FBAR Penalities and The OVDI decision – A former IRS attorney talks to a seasoned “minnow”

On January 9, 2012 the IRS reopened  “OVDI” (Offshore Voluntary Disclosure Program). Some people with past compliance problems will surely consider (with the encouragement of the “cross border professionals”) whether to enter OVDI. The Isaac Brock Society issued a press release warning people to not enter OVDI without carefully considering the merits. Obviously nobody should enter OVDI without a careful consideration of the penalties. At the risk of oversimplification (and this post is not legal advice or any other kind of advice):

1. If you enter OVDI, in addition to paying any taxes owing, you are agreeing to pay penalties of a percentage of your net worth (a range from 5% to 27.5%).

2. If you do not enter OVDI and information return penalties become an issue (outside the context of voluntary disclosures), they will not be automatically presumed (but again this is heavily dependent on the circumstances and you should absolutely get legal advice).

The following comments are part of a thread. I thought they were worth a separate post. They are a conversation between a former IRS attorney and a famous “minnow”. They are relevant to the issue of penalties for failing to have filed information returns.

Interpret this as you will. It is  not offered as legal advice. But, it does raise issues that might we worth discussing with your lawyer. Thanks to Mr. Mopsick. It is a rare lawyer indeed, who is willing to talk about anything but OVDI! You may want to read the complete post before reading these comments. (I have made no effort to fix the typos in these comments.)

 

Steven J. Mopsick

@ Just Me: I did read your facts a while ago and your case really has “poster child” facts. I assume you signed a form 906 Closing Agreement with the IRS and the tax and penatly is paid. Your case is definitely over.

Totally apart from the bait and switch issue and voluntary dislcosures, take a look at the FBAR regulations on the internet (cite later) and read the sections of the Internal Revenue Manual which talk about what an agent should do if an FBAR issue pops up in one of their audits. THE MANUAL or IRM is what mid-level IRS Managers talk about sitting around at meetings all day long. It tells them how to their jobs. And if they follow the Manual at all times, they can be almost sure no one will yell at them and they can go home and enjoy a football game on TV, have some beers and not worry about work.

The Section of the Manual on how to apply the FBAR penalties ALMOST SCREAMS out to the IRS employee, that one of the ways of disposing of the issue might be WRITING THE TAXPAYER A WARNING LETTER as the appropriate thing to do.

One way the government could be challenged on FBAR or FATCA penalties, in Court if someone came forward and had facts that showed the IRS has ABUSED ITS DISCRETION in its administration of these penalties. Can anyone meet that standard in a real live case?

Just Me’s voluntary disclosure is entirely different simply because of what it is. In a VD, the taxpayer is coming forward to make a deal with the government not to prosecute them in exchange for a tax you have to agree you owe. The IRS refers to the penalty paid under the programs as a “proxy” payment for all other penalties, a dozen or more pr probably apply.

Everyone is different. Remember, some people who used the voluntary dislosure process “were getting away with murder for years.” I know I am not talking about the Bait and Switch issue. I am talking about how a Canadian could get tangled with the IRS if there were an audit and an IRS manager failed to pay attention to the fact that the government was about to do something which made no sense.

A later post will tak about how the Tax Court could ever get involved here.
Respectfully submitted,
30 Year IRS Vet


Just Me

@Steven J. Mopsick

I do appreciate your comments, and thanks for the time and effort to make them.

I was not looking to be a poster child of the OVDP, and yes I have signed the 906. My ordeal is over. One does eventually move on. However, it leaves its mark.

The Mark of the Beast!

I did not like the final penalty, still think it was inappropriate for me, but in the end given the mindset from IRS leadership and the OVDP Examiner team, it was the judgment of the TAS that the $25K penalty was the best I could get without a lengthy drawn out process. I already was 2 years in by then, had wasted enough LCUs, so at some point, enough is enough.

They wore me down, I guess. $25K is a big improvement on the $172K I was facing, so in price anchoring terms, it seemed a reasonable result.

I totally understand now, what the VD program was, and what the “in lieu of” penalty is (proxy you call it). I also understand now, that I probably did not have to enter the program in spite of all the IRS threats to the contrary. I am absolutely sure there are some egregious homeland Whales out there, where this program was appropriate and maybe even a great deal, but generally speaking it was a crappy deal for Minnows. But, the IRS just had not considered them when they designed their program in the flushed excitement of the DOJ victory over UBS. It clouded their judgment. They were giddy with success. They displayed a lot of hubris in their celebrations of cracking the Swiss secrecy code.

As I have said many times, and will say again, if the IRS goal was just compliance, it could have gone with a Canadian Voluntary Disclosure program of no penalties or prosecution, but our IRS doesn’t operate that way. This was always about revenue generation, not improved compliance, and THREATS and PENALTIES are preferred arrows in their quiver of marketing and education tools.

