District Court Rejects Complaint Denying Full Streamlined Relief for OVDP Participants (7/26/16)

The District Court for the District of Columbia has rejected taxpayers' attempt to force the IRS to admit them into the full Streamlined Procedures rather than the Streamlined Transition Treatment in OVDP 2012.  Maze v. IRS, 2016 U.S. Dist. LEXIS 96471 (D. D.C. 2016), here.  The fight, as it usually is, is about money, but seasoned by the risk of criminal prosecution theoretically looming in the background (relief from which is the common inducement to join any IRS voluntary disclosure program).  In order to follow the money, I first have to review key features of the programs in question:

The common features of the various iterations of the IRS offshore voluntary disclosure programs (referred to here collectively as OVDP) have been:  (i) filing delinquent or amended income tax returns for 8 years, (ii) payment of income tax penalties (20% accuracy related penalty for amended returns or the delinquency penalties (up to 45+%) for delinquent returns), (iii) filing 8 years of delinquent or amended FBARs, and (iv) a Title 26 Miscellaneous Offshore Penalty ("MOP") based upon a percentage -- currently 27 1/2% (increasing to 50% if a bad bank is involved) -- of the highest balance in the offshore accounts for the 8 year period.  The inducement was that, with completion of the OVDP process via a closing agreement, the IRS will not refer the taxpayer to DOJ Tax for criminal prosecution.  A taxpayer joining OVDP who thought the OVDP civil penalty structure was too high under the circumstances could opt out and be subject to a regular IRS audit that covered both income tax and FBAR noncompliance.  Usually, taxpayers who were relatively innocent -- i.e., nonwillful -- with respect to income tax and FBAR noncompliance might want to either forego joining OVDP altogether or joining OVDP and opting out.  If they were relatively innocent -- nonwillful -- the results of the audit would often be much better than the OVDP civil penalty regime, except possibly if certain other returns or forms (such as for foreign corporations or trusts) were not filed.  But the "typical" U.S. taxpayer would only have foreign accounts with no foreign entities to muddy the water with other penalties that might apply and could, in any event, probably avoid those penalties with true nonwillfulness.  The risk of opting out was that the taxpayer has miscalibrated as to his nonwillfulness.

In 2014, the IRS substantially amended its Streamlined Filing Compliance Procedures.  As I understand it, the design of the revision was to catch relatively innocent taxpayers -- those who could certify nonwillfulness and provide a supporting narrative -- who would otherwise choose not to join OVDP or, if they joined OVDP, would opt out.  The Streamlined tax and penalty regime was calibrated to impose, roughly, the result they might obtain upon audit (either audit if they did not join OVDP or audit after opt out if they did join OVDP).  The key to this procedure with substantially less financial cost than OVDP was that the taxpayer must certify that his income tax and FBAR noncompliance was nonwillful and provide a narrative supporting the certification.  Based upon that certification and narrative, the procedure requires 3 years of amended returns or, in the case of foreign resident taxpayers, delinquent returns during the period (a domestic taxpayer does not qualify if he filed no return in the key 3 year period) and 6 years for delinquent or amended FBARs (although the narrative make take some explaining about bank accounts omitted from original FBARs).  The income tax and interest is due for the three years; there is no accuracy related or other income tax penalties.  The MOP will be 0% for the foreign resident taxpayer and 5% for the domestic resident, based upon the high year-end balance in the 6 year period.  The Streamlined Procedure does not result in a closing agreement, the taxpayer can be audited (although as an initial step such an audit might focus on the validity of the certification and narrative), and the taxpayer is given no assurance that he will not be criminally prosecuted.  (I have recently noted that DOJ Tax has noised about potential criminal prosecutions for improper certifications and narratives, as well as the underlying conduct.)

At the same time in 2014, the IRS adopted Streamlined Transition Relief for taxpayers then in the OVDP process prior to the closing agreement.  The Streamlined Transition Relief permits the taxpayer to reduce the MOP from the 27 1/2% (or 50%) required in OVDP (without opt out) to the MOP that would have applied had the taxpayer been in the Streamlined Procedure (0% or 5%, as indicated above).  The Streamlined Transition Relief, however, did not change the income tax, penalties and interest for the 8 year period, so the taxpayer would pay 5 more years of income tax, penalties and interest and, during the 3 year period would have to pay the applicable penalties (accuracy related or delinquency).  So, apparently, that was where the fight was in Maze -- over the income tax, penalties and interest due under OVDP which was not changed under Streamlined Transition Relief.  Of course, those taxpayers still unhappy with even the Streamlined Transition Relief can opt out of OVDP and take their chances on audit (which, if they were nonwillful, would likely be better because the three or six-year statute of limitations would apply, cutting off 5 or 2 years of income tax adjustments).

And, even beyond the money, there is an issue of fairness (at least as I judge fairness).  Those taxpayers who joined OVDP to resolve their offshore issues are treated worse than those taxpayers who waited until the new Streamlined procedures were announced in 2014.  At least they are treated worse if they complete the OVDP with Streamlined Transition Relief.  If they opt out and are truly nonwillful, they likely could get some income tax, penalty and interest relief not offered by Streamlined Transition.

So, as best I see it, that was what the fight was about.

In the context, the Court's dismissal of the cases is relatively straightforward application of the law discussed -- § 7421(a) (generally prohibiting tax injunctions) and the tax exception to the Declaratory Judgment Act.  Further, the Court indicated that the taxpayers could still pursue their refund remedy to seek return of any tax they overpaid based on the claims presented in this case and that that remedy would be adequate.  An adequate remedy at law is a classic basis for denying equitable injunctive relief even if it were not prohibited as it is here.

