Why the Voluntary Disclosure Program is off the rails and how to fix it
I have been thinking a lot about the Voluntary Disclosure Program and enforcement of tax violations by the IRS. The recent guilty plea by Jack Barouh clarified things for me a bit. Yeah, I’m a slow learner. It took 29 years of practice and watching 7 guilty pleas go by for me to see this.
Two mistakes by Mr. Barouh
I see two major errors (I’m being polite here — the correct word would be “crimes”) made by Jack Barouh:- The skimming problem — Mr. Barouh skimmed money from his business and didn’t report it for income tax purposes; and
- The hiding problem — he then hid the money he skimmed, using a variety of methods.
The true crime — tax evasion
To my mind the serious offense is the fact that he skimmed money from the business and that he didn’t pay tax on that money. That’s tax evasion, pure and simple. And ultimately the objective for law enforcement is to make sure that people fully report all of their income — no skimming allowed, thank you very much. The skimming problem is the one that is harmful to society. We’re all chipping in to support the government by way of our taxes, and people who use self-help to opt out will be punished. Fair enough. It is extremely hard for the government to find and catch people who skim money from their businesses. It takes time, human effort and ingenuity, and hard, hard work on the part of the Special Agents in Criminal Investigations — and others in the Service — to find these people and develop enough evidence to convict them. It frequently takes a bit of luck, too — a random piece of information pops up at audit, an informant presents himself to the Service with valuable information, etc. Bottom line, though — if it were left to pure detective work by the Service, more people would get away with more bad stuff.The artificial crime — “hiding” offenses
Once Mr. Barouh had that pot of “black money” gained from skimming money from his business, he had to put it somewhere. That’s the “hiding” problem. By creating a whole host of anti-hiding laws, the government gives itself a variety of ways to convict someone that they couldn’t otherwise toss into prison. You didn’t check the box at the bottom of Schedule B. You didn’t file Form TD F 90-22.1. You should have filed Form 5471 or Form 3520. You didn’t do this. You didn’t do that. These more technical violations are easier for the government to prove, and are easier to use to gain a conviction. I simplify, but that’s the idea. These “anti-hiding” rules are not so much a direct way to prevent tax evasion as they are a method for making it easier to prosecute someone who has engaged in tax evasion. The simplest analogy that everyone knows is the conviction of Al Capone on tax evasion charges rather than bootlegging or other criminal offenses. It is sufficient for the integrity of tax policy, in other words, that Mr. Barouh and his type go to jail. The precise technical method by which the Department of Justice achieves that aim is less important for the purposes of furthering tax policy. That’s why I call it an “artificial” crime. The failure to file Form TD F 90-22.1, of itself, does not cause the Treasury to lose tax revenue. The failure to file Form TD F 90-22.1 just helps the government prosecute someone who is egregiously in the wrong.Over-zealous enforcement of the “hiding” offenses
Mr. Barouh created his own problems by his tax evasion. He will now have the opportunity to make amends to society by paying massive fines and spending some quality time in prison. The anti-hiding laws are what they are. “God grant me the serenity to accept the things I cannot change, etc. etc.” I don’t beef with them, although I DO think they create unnecessary and unproductive complexity in too many situations — for the Service and for taxpayers alike. Never mind that. The tax system has run amok, however, in the recently aggressive application of the anti-hiding laws. Laws designed to catch and convict the Jack Barouhs of the world are now entrapping normal people — regular U.S. citizens living abroad, elderly immigrants, etc. — who face losing their life savings to the Voluntary Disclosure Program. People with legally earned and already-taxed money are faced with catastrophic and life-altering fines. In my experience the people in the field at the IRS — Special Agents at Criminal Investigations, Revenue Agents assigned to audit these cases — are sensitive to the realities of the situation, but feel helpless to make nuanced resolutions of cases–their hands are tied by lack of guidance from Washington DC. The Voluntary Disclosure Program was designed to flush Jack Barouh-category taxpayers out of the bushes and into compliance. For Jack, paying the “20% of highest balance” penalty would have been a God-send. I’m guessing, but I would think that for every Jack Barouh who entered the Voluntary Disclosure Program, the Service got 100 ordinary citizens. Small potato people. Small undisclosed balances in offshore bank accounts, small unreported income.Harsh penalties box you in
