They often refer to themselves as minnows. They are -- or, in some cases, were -- Americans who reside abroad and who had undisclosed bank accounts in their local jurisdictions. In an attempt to become compliant, some found themselves entangled in the offshore voluntary disclosure programs (OVDPs) that were intended for larger and more culpable taxpayers.
Some were U.S. taxpayers who intentionally hid money from the IRS in foreign bank accounts. Some continue to hide assets. But not everyone who entered the 2009 or 2012 OVDPs or the 2011 offshore voluntary disclosure initiative (OVDI) was intentionally concealing large sums and purposely evading tax.
The stated objective of the offshore disclosure programs was to bring taxpayers "that have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax" into compliance. However, the language in the FAQs for the programs appeared to apply generally to anyone with an undisclosed foreign account, regardless of circumstances.
U.S. citizens who have moved abroad and have bank accounts there often may not fit the profile of a tax evader. This set of taxpayers typically faces unique and diverse filing and reporting challenges. Those who wish to be compliant frequently have limited access to professional assistance and have difficulty determining the appropriate tax treatment of specific foreign accounts. Since the UBS scandal opened the floodgates of offshore enforcement in 2008, those taxpayers have sometimes lived in fear of owing large, and perhaps financially devastating, penalties for unwitting compliance mistakes. Some taxpayers have legitimate reasons for owning foreign bank accounts, and their failure to declare them was merely negligent, as National Taxpayer Advocate Nina Olson has pointed out.
One taxpayer who lived and worked abroad for 25 years and filed U.S. tax returns the entire time underwent a two-and-a-half-year ordeal in the OVDI after having learned by chance in 2010 of her obligation to file foreign bank account reports on the foreign bank and retirement accounts that she had established while resident in several foreign countries. Ultimately, the IRS imposed no tax or FBAR penalties. But it took an extraordinary effort by both the taxpayer and the IRS to reach that point. "It was a waste of my time and money," the taxpayer said.
Fear was a major factor motivating the taxpayer to enter the OVDI. While looking online for information on another return filing issue in 2010, she stumbled across some of the IRS's statements about FBARs and discovered her obligation to file. The taxpayer had about 20 accounts in different countries, including Switzerland, where she had lived for over a decade. Some of her accounts held mutual funds.
She was audited by the IRS twice while living abroad, and those experiences were straightforward and pleasant, she said. One resulted in a refund, and the other arose because of a common mistake that the IRS agents helped her correct. The audits were efficient, which was one reason she elected to enter the OVDI after learning of her failure to file FBARs. "I never expected this approach of guilty until proven innocent in the OVDI," she said.
Because she discovered her filing obligation after the 2009 OVDP had closed, the taxpayer submitted her voluntary disclosure in accordance with the traditional voluntary disclosure program outlined in the Internal Revenue Manual, but without knowing that the program was part of the IRS Criminal Investigation division. "I realized that the CI voluntary disclosure was the wrong program for me when I got all these questions about who was your banker," the taxpayer said, reflecting on the many forms and questions she was sent. Although a bank employee had been assigned to her account, contact had been limited to the provision of brochures on publicly available bank products. Her interaction with bank employees was primarily with tellers.
When the 2011 OVDI opened, the IRS agent on the taxpayer's case told her lawyer that she would have to move into that program. She initially resisted because she knew that she would not be allowed to argue reasonable cause, but she decided to cooperate and resubmitted all of her documents from her original voluntary disclosure. The prospect of a devastating penalty was stressful. "I didn't see a way out," she said, noting that at the time, the OVDI did not have a 5 percent penalty, and the value of foreign real estate was included in the penalty base. She paid additional legal fees as a result of the resubmission.
When her disclosure was rolled over into the OVDI, the taxpayer said, "I was in shock and told everyone about it because I could not believe what I had to go through in order to 'correct and explain' a paperwork foot fault." One person she told asked an acquaintance at the U.S. Embassy about what to do for an American family member who taught elementary school abroad. The reply was that the teacher should not enter the OVDI because it was intended for "criminals, not schoolteachers." The taxpayer, who was already in the OVDI, felt humiliated and angry, because her lawyer had told her it was her only option, and, she said, "I do not have any diplomatic connections who could advise me who the program was really intended for."
