International Financial Law Prof Blog

Editor: William Byrnes
Texas A&M University
School of Law

Monday, July 28, 2014

Substantial money laundering penalties but not tax collection from OVDI disclosures

Disclosures and amount recovered thus far by OVDI from non-compliant taxpayers 

Treasury-Dept.-Seal-of-the-IRSOn June 18, 2014, IRS Commissioner John Koskinen disclosed that the 2009, 2011, and ongoing 2012 Offshore Voluntary Disclosure Initiative (the "OVDIs") have generated more than 45,000 disclosures and the collection of about $6.5 billion in taxes, interest and penalties.  Thus, on its face, the OVDIs look to be batting an average of approximately 9,000 taxpayers a year with approximately $1.3 billion revenue.  Better than the JCT predicted.  Hats off to the IRS....

However, at the beginning of the year it was reported that the OVDIs have led to 43,000 taxpayers paying back taxes, interest and penalties totaling $6 billion to date.  Thus, the past six months only generating 2,000 additional disclosures and $500 million additional revenue may lead one to speculate that the OVDI program, at least for high net wealth disclosures, is petering out. 

Regarding the 2012 IRS Streamlined OVDI, the Taxpayer Advocate found that as of September 2013, 2,990 taxpayers submitted returns reporting only an additional $3.8 million in taxes.  To add perspective, that's about $1,270 of additional taxes per non-compliant taxpayer, or about $212 a year understatement of tax over a six year look-back.  

It is possible that most non compliant taxpayers have been rounded up.  Thus, fewer and fewer are in need of an OVDI.  Let's look at some additional numbers.

Substantial money laundering penalties – but not tax collection

The substantial majority of the $6.5 billion OVDI revenue is FBAR penalty, not tax collection and not tax penalty.

Taxpayer AdvocateIn the July 16, 2014 report, the Taxpayer Advocate found that the 2009 OVD program, the median offshore penalty paid by those with the smallest accounts ($87,145 or less) was nearly 6x the tax on their unreported income.  Among unrepresented taxpayers with small accounts it was nearly 8x the unpaid tax. The penalty was also disproportionately greater than the amount paid by those with the largest accounts (more than $4.2 million) who paid a median of about 3x their unreported tax.

GAO-13-318, Offshore Tax Evasion: IRS Has Collected Billions of Dollars, but May be Missing Continued Evasion

Table 2: Selected Penalty Information for 2009 OVDP Individual Taxpayers with Closed Cases as of November 29, 2012  
    10th percentile 25th percentile Median 75th percentile 90th percentile  
Offshore account(s) balance   $78,315 $190,365 $568,735 $1,595,805 $4,054,505  
2009 OVDP penalty   $13,320 $35,670 $107,949 $310,476 $793,166  
Additional tax owed, tax years 2003-2008   $103 $1,661 $12,748 $60,449 $190,399  
tax years 2003-2008
  $52 482 3,486 17,398 57,129  
Other penalties   84 605 3,457 14,290 45,163  
Total penalties, interest and taxes   $2,318 $22,120 $95,982 $330,185 $923,300  
Source: GAO analysis of IRS’s Enforcement Revenue Information System (ERIS) and Individual Returns Transaction File.        

In her January 9, 2014 report, the Taxpayer Advocate previously found that for noncompliant taxpayers with small accounts, the FBAR and tax penalties reached nearly 600% of the actual tax due.  The median offshore penalty was about 381% of the additional tax assessed for taxpayers with median-sized account balances.  

US_Government_Accountability_Office_sealThe GAO Report of 2013 found that for small accounts of less than $100,000, over a six year period only on average a total of $103 tax was underreported ($17 a year), yet the IRS imposed an average FBAR penalty of $13,320 (i.e. $2,220 a year FBAR penalty on average for $17 dollar tax understatement, in additional to the tax penalty and interest).  The 25% percentile paid on average a $5,945 FBAR penalty for an average annual $277 tax understatement.  The median paid a FBAR penalty $17,991 a year for $2,125 a year understatement.

When the IRS audited taxpayers who opted out (or were removed), on average, it assessed smaller, but still severe, penalties of nearly 70% of the unpaid tax and interest.   Given the harsh treatment the IRS applied to benign actors, the Taxpayer Advocate reported that:

non-compliant taxpayers have made quiet disclosures by correcting old returns or by complying in future years without subjecting themselves to the lengthy and seemingly-unfair OVD process.  Still others have not addressed FBAR compliance problems, and the IRS has not done enough to help them comply.

