GAO Report Targets Strategies Other than OVDP (4/26/13)

The U.S. Government Accountability Office (GAO) has released a report titled Offshore Tax Evasion:  IRS Has Collected Billions of Dollars, but May be Missing Continued Evasion (GAO-13-318, Mar 27, 2013), here.  The summary is here.

The summary page is here.

What GAO Found 

As of December 2012, the Internal Revenue Service's (IRS) four offshore programs have resulted in more than 39,000 disclosures by taxpayers and over $5.5 billion in revenues. The offshore programs attract taxpayers by offering a reduced risk of criminal prosecution and lower penalties than if the unreported income was discovered by one of IRS's other enforcement programs. For the 2009 Offshore Voluntary Disclosure Program (OVDP), nearly all program participants received the standard offshore penalty--20 percent of the highest aggregate value of the accounts--meaning the account value was greater than $75,000 and taxpayers used the accounts (e.g., made deposits or withdrawals) during the period under review. The median account balance of the more than 10,000 cases closed so far from the 2009 OVDP was $570,000. Participant cases with offshore penalties greater than $1 million represented about 6 percent of all 2009 OVDP cases, but accounted for almost half of all offshore penalties. Taxpayers from these cases disclosed a variety of reasons for having offshore accounts, and more than half of them had accounts at Swiss bank UBS. 

Using 2009 OVDP data, IRS identified bank names and account locations that helped it pursue additional noncompliance. Based on a review of cases, GAO found examples of immigrants who stated in their 2009 OVDP applications that they were unaware of their offshore reporting requirements. IRS officials from the Offshore Compliance Initiative office said they have not targeted outreach efforts to new immigrants. Using information from the 2009 OVDP, such as the characteristics of taxpayers who were not aware of their reporting requirements, to increase education and outreach to those populations could promote voluntary compliance.

IRS has detected some taxpayers with previously undisclosed offshore accounts attempting to circumvent paying the taxes, interest, and penalties that would otherwise be owed, but based on GAO reviews of IRS data, IRS may be missing attempts by other taxpayers attempting to do so. GAO analyzed amended returns filed for tax year 2003 through tax year 2008, matched them to other information available to IRS about taxpayers' possible offshore activities, and found many more potential quiet disclosures than IRS detected. Moreover, IRS has not researched whether sharp increases in taxpayers reporting offshore accounts for the first time is due to efforts to circumvent monies owed, thereby missing opportunities to help ensure compliance. From tax year 2007 through tax year 2010, IRS estimates that the number of taxpayers reporting foreign accounts nearly doubled to 516,000. Taxpayer attempts to circumvent taxes, interest, and penalties by not participating in an offshore program, but instead simply amending past returns or reporting on current returns previously unreported offshore accounts, result in lost revenues and undermine the programs' effectiveness. 

Why GAO Did This Study 

Tax evasion by individuals with unreported offshore financial accounts was estimated by one IRS commissioner to be several tens of billions of dollars, but no precise figure exists. IRS has operated four offshore programs since 2003 that offered incentives for taxpayers to disclose their offshore accounts and pay delinquent taxes, interest, and penalties. GAO was asked to review IRS’s second offshore program, the 2009 OVDP. This report (1) describes the nature of the noncompliance of 2009 OVDP participants, (2) determines the extent IRS used the 2009 OVDP to prevent noncompliance, and (3) assesses IRS’s efforts to detect taxpayers trying to circumvent taxes, interests, and penalties that would otherwise be owed. To address these objectives, GAO analyzed tax return data for all 2009 OVDP participants and exam files for a random sample of cases with penalties over $1 million; interviewed IRS Offshore officials; and developed and implemented a methodology to detect taxpayers circumventing monies owed. 

What GAO Recommends 

Among other things, GAO recommends that IRS (1) use offshore data to identify and educate taxpayers who might not be aware of their reporting requirements; (2) explore options for employing a methodology to more effectively detect and pursue quiet disclosures and implement the best option; and (3) analyze first-time offshore account reporting trends to identify possible attempts to circumvent monies owed and take action to help ensure compliance. IRS agreed with all of GAO's recommendations.
For more information, contact James R. White, (202) 512-9110 or whitej@gao.gov.