Following her submission to the OVDI, the taxpayer learned about the Taxpayer Advocate Service (TAS) and tried repeatedly to have it accept her case. In the interim, the IRS announced a reduced penalty option in the OVDI. The taxpayer's attorney advised her to seek the 5 percent penalty on the grounds that her facts were favorable and her legal fees for an opt-out would be higher than a five-figure 5 percent penalty. After submitting a letter from her congressional representative, an explanation of how her legal and accounting fees (which by then were $52,000) were causing financial strain, and documents showing that she had been transferred from the traditional voluntary disclosure program into the OVDI and thereby lost the ability to argue reasonable cause, her case was accepted by TAS and she terminated her legal representation. The taxpayer completed the opt-out process with assistance from TAS.
TAS eventually issued a taxpayer assistance order requesting that the IRS assign her case to an agent. The taxpayer had by then been in the CI voluntary disclosure program and then the OVDI for approximately two years, and the IRS had indicated that it would be another year before her case was assigned. The IRS complied with the order.
The taxpayer was satisfied with her interactions with TAS. It intervened five times in her case -- to stop collections temporarily on years for which the taxpayer had paid tax and filed her FBARs, to request a date by which the case would be assigned, to issue a taxpayer assistance order to get the case assigned, and twice to help move her opt-out submission through the process. TAS's assistance was instrumental in relieving the taxpayer's anxiety. The OVDI "was such a confused process, I was happy to know they were there," she said.
There was another bright spot in the process: the professionalism of the revenue agent. "The agent tried to explain things to me and used the limits of the discretion given to agents," she said. The agent expressed the goal of ensuring the taxpayer became compliant and knew how to stay compliant, which the taxpayer thought was helpful. "I felt respected by my agent," she said, adding, "I wish every agent could be like that."
In reflecting on her experience, the taxpayer said, "It makes me angry that the IRS has not come out and said, 'We understand that one size does not fit all,' but they seem to believe that." Such a statement would reassure taxpayers abroad who want to correct any past mistakes, she said. Advertising all the possible penalties, including the reduced penalties that may be applied in non-willful situations, as well as what constitutes reasonable cause, would help bring taxpayers in, the taxpayer said. "I think a lot of people just panicked" at the potential size of the fines and penalties, she said.
Another taxpayer, a permanent foreign resident for decades, heard a U.S. radio report in early 2009 mentioning the requirement that Americans pay taxes on their worldwide income. It surprised the taxpayer, who immediately started to self-prepare past returns, including FBARs.
The taxpayer's unreported accounts were all local bank accounts opened and maintained to support daily living. They included checking and savings accounts and an investment account that held stocks. "If anybody looks at my bank records, it is quite obvious that I'm not a good investor," the taxpayer observed. Ultimately, the taxpayer owed no taxes to the United States and received no penalties. But the road there was long and trying.
After filing past tax returns, the taxpayer learned about the 2009 OVDP and read the FAQs, realizing then that the already-submitted late filings were considered a quiet disclosure. "I also learned in FAQ 35 that they would not punish me more inside the program than outside the program. I thought nothing could go wrong," the taxpayer said. "I imagined that once I turned in all my bank records, that they would figure out that I wasn't the kind of person they were looking for and that would be it."
In submitting to the OVDP, the taxpayer expressed doubt as to whether it was the right approach. The IRS responded with a letter from CI explaining that the taxpayer's file was being forwarded to the OVDP. That was followed by another letter a month later with instructions to send bank records to the revenue agent in just over two weeks. Several times over the next few days, the taxpayer called the Philadelphia telephone number that was included in the letter but only reached a voice mail message that promised a call back if the caller left a name and phone number. Finally the revenue agent called, using a manager's phone because the agent was unable to make international calls. "That made me realize that I was in deep trouble. How can you go after international people with regular bank accounts outside the U.S. if you can't make a telephone call?" the taxpayer said.
