This is cross posted from the RenounceUScitizenship blog.
“Trust is like a vase.. once it’s broken, though you can fix it the vase will never be the same again.”
This post should be read with a previous post: “The taxpayer, the IRS and the “professionals” – where to go from here“. This post will suggest why, given the IRS shift in policy on March 1, 2011 lawyers had difficulty advising clients whether to enter OVDI (2011). With the exception of the most extreme cases (clear tax evasion at one end vs. Ambassador Jacobson’s 70 year old Gramma at the other), lawyers neither trusted nor understood the IRS. They could not. This post will suggest why. At the outset, it is important to recognize that “hindsight is always twenty twenty” and during the desperate summer of 2011, nobody had the benefit of hindsight.
The facts and issues are summarized by the conclusion of Taxpayer Advocates directive to the IRS on August 16, 2011:
1. From the perspective of the taxpayer:
The decision to enter OVDI had absolutely nothing to do with taxes that may have been owing. It was completely driven by the perception of FBAR (and possibly other “information return”) penalties. It was the FBAR penalties that were the most fearsome.
2. From the perspective of the IRS:
OVDP (2009) and OVDI (2011) were programs that were designed for people who where using “offshore” vehicles to avoid or evade taxes. This is consistent with the stated objective of OVDI 2011 as stated in OVDI FAQ 2.
“The objective remains the same as the 2009 OVDP – to bring taxpayers that have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax into compliance with United States tax laws.”
Note that this focuses on the use of foreign entities to avoid or evade tax . Furthermore, the IRS has made it clear that another important objective was to bring taxpayers back into the tax system. (If you are thinking an amnesty is a good idea, I agree.)
The IRS assumed that anybody entering the program was a criminal and was admitting to being a criminal. Once entering the program a taxpayer was presumed to have acted “willfully”. (For those people OVDI was a pretty good deal.) Note that this focuses on the use of foreign entities to avoid or evade tax into compliance.
It is quite obvious that only criminals had any incentive to enter OVDI. For everybody else, it was a question of: Yes, I want to be in compliance. But, I can’t use OVDI.
3. From the perspective of the lawyers:
Part A – The Mind of the lawyer in 2009:
OVDP (2009) was NOT (at least at the beginning) a program that was understood to presume criminality. The lawyers understood the OVDP information, including FAQ 35, including to allow for the consideration of “reasonable cause” and “non-willfulness”:
“Voluntary disclosure examiners do not have discretion to settle cases for amounts less than what is properly due and owing. These examiners will compare the 20 percent offshore penalty to the total penalties that would otherwise apply to a particular taxpayer. Under no circumstances will a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes.”
S. 5314 of the FBAR is an “existing statute” that bars the IRS from imposing FBAR penalties if “reasonable cause” is demonstrated and the FBAR is filed. Furthermore, the maximum “non-willful” penalty is $10,000. Quite obviously the “non-willful” penalty of $10,000 or a complete abatement of penalties due to “reasonable cause” could be much better than 20% of the value of your assets.
Again: the lawyers understood “liable for under existing statutes” to include considerations of “reasonable cause” and “non-willfulness”. They counseled their clients accordingly.
Well, at least until March 1, 2011 …
On March 1, 2011, (two years into OVDP) the IRS simply began taking the position that FAQ 35 did NOT allow for considerations of “reasonable cause” and “non-willfulness”. This was interpreted to be a change in the rules and was characterized as a “bait and switch”. “Reasonable cause” and “non-willfulness” could be considered on an “opt out”. As you can imagine this upset a number of people. (Lawyer Asher Rubenstein has written a good analysis of this.)Taxpayers were understandably afraid to subject themselves to the perceived “IRS thuggery and arbitrariness” on an opt out. Non-willful taxpayers who may have had “reasonable cause” paid far higher penalties than they thought they would have to pay. So much for OVDP 2009. The IRS can do what it wants. Why would a taxpayer pay the non-willful penalty instead of “opt out”? Here is what the IRS said about the “opt out” option:
“If the offshore penalty is unacceptable to a taxpayer, that taxpayer must indicate in writing the decision to withdraw from or opt out of the program. Once made, this election is irrevocable. An opt out is an election made by a taxpayer to have his or her case handled under the standard audit process. It should be recognized that in a given case, the opt out option may reflect a preferred approach. That is, there may be instances in which the results under the applicable voluntary disclosure program appear too severe given the facts of the case. There will be other instances where this is less clear. In the latter cases, the Service will look to ensure that the best interests of the Service and the integrity of the voluntary disclosure program remain intact. In these cases, it is expected that full scope examinations will occur if opt out is initiated. It is expected that opt out will be appropriate for a discrete minority of cases. Moreover, to the extent that issues are found upon a full scope examination that were not disclosed by the taxpayer, those issues may be the subject of review by Criminal Investigation. In either case, opting out is at the sole discretion of the taxpayer and the taxpayer should not be treated in a negative fashion merely because he or she chooses to opt out.”