JAT Comments:

1. This report specifically targets the two strategies clients consider as alternatives to joining the OVDP -- the "quiet disclosure" strategy (meaning filing some number of amended income tax returns and delinquent FBARs) and the "go-forward" strategy (meaning no correction of the past, but being squeaky clean on filings for the future.
2. From the practitioner perspective, these two alternative strategies should only be considered if (i) the taxpayer has no reasonable risk of criminal prosecution and (ii) the taxpayer has no reasonable risk of the willful FBAR penalty.  This is where the taxpayer needs experienced counsel to make these judgment calls.  The two issues are different sides of the same concept -- except in a criminal and civil context.  I can't get into detailed analysis of that now, but diligent readers of this blog will have certainly picked up my thoughts on that by now.
3. If the taxpayer cannot reach BOTH of the conclusions in paragraph 2, the taxpayer should join the OVDP.
4. All of the taxpayers that I have counseled and who have implemented the alternative strategies have fit the profile in paragraph 2.  So their risks, if I have correctly assessed the risks, are only the possibility of audit and accuracy related income tax penalty a nonwillful FBAR penalty upon audit that will be less than the inside the program costs (including most prominently the "in lieu of penalty" which has ratcheted from 20% to 25% to 27.5%).  In effect, if audited, these taxpayers will achieve the same result as a favorable opt out.  (This may not be strictly accurate; I understand that, on opt out, the taxpayers with the audit profile may be able to avoid the accuracy related penalty since they have filed amended returns that should qualify as Qualified Amended Returns; so the benefit foregone from the alternative strategy possible relief from the accuracy related penalty for the open years.)
5. The report concludes that some taxpayers have implemented the alternative strategies without the conclusions in paragraph 2.  I can't speak to that, but I would just say that these taxpayers took a lot of risk in and, in effect, played the audit lottery with the downside risks greatly enhanced.
6. The report recommends that the IRS beef up its efforts to detect particularly the implementers of the strategies under the conditions set forth in paragraph 5.  Of course, in both cases, audits will pick up additional revenue and some potential for penalties (just as any audit would), but larger revenue will be available from the taxpayers implementing the strategies under the conditions set forth in paragraphs 5.  I do note, however, that the implementers of the strategy under the circumstances set forth in paragraphs 2 and 4 should be no worse off than had they joined the program and opted out (except with respect to QAR penalty relief).  In a sense, therefore, they too are playing the audit lottery, but there appears to be no or little downside to doing so.  And this is not the usual type of audit lottery because it only deals with the past and failure to correct the past; it does not deal with a situation involving a current compliance failure based upon the IRS's limited ability to detect and correct.  The strategy of not correcting the past is based upon the fact that there is no legal requirement to file an amended return or, by extrapolation, a delinquent FBAR where the failure to file has already occurred.  There may be prudential reasons to do so -- most particularly if it will avoid or mitigate the risk of criminal prosecution or avoid or mitigate the risk of draconian penalties.  But, where, under the facts, those risks are not material, the law's "permission" not to correct the past may be a good strategy.  (In this regard, I have said before that the IRS should sweeten the opt out penalty to be, for example, 1/2 the result that would be obtained on audit; that should attract many taxpayers with low risk profiles to join the program and thus come out noisily rather than implement either of the strategies to which GAO directs its comments.)

Addendum on 4/27/13:

Here are some of the key excerpts on the issues related to quiet disclosures and go forwards from the report itself (footnotes omitted):

IRS May Not Be Detecting Some Quiet Disclosures
_____________________________________________________________________
Quiet Disclosure Detected
According to the criminal information and plea agreement, a taxpayer held an account at HSBC Bank Bermuda. With the assistance of a business partner, the taxpayer arranged to have investment income in the amount of $297,816 wired to his business partner's secret account at UBS in Switzerland. From there, the taxpayer's share of the investment ($99,273) was transferred to his HSBC Bank Bermuda account. The taxpayer did not report this taxable income, or the interest income that accrued in the account, thereby avoiding $40,624 in taxes. Following the widespread media coverage of UBS's disclosure of account records to IRS, the taxpayer made a quiet disclosure by preparing and filing FBARs and amended Forms 1040 for tax year 2003 to tax year 2008, in which he reported the existence of the previously undeclared account. As part of the plea agreement, the taxpayer agreed to pay an FBAR penalty of $76,283, which was 50 percent of the high balance in the account. The taxpayer also faces up to 5 years in prison and a $250,000 fine.
____________________________________________________________________ 

We identified 10,595 potential quiet disclosures, a number much higher than the potential quiet disclosures identified by IRS. In a series of Questions & Answers that IRS first released on February 8, 2011 to announce the 2011 offshore program, IRS reported that it had identified, and will continue to identify, taxpayers attempting quiet disclosures.29 In the Questions & Answers, IRS stated that it would be closely reviewing amended tax returns to determine whether enforcement action is appropriate. (See sidebar for one example of a quiet disclosure being detected.) 