The exchange was discouraging. The agent told the taxpayer that a submission was needed by the approaching deadline, so the taxpayer proceeded to translate bank statements and prepare tables explaining the accounts and where they appeared on previously filed returns. During that process, the taxpayer found some minor errors in those returns and corrected them. After submitting the amended returns and explanations to the revenue agent in early 2010, the taxpayer waited.
Eight months later, a different agent sent the taxpayer a letter, asking questions that the taxpayer had already answered in the original submission to the OVDP. The agent also requested that the taxpayer calculate the penalty. The taxpayer responded to the questions and said the IRM indicated that there should be no penalty.
The IRS agent was apparently not so sure, despite an initial conversation in which the agent had agreed that the taxpayer did not owe any taxes. So it came as a surprise to the taxpayer when, in early 2011, the agent sent two versions of the Form 906 closing agreement, one having a far lower sum than the other. After a consultation with a TAS agent and another revenue agent, the taxpayer decided to opt out, although the revenue agent had been careful to say that the result was unpredictable. Shortly after the opt-out submission, the taxpayer learned that opt-out procedures had changed. The change resulted in the taxpayer writing two more opt-out letters.
Several months later the revenue agent called, explaining that the taxpayer would not be audited.
"What I got back were forms -- one for each year -- that said that the investigation was done, and that was it. No penalties," the taxpayer said. The entire process had taken about two years, during which the taxpayer sent the IRS hundreds of pages of bank records, returns, and related information.
The experience with the OVDP led the taxpayer to expatriate. It seemed as if Congress and the IRS were unconcerned about the needs of Americans living abroad, the taxpayer said.
Not all taxpayers who have become compliant with their FBAR obligations have entered the formal disclosure programs. Some are still afraid to, although they have since complied with their reporting obligations. One taxpayer who lives abroad and has filed returns and paid U.S. taxes consistently chose quiet disclosure out of fear of what might happen within the OVDI. He believed that even though the program was billed as amnesty, there was no assurance that he would not be penalized for mistakes. It was a difficult decision. "I am the kind of person who does not like to take risks. From time to time I think, my gosh, suppose that is not what I should be doing. I get very scared what might happen," the taxpayer said.
While visiting friends in the United States in 2010, the taxpayer -- who had been paying tax on income earned abroad and in the United States while a citizen -- learned of the FBAR requirement and the staggering penalties associated with failure to file FBARs. Since 2010 the taxpayer has received conflicting professional advice, often as the result of the changing terms of the offshore disclosure programs. Although the taxpayer's current adviser has indicated that everything is fine for now, the taxpayer still worries. "It's not clear what I should do and what the outcome will be. If it was, I'd be sleeping well," the taxpayer said. The taxpayer added that entering a disclosure program would be acceptable if the IRS offered a reasonable penalty for those who made minor missteps but that the potential FBAR penalties for local accounts opened solely for the purpose of living in an overseas home would wipe out the taxpayer's life savings.
The taxpayer said that although filing returns and paying U.S. taxes from abroad has been frustrating, IRS officials at the U.S. consulate have helped in the past. It is still a difficult process, made more so by the elimination of consulate assistance. For example, the taxpayer's home country automatically deducts taxes from dividends from mutual funds and does not report the total amount of the dividend, only the net amount due. "I have to go to each bank and ask them how much I really paid in taxes to [my home country]. They look at me like I'm crazy. It takes three weeks for them to find out," the taxpayer said.
Former residents of the taxpayer's residence country who have green cards in the United States are generally unaware of the FBAR requirements, the taxpayer said. "I try to explain to them. They are scared of what is going to happen to them if they start declaring. So they hide," the taxpayer said.
The taxpayer, like many others, sought help from a congressional representative in reaching a satisfactory resolution with the IRS. The response that the lawmaker received from the IRS -- that the taxpayer could renounce U.S. citizenship -- was disappointing. "I lived in the U.S. for 30 years; I never was treated unfairly for 30 years. I was proud of it. And here the IRS is telling me to renounce my citizenship because it may be the best solution considering my situation," the taxpayer said.
