Monday, August 13, 2012

A Stupid -- At Least Unfair -- IRS OVDI/OVDP Trick; Denying Overpayment Credit for Barred Years (8/13/12)

I write to rant about a practice inside the OVDI/OVDP civil penalty structure.  I start with the relevant Code sections, 6501, here, and 6511, here.  Section 6501(a) provides a 3 year statute of limitations for assessments.  Section 6501(c) provides certain exceptions to the 3 year limitations on assessments.  The key exception for present purposes is the Section 6501(c)(1) "a false or fraudulent return with the intent to evade tax," for which there is no statute of limitations.  (I ignore the 6 year statutes of limitations that might apply, and assume for present purposes they do not apply.)  Section 6511(a) provides a statute of limitations for refunds.  Basically, the taxpayer filing a timely original return and paying the tax has 3 years in which to file a claim for refund of the tax.

The OVDI/OVDP programs have involved a lookback window from 2003 forward.  (I ignore the possibility of a later starting date under 2012 OVDP but even if a later starting date were involved, the concepts discussed in this blog would still apply.)  The taxpayer is required to file amended returns during that lookback period and pay all applicable taxes.

Commenters to other blog entries have noted that, if there are refunds due for years for which refund is barred under the above rules, the IRS will not give the taxpayer credit for those refunds against taxes reported on the amended returns for years in the lookback window.  Here is an example:

2003 – additional tax reported on the OVDP/OVDI amended return - $1,000.
2004 – refund of tax paid with original return but claimed for first time on OVDP/OVDI amended return – ($1,000)
2005 – additional tax reported on the OVDP/OVDI amended return - $1,000.

Assume the years 2003-2005 are closed for assessments and refunds.  As to assessments, assume that the IRS has not made a specific finding of fraud as to the taxpayer and, should it investigate, could not prove fraud by clear and convincing evidence so as to invoke Section 6501(c)(1).   In this case, the IRS will not give the taxpayer credit for the $1,000 overpayment for 2004, even though it collects the underpayments for 2003 and 2005.

I have not experienced the barred year refund / credit denial in my filings.  Upon polling a group of practitioners, I find that others have experienced it.  As I understand the reports of the IRS's position on this issue, the IRS asserts that Section 6511(a) is a bar.   Some of the practitioners think that the IRS reading is correct and that it would be illegal for the IRS to credit the refund amount for the barred year.  Textually, of course, that is exactly what Section 6511(a) says.

I hope readers can see, however, a lack of symmetry here.  Although not worded in exactly the same text, the concept in Section 6501(a) is the same.  It is illegal for the IRS to assess taxes for a barred year and, if the IRS does that, any amount paid is an overpayment of tax for which the taxpayer is entitled to be credited and the IRS should refund or credit it.  Section 6401(a), here.  So, how is it that the IRS can refuse to do the supposedly illegal act (the refund outside the Section 6511(a) period) when it does the other illegal act (the assessment outside the 6501(a) period)?

Some practitioners perceive no lack of symmetry here because the taxpayer, by entering the program, is agreeing to the illegal assessment, whereas the IRS is not agreeing to the illegal refund.  I view this as nothing more than a statement that the IRS sets the rules of this game, and it has decided to impose this asymmetrical rule.  It is not a justification for being inconsistent.  Nor is it a justification, because of the inconsistency, to be unfair, in my view.

Some practitioners have asserted that, well, under the program the IRS just assumes that everyone committed fraud with a resulting unlimited statute of limitations via Section 6501(c)(1).  My argument to that is the same as Vinny's responsive argument in My Cousin Vinny, here, paraphrased, "That's bullshit."  Speaking from my experience, very few of the participants committed fraud -- at least fraud that the IRS could meet the civil burden of proof of fraud by clear and convincing evidence.  The IRS makes no finding of civil fraud and cannot, in my judgment, invoke Section 6501(c)(1) simply by making an assumption that is contrary to fact in many, perhaps most cases.  The IRS has to at least work the specific case and believe that it has sufficient facts to assert fraud by clear and convincing evidence before it can assert the consequences of that finding upon a taxpayer who, after all, is a citizen of the U.S.  It is patently not true that citizens joining the program are admitting fraud and thus relieving of the IRS of its predicate obligation to make a good faith finding of fraud specific to the taxpayer involved.

