from which they fled might pursue them; and

• Holocaust survivors and their children who are frightened that the Holocaust could happen again and feel safer spreading their assets around in case they are seized in one place or another.

Hundreds of similarly situated taxpayers came in under the 2009 and 2011 IRS voluntary disclosure programs, believing that they could avoid the IRS’s stiffest penalties. Generally, the penalty on taxpayers for non-willful, meaning accidental, failure to file a record of foreign bank and financial accounts, or FBAR, is capped at $10,000. Willful failure, on the other hand, imposes a penalty of 50 percent on the highest account balance for each year covered. The 2009 voluntary disclosure program, however, capped the maximum penalty at 20 percent, while the 2011 program raised the cap to a maximum of 25 percent.

In February 2011, the IRS said it would no longer consider arguments from taxpayers that their lack of compliance with the FBAR requirements was not willful. Thus, many taxpayers who had accidently failed to file, would still be subject to the 25 percent penalty. In the report, Nina Olson wrote, “The IRS’s offshore voluntary disclosure program bait and switch may undermine trust for the IRS and future compliance programs”.

Nina Olson’s theory will soon be put to the test. On January 9, 2012, IRS re-opened a voluntary disclosure program for non-compliant taxpayers holding money in offshore bank accounts in countries like Switzerland.

The renewal of the program may well be an indication that the IRS will receive the names of hundreds of American taxpayers who are clients of Swiss banks, as the US Department of Justice continues a sweeping investigation into the Swiss banking industry.

The IRS has generally been more sympathetic toward taxpayers who come forward of their own accord, before their names are disclosed. So despite Nina Olson’s concerns, the voluntary disclosure program may still be the best option for many non-compliant taxpayers.

In light of the report, it is critical that you seek counsel from an experienced professional, if you are considering participating in the IRS’s voluntary disclosure program.

To read the Taxpayer Advocate’s Congressional Report, click here.

If you have any questions regarding the IRS’s voluntary disclosure program or any other tax-related matter contact one of our experienced attorneys at (916)488-8501.