Wednesday, February 12, 2014

Article Analyzes Counter-Intuitive Effects of IRS Offshore Penalty Structure (2/12/14)

In a comment, a reader directed me and other readers to a recent article that is quite good, so I decided to elevate the article to a separate blog entry.  The article is Patrick W.Martin & Michelle Ferreira, The 2013 GAO Report of the IRS Offshore Voluntary Disclosure Program (1/10/14).  The web version is here, and the pdf is here.  The authors' bios are here and here.

As the authors note, "the GAO Report indicates [that] taxpayers with little or no criminal or civil fraud exposure were punished proportionately in higher amounts than those who participated and had true criminal tax exposure."  The authors break these categories into Bad Actors and other actors, referred to as Benign Actors.  That Bad Actors would be treated better than Benign Actors is a counter-intuitive result.

The authors also analyse the data to conclude that, relative to aggregate collections from those who don't opt out, the income tax is relatively small -- i.e., 64% of the collections is the in lieu of penalty, called the "Offshore Penalty," and 36% is income tax, penalty and interest.

The authors state:
One key question that the GAO Report raises, is why would so many taxpayers enter into the Offshore Voluntary Disclosure Program if they were not at least as liable for income taxes or penalties under the law? The authors think the answer to this question can be simply answered. Neither taxpayers nor many of their tax advisors understand how tax penalties actually apply under the law, particularly because some penalties are not in the Internal Revenue Code. Instead of understanding what the requirements are under the law, taxpayers simply relied upon the  Internal Revenue Service to inadequately explain how penalties could apply in and outside of the Program. Based upon only the Frequently Asked Questions (which were published subsequent to the Program’s announcement), taxpayers and their advisors had to make swift and uneducated determinations as to whether a taxpayer should participate on the Offshore Program at all and many feared all would be criminally prosecuted, as the IRS continuously led them to believe. 
The authors state that the IRS pronouncements -- particularly the FAQs are not very helpful in given good information to help taxpayers and practitioners assess true exposure under the law, thus causing many of them to accept the OVDP program and the Offshore Penalty from fear rather than understanding.  Thus, the opt out procedure is not the safety valve that the IRS perceives it to be. More from the authors:

If a taxpayer does not understand how the complex law applies to their actual circumstances they can easily be misled into making a poor decision and participating in the OVDP; especially when faced only with the choices that are presented in the IRS materials. Many taxpayers are not getting better advice from various tax professionals, who themselves read the IRS website and pass them along to their clients, sometimes verbatim. These choices, in the author’s view are commonly a false choice of (a) losing a large portion, if not all of, their assets to penalties, or worse, going to prison; compared with (b) paying a certain percentage of their assets to the IRS in order to resolve their case. One can understand how and why almost all taxpayers faced with this choice would choose the one that would lead to a more certain outcome, instead of a choice that would most certainly be filled with anxiety, stress and confusion, especially if the taxpayer continued to go back to and read the IRS FAQs and answers, representing some 28 pages in length with more than 16,000 words of explanation. To be repetitive, in no part of the IRS FAQs, is there any attempt to explain how penalties under the law actually apply to any particular factual circumstances if the taxpayer were to NOT participate in the OVDP. To the ill-informed taxpayer, this necessarily would leave them in a deeply confused state, regarding the application of U.S. tax law. 
A layperson who has no real understanding of the complexities of the tax law (particularly in the international area) can be forgiven for their lack of understanding of legal concepts, which for many created the inadvertent mistake in not reporting their foreign accounts. Many U.S. taxpayers are unaware of their Constitutional rights and protections afforded to all U.S. citizen taxpayers in an audit, i.e. if they do not participate in the Offshore Voluntary Disclosure Program. The authors are of the view that many tax lawyers and CPAs do not themselves understand the complexities of the tax law; when penalties can apply under the law, and when a criminal act has actually been committed when evaluating a taxpayer’s options. The result is that many of these advisors may simply have neglected to truly advise their clients of the law and its application and the options available to each and every Benign and Bad Actor separately. 
I highly recommend that readers interest in this subject review and, as appropriate, drill down on this article.