My biggest complaint was and still is this…. At the FRONT END of this process, the IRS made it seem you had no option but join (in spite of your previous comments about not being appropriate for some), and then they did not design an easy off ramp to separate the Minnows from the Whales into different processing streams. One using the “in lieu of” penalty and one using FAQ 35 style of administration, as an example.

At the BACK END, they had no management review process to see if the penalties were actually matching the facts or the so-called crime. There was no appropriateness test. They designed a thoughtless program, which was stupidly and rigidly administered. When you have a hammer, every thing looks like a nail, and that is how the IRS operated.

The only relief they offered after you were ground up in a 2 year process is that if you don’t like the penalty, they kindly give you have the choice of the irrevocable “Opt Outing”. Doesn’t that sound inviting? Just throw in an “irrevocable” as a nice warm and fuzzy word to discourage the use. Never mind that they hide from view any indication on how they are handling those that do Opt Out. Opaqueness is what they want. Transparency doesn’t exist. As you know, they even hid their letter withdrawing the FAQ 35 discretion and would not make it public to see until the TAS issued only the 6th Directive (TAD) since the their creation!

What the IRS was doing with the application of OVDP penalties, such as in my case, was just punitive in application, confiscatory in practice, and not positively corrective in a compliance objective.

I think now, I would have been well advised to do a QD, or just be compliant from the moment of awareness forward and done with it. Play the audit lottery and take my chances on being found and audited later where normal IRM processes would apply. However that was not the advice of Council at the time, (I bet that wasn’t your advice either in September of 2009).

Given the threats by the IRS in the FAQs, it did not seem these were viable alternatives. So, we did what we thought was the right thing to do and entered via the front door. WRONG DECISION, if outcome is to be the judge of the approach.

To your point about the IRM….Yes, I am very very VERY familiar with the IRM. Up until this time in my life, I never knew it existed, but that is one document I would never want to have to read again. It is mind numbing! In the end, I knew it much better than my Examiner! I kept repeating it to her. It is now one of my core recommendations to someone who is in the OVDI now or thinking they should join. Do the drudgery, educate yourself, study the IRM, then get Council.

You are right, that it practically SCREAMS at the Examiner to use discretion, and that a warning letter might be all that is necessary to increase compliance. It practically begs the Examiner not to apply absurd penalties.

However, the Examiner operated in an environment where IRS Leadership had deliberately decided to use the FBAR penalty as their weapon of choice to assert draconian penalties and were SCREAMING about MAXIMUM penalties, bragging about their success in catching Tax cheats and bringing in more revenue. The media went along with the propaganda as compliant little scribes without ONE skeptical question! NONE! ZERO! NADA. Hell, I can fill an entire blog with a list of questions to counter the IRS claims, but reporters, nothing… Sorry, but I digress with that little rant!

This VD was a revenue collection program pure and simple, not a compliance one. That is clearly shown by IRS leadership withdrawing FAQ 35 penalty relief when they discovered it was being used in the field. If they continued to allow agents to use FAQ 35 the revenues would not be nearly as good as they were being trumpeted in the press. If agents used their discretion to do the right thing and just issued Warning Letters, the collection plate wouldn’t look nearly as plentiful. Leadership set a tone by its actions and its words and the atmosphere of fear and threats they created permeated throughout the bureaucracy in every interaction and decision an Examiner made.

This was about the MONEY!

I don’t how many times I pointed out the provisions of the IRM to my Examiner. Didn’t matter. She was operating under lock down restriction on any discretion that was being strictly enforced by the Technical Adviser’s rigid attention to the letter of the FAQ rules. $1 of difference from a technical rule threshold could make a BIG difference in penalty applied. Didn’t matter. If you were over a threshold, you were over. End of story, black and white. No discretion allowed.

Remember, after they removed FAQ 35 there was the statement issued by IRS leadership it had always been the intention of the Commissioner that the VD “in lieu of” penalty should be compared to MAXIMUM FBAR penalties, and only if a VD proxy penalty came out worse than maximum FBAR penalty, then “only the maximum FBAR penalty would apply.”

How generous of them! That was the only discretionary relief they would allow! A Maximum penalty!!

That is great, if everyone you are dealing with is already presumed guilty, and this is just the sentencing phase.

The problem was that the IRS had a “they are guilty” mindset. They had a quota in mind, but had no way to readjust their nets when they saw they were hauling on board the wrong fish. They just processed them anyway, extracted their oil, and turned them into fertilizer.

The IRS Leadership, apparently could not conceive that there was anyone in their program but egregious cheating Whales, my letters to the Commissioner not withstanding.