Would you opt out under these circumstances?
This is bettered described by Taxpayer Advocate in the following language:
“On March 1, 2011, more than a year after the 2009 OVDP ended, after learning that examiners were spending the time to compare the 20 percent penalty to what would be due under existing statutes, the IRS “clarified” its seemingly unambiguous statement in FAQ #35.
The March 1 memo directed examiners to stop accepting less than the 20 percent offshore penalty under the 2009 OVDP regardless of whether a taxpayer would pay less under existing statutes, except in narrow circumstances. Even in those few cases where the IRS was supposedly still applying FAQ #35, it generally did not consider reasonable cause and assumed the violation was subject to the maximum penalty for willful violations unless the taxpayer could prove that the violation was not willful.
Thus, in the absence of evidence, taxpayers who would be subject to the lower penalty for non-willful violations (or given a warning letter or overlooked) outside of the program would be subject to the 20 percent penalty inside the program. Moreover, the IRS did not provide any guidance to taxpayers regarding what evidence they could use to establish non-willfulness or reasonable cause.”
But the story gets even worse. This great IRS “bait and switch” took effect on March 1, 2011. This means that taxpayers who had been processed prior to March 1, 2011 DID have the benefit of “reasonable cause”. This exacerbated the level of unfairness. From that moment on the IRS made it clear that it simply could not be trusted. As proof of that, AND THIS IS A BOMBSHELL (assuming this to be true), according to the results of a request under the Freedom of Information Act (are you ready for this):
“According to the IRS, all of the 3,000 applications to the 2011 OVDI came in after the 2009 OVDP deadline and before the IRS’s announcement of the 2011 OVDI on March 1, 2011. IRS response to TAS information request (July 13, 2011). Thus, it appears that the 2011 OVDI may not have received any significant number submissions after the IRS’s reversal became known.”
In case you missed this, the March 1 shift in IRS policy appears to have made people reluctant to enter OVDO 2011.
Part B – The mind of the lawyer in 2011:
The IRS “bait and switch” of 2011 made people very distrustful of the IRS. It underscored the IRS presumption that OVDI was a program designed for criminals. That didn’t mean that other people couldn’t participate. But, it did mean that participation in OVDI 2011 meant that you were knocking on the door of the IRS and presenting yourself to be a criminal. Hence, it is reasonable to expect that you would be treated as a criminal. Of course you could always opt out and be subjected to the “standard audit”.
Why would any poor U.S. citizen living outside the United States who didn’t know about and couldn’t imagine that an FBAR requirement existed get involved in this. To add to the ridiculousness, if one entered OVDI 2011 the taxpayer had to calculate their own penalty and include a check. This reminds me of:
– if the Chinese government shoots one of its citizens the family has to pay for the bullet (maybe the Obama administration should consider this next time they kill a U.S. citizen abroad);
– Jesus being forced to carry how own cross to the crucificion.
How could any lawyer recommend that anybody but a tax evader enter this program? (If you are a lawyer reading this please comment.)
4. From the perspective of Taxpayer Advocate – Calling in the Cavalry:
Now back to the OVDP 2009 AKA “The Great IRS “Bait and Switch”. But, if you really want to fight the IRS you need somebody with the legislative authority. Believe it or not (and like most of you I had never heard of this until recently) there is a “Taxpayer Advocate in the IRS”. (The IRS probably views Taxpayer Advocate as a tumor inside the IRS.) In any case, Taxpayer Advocate agreed that the change in the IRS position with respect to FAQ 35 was a classic “bait and switch” and cried foul! they wanted to help the taxpayers. Now Taxpayer Advocate has a couple of “big sticks” available. They are “Big Stick – TAO” and “Big Club – TAD”.