One taxpayer who is married to a foreign resident and had spent extended periods outside the United States eventually retired abroad. He learned of the IRS's international enforcement efforts while listening to a radio broadcast during a visit to family in the United States and contacted a CPA and a tax attorney who told him about the OVDP. He realized that he had not been compliant with his U.S. tax obligations and FBAR filings. "My wife thought surely this didn't apply to us, but I came to the painful conclusion that we had to join," he said. "We could not ignore it and be willful."
But because time was running out on the OVDP, the taxpayer scrambled to gather his bank account records. "It was no small feat, as they were thousands of miles away, back home," he said. He also wrote a letter to IRS Commissioner Douglas Shulman explaining that he was "benignly negligent." Worried that he might miss the deadline, the taxpayer hand-delivered his OVDP application to the IRS CI office. "It was a very discomforting feeling," he said.
About six months later, when the taxpayer was back home, he received a phone call from an IRS agent. The agent wanted copies of bank records and duplicates of the amended returns and FBARs that had been submitted with the application. The taxpayer said he spent a lot of time organizing and explaining the bank records to make it easier for the agent to process them. All of their communication was by letter and phone, because the agent could not use e-mail. The taxpayer paid the taxes that he owed, but the penalties became a point of contention. The taxpayer said that when the agent wanted to include the value of the taxpayer's overseas home in the penalty base because he had made a small amount of rental income on it, he realized the agent "was working in a very black-and-white regulatory rule environment and all discretion was gone. There was no way to argue that the penalties were very disproportionate."
Opting out involved a lot of uncertainty. "At the time that I was getting pushed up against the deadlines to accept the penalties or be kicked out of the program, they had not yet designed an opt-out program," the taxpayer said. "My examiner indicated that penalties would be much higher outside the program." He then contacted the delegated author of the reply to his original letter to Shulman, asking for discretion to be used in his case. The reply from the IRS had restated FAQ 35, which had since been removed. He asked TAS to intervene because it had issued a directive that FAQ 35 be reinstated. That led to a conference call with IRS officials, a TAS attorney, and the taxpayer. TAS issued a taxpayer assistance order that stopped the clock to allow the taxpayer and his TAS case advocate to negotiate the penalty amount with the IRS.
The negotiations resulted in a $25,000 penalty, down from the agent's initial calculation of $172,000. The $25,000 amount represented the non-willful FBAR penalty, applied on the basis of combining the taxpayer's accounts so that only one penalty of $5,000 per year applied. "I was relieved, and yet I didn't like it," the taxpayer said. The IRS eventually sent the taxpayer a refund as a result of overpayments made while in the program.
The taxpayer said the experience was emotionally exhausting and still stings. "Is there a bigger waste of resources than spending 851 days processing 'benign' people?" he asked. He said he believes the problem with the program is the lack of discretion given to agents. "Under normal IRM discretion, it doesn't have to be so scary. There has to be an easier, less threatening route to compliance," he said.
Bringing the 5 to 7 million Americans abroad into compliance is difficult. But everyone interviewed for this story thought the compliance effort should focus on giving taxpayers three things: certainty, an equitable resolution, and an opportunity to explain and be heard.
Olson wrote in her fiscal 2013 objectives report that she "remains concerned about the apparent lack of clear procedures and transparent published guidance in the Internal Revenue Bulletin (IRB) that describes and reaffirms the taxpayer favorable procedures provided by IRM regarding the application of these penalties to 'benign' U.S. taxpayers abroad." TAS has been beating this drum for a few years now, with only some success. In the fiscal 2014 report, Olson wrote that TAS will continue to advocate for taxpayers experiencing problems with the IRS's voluntary disclosure programs.
Clarity is critical in solving the disclosure problems faced by Americans living abroad. Making it easier for taxpayers to understand their filing and reporting obligations could improve compliance. One taxpayer pointed out that the publications targeting taxpayers living abroad often assume that all U.S. taxpayers are working for an American company that provides Forms W-2. "They really ought to have some examples of how to deal with it when you have absolutely no American forms," the taxpayer said.