Having announced a policy of imposing harsh and non-negotiable penalties, the IRS cannot now be seen to back off and enforce “failure to file Form TD F 90-22.1” penalties in a sane manner. I’m imagining thought bubbles above some bureaucratic heads here: “If we don’t impose a ‘20% of highest balance’ penalty, taxpayers will think we are wimpy and will no longer fear or respect the IRS.” On the other hand, sticking with the harsh penalties will have a deterrent effect. For every normal taxpayer who is hit with a harsh penalties, 100 bystanders will see that good-faith compliance is promptly rewarded with pain. They will not come forward voluntarily. The IRS can’t enforce the harsh penalties (I deem the “20% of highest balance” penalty to be extravagently harsh) without ill effects, and it can’t wimp out, either. This is a management failure. This is like when the traffic cops in Pasadena (where I live) decide to be obsessive-compulsive about parking tickets. By doing so they create a whole new group of people who say “I will never come to Pasadena to shop ever again.” Smart cops. Got their promotions.Harshness and uncertainty reduces voluntary compliance
At the moment there is a vacuum of certainty about the enforcement posture of the IRS in the arena of offshore accounts. There are many, many people who want to do the right thing — report their goofups, pay up on back taxes, do the right paperwork, get clean. Yet they don’t do it.- Think of the retired public school teacher who bought a condominium in Baja California for $200,000 cash and didn’t know about the requirement for filing Form 3520 because she owns the condo through a fideicomiso. Are you going to tell her that she has a potential $70,000 penalty if she voluntarily cleans up that paperwork failure?
- Think of the British immigrant who left a small ISA behind when he came to the United States. He couldn’t cash it out in Britain without penalty — he’s not retirement age. Are you going to tell him that he faces Form 3520, Form 3520-A, and Form TD F 90-22.1 penalties in the tens of thousands?
- Think of the woman who received a $200,000 gift from her parents overseas to use as the down payment for a house. How will she react when faced with a potential $50,000 penalty for failing to file Form 3520 to report a simple nontaxable gift?
Q1. Why did the IRS issue internal guidance regarding offshore activities now? A1. The IRS has had a voluntary disclosure practice in its Criminal Manual for many years. Once IRS Criminal Investigation has determined preliminary acceptance into the voluntary disclosure program, the case is referred to the civil side of IRS for examination and resolution of taxes and penalties. Recent IRS enforcement efforts in the offshore area have led to an increased number of voluntary disclosures. Additional taxpayers are considering making voluntary disclosures but are reportedly reluctant to come forward because of uncertainty about the amount of their liability for potentially onerous civil penalties. In order to resolve these cases in an organized, coordinated manner and to make exposure to civil penalties more predictable, the IRS has decided to centralize the civil processing of offshore voluntary disclosures and to offer a uniform penalty structure for taxpayers who voluntarily come forward. These steps were taken to ensure that taxpayers are treated consistently and predictably. [Emphasis added.]That has not happened. We still have “potentially onerous civil penalties” except we have the implicit promise that “20% of high balance” is the FLOOR on what your “potentially onerous civil penalties” will be. We have a completely opaque, unpredictable environment for people who have messes they would like to clean up. In short, the six month “amnesty” (the IRS doesn’t call it that, but the real world does) made the situation worse, not better.
Modest suggestion
The IRS and the Department of Justice can — and should — chase and convict the Jack Barouh-type taxpayers. But there should be a completely different approach for regular people. I suggest that the IRS identify and expedite many run-of-the-mill Voluntary Disclosure Program cases in which the taxpayers experience the following results:- Pay the back taxes on unreported income, plus interest, plus a modest late payment penalty. Treat this unreported income just like any other normal audit.
