A real life Voluntary Disclosure Program participant’s story


Posted by:
Phil Hodgen

Written on:
September 21, 2010

Posted in:
Voluntary Disclosure

Over the weekend I received an email from a regular person in the amnesty program.  He is not a client of our firm, and we have never met.  I asked him if he would be willing to let me post his story on the web.  He agreed.

This person is being buffaloed into a $14,000 penalty in the Voluntary Disclosure Program when he owes only $218 of tax for all six years of 2003-2008.  If he does not take it, he is being threatened with vastly higher penalties by the IRS agent.  Much like the school yard bully.  Give him your lunch money now or he’ll be waiting for you after school.

For all of you out in the real world, this is what a foreign bank account criminal looks like to the IRS.

Shame on you, IRS.

Here is his story.

Call us stupid or naive, but we really didn’t know there was a penalty of 20% when we joined the amnesty program last year.  We just wanted to do the right thing. After informed by IRS VDP Agent of the penalty, I called FBAR and spoke with an agent in July. She gave me indication that they are not enforcing the penalty. 

I have always done our tax returns.  I am married with two teenagers and work for [major corporation everyone has heard of]. My spouse is a housewife. Our income tax returns were pretty straightforward from 2003 with 2008 with mainly W-2 salaries, some interest, and very light equity activities (all long-term gains/losses).

Now we are facing a penalty that is 6400% of the extra income tax the IRS decided I owed. It’s much easier to just pay and move on but my wife and I really don’t feel we have done anything wrong.

The problem my wife and I face is that they are the IRS. It’s like David and Goliath.  The total income we did not report from 2003 to 2008 was only $725 but they want us to pay more than $14k penalty for being honest (or stupid enough) to come forward and join the program.

I have two life insurance policies issued by a company in (Country) that I bought in the early 1990’s when I was living overseas.  I pay about $10,000 per year for the premiums on these policies. 

The policies paid survival benefits every three years which are also used to pay the premiums so all of the money stays in the policies. The interest of the survival benefits is the cause of my headache.

I did not report $725 of interest from 2003 to 2008. I didn’t know that it was taxable, because the interest payments always stayed in the insurance policy. In addition, the company simply stopped sending annual interest statements in 2007.

The survival benefits was $14,000 every three years and the IRS agent originally thought I also have to pay taxes on that. However, I argued with him since there was no gain (3 year premium is more than the survival benefit paid every three years) and he finally agreed after checking internally.

– In the end I had only $725 of unreported interest income for the six years from 2003 to 2008. 

– The tax we have to pay for 2003-2008 is $218.

– The IRS agent is telling us we have to pay a penalty of approximately $14,000. 

This is based on the cash surrender value of my life insurance policies.  I had no idea I had to file the FBAR until notified by the IRS agent.  I have a life insurance policy, not a banking account. We had no clue this is treated like a financial account, making it a requirement to file the FBAR.

The letter the IRS agent sent made us uncomfortable and we are afraid they will penalize us severely in the audit for opting out of the program. The more I read, the stronger I felt I should fight this. My case should be at the most negligence per IRS own guidelines which is $500/year max and they are supposed to take discretion.

A person or entity can know about the requirement to file but don’t file and still be negligent. They are saying I’m better off staying in the program because they are comparing with the max penalty for non-willful violation (in my phone discussion with VDP Agent).

The story is the gentleman’s. I edited his email, and he approved it. Here is his followup email to me–with a single edit within the brackets.

I made minor updates to the text [above] and you can go ahead and post it including my update and wife’s feeling.

I spoke to Agent today to update him of my request for extension and supporting documentation that the 20% is appropriate. I mentioned that my case is negligence at the most. To my surprise, he said he only considered non-willful and will-full violations for my case and was not aware that there is negligent violation. He asked me for the website and I provided to him. Wow, I have to tell IRS their own rules. He is probably a new or junior agent but no excuse for IRS particularly since he mentioned that he had reviewed my case with his manager.

In addition to faxing him my letter, I also mailed it to him along with Federal tax amendments from 2003 – 2006 (I already send him 2007 – 2008) and the document I got from IRS site on the different FBAR violations. I’ll call him later on the week to follow up.

Here is my wife’s feeling (I have to edit since her English is limited).

After reading Phil’s letter, it’s just like we get a righteous person to speak out for us.  Nobody could help or advice us in the past, not even the CPAs we spoke to. When I first read his letter, my body shook. I did not know if it was because I felt cold at that time. I put on a long sleeve shirt and tried to read again. I really hope we can get rid of this trouble ASAP. May God uses our case to help people…..I do not know.