  1. "... that many tax lawyers and CPAs do not
    themselves understand the complexities of the tax law; when penalties
    can apply under the law, and when a criminal act has actually been
    committed when evaluating a taxpayer’s options. The result is that many
    of these "advisors" may simply have neglected to truly advise their
    clients of the law and its application and the options available to each
    and every Benign and Bad Actor separately......

    Jack, 100% true - from my personal,anecdotal and professional experience over the last 3 years

  2. Thanks for elevating this one. Wasn't sure my comment back on the GAO report would catch your attention. It does add weight to the many questions I have had about the OVDI/OVDP and the effectiveness..

    Have have posted many of them like this on Market Place back in 2012. first comment out of only 4.

    I did note, that authors mentioned that 64% penalty compentent to total revenues. I had estimated 66.1%, but I won't quibble! LOL I have often said, that the on going tax revenue is NOT as much as the IRS and Treasury want everyone to believe. $104 Mil annually finances our government spending for a milisec, and when you compare that to all the ID Theft ($21 Billion over 5 yrs and Child tax credits fraudulent payment (~$10 Billion over 5 years I think the GAO said) and issues $2.3 Billion a year on Fraudulent employeer IDs abuse ( to name just a few, and things begin to come into stark relief. This is NOT to condone offshore tax evasion, but just put it into some kind of context. The BIGGER problem is in homeland evasion!!

    I keep wondering if any investigative journalist will take this subject up, but frankly I think it is too boring and too counter intuitive for them. The anti-tax evasion meme wins the day. Anything that is getting tax evaders, seems to be good, no matter the damage being done to benign actors. (I say minnows) As we know Congress and the IRS seem to ignore report after report from Nina.

    So it goes.

  3. I also thank you for elevating the article to a blog entry. I commented to JustMeAlso's original entry that the article is very well written, and that I am not sure that the denial of most of the FOIA request would hamper law enforcement or effective tax administration. I believe it would cause fewer people to be intimidated by the mystery of the process, and would show how many small fry are paying FBAR penalties disproportionate to unpaid taxes.

  4. Jack - The Statute of Limitations for tax purposes states that the SOL is tolled for the time spent outside the US OR while being a fugitive from justice. Does this mean that US citizens living in foreign countries have an unlimited statute of limitations (both for tax and FBAR) even if they are NOT fleeing from justice. Or are they exceptions to the tolling provision while being outside the US. Unlimited SOL is a very scary situation.

  5. The criminal statute of limitations provision, 26 USC 6531 (flush language), says

    The time during which the person committing any of the various offenses arising under the internal revenue laws is outside the United States or is a fugitive from justice within the meaning of section 3290 of Title 18 of the United States Code, shall not be taken as any part of the time limited by law for the commencement of such proceedings.

    So, the answer to your question is that mere absence from the U.S. will suspend the criminal statute of limitations. But keep in mind that this is the criminal statute of limitations. Most persons who are not fugitives and who spend significant amount of time outside the U.S. are not at material risk of criminal prosecution. And, of course, for conduct that could be subject to criminal prosecution, the civil statute is probably open under Section 6501(c)(1).

    Section 6531 is here.

  6. Interesting NPR story this morning about the increasing number of U.S. citizens renouncing their citizenship. Links to FATCA because overseas banks are now closing the accounts of U.S. citizens, and won't accept new accounts! I feel sorry for their inconvenience, but maybe the "noise" of all these disgruntled ex-pats will move someone in Congress to take up this whole sorry mess. Lots of comments on the NPR site in response to the story (unfortunately, many in the vein of "good riddance" to U.S. citizens with foreign issues); I posted there and borrowed the comment of one blogger from this site--"What would U.S. taxpayers say if the IRS took 30% of your assets as an amnesty? Irregardless of taxes owed?" Also noted the presumptive unconstitutionality under Article 8, and the much more reasonable approach promoted by American Citizens Abroad at

  7. Jack as we AND the US know :

    Vice President Biden’s HOME STATE of DELAWARE IS A TAX HAVEN ( ) ;

    ” ………As for the US, the country was not judged as “totally conforming,”
    but only “mostly conforming” with a large part of the objections
    pertaining to the state of Delaware….”

