Tax compliance for U.S. citizens living abroad is complicated and expensive. This is the fourth of a series of posts I have written on the recent problems of citizenship-based taxation.
Those interested in this post might also be interested in:
Possible Waiver of Tax and FBAR penalties for U.S. citizens living in Canada – December 2, 2011
Tax Payer Advocate vs. The IRS: A question of trust – January 9, 2012
This post is related to this discussion.
As I have written on many occasions most U.S. citizens wish to be tax compliant – the problem is that they don’t know how. When one doesn’t “know how” – one seeks professional advice. In this case that professional advice comes from the “self proclaimed” “cross border professionals”. This post is prompted by the following part of a comment to a recent article in the Globe and Mail:
“And finally, ixnay on the infomercialsway– for all those designated “cross-border tax specialists” whom Globe writers have plied as sources since breaking the thread last June. The inevitable tagline? “Phil N. LeBlanc recommends seeking professional advice.” To paraphrase California legislator Hiram Johnson, the first casualty of tax war is integrity”
There are competent professionals and there are incompetent professionals. By competent or incompetent, I mean in a “technical” sense. Do they know the law? Do they understand the context of the law? Have they had experience with the IRS? The vast majority of lawyers and accountants do NOT have the technical expertise to advise you. There is a great line from the movie “The Untouchables” – what was:
“Just like a ___________, brings a knife to gunfight!”
There are also good professionals and bad professionals in a moral sense. The good professionals see the client’s interest as unrelated to the professional’s financial interest. For those who have the money to be fleeced, there is no shortage of “cross border professionals to help”.
Professionals are overwhelmingly comprised of lawyers and accountants. If you deal with a lawyer you have the advantage of “lawyer client privilege”. If you deal with accountants you don’t. Therefore, all other things being equal, I would suggest a lawyer. That is if you can afford one and find one you can trust.
The IRS assault on U.S. citizens living outside the United States has been a frightening interplay among three groups:
1. The Taxpayers
2. The Cross Border Professionals
3. The IRS
Let’s imagine the perspective of each.
The Perspective of the Taxpayers
I suspect that few U.S. expats will forget the events of 2011. It was a year where they realized how quickly life could change. For the most part U.S. citizens living abroad are hard working honest people who are paying higher income and value added taxes than they would be in the U.S. The U.S. uses citizenship-based taxation. Many of them have been filing U.S. tax returns. But, virtually none of them (except those who always had the benefit of specialized and expensive legal and tax advice) knew about FBAR. When they heard about FBAR, OVDI and the rest they were:
- scared out of their minds; and
- wanted to be compliant
It’ just that they didn’t know how. Hence, they did what anybody would do. They sought professional help.
Furthermore, professional help did not come easily. It did not come inexpensively. It was typically like this: “Yes, I will meet with you. But, bring in a money order for $2000 (or more) and we will start the conversation. The conversation usually focused on whether to enter OVDI. Entering OVDI was a logical option, an expensive option, but I believe for most people a bad option. It was also (because it was a new kind of program) something not well understood by the so called “cross border professionals”.
The Decision To Enter OVDI
For many there was no “decision” to enter OVDI. The entry into OVDI was an “emotional reaction” based on fear.
What happened was something like this:
1. Media publishes articles written by journalists who don’t have a clue what they are talking about. Yes, the IRS is going after U.S. taxpayers who don’t reside in the U.S. Yes, there is OVDI and you must get in the program by August 31, 2011. No, OVDI is not amnesty – but let’s pretend that it is and enter it. I have said before and I will say again that some people entered the OVDI program, without a consideration of their individual circumstances, following the advice of the so called “cross border professionals”. They will regret this.
It is interesting that the advice from a number of lawyers was something like:
“You must enter OVDI” – the IRS frowns on quiet disclosures, etc. These lawyers either did not think that “reasonable cause” was available or that the IRS would not consider arguments based on “reasonable cause”. The important point is that there were “cross border professionals” who did NOT inform their clients that:
A. OVDI was an optional program
B. Filing of FBARs was mandatory
C. The FBAR statute recognizes that “reasonable cause” was and continues to be a defense
(It is interesting that the effect of this advice was to deter people from doing what was mandatory (just file the damm FBARs) and encourage people to do what was voluntary (enter OVDI).
The purpose of OVDI was to go after people who were using foreign banks and other entities to evade U.S. taxes. There is nothing illegal about having a foreign bank account. Most U.S. citizens living outside the United States had local bank accounts for the purpose of living their lives. On the other hand, the IRS has publicized the cases of U.S. citizens living inside the U.S. who used foreign bank accounts for tax evasion. Those of you who are aware of (outside of OVDI) anybody paying FBAR penalties based on willfulness) please leave a comment.