My deep feeling is just like Psalm 142, 143 (that is my prayer to God) after we joined this trap program and IRS treats us with no basic human passion. They just want to get money. They waste our citizen tax money on our very little honest, stupid case. 

  • http://www.assetlawyer.com Asher Rubinstein

    Until 2010 (when the U.S. Treasury Department issued proposed rules), there was incomplete guidance from the IRS on whether a foreign life insurance policy constitutes a “foreign financial account” that would give rise to an FBAR requirement. Under a Notice of Proposed Rulemaking dated February 26, 2010 (Federal Register Vol. 75, No. 38), “other financial account” under the FBAR rules would include “an account that is an insurance policy with a cash value”.
    I would explore whether incomplete guidance prior to 2010 might be grounds to lower or eliminate the penalty.

  • http://hodgen.com/ Phil

    @Asher,

    Thanks. I am sure the gentleman is reading this and you’ve made an excellent suggestion for remedial relief on this particular case.

    The underlying attitude at the IRS, however, still stinks. If a domestic audit turned up an additional $218 of tax liability (over 6 years, FFS!) there is no way in the world that a $14,000 penalty would be imposed.

    Phil.

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  • Don

    …….Then the IRS wonders why 70% of Americans resident abroad do not file income tax forms every year – it’s more risk than its worth. If they’re going to charge penalities in excess of US based taxpayers – screw it.

  • The Regular Person

    Asher and Phil,

    Thank you very much. I always wonder if Insurance is considered financial account. No one seemed to know until I emailed FBAR and spoke with VDP agent. However, they didn’t inform me of the notice. I doubt the agent would know.

  • Thomas

    “The public may be unaware of their obligation to report their foreign bank accounts to the Department of the Treasury……” Source: Website: US Embassy Berlin Sept 22, 2010

    Above is a quote taken directly off the US Embassy website in Berlin. Obviously, the US Government knows that there is a huge problem of past (un)awareness regarding the FBAR (they even admit it publicly) ! How can they possiblly impose such draconian penalties when they know the general public may have been unaware of this filing requirement in the past ?

  • John Nolan

    So far as I am aware, there has never been a direct constitutional challenge to the penalties imposed for failure to file a FBAR.

    Shortly after the Bank Secrecy Act was passed in 1970 the Supreme Court handed down its decision in California Bankers Assn v. Shultz, 416 U.S. 21 (1974).

    The Court ruled that certain enumerated provisions that were (rather weakly) challenged by plaintiffs – most of whose standing was legally dubious – were constitutionally valid.

    The FBAR filing requirements and penalties were not explicitly challenged or even mentioned by the Court. There is, however, material in the Court’s analysis that might support a challenge since many of the aspects of FBAR reporting differ greatly in substance from the provisions (e.g. reporting cross-border transportation of cash, monetary instruments, etc.) that the court found passed constitutional muster.

    In my view, before the Jobs Act of 2004 FBAR was vulnerable to constutional challenge on the following grounds:

    1. privacy (weak) – Query whether Americans have any constitutional right to personal financial privacy vis-a-vis their government. (But see Justice Douglas’ vigorous dissent in California Bankers)

    2. substantive due process (solid) – a statutory requirement that is not reasonably related to any legitimate state interest. The FBAR enabling statute – and the Supreme Court emphasized this in the California Bankers decision – says the Treasury may require only reports that Treasury has determined by regulation would have a “high degree of usefulness” in combating the crimes that are the target of the Bank Secrecy Act. Perhaps a “Brandeis brief” based on inquiries directed to Treasury and FINCEN asking them to substantiate with empirical evidence that the information contained on any FBAR filed over the last 40 years has ever led to the discovery of a crime much less the initiation of any successful prosecution of a crime unrelated to the FBAR filing requirement itself. In addition, Treasury officials should be asked to produce Treasury’s own internal analyses from 1970 – if any – predicting what “high degree of usefulness” to law enforcement could expect to realize from future FBAR filings.

    After the Jobs Act:

    3. 8th Amendment – cruel and unusual punishment – (stronger). I suspect that the IRS’s confusion and indecision about enforcing the 20% “hi-year” FBAR minimum even against the minnows is based on fundamental uncertainty as to what will happen if one of the minnows (especially one whose “financial account” is a foreign life insurance contract) calls their bluff and says: “Take your VD agreement and shove it. You want to try for a max FBAR penalty against me for my failure to declare the legal ownership of something you yourselves have utterly failed to coherently require me to report? Then bring it on. Sue me for the FBAR max and we’ll find out what it takes to make 9 justices gag all at once.”