- Impose the MINIMUM penalty under the guidelines for non-willful failure to file FBAR forms as outlined in the Internal Revenue Manual, or at least make it cheap for the taxpayer.
- Tell the taxpayer to “Go and sin no more” much in the same way you have a consent degree from the Securities and Exchange Commission.
A35. 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. If the taxpayer disagrees with the IRS’s determination, as set forth in the closing agreement, the taxpayer may request that the case be referred for a standard examination of all relevant years and issues. At the conclusion of this examination, all applicable penalties, including information return penalties and FBAR penalties, will be imposed. If, after the standard examination is concluded the case is closed unagreed, the taxpayer will have recourse to Appeals. See Q&A 34. [Emphasis added].See, the IRS gave itself an “out.” These cases can be proactively settled by the IRS as regular audits, with minimal (maybe zero) penalties. Publicize this, IRS people. Heavily. Break your arm because you’re patting yourself on the back with such vigor. 🙂 By doing so the IRS will demonstrate that normal taxpayers with normal problems will have nothing to fear. The Jack Barouhs of the world won’t be getting a hall pass. The immigrant grannies will be able to breathe a bit. The integrity of the enforcement system will be enhanced, not harmed, if the IRS brass understands the difference between those two categories of taxpayers.
Phil
Noted!
Will check sources.
and report back.
Peter
@peter – yes the big question is whether a transfer can be done under pension rules. Traditionally the employee has a vested right to receive pension benefits at some point in the distant future, and that right cannot be (easily) transferred, if at all.
Phil
As I see it, where one person is UK or non-US, it might be possible to transfer the fund into the hands of spouse, leaving the US tax payer with no interest. This would remove the pension trust from reporting.
Assuming this is possible under Pension Rules.
This would keep the future pension in the hands of the family and out of the clutches of US.
Also it is possible to give up US citizenship and not have to report again.
For many, this might be a relief.
I just received form 906 and they are asking for more than 60K in penalties for a wrong figure on form 4549-A. I’m trying to see if this number can be fixed. I can’t understand why they are doing this to regular people. I’m already 75 years old and at this point I can sleep, nor eat properly due to this letter.
I sincerely don’t know what to do. I wonder though how this will effect the economy, who will go shopping thinking that one might have a large penalty waiting to be collect.
This is truly unjustified because we are being penalized, for something that even till date, some tax professionals are still unfamiliar with, let along a person who does not understand the tax law and was never advised.
I hope something can be done to change this.
I’m an immigrant from France, an I also went into the program for an account I have there, that had been opened 20 years ago (and credited) by my parents. This account had a small interest rate (2%) and I suppose I should have paid interest on this…so I’m trying to get that done.
What bothers me the most is not so much the penalty, than the IRS propaganda that offshore accounts are a major cause of missed revenues, and that “people should be prosecuted to the full extent of the law”.
The IRS openly states that the tax gap is 14%, meaning that in average, people voluntarily pay 86% of the taxes they owe. If you try to put the good guys on one side and the bad guys on the other, this seems like the best criteria. So my question is, can you justify imposing hefty penalties on someone who paid 99% of their dues, and the remaining 1% is due to the (undeclared) interest of an offshore account ?
When the IRS claims an 86% tax gap, it already tells to all the people who pay more than 86% : “You are been robbed by the others”. Yet because of your offshore account, we’re going to make it look like you’re the bad guy, and take a bit more from you.
The thing is, if everybody paid 99% of their dues, the tax gap would be 1%, and the IRS probably wouldn’t bother going after the remaining 1%.
So I’m wondering about the real meaning of “In God we trust”, written on every bill. I suppose, as Elwood said, that He works in mysterious ways…
Phil, I have some suggestions for anyone in the “Program”-WATCH your
lawyer-I had to fire my first one-Their hourly rates I found to be very high.I did a lot
of the work directly with my revenue agent and I think that I saved some fees. If you
don’t cooperate they will tell you”you can simply leave the program”. Then what
option does one have-not a very good one. I went ahead and had my amended
federal and state returns done by a CPA-watch that too. I paid my amended state
taxes due plus interest and penalties before my case was settled. Also I had to
file a #1116 Foreign tax form to recoup some of the taxes I had paid to Switzerland.