    So, when will Vice President Biden and the State of Delaware be entering OVDI/P?

    will the IRS and Treasury invent a special ‘Streamlined Compliance’
    process for US States that aid and abet US and non-US tax evasion? When
    will the Fortune 500 incorporated in Delaware be preparing their
    submissions, and paying 50% of their net worth?

    Or will they just get a ‘Geithner’ pass and no penalties?

  8. Jack, I think this is an important point to highlight for the millions of U.S. citizens who reside outside the U.S. (and other possible millions of lawful permanent residents who spend a large part of their time outside the U.S.).

    Can you please focus on your comment of why you say -
    "Most persons who are not fugitives and who spend significant amount of
    time outside the U.S. are not at material risk of criminal prosecution."
    This is important for the several million of U.S. citizens (many who I have referred to as Accidental Americans - see,Accidental Americans” – Rush to Renounce U.S. Citizenship to Avoid the Ugly U.S. Tax Web” International Tax Journal,CCH Wolters Kluwer, Nov./Dec. 2012, Vol. 38 Issue 6, p45) and LPRs.

    How might your statement be modified, if a U.S. citizen living most of their lives outside the U.S., knew and understood they had a tax filing obligation (and presumably taxes owing in a particular case) and still did not file U.S. tax returns?


  9. Patrick,

    To answer your question statistically, the IRS has limited investigation resources, DOJ Tax has limited prosecution resources, the courts have limited trial and related proceeding resources, the probation office has limited resources and the prison system has limited resources. All of that means that very few tax crimes get prosecuted. So, just statistically -- driven by limited resources -- very few tax crimes generally get prosecuted and that applies to all classes of taxpayers, including those living abroad.

    Now, that is a systemic overview. Each taxpayer's situation needs to be evaluated to see if there are some unique features that would motivate the components of the prosecution system to devote limited resources to that taxpayer.

    There will undoubtedly be some of the taxpayers in the profile you present that may be prosecuted. But it will not be near most of the taxpayers in that profile. Indeed, I repeat that most of those taxpayers are not at risk of criminal prosecution.

    Some are at risk. And, some may even not be at identifiable risk based on more egregious factors than others in the group (i.e., they are picked up by chance or the luck of the draw).

    That is the way the criminal tax prosecution system works. Those prosecuted are in many ways samples from the larger set with those not picked / prosecuted representing most of the set.

    From the taxpayer's perspective, the question is whether the taxpayer is willing to take that risk, based upon the low percentage of prosecutions and the taxpayer's own unique profile. If the taxpayer is not willing to take the risk, the taxpayer should join the program. At a minimum, even if the taxpayer does not disturb the past, the taxpayer must be squeaky clean for the future -- meaning that all FBARs must be filed and all returns should be filed and filed correctly.

    Jack Townsend

  10. Unfortunately Patrick you will not get much "modified" out of Jack these days - take a look at his response to my FATCA posts.
    We have to assume that Jack has been already practicing for too long in the "belly of the beast" ....... you can take the man out of the IRS but not the IRS out of the man !

  11. A minor correction. I have never been in the "belly of the beast" which, you apparently mean the IRS. I have never worked for the IRS. I did work for DOJ Tax. Whether that is the same or different or better, worse or neutral, I will let you and other readers decide.

    Jack Townsend

  12. The US is adding clauses exempting itself from providing information under reciprocity:

    "More than 40 countries including the US, Germany and France have already
    announced that they want to introduce it as quickly as possible.

    is becoming apparent that Washington is reserving some benefits for
    itself by refusing to offer full reciprocity and introducing exceptions
    for trust and offshore rules. The inevitability annoys Geiger. “The US
    is not adhering to the standard, which reflects its clout in the world.”"


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