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September 17, 2010 - Phil Hodgen

Wholesale reassignment of amnesty cases to new auditors

We are seeing many of our offshore bank amnesty cases reassigned to new Revenue Agents for handling the civil audit.

I don’t know the reason for this, though I can think of several possible explanations:

  • The Revenue Agents who received cases initially were overworked and needed relief (OTOH aren’t we all overworked?);
  • The Revenue Agents who received cases initially were not sufficiently trained to handle the cases (not likely, given that there is a special training given to auditors who are assigned to these cases);
  • The amnesty cases were assigned without any systematic thinking (this one makes sense given that the geographic location of the Revenue Agents is frequently completely unrelated to the geographic location of the taxpayer); or
  • There are still amnesty cases to be assigned for civil audit (I know this to be true for a fact because we have an inventory of people who cleared Criminal Investigations but have not yet heard from a Revenue Agent).

Why is this happening?

Applying Occam’s Razor to the situation and considering the Offshore Voluntary Disclosure Program’s history, I would guess that this is just the Commissioner’s attempt to cope because they’re in over their heads with paperwork, cases, and resource drains.

  • Too many cases (but we knew that)

The problem is unexpected volume on the front end (the Commissioner said as much–that they never expected the number of applicants they actually had). That’s obvious. But if that was the only problem, they would have left most of the reassigned amnesty cases with the auditors that had them originally, and just thrown extra cases at new people until all 15,000 or so cases were assigned out to Revenue Agents.

  • Not enough “roll over and play dead” happening? (speculation)

But there’s another problem that I think we may be seeing. This is pure speculation on my part. Bear with me.

I would guess that the Service is seeing intransigence and pushback from people in the Voluntary Disclosure Program. The Revenue Agents are given no discretion. They must hand out “20% of high water” penalties.

I would guess that the decision-makers at the Service thought taxpayers would roll over and play dead in the Voluntary Disclosure Program. The constant refrain in the early days of this program, from high and low alike in the Service, was that “We think this is a bargain for the taxpayer” and yes they used the word “bargain.”

From the perspective of the normal taxpayer in the Voluntary Disclosure Program, however, the 20% of high balance penalty is usually grossly unfair: it is a massive multiple of the actual tax liability on unreported income. A normal domestic audit that turns up $7,000 of unreported income in six years of tax returns wouldn’t even cause a Revenue Agent to think twice about closing the case with modest–if any–penalties. Yet in the Voluntary Disclosure Program we are seeing cases like this trigger penalties of $250,000.

Thus it is no shock to us (thought it may be a shock to the IRS) that the taxpayers would reject closing agreements. Now the IRS has a problem. The Service has doubled its workload. A whole new audit erupts.

Over the course of the last year I have seen Revenue Agents assigned to these amnesty cases flip back and forth. They were allowed to handle the regular audit if the taxpayer rejected the VDP closing agreement. Then they weren’t–the case would be reassigned to a new agent. Reverse course, and reverse course again. There is something happening behind the scenes here in management at the IRS.

If we look back at prior enforcement initiatives that the IRS has had, we see that they bogged down and cases in some cases dragged on for years. I’m guessing that this is starting to be visible internally at the Service and they’re trying to figure out what to do.

The solution is obvious

The solution is obvious. The penalties are too high for a whole category of people in the Voluntary Disclosure Program. I call it the whale and minnow problem. The IRS went hunting for whales and netted a bunch of minnows, too.

However you choose to define “small,” there are a lot of “small” Voluntary Disclosure Program people. If the Service handles those quickly and with appropriately-scaled penalties, they can then concentrate on the whales.

Reduce the caseload by eliminating the small fry.

And it doesn’t take too much imagination to figure out how to do it. The guidelines are right there in the Internal Revenue Manual Section 4.26.16. Yes, in the procedure manual written for Revenue Agents for how to handle penalties in the case of failure to file Form TD F 90-22.1.

The Internal Revenue Manual on why and when penalties should be assessed

Section 4.26.16.4, Paragraph 4 gives the philosophical guidance for why and when penalties should be assessed for failure to file Form TD F 90-22.1:

Penalties should be asserted only to promote compliance with the FBAR reporting and recordkeeping requirements. In exercising their discretion, examiners should consider whether the issuance of a warning letter and the securing of delinquent FBARs, rather than the assertion of a penalty, will achieve the desired result of improving compliance in the future.

Penalties are on a “per account” basis. If you have someone living a normal life, it is not unusual for them to have many bank accounts. The cascading effect of these penalties can be awe-inspiring. In fact the IRS took great pains to gloat about how scary the penalties-upon-penalties can be for taxpayers in FAQ Q and A #12.

The Internal Revenue Manual guides the examiner in cases where there are multiple violations on a single Form TD F 90-22.1 filing (or late filing or nonfiling). From Internal Revenue Manual Section 4.26.16.4.7, Paragraph 4:

“Given the magnitude of the maximum penalties permitted for each violation, the assertion of multiple penalties and the assertion of separate penalties for multiple violations with respect to a single FBAR form, should be considered only in the most egregious cases.”

Do you hear that, IRS? Only in the most egregious cases. From your own operating manual.

The solution: follow your own playbook, IRS

Simply put, my suggestion is that the IRS brass recognize that there is a difference between whales and minnows. Egregious vs. not.

  • Go through the inventory of amnesty cases and divide the whales from the minnows.
  • Give your people the authority to settle minnow cases using the procedures outlined in the Internal Revenue Manual.
  • Encourage your people to err on the low side for penalties.

Publicize the hell out of this, too. Because, dear IRS, you have no idea how attitudes have turned in the U.S. expatriate community for filing U.S. tax returns.

Me personally, I would make the bar fairly high for “minnow” territory.  And I would tie it to tax liability, because isn’t that what the FAQs keep harping about?  If there is no additional tax liability the philosophy there is to waive penalties.  See FAQ #9, #40, and #41.

Or . . . keep doing what you’re doing and you’ll keep getting what you’re getting.

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