Another taxpayer echoed others' concerns about the complexity of the forms and instructions. Taxpayers outside Canada, the United Kingdom, and Switzerland often self-file because there are not enough U.S.-trained accountants in foreign jurisdictions, and those who are there often charge a premium. "Filing needs to be simplified for Americans abroad," the taxpayer said, noting that the foreign tax credit and passive foreign investment company forms are too difficult for the average American overseas to complete without professional assistance.
From the start, the OVDPs and OVDI advertised that they were designed to provide more certainty than the normal voluntary disclosure program. "Making a voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues," the IRS explained in its original set of FAQs. But for taxpayers living abroad who thought their mistakes were only negligent, even a 20 percent penalty seemed high.
The 2013 TAS report recommends that the IRS increase certainty for both taxpayers abroad and its own employees. The agency would benefit by gaining assurance that the taxpayer is back in the tax system "with his or her past noncompliance treated appropriately, and in such a way that it encourages (rather than discourages) future compliance," the report suggests.
The pursuit of absolute uniformity created more work for both the IRS and taxpayers in the programs. Taxpayers who made mistakes, but who were not attempting to evade tax, entered the programs and then opted out in order to seek a more equitable resolution. TAS outlined a three-category approach based on the taxpayer's level of noncompliance that would reduce many of the criticisms of the programs by taxpayers living abroad.
'Catch More Flies With Honey'
A less-threatening approach to voluntary disclosure could yield significantly better results. There are likely still millions of U.S. citizens living abroad who are not fully tax compliant. One taxpayer pointed out that the IRS would be wise to heed the aphorism "You catch more flies with honey than with vinegar."
Using word of mouth to reach U.S. taxpayers abroad can be challenging, and its efficacy is at least partly dependent on the message being conveyed. "I think the approach of scaring people is totally wrong," a taxpayer said, adding that it damaged the relationship that many Americans abroad believed they had with the United States. The taxpayer said that two ways to mitigate the damage would be to admit that one size does not fit all taxpayers with foreign accounts and to apologize to Americans abroad.
The OVDI and OVDPs should be reserved for U.S. persons with foreign accounts who reside in the United States, and criminal risk should be the major consideration in directing taxpayers into the program, suggested one taxpayer who went through the program but had no criminal exposure. Taxpayers who lived abroad and made mistakes, but did not attempt to evade tax, should be allowed to come in voluntarily and pay the taxes due and interest, the taxpayer suggested.
Non-threatening outreach to educate Americans abroad would be helpful, taxpayers agreed. One suggested that the IRS place friendly advertisements in local languages in countries where large numbers of Americans live. Reminding Americans of their tax responsibilities when they renew their passports would also help, although using the embassies and consulates is an imperfect solution.
The IRS also should hasten its processing of voluntary disclosures. TAS had to intervene in one taxpayer's case to keep it from languishing in the system. Other taxpayers encountered similar delays. "I really would have appreciated it if they had gotten to my case a lot quicker," said one taxpayer whose case took two years to resolve. Sometimes the IRS expected taxpayers to move quickly, even though it did not.
Some OVDI information may have completely failed to reach taxpayers already in the system. One taxpayer hoped that the IRS would publicize to Americans abroad the option to apply retroactively to the streamlined program or to seek the 5 percent penalty. The taxpayer suggested that the IRS send a letter explaining the possibility to those who lived abroad during the years at issue in the program. "It bothers me that they just have a note in the FAQ," the taxpayer said.
Nearly every taxpayer said they wished the IRS would allow agents to make international calls. Although some taxpayers reported having received calls from agents, they were the exception. The reliance on mail delivery hampered communication. "It lengthened the process because I would have to wait for the letters to come," said one taxpayer.
Another taxpayer suggested that the IRS consider time zones in assigning revenue agents, because it would make telephone communication easier. "People in Asia should have someone on the West Coast, and people in Europe should be assigned to East Coast agents," the taxpayer said.
The evolution of offshore enforcement over the past four years has not been as smooth as taxpayers and the IRS hoped when the 2009 OVDP was announced. The IRS responded to problems in the programs by creating the opt-out process, simplified solutions, and streamlined procedures, but those developments came long after taxpayers, their representatives, and IRS agents had spent much time and money navigating the system.