Criminal tax evaders have an easier time coming clean with the Internal Revenue Service than those who didn’t intend to hide money from U.S. authorities, according to Nina Olson, the National Taxpayer Advocate.
U.S. citizens who purposefully stashed money offshore can come forward, pay a set fee to the IRS and avoid criminal prosecution. The situation is more complicated for persons who unintentionally shielded assets from the U.S. They might learn that they could owe the IRS less if they backed out of the so-called voluntary disclosure program. That, in turn, could trigger an examination that might be more strenuous than if they participated in the disclosure initiative, Olson says.
The voluntary disclosure program is part of efforts to close the estimated $385 billion gap between taxes owed by U.S. citizens and corporations and the amount collected by the IRS. Olson warned Congress in a Jan. 11 report that confusion over the treatment of accidental tax evaders could hurt future collection efforts.
The agency’s 2009 voluntary disclosure program “appears to have been a great deal for those engaged in criminal tax evasion,” Olson said in her annual report to Congress. The IRS “is likely to have more difficulty gaining participation in any future settlement initiatives.”
Michelle Eldridge, an IRS spokeswoman, said the agency “strongly disagrees” with Olson’s findings.
The 2009 voluntary disclosure initiative was a “highly successful program that provided a way for taxpayers with previously undisclosed accounts and unreported income to come into compliance with the U.S. tax laws,” Eldridge said in a statement.
Olson operates as an autonomous figure within the IRS, working on behalf of taxpayers to resolve conflicts with the agency. Her report was sent to lawmakers two days after IRS Commissioner Doug Shulman announced that the agency would revive the voluntary disclosure program a third time. He said the agency collected $4.4 billion in the first two iterations of the program and is “gaining momentum” in its fight against tax evasion.
Meanwhile, it is fairly common for taxpayers to find that they didn’t declare some assets or pay taxes, without intending to evade their U.S. tax bill, said Kenneth Silverberg, a partner at Nixon Peabody LLP in Washington. He said he has clients who are dual citizens and didn’t realize they had tax liabilities in the U.S. Others, he said, inherit offshore accounts from relatives that were never declared. “I continue to be surprised at how many clients I have in these situations,” he said.
Beyond the disclosure initiative, the U.S. has prosecuted clients of UBS AG and HSBC Holdings Plc for tax evasion. Switzerland’s Weglin & Co. said on Jan. 4 that three of its bankers were charged with conspiring to help U.S. clients hide more than $1.2 billion from tax authorities.
Also, the IRS and Treasury Department are working to craft rules that would require overseas banks to identify customers who are U.S. citizens, making it more difficult for them to escape their tax bills.
The IRS voluntary disclosure program began in 2009 with a promise that participants wouldn’t pay a penalty higher than would be assessed under current law. In her report, Olson calls this pledge the “bait” that encouraged citizens to work with the IRS.
Cap on Penalties
The current penalty for a citizen who unintentionally fails to disclose and pay taxes on overseas holdings is capped at $10,000 for each instance. For some, that penalty could be much less than what he or she would have to pay as part of the voluntary disclosure program. In 2009, the IRS assessed participants a penalty that was 20 percent of their most valuable offshore assets or their largest bank accounts. That penalty increased to 25 percent in 2011 and 27.5 percent announced last week for 2012.
Olson’s report says IRS agents initially had discretion to lower the penalties in voluntary disclosure cases where the evasion wasn’t purposeful. That approach changed on March 1, 2011 when the IRS sent a memo to agents limiting their authority to reduce penalties. Olson said this memo was the “switch.”
Silverberg says one of his clients unintentionally failed to disclose income and pay the required taxes. His tax bill is about $4,000, and the IRS wants to charge him more than $550,000 in penalties.
Even though the client’s tax bill is relatively small, his penalty could be large because the IRS levies it against the participant’s largest bank account or most expensive asset.
“The IRS is trying to coerce people,” he said.
Eldridge, the IRS spokeswoman, called the bait-and-switch accusation “inaccurate.”
“The 2009 effort was a voluntary program that taxpayers could choose to enter into,” she said in a statement. “If at any time during the certification process a taxpayer disagreed with the results provided for under the program, the taxpayer could opt out of the program and make their case for lower penalties.”
Opting out of the disclosure program presents its own challenges, said Jorge Rodriguez, an attorney who has a tax practice in Washington and New York.
“The problem with the opt-out is the taxpayer almost certainly faces an examination and certainly faces a skeptical IRS agent reviewing their file,” he said.
Guidance released by the IRS said a taxpayer shouldn’t be “treated in a negative fashion merely because he or she chooses to opt out.” The agency outlined several examples where it might make sense for someone to leave the voluntary disclosure program, including when the taxpayer doesn’t have a deficiency even though the person didn’t report income.
Lawyers said they still aren’t willing to risk the examination process that might be triggered if their clients left the disclosure program. Silverberg said he is awaiting guidance from Shulman on whether IRS agents should have more discretion to reduce the penalties for those remaining in the voluntary disclosure program.
“I’m stalling,” he said. “I’m hoping it won’t be necessary to do the opt-out.”