They were bureaucratically hide bound. Individual agents could see that it wasn’t right, the practitioner community protested, but IRS management apparently either couldn’t hear, or would have nothing of it, or else they would have left FAQ 35 in place. How else do you explain its removal? They wanted the money, pure and simple.

They were so wedded to a ‘uniform penalty” structure, were so rigid in their application of their rules, that even criticisms by past IRS senior attorneys about how they were conducting the program were to no avail. If they had no influence, to change the IRS way of approaching the problem of compliance, I certainly had no chance with my little letters.

You certainly must be familiar with the two excellent reports that Mark E. Matthews and Scott D. Michel did. You may even know of them, as their past careers seem similar to yours. Has that changed anything in IRS VD administration?

The first report on the OVDP in September of 2010.
http://www.morganlewis.com/pubs/TaxReport_OffshoreAccounts_21sept10.pdf

and the second on the OVDI in October of 2011
https://docs.google.com/viewer?a=v&pid=explorer&chrome=true&srcid=0B0SLTNWD-Z3YNjg0MGJmMjUtMDk1NS00NmQ5LWI1MTgtYTNmYTljZDI3NTJh&hl=en_US

You certainly know of Nina Olson’s TAD. Has that changed anything? Shulman is apparently stonewalling her and is past due on the response date of January 26th.
http://www.irs.gov/pub/irs-utl/recommendations_tad2011-1.pdf

Have you read her report to Congress, especially MSP 12. Has that changed anything?
http://www.taxpayeradvocate.irs.gov/userfiles/file/2011_ARC_MSP%2012.pdf

She will probably be treated like Brooksley Born of the CFTC during the Clinton administration. The BIG boys will ignore her, even when she is right! Probably someone like Carl Levin is trying to have the position abolished by slipping some amendment into a must pass piece of legislation. She annoys them and pricks their conscience about how they practice their craft. She has to go!

My case finally only came to a more reasonable conclusion when the TAS intervened, and convinced the OVDP management group to reinstate FAQ 35. Suddenly the Examiner had discretion and there was a new cooperative spirit. I was hopeful that something better might result. With this new found freedom, do you know what my Examiner came up with? She suggested she could reduce my penalty from $172K down to $115K. That was it! That was the best she thought she could do given the discretion of the IRM, in spite of my pointed references to the issues that you so rightly point out.

Compliance in my case was already assured if that was the goal of the mission. What more did she want of me that would improve on that? MONEY, it seems was what she was after, to justify her efforts I guess.

In fairness to her, I think she was under pressure to not give in too much. She had a tough technical adviser. The discretion she was supposed to exercise would be by the letter of the lRM and not the intent. Her duty was to collect revenue, not increase compliance.

As a side point, my understanding was that her entire case load of 25 clients were minnows like me, and she could not understand why I wouldn’t just send a check like everyone else did? Letting me off lightly might not set well with office procedure on how everyone else was being treated. I wonder now how those Minnows must feel after reading the TAS report to Congress. I think I would be writing the IRS and asking for a refund of penalties, if I were them.

The TAS countered her $115K discretionary penalty with the $25K, and to my surprise she or her management agreed.

After already investing almost 2 years into this long ordeal, we made the “cat surgery decision” and gave up and settled. Now that I look back, I probably left money on the table, and after the public scolding the TAS has given the IRS recently, they may be more accommodating now if Minnows Opt Out. Of course, still, the only way we know is by anecdotal stories told on blogs. There is no data base by practitioners or the IRS that one can look at and see how the processing is going. If I read you right, in your previous statements, even you don’t know.

In the end, for me, the Opt Out procedure was too new and too opaque, with no examples of how Opt Outs were being handled. The Examiner and her manager had heard a rumor of one, but they too were in the dark as to what had happened. Given the mindset inside the Examiner community and uncertainty at the time, we figured it was time to end it there.

Btw, the cat surgery relates to the time my wife decided to take our feral cat to the small animal veterinarian surgeon for a dislocated hip. She had been frightened that it was going to cost more than $2000 to repair like a neighbor just spent on their cat. When the vet asked her if she was prepared to spend $650 for the procedure, relief overcame good judgment! She paid it!

Looking back on it and all the anxiety,fear and worry about the unknown, and given the advice I did obtain from Council, I can understand the fears of many Minnows that are confronting the same dilemmas now that I did when I discovered my noncompliance back then.

Ij is one you see comment here from time to time. He has been facing a bleak and worried outcome, and I have been trying to stiffen up his spine for the battle. He was not the target of these programs, and in my opinion there is no way a DOJ lawyer is going to waste time trying to extract an FBAR penalty out of him in court. He should not accept the “in lieu of penalty”, but then that is just my opinion based upon my experience, and each has to make their own decisions. If the IRS insists on using his RRSP in the highest aggregate he might consider Opting Out like Moby did, and I would bet he gets a better result.

