IRS Contemplates Reduced Penalties for Non-Willful Taxpayers with Unreported Offshore

After serving as IRS Commissioner for only a few months, John Koskinen offers hope for taxpayers with unreported offshore accounts. As the next phase of the Foreign Account Tax Compliance Act (FATCA) begins in July, in which foreign financial institutions will begin reporting information about their U.S. account holders, practitioners have questioned the fate of the IRS' Offshore Voluntary Disclosure Program (OVDP). After all, once the banks start disclosing information, how can a taxpayer voluntarily disclose the same information and receive protections under OVDP?

One of the largest hurdles for many taxpayers is the harsh penalty structure of OVDP, particularly for those who were unaware of their reporting requirements, or in some cases, were unaware of accounts opened in their names. While most agree that true tax evaders who promote illegal tax shelters and encourage taxpayers to enter into schemes to hide assets offshore should be dealt with more harshly than those who simply were unaware of the tax reporting laws, there are an astonishing number of "innocent" accountholders who must make a choice regarding whether they come forward to the IRS or not. The decision is typically a balancing act based on weighing the penalties that will be imposed inside the OVDP program, versus those that would be charged if the taxpayer is caught and penalties are assessed outside of the OVDP program.

In its three successive offshore voluntary disclosure programs, beginning in 2009, each program has had slightly more burdensome penalties. The 2009 program required only a six year look-back, while the 2011 and 2012 programs consider eight years for tax and penalty assessment purposes. The penalty has steadily increased to a top rate of 27.5 percent for taxpayers who had an aggregate of $75,000 in offshore accounts during the past eight years.

The IRS has netted more than $6 billion in back taxes, interest and penalties with over 43,000 individuals participating in one of the IRS' voluntary disclosure programs. As foreign banks have entered into agreements with the United States to provide information including taxpayer names and account data, more taxpayers have rushed to participate in the program before their bank beats them to disclosure.

Commissioner Koskinen has indicated the IRS is making modifications to accommodate taxpayers who were not willful, and thus not at risk for criminal prosecution, in their failure to disclose their offshore accounts. Koskinen acknowledges the dilemma for those who want to be in compliance, but the penalties are so severe that they far exceed a reasonable penalty for the non-compliance. The obvious question that is not answered relates to those who have already entered into OVDP. Those who have already paid the penalties associated with OVDP are likely to make a significant outcry regarding the inequity of providing more favorable treatment to similarly situated taxpayers who took a longer period of time to come into compliance. Will refunds be offered to qualified taxpayers? What data is available to determine the number of taxpayers who would qualify under the new program assuming penalties are not as harsh for taxpayers whose compliance was non-willful.

With the automatic exchange of information contemplated to be received under FATCA, the IRS would benefit by reducing penalties in some cases to encourage otherwise non-compliant taxpayers to come forward at this time. That would allow the IRS to focus its efforts on the willful tax evaders. FATCA has been a regular headline internationally for the past two years; therefore, it will be difficult for taxpayers to argue they were unaware of their obligations or options to come into compliance with the tax laws. To read the Commissioner's full statement, click here.

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