    There is also evidence out there – if it ever gets that far – that the real reason for seeking enhanced FBAR penalties under the Jobs Act of 2004 and the preceding shift of FBAR enforcement from law enforcement to the IRS was totally unrelated to any of the BSA’s lawful purposes but was instead motivated by two things:

    1. A desire to discourage and otherwise slow foreign investment by US residents by
    2. turning the FBAR into a compliance weapon and “revenue enhancer”.

    In short: keep American capital at home by quasi criminalizing their foreign investment.

    The evidence for this proposition: TIGTA Report 2005-30-101. I downloaded the report from somewhere on the internet but the version I got was heavily redacted before release to the general public. Whether the editing was legitimate or not we, of course, do not know.

    The report begins like this:

    MEMORANDUM FOR DEPUTY COMMISSIONER FOR SERVICES AND ENFORCEMENT
    DATE: July 26, 2005
    FROM: Pamela J. Gardiner
    Deputy Inspector General for Audit
    SUBJECT: Final Audit Report – Compliance Opportunities Exist for the IRS to Use Foreign Source Income Data (Audit #200430002).

    “. . . . The overall objective of this review was to determine whether compliance opportunities existed for using the foreign source income data and Reports of Foreign Bank and Financial Accounts (Form TD F 90-22.1) (referred to as FBAR) received as part of the Automatic Exchange of Information Program (AEIP).

    In summary, we found that investments made abroad by US residents have grown in recent years, nearly tripling from $2.6 trillion in 1999 to $7.2 trillion in 2003. ” [ a half page of text that follows has been redacted out]

    Except for a reference to the transfer of FBAR enforcement authority to the IRS and a sentence or two on treaty restrictions on the use of certain tax information, almost the entire document has been redacted out.

    The audit methodology despite redactions is clearly focused on FBAR enforcement and maximizing penalties. They apparently did a random sample of tax information reported from foreign sources under treaties and matched that info with FBAR filing records over the same period to see how much FBAR gold lay in them thar hills.

    TIGTA recommendations, however, have been nearly completed edited out.

    The reported management response from Deborah M. Nolan, IRS Commissioner, LMSB (no relation) is very interesting because the Service evidently strongly disagreed with TiGTA’s sanguine projections about how much enforcement would bring.

    Apparently the IRS management voiced concern about using data received under treaty exchange programs for FBAR enforcement but TIGTA dismissed these concerns as being behind the times.

    In addition, in her management response to TIGTA Ms. Nolan points out that “The BSA requires persons to report certain financial transactions to the government; however, its purpose is not to generate revenue for the United States.”

    She also says something very interesting that I was previously unaware of and quite frankly don’t know whether it is true or not:

    “. . . but the amount of the penalty is determined by the amount on deposit on June 30 following the close of the reportable year. Without proof of the actual amount on deposit on June 30 following the close of the reportable year, the penalty is limited to the lesser figure of $25,000 or the maximum unverified amount in the account.”

    She also points out that TIGTA appeared to believe – erroneously – that there were MINIMUM FBAR penalties rather than maximums.

    In a heavily redacted section she also takes pains to point out to TIGTA that the Service has implemented penalty mitigation guidelines in the IRM and she obviously does not want those ignored.

    Guess whose views ultimately prevailed?

    This institutional contretemps may account for the IRS’s nearly 5-year dragging of its heels in producing the new TD F 90-22.1 after getting FBAR enforcement authority.

    In short, very interesting reading.

    Again, I suspect that the reason why there have been no known efforts to enforce FBAR maximums independent of the VD program is because the IRS justifiably fears that an aroused – conservative – court could wrest the FBAR “revenue enhancer” from its hands completely and for good.

  • The Regular Person

    I’d like to update folks on my status.

    IRS agent and his manager called me in mid October. The manager pretty much told me that he can’t waive FBAR penalty because life insurance policy is still considered reportable foreign account even though they are clarifying it. He gave me option to pay or opt out. He said he has “no discretion”. I told him I wanted to opt out. He doesn’t seem to know what’s going to happen next. He told me I’m going to get a letter saying I am out of the program. However, he is not sure if I need to re-file my federal tax amendments and FBARs.