The best I can say is “just settle” if you are in the program. CB
@fred – I don’t have the skill set to answer this. However my general sense is that the courts defer to the bureaucrats when the bureaucrats impose penalties. As long as the penalties are within the approved range the courts go along with them. The exception is at the extreme: death penalties for parking tickets. This is where you would get an ACLU type of organization involved.
Can tax laws which may potentially be discriminatory be challenged in court?
For example, the ACLU has successfully challenged other laws.
Carol, since you have finished the program I think you should consider being loud and public about the treatment you received. It is a complete abomination. By publicizing what the IRS is really doing you can help drive a wooden stake through this vampire.
Your comment about the revenue agent’s hands being tied — absolutely. This is not a problem at the revenue agent’s level. This is a failure of leadership at 1111 Constitution Avenue. It builds career at the expense of public policy. It callously and unnecessarily damages individual lives.
@Fred, if you look at people with money in pension plans (like you) there is a basic problem with the IRS approach. Technically the pension plan is a foreign trust and you are the beneficiary of the foreign trust, with all of the IRS paperwork that is spawned by that characterization. The penalties are staggering. You can’t get at the money because it is a pension plan. The IRS figured this out for Canadians with RRSPs a few years ago by publishing Form 8891. They still haven’t figured out that the same concept applies to people with money in ISAs (the U.K. analog to American IRAs or Canadian RRSPs). As for “normal” pension plans? Good luck. The U.S. tax system can’t figure those out.
And yes I have seen exactly what you describe — people have money stashed quietly and safely somewhere for entirely non-tax reasons. Holocaust. Fleeing the overthrow of the Shah. Eastern European confiscation as you have described.
In my case the funds came from a company retirement pension plan while working in Switzerland as well as inheritance. My father , who was a joint account holder, strongly felt that we should keep an emergency secret fund. He lived in eastern Europe were everything he owned was confiscated by the Communists, then went to Brazil where he lost his savings in the 50s and 60s twice, due to revaluation or freezing of bank accounts by the government. In all these situations, reporting a foreign bank account would have targeted him, and with the current controls and paranoia towards anything foreign now in the USA, I wouldn’t be surprised if this will someday happen here. I am in VDP and am waiting to hear from CI and/or IRS. Had my Swiss pension been in the States, the pension would have gone into a tax-free IRA and the inheritance taxed normally. I feel the IRS practice is taking unfair advantage of individuals who saved overseas and is exploiting the circumstances of foreigners and immigrants. It is always convenient to punish and tax a foreign minority, as opposed to investigating and taxing individuals who are closer to the home base.
This is a political situation, so please write to your public representative.
Phil, I am in the Program, paid the 20% penalty, back taxes which didn’t amount
to a total of $5,000, interest on the back taxes and a 20% penalty on the taxes
owed. The program is draconian. Also every other week the revenue agent
calls and tells me I need to sign another paper for the IRS. I must say that the
agent I think “has her hand tied”. If they can’t handle this program how will the
government ever deal with health care. It has been a TERRIBLE stressful
experience for me. I even ipaid my 35% Swiss bank withholding taxes each
year and never withdrew any funds from my account. CArol
Phil, Be sure and put me on your list. I think that I will have lots to tell the
people before the IRS is finished with everyone. I don’t think that the
program was well thought out. Carol
Phil, Be sure to put me on my list.
I am currently in the OVDP and have paid my 20% penalty, back taxes which
did not even amount to $5,000 and paid a 20% penalty for the taxes not paid.
I paid the 35% Swiss tax on my account each year and never withdrew any
funds from the account. Also every other week the revenue auditor calls
and tells me there is something new in the program and I need to sign some
paper. I don’t think that I will ever get finished with this issue. I feel that
this is a draconian program . I have found my revenue agent to be very
professional but I think that “her hands are tied” I would like to be on your
list.