Have these efforts substantially increased taxpayer compliance?

The Taxpayer Advocate, replying on State Department statistics, previously estimated that 7.6 million U.S. citizens reside abroad and many more U.S. residents have FBAR filing requirements, yet the IRS received only 807,040 FBAR submissions as recently as 2012 (see Report Volume 1, Page 229).  The Taxpayer Advocate noted that in Mexico alone, more than one million U.S. citizens reside, and many Mexican citizens reside in the U.S. (and thus are required to file a FBAR for any Mexican accounts of $10,000 or greater).  Thus, currently, less than 10% of taxpayers with FBAR filing requirements are probably compliant, as regards the FBAR requirement.  But lack of filing a FBAR does not necessarily imply an underreporting of income.

The Taxpayer Advocate noted that “more than one million U.S. citizens reside in Mexico and many Mexican citizens reside in the U.S.”  The Report pointed out that most persons that worked in Mexico had to pay into a government mandated retirement account (known as an AFORES), and that this retirement account may be reportable to the IRS as a foreign trust.  (AFORES retirement accounts are, in general for FATCA products, exempt products from reporting pursuant to the U.S.-Mexico FATCA intergovernmental agreement.)

The GAO reviewed the 2009 OVDP and found that some immigrants stated in their 2009 OVDP applications that they were unaware of their FBAR filing requirements. The GAO found that the immigrants had opened banks accounts in their home country prior to immigrating. The GAO Report revealed:

IRS officials from the Offshore Compliance Initiative office stated that although there are several FBAR education programs, none are specifically targeted at new immigrants. These officials stated that one of the challenges that they face in their office, which is part of IRS’s Large Business and International Division, is that taxpayer education and outreach is the responsibility of IRS’s Wage and Investment Division and that issues concerning FBARs fall under IRS’s Small Business/Self-Employed Division.

The IRS reported to the Taxpayer Advocate that its FY2014 FBAR Communication Strategy includes efforts to reach U.S. citizens residing abroad via Internet, social media, and collaboration with the State Department.

The IRS also responded as follows (excerpted):

Congress enacted both the Title 31 and the Title 26 provisions regarding the reporting requirements of the FBAR … and Form 8938 (Statement of Specified Foreign Financial Assets). Reporting on the FBAR is required for law enforcement purposes under the Bank Secrecy Act, as well as for purposes of tax administration.  As a consequence, different policy considerations apply to Form 8938 and FBAR reporting. These are reflected in the different categories of persons required to file Form 8938 and the FBAR, the different filing thresholds for Form 8938 and FBAR reporting, and the different assets (and accompanying information) required to be reported on each form. Although certain information may be reported on both Form 8938 and the FBAR, the information required by the forms is not identical in all cases, and reflects the different rules, key definitions (for example, “financial account”), and reporting requirements applicable to Form 8938 and FBAR reporting.

These differing policy considerations were recognized by Congress during the passage of the HIRE Act and the enactment of Section 6038D. Congress’s intention to retain FBAR reporting requirements, notwithstanding the enactment of section 6038D, was specifically noted in the Technical Explanation of the Revenue Provisions Contained in Senate Amendment 3310, the “Hiring Incentives To Restore Employment Act,” …

The Technical Explanation states that “[n]othing in this provision [section 511 of the HIRE Act enacting new section 6038D] is intended as a substitute for compliance with the FBAR reporting requirements, which are unchanged by this provision.” (Technical Explanation at p. 60.) …

Thus, it is clear that Congress intended to keep separate and distinct FBAR, and it is clear that the IRS administers FBAR compliance by a Memorandum of Agreement with FinCEN.  It is likely, based on the data, that a majority of U.S. taxpayers with a FBAR filing requirement are not compliant with that filing requirement.  

But it is not clear that a majority of U.S. taxpayers with foreign income are underreporting. Certainly, the 45,000 U.S. taxpayers that came forward in the OVDIs were annually underreporting to a varying degree.  The question remains open as to how many more of these underreporting taxpayers are still out there? 

FBAR penalties of more than $2,000 for $17 tax underreporting seems a rather heavy handed approach, in light of a tax penalty of only $14, to encourage the small account holders to 'come clean'.  There is an argument to be made that the amount allowable for tax penalties for underreporting of income of foreign accounts needs to be (substantially) increased by Congress.  