So, I am not convinced of the merits and fairness of the IRS hiding behind Section 6511(a) as a basis for being inconsistent and fair in this program.  But, I do recognize that the IRS makes the rules, so the better response for the IRS to make when asked why they are denying a credit for the otherwise barred year is that "We (the IRS) makes the rules."  At least that is a more honest answer, in my mind, for as I indicated, if the IRS can get past the requirement that it not make illegal assessments, it should be able to get past the requirement that it not make illegal refunds.  Basically, as I perceive the program, it is a program where the IRS can make the rules regardless of statutes of limitations and the taxpayer; the IRS can agree to reach a settlement requiring payments regardless of the statutes of limitations.

I would suggest as one solution, albeit partial, is that the IRS could permit a credit for an otherwise barred refund year against assessments due for an otherwise barred assessment year.  At least that would bring some partial symmetry.  This is just a small way in which the IRS could make the program more fair, in my view.

I would appreciate readers' comments.


  1. Jack, many thanks for speaking out on behalf of taxpayers. In case of opting-out, this issue will go away --- it will be illegal on both side to open years that are closed due to SOL.

  2. Well, Jack. Your headline got my attention, and I hope it will get the attention of IRS lurkers reading here. I appreciate you speaking out forcefully. You don't rant often. Your normal measured commentary makes this blog post all the more note worthy!

    The IRS continues to lose trust under their administration of these ridiculously complex and technical programs, and frankly, like the "bait and switch" of 2009 OVDP, they don't seem to care, or at least they do not respond! I really don't get it! Is it an internal mindset, or an unwillingness to politically admit to faults.

    Just because they write the rules and CAN do something, doesn't mean that they SHOULD do it. However, time and time again, they seem to make the wrong decisions. This stems from Leadership moral bankruptcy in my opinion. Shulman is leaving soon, although given the ITN and child credit scandal in the homeland, I wished he would be kicked out sooner, just on principle. But we know that as in Wall Street, there is no accountability anymore. If he were half a man, he would resign now, and not wait for November.

    For readers who haven't seen or followed this story, I will post these again. and

    That said, Stephen Miller, is in the wings to at least be the temporary commissioner, until a new one is chosen and confirmed. At least that is my bet. but I could be wrong. Given his involvement in the 2009 "Bait and Switch", I am not hopeful for any change of direction.

    Next milestone, for testing the "IRS restoring trust" meme, will be the release of the details of their so called amnesty for certain super minnow Expats with only small amount of offshore tax deficiency.

    Let's see how technical and narrowly drawn it is, and what new traps lurk beneath the details. That will tell us a lot about any new found enlightenment at the top!


  3. OVDI has never been about fairness. It has always been a one-sided way of milking
    the maximum amount of revenue from taxpayers even when it is clear their facts
    are benign and they are acting in good faith.

    You asked what readers think. As an OVDI victim, I had already written off
    the $315 refund I am owed for 2006 based on the two year refund claim
    limitation. This refund more than wipes
    out the $313 I owed in total for the non-compliant years between 2007 and 2010.

    For me it is all relative. While it is unfair, of bigger concern to me
    are two other matters where I am worried about the unfairness of the IRS.

    A major concern, considering what I owed in my last 3
    non-compliant years, is whether there will be a conversion program for overseas
    citizens already in OVDI to be treated under the same terms as those who try to
    become compliant now under IR-2012-65. The
    IRS always has tried to make sure that early entrants didn’t get penalized for
    being early, e.g., by making the penalties for those in OVDI greater (25%) than
    on those who entered in OVDP-1 (20%). I
    have no trust that the IRS will realize that it is punishing overseas citizens
    who complied before September 1, 2012 by joining OVDI, while rewarding those
    who waited with easier terms and conditions.

    My other concern is how the IRS will handle closed years
    once one opts out of OVDI. My
    ex-attorney told me that the IRS was unlikely to give back any money that it
    thinks is owed to them.

  4. I simply don't understand the concept of money owed not being paid, regardless of which side is involved. A bill should be a bill for as long as it takes for it to be settled.

