The 2011 IRS Offshore Voluntary Disclosure Initiative:
The First Step in a Massive Crackdown?

By Attorney Morris N. Robinson, CPA, LLM
June 1, 2011

Executive Summary

 
On February 8, 2011, the Internal Revenue Service (IRS) announced its second voluntary disclosure initiative in less than two years for U.S. taxpayers with unreported foreign bank accounts. IRS calls it the 2011 Offshore Voluntary Disclosure Initiative (“2011 OVDI”). In the IRS News Release, the IRS quotes its Commissioner, Douglas H. Shulman, as saying:
 
      “Combating international tax evasion is a top priority for the IRS. We have additional cases and banks under review. The situation will just get worse in the
       months ahead for those hiding assets and income offshore. The new disclosure initiative is the last, best chance for people to get back into the system.”
 
This article demonstrates:

      Why IRS may be planning a crackdown against massive non-compliance with the international tax and disclosure laws of the United States; and

      Why the 2011 OVDI might well be the “last, best chance” for affected taxpayers to avoid the crippling civil fines and possibly intensified criminal
      prosecutions associated with a threatened crackdown.

Background: IRS Experiences Institutional Humiliation

 
Following tips from whistleblowers, on March 23, 2009 the Internal Revenue Service opened admission to its first Offshore Voluntary Disclosure Program (“2009 OVDP”). This widely reported response from taxpayers stunned and humiliated IRS officials who had expected around 1,000 participants. Instead, nearly 15,000 taxpayers came forward by the October 15, 2009 deadline and about 3,000 came forward after that deadline. Those who came forward represent only a fraction of taxpayers who have failed to comply with United States income tax laws and bank secrecy laws. Thus, the 2009 OVDP strongly suggested that IRS was either unaware of or complacent with the massive noncompliance with our laws – the very laws IRS is obligated to enforce. Simply put, the 2009 OVDP caused IRS intense institutional humiliation.
 

Comparison of Lead-Times Between 2009 OVDP and 2011 OVDI

 
Humiliation is a powerful emotion. Thus, institutional humiliation may explain why IRS intentionally structured the 2011 OVDI so that many affected taxpayers who come forward will NOT become compliant by the August 31, 2011 deadline. IRS may punish those who fail to become fully compliant by August 31, 2011 with civil fines greater than those publicized under the 2011 OVDI. FAQ A11. (i) Those who chose NOT to come forward may face intensified criminal prosecution. For details, see below.
 
This bias towards punishment becomes clear when we compare the lead-times associated with the 2009 OVDP and the 2011 OVDI. The length of the 2009 OVDP and the 2011 OVDI are approximately identical: about 6 months and three weeks. Both were announced by IRS during "tax season" – March 23, 2009 and February 8, 2011, respectively – when CPAs are busiest. However, the lead-time for acceptance into the 2011 OVDI and its penalty structure is many times greater than the lead-time for acceptance into the former 2009 OVDP and its penalty structure. 

Amount of Lead-Time Required to Enter the 2009 OVDP. For the 2009 OVDP, the taxpayer could enter by filing a relatively short disclosure letter with the Voluntary Disclosure Coordinator by the October 15, 2009 deadline. The lead-time for acceptance was less than a week.

Amount of Lead-Time Required to Enter the 2011 OVDI.  For the 2011 OVDI, the lead-time for acceptance is three or four months. Under the 2011 OVDI a taxpayer must do all of the following tasks by the August 31, 2011 deadline:

      Obtain monthly statements and other information from foreign banks and brokerage companies for all years beginning with 2003;
 
      File accurate and complete income tax returns, Foreign Bank Account Reports (“FBARs”), and Title 26 offshore-related information returns (such as Form
      3520) for the years 2003 through 2010; and
 
      Pay the related tax, penalties and interest (or make payment arrangements satisfactory to the IRS).
 
This massive change in the lead-time is a huge challenge – and one that many taxpayers will NOT be able to meet – even if they hire competent and experienced advisors and begin work immediately.

The Shape of the Coming Crackdown: Possibly Crippling Civil Fines and Intensified Criminal Prosecutions

 
As noted above, IRS has announced that taxpayers who are NOT fully compliant by August 31, 2011 will be subject to higher, possibly crippling civil penalties.
 