@Kronos, this is now set up and operational at http://foreignbankaccountamnesty.com/forum/. You can post anonymously as a guest. You do not have to set up an account and provide contact information.
Please post something in the forums and tell the world what you think about the offshore bank account enforcement program.
Thank you for your answer and please organize this blog.
Phil –
Suppose a taxpayer has paid all taxes and filed all forms and is delinquent on FBAR only. As you point out, the government has therefore suffered no loss or damage.
Does not the 8th Amendment to the Constitution apply?
“Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted. “
@Phil
Great idea to get an anonymous discussion website/forum operating. I think more visibility of real stories of what is actually going on (i.e. shakedown of immigrants and expats) on is a great thing. I really look forward to it… thanks!
A comment on the success of the VDP: Here are some numbers I scraped together from various places on the interweb over time (I’d have to relocate the references to make these more credible).
Number of FBARS filed in 2007: ~300,000
Number of Americans living overseas at at one time: ~6 million
Number of immigrants to US getting green cards each year: ~1 million
If me make some more spurious assumptions:
We assume that 1/3 of all expats have opened local bank accounts in their guest country and have more than $10K in them;
And we assume that 1/3 of immigrants getting greencards arrive with accounts containing more than $10K in their home countries;
And we add all these expats with (say) six years worth of immigrants, (all with the fbar requirement) together
–>Then we get (6m/3) + (1m/3 x 6) = ~4 million people needing to be filing fbars.
Which means that the VDP brought forward less than 0.5% of the non-compliant taxpayers (on top of the less-than-10% who are currently filing fbars).
Successful program? I’d say not.
By all means question (or deride) my numbers and assumptions, but I think the order of magnitude is about right.
Phil, excellent article.
The above discussion has turned to the alleged success of the VDP. Of course the IRS has claimed it to be a success, when 14,700 taxpayers came forward. But on a dollar basis, success is questionable. Based on what I have seen, people with lots of offshore money, let’s say $10M+, once I tell them how large a check they will be writing to the IRS to become compliant, they elect not to enter the VDP and hope they will squeek by without discovery.
@NK –
You’ve identified a key question when you used that phrase “ultimate goal.” I suspect the government has several conflicting “ultimate goals” in the Voluntary Disclosure Program. Some “ultimate goals” serve the country’s revenue stream. Some serve individual career advancement motivations. That’s why it isn’t working.
We must of course expect the program’s evangelists to sing its praises loudly despite appearances to the contrary. We can only hope that in the quiet of their own hearts there is some self-honesty, openmindness, and willingness to effect a change in direction.
@Kronos – I agree that the voluntary disclosure program could be reworked for the benefit of all — the Treasury would collect more money, enforcement standards would be upheld, and taxpayers would be more likely to fly straight.
This is not a legal problem. This is a political problem. Solving political problems is beyond my skill set. I know how to write, how to talk, and how to solve intractable problems. I am not a politician.
Here’s an idea. Let’s see if we can set up an anonymous website for people like you to comment and tell your stories. If there is a critical mass of real people telling the truth, perhaps that is a start. I’ll get something set up and let everyone know. No one out there in the “real” world understands what is happening here. Ordinary people think anyone with a foreign bank account must be a criminal. Time to change that, I think. That would be a start.
I’ll post when this capability is operating.
Unfortunately the IRS has declared it a huge success. The main reason is that previous initiatives have been much less productive and in the typical year they handle less than 100 disclosures. Depending on how many people are out there with these issues, 14,700 is probably a drop in the bucket. The real shame is that there has to be a better way than to have such draconian potential criminal and civil consequences that are probably a deal breaker for many. I think Phil hit the nail on the head by comparing the willful vs. the non-willful senario. I guess it depends on what the ultimate goal is. Is it to bring folks back into the fold who may have been careless or ignorant or is it to just scare the hell out of folks to the point that a few come in but many more are afraid to act? Now with the end of the initiative, there is more uncertainty for those who did not step up. When you look at the folks who were turned in by UBS they all seemed to get a limited incarceration if any along with a 50% FBAR for 1 year as well as paying back tax with interest and a penalty. I guess that is the ceiling to this point but who knows what the future will bring. It just seems so uncertain and potentially horrible when it could be so much more straight forward while reaping better results for the government. It’s kind of like how the Laffer curve works for generating revenue.