  5. Jack,
    6511(c)(2) states as follows
    (c) Special rules applicable
    in case of extension of time by agreement

    If an agreement under the provisions of section 6501 (c)(4) extending the period for assessment of a
    tax imposed by this title is made within the period prescribed in subsection
    (a) for the filing of a claim for credit or refund—

    (2) Limit on amount

    If a claim is filed, or a credit or refund is allowed when
    no claim was filed, after the execution of the agreement and within 6 months
    after the expiration of the period within which an assessment may be made
    pursuant to the agreement or any extension thereof, the amount of the credit or
    refund shall not exceed the portion of the tax paid after the execution of the
    agreement and before the filing of the claim or the making of the credit or
    refund, as the case may be, plus the portion of the tax paid within the period
    which would be applicable under subsection (b)(2) if a claim had been filed on
    the date the agreement was executed.

    Wouldn't this mean that for the example above, you should have to pay only
    $1000 (ie get the credit for 2004)

  6. I don't understand why you think that would apply. Can you articulate your reasoning?


  7. Jack,
    If i am reading 6511 (c)(2) correctly, it states "the amount of the credit orrefund shall not exceed the portion of the tax paid after the execution of the agreement "

    If i apply the above to the example you have stated

    2003 additional tax to be paid to IRS + 1000
    2004 tax irs has to refund - 1000
    2005 additional tax to be paid to IRS + 1000

    since 2003, 2004,2005 are closed years under normal SOL and
    special rules (6511 c 2) apply for extensions, if IRS denies the 2004
    refund stating (6511 (a)), can you not under 6511 (c)(2), claim
    the 2004 refund since the amount of credit (1000 for 2004) does not
    exceed the portion of tax (which is $1000 for 03, $1000 for 05 a total
    of $2000).

  8. If you agree to open the years 2003-2010, then based on my understanding,of IRC 6511 (c) (2), you should be refunded $313 since that is the portion of tax you have paid for those years. (since this is less than $315, you will get the lesser of the these two. you will forfeit $2 , 315-313 =$2).

  9. I still don't understand what your point is. Maybe some other reader will understand it and respond.


  10. Jack

    Is this denying of refunds in the OVDI program 'official' IRS policy or is it just what agents (out of poor guidance or ignorance) are applying ? If the latter, then its possible that raising the basic unfairness of such an assessment might convince the IRS otherwise.

    The only legitimate reason for the IRS to not refund money in years where refund is due is the remote possibility that a wily taxpayer with no FBAR violation (or violations with minor amounts) might game the system by joining the program and submitting valid refund requests for closed years thereby ending up a net positive.

  11. As part of the OVDI submission, while amending say the 2005 tax return, can one claim a deduction that one had missed but that is unrelated to the foreign income? The net result in my case would be still a tax due to the IRS but less than what it would be otherwise. Is this allowed? Does IRS accept such an amendment , or are we allowed to amend taxes to only include previously (mistakenly) un-reported foreign income?

  12. yes. you can. I did the same for mine and there was no issues.

  13. Yes. The amended return should be complete and correct (see the jurat), so you should prepare a correct return. As I understand it, the IRS's only problem is if the correct return for the year shows a net previously unclaimed refund for the year.

    In the same regard, of course, since a correct and complete return is required, you need to correct via the amended returns any other errors on the returns whether related to the offshore accounts or not.

    Jack Townsend

  14. Jack, thanks you for posting this. It is important because it comes from a credible source, not just some anonymous poster but an attorney who has spoken with other practitioners about what is going on.
    This is really not about denying a $1,000 refund. The bigger picture is the bad publicity to the IRS and the voluntary disclosure program, and the harm it does to those on the sidelines considering a voluntary disclosure. I am one of the 35,000 who has entered OVDI but there are probably millions with foreign accounts, since there are 5 to 7 million Americans residing abroad and 35 to 40 million foreign-born US citizens.
    The IRS seems to be sending the message that the more forthcoming and cooperative you are, the worse they're going to treat you -- not a good message to send.

  15. I was notified by my OVDI agent that for the 1040x form, "only items related to OVDI are considered" and they would not allowed me to claim tax deductible amount that I forget to deducted in the original return for the closing year! Is the OVDI 2011 rule changed or it is just my agent's misunderstanding? Where could I find the help to make it fair?!