IRS officials told us that the Offshore Compliance Initiative office tested several different methodologies to identify quiet disclosures. First, IRS looked at amended returns during tax year 2003 to tax year 2008, the period covered by the 2009 OVDP, and removed any non-offshore related adjustments, such as filings status changes and additional exemptions. IRS also looked at amended returns with increased tax assessments over an established threshold during tax year 2003 to tax year 2010. 

The effectiveness of a third effort was questioned by IRS. In this effort IRS compared taxpayers with a history of filing FBARs in non-secrecy jurisdictions between tax year 2003 and tax year 2008 who filed delinquent FBARs processed in 2009 involving a secrecy jurisdiction along with an amended return. 

In 2012, a fourth effort, which was not designed to detect quiet disclosures, but to reroute misaddressed amended returns sent in by participants in the 2011 offshore program, was the most successful effort to find them.\ 

Together, these four efforts led to the review of several thousand tax returns. Of those, several hundred returns were identified as quiet disclosures. An IRS official told us that the tax returns that were identified as part of a quiet disclosure will be examined and that cases already examined had penalties assessed. Because they were quiet disclosures, the official said the taxpayers did not receive the reduced offshore penalty. 

Given the importance of IRS's ability to detect quiet disclosures and evidence that they exist, we tested a different methodology to identify potential quiet disclosures, and found many more than IRS detected. Unlike IRS, we looked at all taxpayers who, for the tax years covered by the 2009 OVDP 

• filed amended or late returns, and
• filed amended or late FBARs.

We then excluded 2009 OVDP participants from this population. While only an IRS examination can determine whether a potential quiet disclosure is an actual quiet disclosure, the 10,595 taxpayers that we identified have an unlikely combination of characteristics that could indicate that taxpayers are quietly disclosing. IRS agreed with our methodology as reasonable and appropriate. (See app. I for additional details about our methodology and app. VIII for a full breakout of our results.) 

Although any of the 10,595 potential quiet disclosures could be actual quiet disclosures, certain subpopulations raised more questions. First, we found 3,386 taxpayers that filed amended or late returns, and filed amended or late FBARs for multiple years. Second, we found that 94 of these taxpayers met the same criteria for all six tax years covered by the 2009 OVDP. 

IRS officials from the Offshore Compliance Initiative office told us that they had no additional work planned to identify potential quiet disclosures and had not yet decided to broaden the methodologies that they had tested, but they expressed strong interest in researching our methodology to identify taxpayers attempting quiet disclosures. We recognize that there are additional costs to using a methodology such as the one we used, but IRS has already committed resources to identifying quiet disclosures. Moreover, without rigorously and systematically searching for potential quiet disclosures, IRS does not have reasonable assurance that it is controlling such disclosures and collecting the delinquent taxes, interest, and penalties due. Exploring different methodologies that include a systematic evaluation of amended returns or late filed returns, along with amended or late filed FBARs, without too narrowly restricting either the amended return or the FBAR populations, and implementing the best option could provide this assurance. 

Increases in Taxpayers Reporting Offshore Accounts May Also Indicate Attempts to Circumvent Some Taxes, Interest, and Penalties that Would Otherwise be Owed 

Data from IRS's SOI division and from FinCEN show that the number of taxpayers reporting offshore accounts on Form 1040, Schedule B and the number of taxpayers filing FBARs has increased significantly in recent years. From tax year 2007 to tax year 2010 (the most recent data available), IRS estimated that the number of taxpayers reporting offshore accounts on Form 1040, Schedule B nearly doubled to 516,000, as shown in figure 4. From tax year 2003 through tax year 2007, only about 1 percent of all taxpayers filing Form 1040, Schedule B checked a "yes" box in response to the question asking if they owned or controlled a foreign financial account, but that share increased to more than 2.5 percent by tax year 2010. Furthermore, FinCEN has reported that the number of FBARs filed more than doubled, as shown in figure 4. Both the increase in the number of foreign accounts reported on Form 1040, Schedule B and the increase in FBAR filings are significantly larger than the approximately 39,000 taxpayers that came forward in one of IRS's offshore programs. 

There could be legitimate reasons for these trends. For example, taxpayers could be reporting new offshore accounts or taxpayers who had always reported income from offshore accounts on their tax returns could be filing FBARs and reporting the accounts on Form 1040, Schedule B for the first time. This could be an indication of more taxpayers coming into compliance as a result of IRS's efforts to combat offshore tax evasion. 

Figure 4: Taxpayers Reporting Foreign Financial Accounts  [THIS FIGURE IS OMITTED HERE BUT IS IN THE REPORT]

Source: GAO analysis of IRS Estimated Data Line Counts Individual Income Tax Returns for tax years 2003 through 2010.

