International Financial Law Prof Blog

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

Monday, October 19, 2015

Offshore Compliance Programs Generate $8 Billion Since 2009, Mostly From FBAR's AML Penalties, Not Tax Collection

With more than 54,000 taxpayers coming in to participate in offshore disclosure Irs_logoprograms since 2009, the Internal Revenue Service reminded U.S. taxpayers with undisclosed offshore accounts that they should strongly consider existing paths established to come into full compliance with their federal tax obligations.

Both the Offshore Voluntary Disclosure Program (OVDP) and the streamlined procedures enable taxpayers to correct prior omissions and meet their federal tax obligations while mitigating the potential penalties of continued non-compliance. There are also separate procedures for those who have paid their income taxes but omitted certain other information returns.

“The groundbreaking effort around automatic reporting of foreign accounts has given us a much stronger hand in fighting tax evasion,” said IRS Commissioner John Koskinen. “People with undisclosed foreign accounts should carefully consider their options and use available avenues, including the offshore program and streamlined procedures, to come back into full compliance with their tax obligations.”

Under the Foreign Account Tax Compliance Act (FATCA) and the network of intergovernmental agreements (IGAs) between the U.S. and partner jurisdictions, automatic third-party account reporting began this year, making it less likely that offshore financial accounts will go unnoticed by the IRS.

In addition to FATCA and reporting through IGAs, the Department of Justice’s Swiss Bank Program continues to reach non-prosecution agreements with Swiss financial institutions that facilitated past non-compliance. As part of these agreements, banks provide information on potential non-compliance by U.S. taxpayers. Potential civil penalties increase substantially if U.S. taxpayers associated with participating banks wait to apply to OVDP to resolve their tax obligations.

OVDP offers taxpayers with undisclosed income from offshore accounts an opportunity to get current with their tax returns and information reporting obligations. The program encourages taxpayers to voluntarily disclose foreign accounts now rather than risk detection by the IRS at a later date and face more severe penalties and possible criminal prosecution.

Since OVDP began in 2009, there have been more than 54,000 disclosures. The IRS has collected more than $8 billion from this initiative. 

The streamlined procedures, initiated in 2012, were developed to accommodate a wider group of U.S. taxpayers who have unreported foreign financial accounts but whose circumstances substantially differed from those taxpayers for whom the OVDP requirements were designed. More than 30,000 taxpayers have used streamlined procedures to come back into compliance with U.S. tax laws. Two-thirds of these have used the procedures since the IRS expanded the eligibility criteria in June 2014.

Separately, based on information obtained from investigations and under the terms of settlements with foreign financial institutions, the IRS has conducted thousands of offshore-related civil audits that have produced tens of millions of dollars. The IRS has also pursued criminal charges leading to billions of dollars in criminal fines and restitutions.

The IRS remains committed to stopping offshore tax evasion wherever it occurs.  Even though the IRS has faced several years of budget reductions, the agency continues to pursue cases in all parts of the world.

Information from IRS taxpayer prosecutions and the OVDP 

The IRS reported that between 2009 and 2014 it charged more than thirty banking professionals and 71 accountholders with tax violations. By example, in 2013, a former UBS client pled guilty to two criminal counts of filing false tax returns for failing to report her offshore accounts left to her by her deceased husband for seven years (2001–2007).

Mary Estelle Curran, uneducated beyond high school, was 79 at the time of her plea, and owed $667,716 in taxes plus interest and penalties over the seven years, thus on average $95,388 lost tax revenue per year including the 40 percent understatement penalty and interest on the understatement. Her imposed penalty for failure to report the foreign bank accounts on her FBAR form, which is a Bank Secrecy Act/FinCEN violation constituting an anti-money laundering penalty instead of a tax penalty, was $21,666,929, comprised of 50 percent of the high balance of the accounts.

