September 21, 2010 - Phil Hodgen

Another real-life story from the Voluntary Disclosure Program

Justice, IRS-style. I posted a story of a couple who face $14,000 of FBAR penalties and owe $218 of tax.

This one is worse.

Zero tax due, $28,280.48 of penalties.

What follows is a real-life email just sent to me, posted here with permission and without edits.  Not a client, and I have never met her.

I am an American living overseas, having moved abroad to improve my foreign language proficiency. One thing led to another and I have now been living and working in country X for 16 years. After once having my US taxes prepared by H&R Block (while still in the US), I have since always prepared them myself by copying the information from the previous year and simply updating the numbers. As a result, I have not carefully read all filing instructions in recent years, and thus failed to file form TD F 90-22.1 (FBAR). In addition, I also failed to report interest income from all accounts with foreign banks due to a fundamental misunderstanding of how this income is treated – again presumably due to a failure to read (or understand) the appropriate instructions. I did, however, consistently indicate the existence of such accounts on Schedule B (Form 1040) (when I actually filed that form, which I also unwittingly failed to do for calendar years 2003 through 2005), as well as duly filing W-9s when any bank requested me to do so. I was certainly not intentionally hiding any information, nor, indeed, could I possibly have had any reason to, as the foreign interest income would have no impact on my tax liability, being well below the amount of my allowed deductions and exemptions.

I became aware of the FBAR filing requirement in late June of 2009. At that time, I was already late in filing my 2008 tax return, so visited to see if I could e-file it. That is when I saw a note/link on one of the pages on the site about the requirement and the extended deadline to comply by September 23, 2009. I filed the delinquent forms on September 14, 2009, as well as amended tax returns for relevant years, and was accepted into the Voluntary Disclosure program. I had total unreported (taxable) interest income of $6,018.13 for tax years 2003 to 2008, but NO additional tax liability.

In August 2010, I received a Closing Agreement from the IRS requesting me to pay the standard 20% of highest balance penalty, or $28,280.48. I know that “ignorance of the law excuses no man,” but the penalty here hardly seems appropriate for the misdeed.

On what planet does the IRS think it is OK to impose a divide-by-zero penalty in cases of misunderstanding laws that few lawyers and accountants knew about? About a form where the IRS has put a chunk of the filing requirements on hold so they can figure out the rules? (PDF).

Voluntary Disclosure