I just have some comments on various statements made by the Court.

1.  The Court said that the IRS conducts investigations into suspected non-compliance, but "in light of the limited resources available for such investigations, the IRS uses a variety of voluntary disclosure programs to encourage non-compliant taxpayers to come into compliance with the applicable law."

JAT comment:  That is certainly true as stated.  However, there is a systemic reason that the IRS (and DOJ Tax) has voluntary disclosure programs and it does relate limited investigative resources.  If the IRS had more resources to investigate, it would create a bottleneck in the system because later stages in the criminal investigation process have limited resources as well.  There are limited systemic resources that can be devoted to criminal tax investigations, indictments, trials, sentencings, incarcerations and supervised release.  Hence, the IRS voluntary disclosure programs are win-win for the IRS and for the agencies involved in the later stages that can otherwise deploy their limited resources.  Since those programs do not achieve 100% compliance for past tax sins, there will still be enough bad actors left to investigate, indict, try, sentence, incarcerate and supervise on release in order to meet the level of systemic resources that can be devoted and, in their way, contribute to overall compliance.

2.  In explaining the difference between the OVDP and the Streamlined Procedures, the Court says:

Lastly, the treatment of participants in these several programs differs with respect to the availability of criminal non-prosecution letters. As noted above, under the OVDP, participants can receive a criminal non-prosecution letter, which provides assurance that the IRS will not refer related tax matters to the Department of Justice for criminal prosecution. Def.'s Mot. at 7. This benefit is not available under the 2014 Streamlined Procedures. See generally 2014 Streamlined Procedures (U.S.). By contrast, the benefit of non-prosecution letters remains available under the Transition Treatment because the participants never exit the OVDP itself; instead, they remain bound by the rules of that program, except that they are eligible to receive beneficial treatment regarding certain penalties, as detailed above. See generally Transition FAQs.

I am not aware that the OVDP programs (whichever iteration) result in non-prosecution letters to the taxpayers.  The OVDP process concludes with a closing agreement.  I have just reviewed one and the only possibly applicable provisions (appearing as paragraphs 1 and 5 in the closing agreement I reviewed) are:

1. This agreement applies to Taxpayer's additional tax liability relating to Taxpayer's voluntary disclosure of foreign source assets and income made to the Internal Revenue Service pursuant to the 2012 Offshore Voluntary Disclosure Program.  Taxpayer had additional unreported income and overstated deductions for tax years 2005 through 2012 relating to the voluntary disclosure as follows:  [Schedule omitted]

* * * * 

5. In addition to the accuracy-related penalties described in paragraph 5, and in lieu of any other penalties that the Internal Revenue Service may impose with respect to the offshore financial arrangements that were subject to the voluntary disclosure referred to in paragraph 1, Taxpayer agrees to pay, and the Internal Revenue Service may assess under Title 26 of the United States Code a miscellaneous penalty in the amount of $________ in taxable year _____.

I don't think these provisions constitute a non-prosecution commitment according to their terms, since they only deal with penalties the IRS can impose.  The IRS does not impose criminal penalties.  Courts impose criminal penalties.  Notwithstanding the absence of a formal non-prosecution letter, the terms of the OVDP program, as in other voluntary disclosure programs, are that the IRS will "generally" not recommend to DOJ Tax that the taxpayer be prosecuted.  DOJ Tax claims, however, the authority -- at least the raw power --  to prosecute taxpayers regardless of whether the IRS recommends prosecution (I am suspicious of that claim both legally and practically, but I won't go down that rabbit-trail here).  So, if there were a non-prosecution letter, I suspect it would have to come from DOJ Tax (e.g., as with the NPAs given Swiss banks in the DOJ Swiss Bank Program).  And to trace that a bit further, the cases of which I am aware where the taxpayers complained of prosecution despite their claimed "voluntary disclosures" did not comply with  the cooperation requirements of the voluntary disclosure programs; voluntary disclosures have to meet the terms, otherwise the taxpayers cannot insist on the non-prosecution benefits of voluntary disclosures.  I am not aware of any case of a true bona fide compliance with the voluntary disclosure requirements that resulted in prosecution for tax crimes.  I doubt that the courts would permit that, but in any event the IRS and DOJ Tax would be incredibly stupid to permit it to happen, because encouraging voluntary disclosures is a systemic "win-win" when the conditions are met.  But, back to the original point, I think that all the taxpayers get is the normal assurance in voluntary disclosures that the IRS will not refer the matter to DOJ Tax for criminal prosecution and that assurance is just an understanding of the program rather than in any document communicated to the taxpayer (other than the general design of the program).

Now, to be fair to the Court, it subsequently describes the criminal "amnesty" -- although the IRS will not call it that -- as being both non-referral and as non-prosecution letters:

Moreover, it appears that Plaintiffs seek to retain benefits that are available only under the OVDP, specifically assurances from the IRS regarding the referral of matters for criminal prosecution for past tax years. Compare Defs.' Mot. at 13 (noting receipt of non-prosecution letters by Plaintiffs) and Defs.' Reply at 3 (detailing benefits [19]  of non-prosecution letters) with Pls.' Opp'n at 20, 31 (failing to relinquish of benefits of non-prosecution letter). 

I suppose that the letter referred to is the preliminary acceptance letter (the step after the optional prequalification letter).  That letter says:

This letter is to inform you that the voluntary disclosure of your client(s) has been preliminarily accepted.  This acceptance is conditioned upon the information provided being and remaining truthful, timely and complete. 

A voluntary disclosure will not automatically guarantee immunity from prosecution; however, a coluntary disclosure may result in prosecution not being recommended.