Big Stick – TAO: Taxpayer Advocate Order: This usually is used in relation to single taxpayer
Big Club – TAD: Taxpayer Advocate Directive: This is used to correct a more general problem.
On August 16, 2011 Nina Olsen (the head of Taxpayer Advocate) issued a TAD against the IRS. (It is the most well written and well organized analysis of this issue that I have been able to find. Read it. You will learn a lot.) But, for those of you who do NOT want to become “OVDP Historians” the TAD of August 16, 2011 really says:
IRS you have cheated. You duped taxpayers into entering OVDP because they thought they could raise arguments of “reasonable cause” and “non-willfulness” without doing an “opt out”. You are like a slimy salesman who does a classic bait and switch. We are directing you (because we have the authority) to give taxpayers the benefit of “reasonable cause” and “non-willfulness” without an “opt out”.
In “Taxpayer Advocate Speak”, Taxpayer Advocate directed the IRS to:
“Immediately direct all examiners that when determining whether a taxpayer would be liable for less than the “offshore penalty” under “existing statutes,” as required by 2009 OVDP FAQ #35 (described below), they should not assume the violation was willful unless the taxpayer proves it was not. Direct them to use standard examination procedures to determine whether a taxpayer would be liable for a lesser amount under existing statutes (e.g., because the taxpayer was eligible for (a) the reasonable cause exception, (b) a non-willful penalty because the IRS lacked evidence to establish its burden to prove willfulness, or (c) application of the mitigation guidelines set forth in the IRM) without shifting the burden of proof onto the taxpayer.”
Well hey, the IRS, like most big bullies, is always up for a fight. They are not going to be kicked around by Taxpayer Advocate. On August 30, 2011 they issued their response. When you can spend the taxpayers money on the finest lawyers that money can buy, you can come up with a pretty good response. Actually I congratulate the IRS on their choice of lawyers. Whoever wrote their response did a good job. Actually, a very good job. I recommend it to you – an excellent example of lawyering. (Also a good example of why people don’t like lawyers).
Without boring you with the $750 per hour details, the response of the IRS was:
No, no and more no. FAQ 35 does not allow for the consideration of “reasonable cause” or “non-willfulness”. If you don’t like it then, you just opt out!
So, the stage has been set for a big brawl – featuring one division of the IRS (the good cop) versus another division of the IRS (the bad cop). We need a referee to settle our differences. Who is this referee to be? Yes, you guessed it – the IRS Commissioner himself – Douglass Shulman
5. The Perspective of Doug Shulman:
Or rather, what’s a poor IRS Commissioner to do? He is required to settle this fight by January 26, 2012. So, keep your eyes and ears open! This dispute is of great interest to lawyers, accountants, taxpayers, the good cop. the bad cops and everybody else. It is no surprise that this has been the subject of:
– a great thread on Jack Townsend’s blog; and
– a fascinating article in Tax Notes
He has two options:
1. Side with Taxpayer Advocate the “good cop”
2. Side with his own people the “bad cop”
As “Just Me” explains neither option is desirable for Mr. Shulman. So, what should he do? The answer depends on his “long term” objectives. If his “long term” objective truly is to bring people back into the tax system he will side with “good cop”. If his objective is something else, then he will side with the “bad cop”. Neither decision would surprise me. To date, Commissioner Shulman has given little indication that he understands most U.S. citizens with foreign bank accounts are NOT criminals. That does not bode well for the “good cop”. As a recent blog post at Roth CPA (by the way this is a great blog) noted:
“It’s not encouraging that the decision rests in the hands of Commissioner Shulman, who hasn’t lifted a finger to intervene in a process that has infamously treated Americans abroad and U.S. residents with foreign accounts as presumed criminals, hitting minor and harmless violations of obscure rules with absurd fines.”
I suspect that Mr. Shulman’s perception of this may be that:
One the one hand, Mr. Shulman states that:
“Collecting additional revenue for past misdeeds – as important as that may be – is not the main consideration here. It’s equally important that we’re bringing U.S. taxpayers back into the system…back into compliance… so they properly report and pay their taxes for years to come.”
and on the other hand:
“… the biggest problem with the administration of the OVDP was the deeply entrenched view of the IRS that the people who entered the program were tax evaders. Lack of consistency also proved to be a problem for OVDP participants, especially those who sought refuge from penalties under FAQ 35 …”
– a lawyer quoted in the Tax Notes article
A decision in favor of Taxpayer Advocate could be the first step on a long long road of restoring some trust. The IRS simply cannot function without it.