Perhaps the new streamlined OVDI program formally announced June 18, 2014 that expands the bifurcation of non-willful from willful will address this uneven application of the FBAR penalties to small accounts?

First, we’re expanding the streamlined procedures to cover a much broader group of U.S. taxpayers we believe are out there who have failed to disclose their foreign accounts but who aren’t willfully evading their tax obligations. To encourage these taxpayers to come forward, we’re expanding the eligibility criteria, eliminating a cap on the amount of tax owed to qualify for the program, and doing away with a questionnaire that applicants were required to complete.

How much tax revenue did Congress expect from these compliance efforts?

13.05.15-SubcommitteeThe Senate Permanent Subcommittee on Investigations issued a report March 4, 2009 entitled “Tax Haven Banks and U.S. Tax Compliance.” This report examined how tax haven banks facilitate tax evasion by U.S. clients that cost U.S. taxpayers an estimated “$100 billion each year”. This Report has been widely cited as authority for the claim that $100 billion is lost in taxes because of evasion of tax through tax havens.

However, the reports citation for this $100 billion figure is only its footnote 1 that cites five magazine articles unsubstantiated information, that also varied widely in terms of opinions regarding the amount of tax losses the U.S. incurs.  The five articles mentioned as the foundation for the $100 billion amount do not refer to any empirical study, do not provide any empirical evidence, and do not provide any statistical methodology.

IRS Commissioner Charles Shulman, in testifying before the Permanent Subcommittee on Investigations on March 4, 2009, was questioned on the analysis of hidden money criminally held overseas:

Senator McCaskell: “Has there been any analysis done of how much of this money that is being hidden overseas is, in fact, a result of criminal activity?”

Mr. Shulman: “Not that I am aware of. I mean, estimating how much money that is overseas and not being paid to the government. As far as I am aware, there is no credible estimate because it is kind of a chicken and egg. It is over there and we have not found it, it is hard to estimate what is there. And all estimates that I have seen have not broken down criminal versus civil because, again, until we see the cases, it is hard to say.”

In the February 25, 2014 175-page bipartisan staff report the Senate Subcommittee increased the $100 billion to $150 billion.  “Contributing to that annual tax gap are offshore tax schemes responsible for lost tax revenues totaling an estimated $150 billion each year.”  To justify the reporting of this $150 billion a year of lost tax revenue due to “offshore tax schemes”, the Senate Report cites its previous investigatory reports supported by third party articles that refer to transfer pricing issues, not to studies about individual taxpayer offshore noncompliance.

Relative to the reported figure of $150 billion, the additional OVDI tax collection of approximately $500 million a year is just .003% (a third of one percent) of the Senate goal.  While the FBAR money laundering penalties more than double the overall collection amount, it’s still a drop in the bucket of the Senate estimate.  

Back of a napkin calculation: Based on a 15% long term capital gain rate, over the past six look-back years, the $150 billion figure of lost annual tax revenue would require $1 trillion of annual taxable, unreported, income.  To generate $1 trillion of capital gains income at a 5% rate of return requires $20 trillion of unreported offshore dollars.  Is it likely that unreported money represents almost double the M2 money supply (Federal Reserve data of March 6, 2014 of about $11T) and about 20 times the actual amount of paper dollars that are in circulation?  Perhaps the applicable tax rate should be 25%, or the rate of return 7%?  It still seems an unlikely large amount to be unaccounted for in the global financial system.  

How much did the Congressional Joint Committee on Taxation estimate?

JCOT_bThe Congressional Joint Committee on Tax estimated that FATCA will only generate $8.7 billion over ten years or average revenue $870 million per year.  The $870 million annually appears not too far out of line with the tax collections generated by the OVDI the past six years.  Hats off to the JCT's forecasting skills.  

Note on FBAR

The FBAR is an annual report and must be e-filed on or before June 30th.  It cannot filed with the Form 1040 in April.  The FBAR must be filed electronically through FinCEN’s BSA E-Filing System.  The application to file electronically is available at

A United States person that has a financial interest in or signature authority over foreign financial accounts must file an FBAR if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year.  An individual filer is a natural person who owns a reportable foreign financial account or has signature authority but no financial interest in a reportable foreign financial account that requires the filing of an FBAR for the reportable year.  An individual who jointly owns an account with a spouse may file a single FBAR report as an individual filer.

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