Criminal tax attorney, Charles Rettig, reported in the June/July 2014 Journal of Tax Practice & Procedure that various taxpayers who have opted out of the IRS’ offshore voluntary disclosure program (OVDP) have already received notices asserting multiple, cumulative, FBAR penalties of 50 percent for each year under audit. Rettig also described the finding of a trial jury against Carl Zwerner. Zwerner, at 87 more elderly than Mrs. Curran, through his tax attorney, made voluntary disclosures to the IRS Criminal Investigation in 2009 before the OVDP was established, for 2004 through 2006, 2007 having been timely filed.

Although the Tax Court and IRS appeals abated a 75 percent civil income tax fraud penalty imposed by the IRS, a jury upheld a 150 percent cumulative FBAR penalty, equaling $3,488,609.33 for an account with a high balance of $1,691,054 during the relevant time period.

In its October 16, 2015 press announcement, the IRS reported that its OVDPs have produced $8 billion since 2009 from 54,000 taxpayers from back taxes, interest and penalties.  But like with Mary Estelle Curran and Carl Zwerner, the substantial majority of this $8 billion revenue is neither tax revenue nor tax penalty, but instead from FBAR anti-money laundering penalties.  

The majority of the $8 billion revenue derives from collection calculated as a percentage of asset similar to an asset seizure action, not based on income like an income tax action.

According to the Government Accountability Office Report of 2013, for small accounts of less than $100,000 that over a six year period had only an average of $103 tax owing ($17 a year additional tax revenue), the IRS imposed a 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 twenty-fifth 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 tax understatement.

The GAO analysis found that the offshore penalties paid by taxpayers with the smallest accounts (i.e., those in the tenth percentile with accounts of $78,315 or lower) were disproportionate ─ at least 575 percent of the actual tax, interest, and tax penalty owed for their unreported income. The offshore penalties were also disproportionately greater for taxpayers with small foreign balances than the amount paid by those with the largest accounts (i.e. those in the ninetieth percentile with accounts of more than $4 million) who paid 86 percent or less.

On its face, since 2009, the OVDPs look to be batting a declining average of approximately 9,000 up until 2014 to only 8,000 taxpayers a year as of 2015, and the average annual revenue falling from approximately $1.3 billion revenue to slightly less than $1.2 billion.  Most of the revenue does not appear to be from actual tax evaded and the accompanying tax penalties, but from FBAR seizure of assets. 

At the beginning of 2014 Treasury reported that OVDIs have led to 43,000 taxpayers paying back taxes, interest and penalties totaling $6 billion to date. Thus, the OVDIs slowed down considerably to only 2,000 additional disclosures and $500 million additional revenue over the first half of the 2014 year. From 2014 through 2015, and additional 11,000 disclosures, presumably many more of these using the stream lined procedures and also presumably relatively small accounts, one may reasonably speculate that the OVDI, at least for high net wealth disclosures, is by the end of 2016 to have petered out. 

Have these disproportionate FBAR fines at least produced a corresponding higher rate of FBAR compliance?  The IRS does not know the answer to this question, and cannot know with its current allocation of internal resources for its Office of Service-wide Penalties (OSP). 

The Taxpayer Advocate noted in its 2014 Report to Congress that two decades prior Congress recommended that the IRS “develop better information concerning the administration and effects of penalties” to ensure they promote voluntary compliance. Yet, the IRS Office of Service-wide Penalties (OSP) is “an office of six analysts buried three levels below the Small Business/Self-Employed Division Commissioner [that] cites insufficient resources, insufficient staffing, employees with the wrong skillsets, and a lack of access to penalty-related data as barriers to conducting penalty research.” 

In 2002, the IRS reported to Congress that the FBAR compliance rate was less than 20 percent because it had received fewer than 200,000 FBARs when one million taxpayers may have been required to file. The 2013 Taxpayer Advocate Report, replying on State Department statistics, cited that 7.6 million U.S. citizens reside abroad and many more U.S. residents have FBAR filing requirements for foreign accounts, yet the IRS received only 807,040 FBAR submissions as recently as 2012. 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. Given only 807,040 FBARs from a potential class of eight to ten million FBAR filers that have breached the non-inflation adjusted $10,000 FBAR filing threshold, compliance with FBAR filing appears to be declining, not increasing.

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