You can expect an update on or around January 26, 2012. Until then, keep thinking about the obligations of U.S. citizenship!
Emma, I totally share your concerns. I am also an immigrant, 5 years in the US, now 3 years with a green card and currently sleepless. We really need some representation, like our expat friends.
@JustMe et al, am I considered new or old immigrant?
Up until this year’s tax return, I was completely ignorant about world-wide income taxation. I could never imagine I would have to pay taxes here over already taxed money in my home country.
I came to know about FBAR last year. Thought it was something new and disclosed my foreign accounts along with 2010 tax return without thinking much or doing any research. After all, I never had anything to hide. To the best of my limited knowledge at that time, I always did everything right.
This year, I’ve faced the 8938 form in TurboTax, which is really the one that made the click on my mind.
CPAs (I have spoken to at least 5 of them) have a very simple vision on this: amend and pay back taxes. I am totally fine with that.
Cross-border tax lawyers (have spoken to 3) suggest OVDI and some of them go further and say that I should get in and opt out. OVDI seems totally unfair to me, even doing the opt out. I am no criminal whale, just made a mistake because of sheer ignorance.
I do want to be totally compliant and up to date, but the options are just too hard. I can’t believe the US is doing this to us.
I understand this is a very personal decision to be made based on someone’s tolerance for risk and uncertainty, but I would love to hear your guys’ thoughts.
By the way, this forum is just an amazing source of information. Thank you all.
Ops… By “no criminal whale” I mean I am neither a criminal nor a whale. Just a minnow immigrant.
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@Emma and Sunset. Welcome to IsaacBrockSociety.
I feel your pain as I am exactly in the same situation: long term immigrant (12 years, got my green card in 2004, married a US citizen in 2005, but never got my US citizenship), who did his taxes by himself and had never heard of FBAR until this year.
Actually, I don’t feel bad for having done my taxes by myself: using a CPA might not have changed anything. Just this tax season, a friend of mine, immigrant too, used one for the first time. He mentioned he was French, but the CPA never asked about his account, checked No on schedule B and of course never mentioned FBAR. So using a professional might not have made a difference.
I’d like to thank all the people on this website who are wonderful listening to our concerns and fears and have helped me tremendously
make a rational decision that I probably would not have made had I not found IsaacBrockSociety. I was ready to jump into OVDI, as when you read the IRS web site, they claim it’s the only solution.
As Just Me mentioned, make sure to read Jack Townsend’s blog and all his comments. While the answers depend a lot on our facts, they can help shape what we think is the best decision for us, a decision that you should validate by paying a couple hours of a lawyer specialized in such tax issues.
Most minnows probably don’t have a risk of criminal prosecution. We have a money problem. Based on that, I came to my decision using a rational process: I computed my taxes and penalties inside the program, and worst case outside in case of audit and went with the one that made more sense.
A link that helped is the penalty mitigation guidelines that was provided by RodgRod.
One last note. Regarless of the decision you’re going to make, you need to be strong.
Whether you choose to enter OVDI, do a quiet disclosure (amend returns), or just be compliant forward, the uncertainty is going to be there for several years. And it’s hard to live with it, whether it’s wondering if the penalties that they’ll compute inside the program will match what you think they should be, or what to expect if and when you’re audited. Also knowing that at least in my case, lawyer’s fees would be higher than my penalty and that I might have to face the IRS by myself is scary.
Best of luck in your journey.
This item is peripheral to my interest but relevant to this thread. I heard recently from a tax law professional that one of the big differences between US citizen and greencarder is that FBAR statute of limitations is different.
For a US citizen, the slate clears after lapse of six years; for a greencarder, the slate never clears. No memory of this factoid ever surfacing at Brock. No attempt to verify in separate source. Have at if you want.
@usxcanada I have never heard that mentioned anywhere, and don’t know what the legal basis would be for the assertion. A SOL is a SOL, U.S. citizen or U.S. person, I would think. If it were different, after reading Jack Townsend for a couple years now, I think he would have mentioned it.