  16. It is NOT true: at least for my case.

    I was notified by my OVDI agent that for the 1040x form, "only items related to OVDI are considered" and they would not allowed me to claim tax deductible amount that I forgot to deduct in the original return for the closing year! Is the OVDI 2011 rule changed or it is just my agent's misunderstand. Where could I get the help to make it fair ?

  17. My kick in the gut today from the IRS was my closing statement. Years 2003-2007 and 2009-2010 I owed tax. All generated by the modified M2M for PFIC's. So a tax on fictitious gains from currency and temporary stock gains. Of course we add an accuracy penalty and interest on the penalty and tax. This interest of course projected through tax year 2008 were I was owned a lot of money. All this seemed so unfair but that wasn't enough. They denied my overpayment of taxes in year 2008 to really put the boot in.

  18. Did the Form 872 not cover the year 2008? If it did, the year should have been open to refund, but perhaps that only applies on the opt out. Just not sure but you might inquire.

    Jack Townsend

  19. You are allowed but not required to use MTM, and can use the default method for PFICs. This can be more complicated if yiu own a lot of PFICs or have many sales of them . I did not, and chose the default method.

    Unfortunately I also had foreign currency CDs and these generated a lot of gains one year, losses the next and so on, which really distorted the true picture of things.

  20. Here are the words from the IRS agent to describe what happened:

    > Generally, claims
    (amended returns) for refunds are allowed if filed within 3 years
    from the due date of the return per IRC 6511.

    So she is taking the position that if the M2M calc had created a taxable gain in 2008 then I would owe tax. Since it created a loss and hence a refund from my original filling then it's denied. As my PFIC's go up and down I can be taxed on the gains but denied the losses. That's a great game to be in if your in the IRS.
    The OVDP/I contains lots of tricks to take as much money as they can from you. Don't fall into the trap I did in entering it. It's a massive time and cost waste.

    I am familiar with the fact that I can use the default taxation for my PFICs and this decision by the IRS forces me to do this.
    I don't see form 872. I see 906.
    Thanks for your input.

  21. At some point (usually with the submission of the complete package) you submitted a Form 872, Consent to Extend the statute of limitations. For the years covered by that consent (and any further extensions required in the process), you should be able to claim a refund and the IRS should give it.

    Now it is true that the Form 872 was needed by the service to protect against an opt out. But it does cover the years that it covers and keeps the refund and assessment statutes of limitations open.

    Check your retained copies of all Forms 872 you submitted and if the loss year is still open, talk with the agent.

    Jack Townsend

  22. I found the form 872. It covers all the years. The wording suggests I should be able to get a refund:

    >(2) The taxpayer(s) may file a claim for credit or refund and the Service may credit or refund the tax within 6 months after this agreement ends, except with respect to the items in paragraph (4).

    My lawyer is talking to the agent to try and find out why they denied.

  23. You have to be careful about the years actually affected by the Form 872. The Form 872 is not valid as to years that were closed when the IRS signs the Form 872. So, even though it states it covers all years, it really does not. So, the drill is to determine whether the statute of limitations was open on the date the Form 872 was signed. If so, then you should be able to get a refund (provided that you have signed successive Forms 872 as the earlier ones lapsed, which, in my experience, is required under the program.

    Jack Townsend

  24. So I think the time to file for a return has lapsed. We didn't sign 872 till Apr 2013 and I expect time to file 2008 expired 4/15/2012. I never filed an update to that tax year either.
    Still a dirty trick my lawyer didn't warn me about that took me by surprise and made me mad as hell.

  25. Jack
    Isn't the form 872 largely irrelevant within the OVDI UNLESS one opts out ? Within the OVDI, the IRS gets to decide the rules of the game and can deny refunds even for years technically opened by the 872. Its certainly unfair, but that's the way it is.

    Now if someone were to opt out, then perhaps the extended SOL in the 872 could be used to claim a refund, assuming of course, that the relevant year was open when the IRS counter-signed. Even then, I suppose the IRS could claim that the form 872 signed in the OVDI was not stand-alone, but was part of a large submission (the OVDI), and hence is not valid anymore on opt out.


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