Anybody could have entered OVDI – why would the IRS stop you? By entering OVDI you are simply agreeing to pay them penalties. Furthermore, the range of assets subjected to penalties in the OVDI program is greater than what is required to be disclosed on an FBAR (something not explained by some lawyers). Hence, it is clearly to the advantage of the IRS that people enter OVDI (plus the IRS doesn’t have to waste time on “reasonable cause” arguments).
It is important to note that OVDI is a program which is designed for criminals and removes “reasonable cause” from the discussion. The only way to get “reasonable cause” into the discussion is to “opt out” and subject yourself to a full audit along with all the risks and high costs associated with it.
“Reasonable cause” has always been a defense to FBAR penalties. S. 5314 of the FBAR statute bars the imposition of FBAR penalties if two conditions are met:
1. Failure to file FBARs was due to “reasonable cause”; and
2. The FBAR is filed
Now, I understand that there is no clear definition of “reasonable cause”. I also understand that this is a determination made by the IRS. My point is that the same “reasonable cause” arguments must be made either inside OVDI (after an opt out) or outside OVDI.
While OVDI was going on, few “cross border professionals” talked about “reasonable cause”. Maybe, they thought that the IRS wouldn’t recognize or apply the law. Who knows? I invite a lawyer who encouraged clients to enter OVDI to comment on this.
The Perspective of the “Cross Border Professionals”
Make no mistake. For the most part they exploited the fear of the taxpayers. It is quite obvious that few had any experience with a problem of this magnitude. As “professionals” they were concerned about their potential liability. Many were simply in over their head. The OVDI decision was not primarily a tax issue. It was a compliance issue. Those are NOT the same thing. To advise on “compliance issues” is more difficult and requires some experience in dealing with the IRS. For that reason, many of the professionals consulted were simply not competent to advise people.
Those who were competent to advise seemed to fall into two camps:
Camp 1 – Let’s get you into OVDI without even considering your facts – yes these people existed – they were clearly just taking advantage of the fear – taxpayers were being exploited
Camp 2 – Let’s make a determination based on your facts and then make the appropriate decision – this is the only kind of advice worth paying for – but it will cost because you need to analyze your situation
Unfortunately, there were few in the second camp. Furthermore, those in Camp 2 were simply too expensive for the average person who was ignorant of FBAR.
A final thought on this: from the perspective of professional liability, I suspect that many professionals thought that there was a liability risk to them if they did NOT encourage people to enter OVDI. Clearly the route of least risk for all was to enter OVDI.
But In Fairness to the lawyers – What About The Risk of The “Quiet Disclosure”?
Some advisers presented the options to taxpayers as follows: entering OVDI or a “quiet disclosure”. The IRS had make it clear that “quiet disclosures” (instead of entering OVDI) were frowned upon and were very risky. On the other hand, shouldn’t the risk of a “quiet disclosure” be understood in the context of people who had been hiding income or who had been using foreign bank accounts to hide evade tax? OVDI was aimed at people using foreign bank accounts and assets to evade tax. I simply cannot understand (and I invite somebody to educate me) how this principle can apply in the context of a U.S. citizen living outside the United States who has not been evading taxes. When you look in the mirror, do you see a criminal? Surely, there must be a way to come into compliance (even if small amounts of tax are owed) that does not require the apparatus of OVDI.
For a post on why lawyers had difficulty in advising clients see here.
The Perspective of The IRS
Although the IRS has great discretion (probably too much) the reality is that the IRS is the administrative agency charged with administering the law. The IRS can neither make nor change the law. For this reason it is impossible for the IRS to somehow offer a special deal or treat Canadians differently. Ambassador Jacobson’s October and December statements and the IRS FS published on December 7, 2011 need to be understood in this context.
There was great disappointment with this FS. Where was the relief for those who had entered OVDI? Where was the FBAR amnesty? Hadn’t the IRS simply just restated the law?
Well yes, but … What the FS sheet DID DO was confirm that the IRS recognized that “reasonable cause” existed and invited taxpayers to make arguments based on “reasonable cause”. Most “cross border professionals” are singing to the tune that the “IRS is not offering anything new”. Of course not. Something new has to come from Congress. It is impossible for the IRS to somehow exempt residents of Canada from the law that affects everybody. In that sense the IRS is not offering anything new (because it can’t).
What the IRS is doing is making it clear that “reasonable cause” arguments may be viable. The IRS is offering the only “something new” that it can – namely communication of the recognition that they understand that “reasonable cause” is a defense. Entering OVDI removed any consideration (subject to the “opt out”) of “reasonable cause”. Now, the IRS is signaling that “reasonable cause” will be considered.
If you are a “cross border” professional – don’t worry – there is lots of money to be made in advising on “reasonable cause”.
Conclusion and a request …
I don’t think that there will be a better time or opportunity for U.S. citizens living outside the United States to come into compliance. If nothing else, the IRS FS makes it clear that it is possible to do so. Why not do it? The answer is: because you don’t really know how. Furthermore, you don’t trust the lawyers and you don’t trust the IRS (all for good reason).
I request your comments sharing your experiences and thoughts on this important issue.