It is also possible that IRS also intends to step-up criminal enforcement of the international tax and disclosure laws. Based on an admitted cursory review of published cases, it appears that the United States Department of Justice (“DOJ”) does not prosecute individual taxpayers who merely hold money passively in a foreign bank or brokerage account and do not report the income earned on their income tax returns. The DOJ prosecutes only those taxpayers who also take extra steps to prove “willfulness” – such as setting up dummy corporations in Panama to launder money or repatriating tens of thousands of dollars of cash on more than one occasion. After two well-publicized initiatives, however, the DOJ may find it much easier to prove “willfulness” – the intentional disregard of a known legal duty – which is key to any criminal conviction.

Will and Means: Can IRS Make Good on Its Threat To Enforce the Laws?

 
Can IRS make good on its implied threat (“last, best chance”) to enforce the international tax and bank disclosure laws with a possibly massive future crackdown? We all have a stake in the answer to this question since a society that loses the ability to tax itself must ultimately lose the ability to govern itself. (ii) Let me break down this question into two parts:

     Has IRS demonstrated the will to enforce the international tax and disclosure laws?
     Does IRS have the means to enforce the international tax and disclosure laws? The short answer to both questions is “yes.” 

IRS demonstrated its will to enforce the tax and bank secrecy laws. Examples follow:

      IRS Auditors. IRS has assigned approximately 10 percent of its auditors nationwide to review the income tax returns, Foreign Bank Account Reports
     (“FBARs”) and other disclosures provided by the nearly 18,000 taxpayers who came forward. IRS has also hired more auditors.

      Investigations of Foreign Banks. According to published reports, IRS is investigating foreign banks and has reached agreement with first-tier banks (such
      as UBS) and second tier banks in both Switzerland and the Far East.

      Other Sources. IRS is actively seeking the foreign account information of United States account holders from a spectrum of activities ranging from (1) 
      whistleblowers to (2) changes in tax treaties to permit the international exchange of information IRS needs to enforce the United States international tax and
      disclosure laws.

IRS is also rapidly acquiring the means to enforce the international tax and disclosure laws efficiently and inexpensively. Examples follow:

      The IRS Learning Curve. IRS has gathered the submissions from the 15,000 2009 OVDP participants and the 3,000 additional taxpayers who came 
      forward after the 2009 OVDP closed on October 15, 2011 to better understand how noncompliance with the international tax and disclosure laws “works.”

      The IRS Database. The IRS has used the information obtained to set-up a computerized database where IRS computers correlate and analyze the
      information gleaned from thousands of taxpayers.

      Computers. Computers are the foundation to any modern system of tax enforcement. Thus, governments enforce tax laws efficiently and inexpensively by 
      requiring banks, brokerage companies and other financial institutions share their financial account information with government computers. Massive
      noncompliance with the international tax and disclosure laws occurred because IRS computers had not obtained the foreign account information of United
      States taxpayers. Congress has responded to this informational loophole by passing FATCA – the Foreign Account Tax Compliance Act discussed
      immediately below.

      FATCA. Briefly, FATCA requires most international banks and brokerage companies to share the account information of United States persons with IRS
      computers. The FATCA implementation date was delayed until January 1, 2013 to allow foreign governments the opportunity to amend their bank secrecy
      laws to permit this information sharing so that foreign financial institutions may legally comply with FATCA. Some international banks, such as HSBC
      Banque Canada, already provide Form 1099 account information to IRS. Other major international banks, such as Bank Leumi – Israel have reportedly
      notified their account holders that they will comply with FATCA.

Conclusions

 
In short, Commissioner Douglas H. Shulman’s statement – “The new disclosure initiative is the last, best chance for people to get back into the system” – is credible. IRS has demonstrated the will and is rapidly acquiring the means to enforce the international tax and bank disclosure laws of the United States. Fueled by institutional humiliation, it is likely that IRS will NOT be understanding of affected taxpayers who have ignored the 2011 OVDI. Thus, affected taxpayers who do not participate in the 2011 OVDI do so at the peril of possibly crippling civil penalties and intensified criminal prosecutions.

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(i) The IRS published Frequently Asked Questions (FAQ) about the 2011 OVDI on the IRS website:
http://www.irs.gov/businesses/international/article/0,,id=235699,00.html
(ii) This issue is also at the crux of the current fight over the massive deficit that is playing out this year on Capital Hill in Washington.