[ADDITIONAL FIGURE OMITTED]

 Source: GAO analysis of FinCEN annual reports.

Note: IRS Form 1040, Schedule B, Line 7a includes a yes/no question asking taxpayers if, at any time during the tax year, they had an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account. The figure contains IRS estimates of the number of forms in which a taxpayer answered "yes" to this question. 

Under the Bank Secrecy Act, U.S. residents or citizens with a financial interest or signature authority over one or more foreign financial accounts with a total of more than $ 10,000 are required to annually file form TD F 90-22.1 Report of Foreign Bank and Financial Accounts (FBAR) with Treasury. The FBAR must be filed for the calendar year by June 30 of the following year. The figures above are the number of FBARs filed during a fiscal year as reported in FinCEN annual reports. 

However, such a sharp increase in foreign account reporting amidst the global economic recession and the publicity surrounding IRS's offshore programs raises the question whether some of these taxpayers may have attempted to circumvent some of the taxes, interest, and penalties that would otherwise be owed in the offshore programs. Unlike taxpayers attempting a quiet disclosure, who would still pay taxes plus interest on previously unreported income covered by the programs, and possibly an accuracy-related or delinquency penalty, these taxpayers would only be paying taxes on the offshore income earned for the year reported. 

An IRS official from the Offshore Compliance Initiative office told us that although the office has coordinated with IRS's Planning, Analysis, Inventory, and Research (PAIR) office, they had not discussed Form 1040, Schedule B or FBAR filing trends, and that he was not aware of the sharp increase. As of January 2013, no projects were planned to research Form 1040, Schedule B filing trends. However, the Offshore Compliance Initiative office has asked PAIR to determine whether taxpayers who reported their offshore income properly, but had not filed FBARs, recently started filing delinquent FBARs, as directed by the 2009 OVDP instructions. This effort may not capture first time FBAR filers who are reporting existing offshore accounts as new. 

Because the increase in recent years in Form 1040, Schedule B and FBAR reporting of foreign accounts is measured in the hundreds of thousands, we recognize that it may be too costly for IRS to audit all of those filings. A less costly approach could involve, for example, IRS drawing a random sample of those cases and auditing them to understand whether taxpayers are trying to circumvent some of the taxes, interest, and penalties that would otherwise be owed in the offshore programs. One of the things that IRS could look for in such an audit is the date that the offshore account was opened. Such a sample could provide an estimate of the magnitude of any problem. As was the case with quiet disclosures, without such information, it will be difficult for IRS to provide reasonable assurance that taxpayers are not reporting, for the first time, offshore accounts that had been open for years to avoid paying delinquent taxes, interest, and penalties. 

Conclusions 

Despite challenges in detecting offshore accounts, IRS's offshore programs have been effective in compelling taxpayers to disclose their unreported offshore income. Through these programs, IRS has collected more than $5.5 billion to date, brought tens of thousands of taxpayers into compliance, and gained increased information on offshore noncompliance. It is unclear how many additional U.S. taxpayers have undeclared foreign accounts and how much unreported income is associated with those accounts. However, the number of quiet disclosures IRS was able to find (some by accident), the number of potential quiet disclosures we identified, and the sharp upswing in Form 1040, Schedule B and FBAR filings all suggest that the amount of revenue to be collected from previously undisclosed offshore accounts could be significant.
We found two key issues that, if addressed, could make IRS's offshore programs even more successful. 

IRS has not used program information to identify populations of taxpayers that would benefit from education and outreach regarding their offshore tax reporting obligations. Such information could promote voluntary compliance and reduce the need for enforcement actions. Additionally, IRS does not obtain information on how taxpayers learned about offshore programs. Without this information, IRS cannot fully evaluate its efforts to promote taxpayer participation in offshore programs. 

IRS may have missed taxpayers attempting to circumvent some of the taxes, interest, and penalties that would otherwise be owed in its offshore programs. Our methodology to identify potential quiet disclosures found many more potential disclosures than IRS detected. IRS may also have missed other attempts at circumvention by not researching the upward trends of taxpayers reporting offshore accounts for the first time. While there would be costs to such efforts, the amount already collected by the offshore programs suggests that considerable additional revenue gains might be possible. By identifying taxpayers attempting to circumvent some of the taxes, interest, and penalties that would otherwise be owed in its offshore programs, and taking appropriate action, IRS could potentially increase revenues, bolster the overall fairness of the program, and have a more informed basis for improving voluntary compliance.