    Agent called me again on Nov 18, 2010. I guess they don’t want me to opt out. They offer to lower penalty to $5000 (based on below penalty 4.26.16.4.6.2). I have until Nov 29 to decide. They do have some flexibility after all. $5K is still a lot of money but it is much better than $14k and save everybody time to go through the full audit. I still think that I have reasonable cause as in 4.26.16.4.4 below because my account is insurance policies but I’ll never know so we might just pay and get it over with. I will try to negotiate the $5k lower perhaps to $2 to $3k.

    4.26.16.4.6.2 (07-01-2008) Mitigation of the Non-willful FBAR Penalty

    5. If the aggregate balance of the accounts is over $50,000, but less than $250,000, the penalty is, per violation, the lesser of $5,000 or ten per cent of the highest balance in the account during the year for which the account should have been reported.

    4.26.16.4.4 (07-01-2008) Non-Willfulness Penalty
    2. The penalty should not be imposed if:
    A. The violation was due to reasonable cause, and
    B. The balance in the account was properly reported on an FBAR. This means that the examiner must receive the delinquent FBARs from the nonfiler in order to avoid application of the non-willfulness penalty.

  • Help!!

    I also didn’t realise I had to pay tax to the USA. I’m an American citizen living in the UK, paying UK tax, running a small business in rental property.

    The FBAR people also want to fine me on 20% of the 2007 value of my rental property!!! Also a fine of 20% of the biggest year of my hard earned savings. Is this legal??
    I thought FBAR was a fine on the banking assets, not building assets.

    My friends told me about this FBAR deadline, otherwise I would not have known about it as I do not consider myself an off shore account.

  • http://hodgen.com/ Phil

    Hello, Help!!

    The IRS brass who are running this amnesty program — they need to get out of the building and interact with the real world. The way they are conducting the amnesty is unfair and creates every incentive for taxpayers to hide. The amnesty program is a ridiculously good deal for the true tax evader, and a horribly punitive result for the average taxpayer.

    Here you are, living in a high-tax country, paying more in tax than you would in the USA. Yet Uncle Sam’s minions think it is logical — and appropriate — to impose a life-changing penalty.

    I completely sympathize. Fight on. Because what else can we do but fight?

    Phil.

  • SR

    Here’s my story in a nutshell: I have lived outside of the US for almost my entire life (left the US before my 2nd birthday). I have paid taxes in full on all my income in my country of residence.

    I have filed US tax returns, though irregularly. Since I found out early that I would never owe tax to the US, I would make the filings a low priority and sometimes forget to file for a year or more. I would then send a batch of returns, and the IRS never sent a warning about the delay in filing. I then assumed that US citizens who were perpetual residents of a foreign country were treated more leniently.

    I had never heard of the FBAR until I hired an accountant to file my returns because my finances were becoming more complicated.

    Now, the IRS is demanding in excess of $100,000 in penalties for failure to file the FBARs (20% of the highest balance of accounts, etc.). However, they agree that no taxes are owing.

  • SR

    I should clarify that my accountant entered me in the VDP, and the IRS concluded that my failure to file FBARs was NON-willful.

  • Cross

    Phil – is it possible to have a group legal action against the unfairness of the FBAR penalty? Would you be able to start the group action?

  • SR

    Has anyone who has been found to have non-willfully failed to file FBARs, but does not owe tax, declined to pay the penalty and gone through the regular audit process? If so, what has been the outcome?

  • J Aspin
  • NC

    Can we start legal action against the penalty ? Can someone lead us to do it ?

  • Michel J. Miller

    RP: In your case, I would probably insist on no penalty due to reasonable cause. Of course, that’s based solely on your post and I don’t necessarily have all of the relevant facts. I don’t think the IRS can collect any penalty from you if you push back.

  • Help!!

    Thank you Phil. Your sympathy is appreciated.

    Yes, they need to get out in the real world. I do not have “off shore accounts” in the Caymans or Switzerland, my accounts are in my country of residence! Very messy communication here by the US government.

    A very smart tax lawyer has hinted that it might have been better for me to have “quietly disclosed” my past taxes rather than to be in the OVDP at all. The relatively small tax due is peanuts compared to the amounts the IRS is looking for. He has also said most people choke and pay the life changing penalty. Not sure I am going to do this.

    This episode of gross mistreatment of honest citizen’s trust is a stain on the reputation of the IRS.
    I hope the IRS come to their senses and alter the terms of this program soon for small fry.

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