Of Fear and Hostages: A Mid-Sight Editorial on The OVDI Program and Extortion (8/1/11)

I write tonight an editorial comment on the OVDI program (and the OVDP program as well). Hindsight, they say, is always better than foresight. When the IRS designed these programs, the IRS did not have the benefit of hindsight. Nor, of course, do I have the benefit of hindsight. I must address the program mid-sight, which is where we are.

My mid-sight view of the OVDI (and its predecessor OVDP) is that it has some very rough edges -- some basic unfairness issues that the IRS should move affirmatively to address and resolve. I doubt that the IRS will listen to me, but I offer my views anyway and hope that the IRS or Congress will listen -- not because this is my issue but because the concerns I address are the concerns of many people who are hurting because of the way the IRS is administering the program and because of fears as to the way the IRS will administer the program.

Let me start with a stark example.

Taxpayer A, an individual, diverted untaxed money offshore during the 1990s, let's say $100,000,000, on which he evaded $30,000,000 in U.S. tax (not considering the interest and penalties since). The money sat in a Swiss bank and earned reasonable return (at least reasonable compared to what the Swiss pirates would permit him to earn after they took their share of U.S. tax thievery).  In order to assure secrecy, Taxpayer A hid the Swiss bank account in layers of tax haven entities, having no purpose other than to hide the U.S. tax cheating and steal from the American people. The account and the entities continued into 2011 when Taxpayer A decided that, for a relatively small amount demanded by OVDI 2011 -- small relative to the aggregate amount of his cheating -- he could effectively launder everything with the blessings of the IRS under the OVDI. Taxpayer A had a number of enablers throughout the existence of the account and the entities. So Taxpayer A joins the OVDI, and he pays only (i) tax, accuracy related penalty, and interest on the tax and penalty for 2003 - 2009 and (ii) 25% of the highest amount in the account for the highest year from 2003 - 2009. To be sure, because the account was large and his cheating was large, the dollar cost is large, but it is small in comparison to his overall stealing from the U.S. taxpayers. He is more than willing to pay that to launder the money, get it back into the U.S. and laugh at the U.S. taxpayers as the suckers he has played them for.  He is home free.

Now, let us consider Taxpayer B, also an individual, who prior to 2006 was a citizen and resident of Country X. Taxpayer B has no obligations whatever to the U.S. prior to 2006. Taxpayer B earns money from his sweat labors in Country X and pays all applicable Country X taxes. He builds a nest egg of $200,000, all of which is deposited equally in 4 Country X accounts at different banks in the area in which he livevs and is fully tax-paid in Country X. In 2006, the taxpayer gets a green card and moves to the U.S., the land of opportunity as we and the world imagine the U.S. to be (at least we like to imagine the world imagines that). He loves his new country and wants to become a citizen. He goes to a tax preparer who may or may not have asked him about foreign accounts (probably didn't but that is shrouded in cultural differences); in Country X , foreign income is not subject to Country X tax and this is the mindset in which Taxpayer B views the world. During the years 2006 forward, Taxpayer B's nest egg earns a measly 1% net ($2,000 per year) upon which Taxpayer B pays Country X tax so that Taxpayer B's net U.S. tax is $50 per year. But, Taxpayer B does not report that the income, claim the Country X tax credit or pay the resulting $50 per year tax liability. Taxpayer B, whose culpability toward the U.S. tax system is far, far less than Taxpayer A's, has the same relative toll charge as Taxpayer A and, indeed, on a relative scale Taxpayer B's toll charge is far larger, because Taxpayer B was U.S. tax noncompliant for only a few years and in a relatively far smaller amount.

Why would anyone design a program that has that effect? I don’t understand it.  And, I think it is inconsistent with the very laws and intent of the laws the IRS is charged with administering.

First, let's see what those laws, as designed by Congress, would do with A who clearly intended to and did cheat the American people out of vast sums of revenue. As to the income tax, the law would create an unlimited statute of limitations for all years and would impose a 75% civil fraud penalty, with interest on both the tax and the civil fraud penalty. Further, as to the FBAR failure, at least for the open years (6 years), the law would impose a 50% penalty per year for the open years. Even if imposing the penalty for all years may create constitutional problems, imposing it for one or two years (100%) might not because of the egregious circumstances. See e.g., Bajakajian. So the IRS is giving up all that for the meager (a relative term) payments required of Taxpayer A under OVDI.

Now, look at what the IRS is extracting from Taxpayer B -- who on any relative scale is a taxpaying saint compared to B. The same "punishment." In these two situations, once the benchmark is set by Taxpayer A, Taxpayer's punishment does not fit the crime, if indeed there were any crime by Taxpayer B to start with.

It is true that the IRS offers -- at least facially -- a safety valve for relative innocent taxpayers to avoid the type of punishment visited on Taxpayer A. They can opt out of the program. The problem is that the IRS has done nothing to alleviate the legitimate concerns of these taxpayers who are more or less like Taxpayer B that they will be treated harshly in the uncertain penalty regime offered by audit on opting out. They are scared as to the IRS's fairness in administering audits on opt out. Like President Obama's yielding to the tea party extremists, they view themselves as having little choice but to yield to the IRS's extortionate program rather than risk the IRS's wrath on audit. I would like to think that their fears are not warranted; I would like to think that the IRS will administer the opt out audits fairly and treat taxpayers like Taxpayer B on a fair relative scale to the largesse that has been granted to Taxpayer A. But I can't assure taxpayers like Taxpayer B that the IRS will be fair. I have to tell them that I hope the IRS will be fair and as a citizen I want the IRS to be fair. But I can't guarantee them that they will be fair.

It is true that the opt out procedures are still in their early stages of being applied. So I don't even have anecdotal evidence that the IRS will be unfair. But, I think that the IRS could be a lot fairer if it started disseminating, perhaps through FAQs or examples, assurances to these people who deserve fairness that the IRS will be fair.

I am concerned that the IRS does not have any idea as to the damage it is doing among this group of people whose footfault was small on any relative scale and in many cases non-existent in terms of culpability (they really did not know they had income tax and FBAR reporting obligations). I urge the IRS and, if not the IRS, the Congress to have enough empathy to address the question of fairness in the program.

Correction as of 8/2/11 7:40am.:  Because of one comment below I changed Taxpayer B's original country from India to Country X.  Scenarios that are not materially different in terms of establishing Taxpayer A as the greater culprit vis-a-vis the U.S. tax system can be constructed with India and, I am sure, are encountered by practitioners regularly.  But, since I needed a crisp example, I just changed to generic a generic country, Country X.  Thanks for the comments.