Take a few less pounds of flesh from many more and have many more back in the fold for the future.
Phil,
As we all know 14.700 is a very small number and the IRS knows that it cannot claim it as a big success.
I know many holders of “clean offshore accounts” who would like to regularize their money if they were offered an easier deal (like the italian deal). That would be good for the US: this money would then become taxable every year in the country.
In addition, it would be subject to the estate tax, if and when congress makes a decision in 2010. The estate tax uncertainty is a strong reason why many people did not come forward for the V.D.
The July 2008 “exit tax” and “covered expatriate” totally unfair status for green card holders were also substantial reasons who pissed off people in doing the VD.
My suggestion: you regroup all people who have made the V.D. or who would like to make it, to fight the incredibly onerous FBAR penalty. Why on the highest amount? why does the account in foreign currencies has to be converted to the $ exchange rate at year-end, most favorable if you look at the numbers, to the goverment.
Why so hard when the base penalty is supposed to be 10 k$/year?
If you could convince the government, to change their approach and reformulate the VD program, I believe it would be a win-win for all.
Wiil you embark in doing it ? And if for your own reasons you do not feel you should do it, do you have any suggestions as to whom could undertake it?
@NK – I too have seen many people choose to remain in the shadows rather than announce themselves to the IRS.
As for the comparison of the U.S. and Italian amnesties, there must be some Puritanical/Calvinistic DNA in the U.S. tax authorities that causes them to think that Sinners Must Be Punished. The Catholic view is considerably more relaxed. 🙂
Phil
Yes indeed. I can relate to this post as I am an immigrant thats all in the program. I have read that the Italian amnesty has been a huge success for both the participants and the Italian fisc. The Italian program seems to have been straight forward, had reasonable costs for the participants and generated a lot of revenue for the government while bringing many back into the system. That sounds like win win. Unfortunately, the US program required you to have nuts of steel just to get through the CID part. Talk about walking around with a tight sphincter of the rear end until the magic letter arrives! Then you go through the unknowns of the civil side of things feeling like an insect thats about to get squashed. Really scary and no suprise to me that different tax practicioners have stated that many have stayed in the shadows. As I understood it, even if you had an unrelated red flag on your IRS account you could be rejected for the program and then run through the meet grinder by both CID and Civil. No wonder many are in the shadows and now they will be even more fearful to come out from the cold as all the harsh rhetoric is fully in play. As for me, I am waiting for the bell to ring and the tab to be presented. I hope I come out with some skin left on me! Still I am thankfull to put this behind me and move on with my life and get my kids through college. If you are in this situation…my best advice would be to get a good attorney and get it behind you. As scary as it has been, I would do it again because its the right thing to do.
God Bless America
@CoE, the holocaust money situation would be particularly ironic if it weren’t so sad. I’ve seen this too.
Phil
Thanks for posting this Phil. It’s a good analysis of the situation. As an recent immigrant who is in the VDP due to my home-country accounts that I left behind, I can only hope that the IRS is looking at ways to make sure that penalties are flexibly applied with the consideration of the circumstances of the case.
One thing that is intrigues me is the potential for “blowback” on the government from this whole exercise if the penalties are ruthlessly applied. 14,700 participants, many thousands of which will have very compelling stories of being victimized by this, and the ease of getting these stories into public view via the internet. The line about supposedly targeting “wealthy tax evaders with hidden Swiss accounts” may come back to haunt the people who architected the VDP.
For example, I understand there are quite a few holocaust survivors in the VDP with family money in European accounts that escaped confiscation by the Nazi German government. To have that same money successfully confiscated by the US government 60 years later sounds like a headline that writes itself.