Forget the distinction between new and old immigrant. Understand that technically all immigrants (new or old) have to follow US tax law, and that includes reporting offshore income and accounts in your home country. This is not unusual anymore, although the IRS does make it more onerous in America. Other countries have similar requirements now. I have lived in NZ, and they do too.
However, unlike NZ, the US (State Dept or the IRS) has done NOTHING to educate newly arriving immigrants that this is a requirement, or warn them that the previously unenforced FBAR were suddenly going to be rigidly applied. Contrast that with NZ, which was nice enough to send me a letter telling me of the upcoming off shore income reporting requirements, so I was informed of my obligations before tax filing time. That is what enlightened Revenue Departments do! That is how they improve compliance. Unlike the IRS, they did not leave it to some check box on some schedule form buried inside one of the countless forms required to file US taxes to give you first knowledge of some other obscure form you have to file.
So, the U.S. has some culpability in the failure of millions of immigrants to know, understand or follow these complex rules. They might as well require you to employee a full time Tax CPA as part of the Greencard application process to advise you on the most complicated tax system in the world.
Instead what they do now to get your attention (and it worked), is insert a new FATCA form 8938 to your 1040 filing get your focus that small check box did not in the past do. It duplicates a lot of the FBAR reporting and essentially doubles up the penalties. Now the cost of failure just went beyond absurd to totally ridiculous! That is how the IRS educates. Create something to make the cost of failure even worse! In these guys compliance tool box, they only have penalty hammers. Educational outreach? What is that? It is easy to see why people begin to characterize them as thugs.
As Christophe has said, there is a lot of information on this site, and I would encourage you to read the threads I have recommended to Emma. Sadly, there is no short cut to reaching a sufficient knowledge level necessary to make an informed decision. Everyone wants quick answers to “What should I do?”. And while there is a strong temptation just to provide one, but in this technical game everything is so very fact specific, it would be irresponsible of me, and extremely silly of you to take advice from one guy posting comments on a blog. You have to do your Drudgery Mate, there is no other way, unless you are quite happy to pay practitioners thousands of dollars and still get bad advice.
If you take the time to methodically read the many links and associated comments you have been provided, you will see others going through the process and arriving at a decision. Christophe did, and I would say that for him it is a reasoned one, not driven by fear implanted by the IRS or an attorney telling him that the OVDI is the only way.
I have a lot of confidence that you can navigate these waters as murky as they seem now. You are asking questions and not afraid to put comments into a blog post. That is a good indicator. You have an inquiring mind, and open to learning. There are many others out there just blindly trusting a Tax attorney or CPA to tell them what to do, and those are the ones that I worry about. They are the fish fertilizer material that is the IRS by-product of a deeply flawed process. The IRS seems incapable of learning at times, but you can.
Good luck, you will figure it out and make the right decision for you.
Only time will tell if I made the right decision…
The next 5 years are going to be long…
I will keep you updated if I ever get audited and what the result is.
Just Me, please let us know whenever you have more information from Steven Mopstick about the potential alternative solution you were talking about. Are you in touch with him? How did you learn about it? Is this going to be an official option blessed by the IRS?
It is something Steve told me about privately, and mentioned on a blog thread recently. I know the gist of it, but am maintaining the confidentially as he continues to work on it. I am not sure the scope of the distribution, and exactly how he is trying to get IRS attention with it, but it does have some positive elements that sadly, the IRS might just continue to ignore, given their mindset.
Time will tell. I wish him well.
2014 TAS Report is out, incl following challenges:
“Establishing less draconian and more reasonable “settlement initiatives” for the millions of taxpayers who have legitimate reasons for overseas bank and financial accounts and whose failure to file reports was merely negligent”
This portion is also relevant: http://www.taxpayeradvocate.irs.gov/userfiles/file/FullReport/International-Taxpayer-Service-Initiatives-Continue-but-Need-a-More-Formal-Structure.pdf
@noname, thanks for the link and good for the TAS in criticizing the IRS for treatment of “benign actors” under OVD, but I think the credibility of the IRS and of the tax policies of the US government has already been damaged irreparably among US expats. Nothing short of the US changing to residence-based taxation can repair it.
It baffles me that US lawmakers and government officials continue to alienate their own citizens with heavy-handed and secret policies aimed at a few “bad actors” but which have negative impacts on so many more ordinary people. If a government sees enemies everywhere and treats everyone as a potential enemy, it will certainly lose friends and create more enemies.