I have to tell you one final thing, and then I have beat a dead horse enough…

If my experience is any indication of how the examining office was thinking here is a final example of what I was up against.

When I asked the Examiner about what the Opt Out might mean and how it would work, (if and when the IRS came up with a process) you want to guess what guidance I was given?

I was to assume the maximum willful penalty in the Opt Out, on each and every CD type account number, and assume that they would double count funds transferred between accounts for figuring the highest aggregate!!! Now, I could quote the IRM to her all I wanted, and say, that’s absolutely absurd, however, both her and her technical adviser insisted that is what I had to do in weighing my decision on Opting Out. Of course, she could not give me advice on what to do and suggested I seek out legal council. I did! Spent more money, but in the end I took my own council and appealed to the TAS.

So…. do you understand the implied threat there? IE, “maybe you better just stay in the program and take your VD penalty, as outside it could be much worse.” I bet a lot of Minnows have done just that. Well, I have learned, to call bullshit on that now, but at the time, it was a frightening prospect. It seemed that in spite of the novelettes I had written to her and God, no one at the IRS was going to listen to reason from me or a “30 year IRS vet”, for that matter.

Thank God for the TAS. It must be a Canadian deep cover team operating in the bowels of the IRS. They are GREAT! Their creation is one Congressional Statute that I approve of!

Again, thanks for your interest and time.

@ij. Your comments about China are a good perspective. I might not like their internet censorship or human rights, but they certainly have the right idea on tax policy and having positive ambassadors around the world. It works wonders for their trade surpluses. The US could take some lessons here, but won’t. And thanks for your kind comments. Hang in there in your fight, and “ILLEGITIMI NON CARBORUNDUM”

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8 thoughts on “FBAR Penalities and The OVDI decision – A former IRS attorney talks to a seasoned “minnow”

  1. Just Me

    This gave me a chuckle to see it here. Sorry I have not noticed it before. I have written so much, I sometimes forget what I have posted, or conversations I have had online. I now read it with new eyes. Thanks for the visibility…

    Reply
      1. Just Me

        They are, and I have a hard time keeping up with all of them. I kinda like Steven. His perspective comes from a different place, and he has been a good sport to weigh in with both critical and thoughtful comments.

      2. renounceuscitizenship Post author

        Agree with you about Steven. It is very hard for people inside the U.S. to understand our situation. Steven has and continues to make a real effort to understand and he has graciously tolerated a lot of criticism. It’s been helpful (even if sometimes painful) to hear his perspectives.

        Would also like to thank you once again for your truly enormous contributions (past, present and future!).

    1. netcurrent

      Does anyone know whether the reporting required by foreign banks under FATCA will extend to prior years? I had a foreign account in 2008-9 with less than $10K (closed in 2009) but did not file an FBAR because I misinterpreted the rules. I filed FBARs for my foreign ‘salary’ account for those years but didn’t include the other account. I am wondering whether it makes any sense to file FBARS for 2008-9 now for the unreported account which was closed in 2009.

      thanks

      Reply
  2. captiveinsuranceplans

    FBAR and international tax are hot issues that are costing people a lot of money. If you don’t do it right you will have IRS problems. Be careful who helps you. It may cost you a lot of money, or in the extreme time in Jail.
    U.S. citizens with financial interest or signature authority over any foreign financial account (including bank, brokerage, securities, or other types of financial accounts) located outside of the United States, are required to report that information each year. Since most, if not all, U.S. citizens residing in a foreign country have a foreign bank account for their ordinary banking activities, they are subject to this same reporting requirement. If a person is required to file FBARs retroactively, they only have to file them for the last six years. The statute of limitations for assessing FBAR penalties is six years from the due date of the FBAR.
    To read More Click:
    http://smartretirementplans.blogspot.com/2012/05/fbar-international-tax-ovdi.html

    Reply
  3. Rose N.

    Thank you for this blog entry. I can relate so very completely. Does anyone know if there really is a way to claim back a penalty that was incorrectly charged? I feel I have a very strong case but am a minnow minnows. I was charged $5,000.00 for not filling out FBAR forms when I didn’t know I had to. Was living way below the normal standard of living (for Switzerland) when I had to pay it out.

    Reply
    1. renounceuscitizenship Post author

      Would you be willing to share a bit more information. How did your fine come about? “Reasonable cause” is a statutory bar to assessing FBAR penalties – why not appeal it on the basis that you did have “reasonable cause”?

      Reply

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