In this Tax Alert, we review the general state of U.S. tax affairs in Washington as 2011 drew to a close, and highlight the transition of the voluntary tax filing initiatives for non-compliant U.S. tax filers from the 2011 Offshore Voluntary Disclosure Initiative (OVDI) program to the 2012 Voluntary Disclosure Program (VDP).
The 2011 calendar year came to a tumultuous and infamous conclusion in terms of U.S. tax developments. Although the Internal Revenue Service (IRS) enjoyed some success as the second tax amnesty program ended, the level of fear created by the 2011 OVDI program, through a lack of clear guidance and a crippling penalty regime, was unprecedented and arguably misdirected. Nonetheless, the IRS collected $4.4 billion in taxes under the 2009 and 2011 amnesty programs, with a total of 33,000 voluntary disclosures.
The media attention garnered by the offshore tax initiatives cannibalized efforts by Congress to restore confidence in the U.S. tax system by eliminating uncertainty created by tax patches, tax extenders and expiring provisions.
In spite of the efforts to increase compliance, on January 6, 2012 the IRS released its first update in five years to its estimates of the tax gap. It found that the effort to reduce the amount of unpaid taxes owed by U.S. taxpayers has essentially failed. The net tax gap for 2006 was estimated to be $385 billion, representing tax that will never be collected by the IRS. The 2001 estimate was $290 billion. In contrast, the voluntary compliance rate for 2006 was 83.7%, the same rate as in 2001. All this comes at a time when the IRS is offering buyouts to 5,400 IRS employees as it begins preparing for a likely budget cut of more than 3%.
The following general comments review the 2012 VDP for those U.S. persons who are still not fully compliant with their U.S. tax filings. A summary of the announcement released in December 2011 for the category of "dual citizens" is also reviewed and should provide welcome relief for U.S. persons living in Canada.
Voluntary Compliance Programs
The new 2012 VDP
The IRS reopened a volunteer disclosure program (VDP) on January 9. This 2012 VDP shares many characteristics with the 2011 program, which officially expired last September. One key difference is that, under the new program, taxpayers in the highest penalty category might see a hike in the amount they will have to pay.
Those who come forward and declare previously undisclosed foreign bank accounts will have to pay a penalty of 27.5% of the highest aggregate balance in those accounts or entities, or the value of the foreign assets during the eight full tax years prior to the disclosure. That is an increase from 25% in the 2011 program.
Some taxpayers will be subject to 5% or 12.5% penalties, which are basically the same as in 2011. Unlike the 2009 and 2011 amnesty programs, however, this one is intended to last for an indefinite time, so the IRS should not need to keep re-extending it and trying to come up with ever harsher penalties.
Though the penalties are somewhat higher under the new program, the IRS was practically forced to increase the penalties because the program is designed to encourage taxpayers to come forward as soon as possible.
However, unlike the 2009 program, the 2011 and 2012 programs do not allow taxpayers to argue reasonable cause to get the penalties reduced. Those who wish to make that argument must submit to an IRS audit. In some cases, taxpayers requested intervention from the IRS's Taxpayer Advocate Service when they felt the penalty was unwarranted. Those who opted out of the 2011 Offshore Voluntary Disclosure Program could also go to the IRS's Appeals Office.
The 2011 Offshore Voluntary Disclosure Initiative took away some of the IRS's discretion under the 2009 program and forced taxpayers to undergo audits if they wanted the IRS to consider any mitigating factors. The new 2012 program is expected to be similar to the 2011 program, but the IRS has yet to issue Frequently Asked Questions (FAQs) and additional guidance, so there may be some relief. In 2011, the IRS continued the recent trend of issuing "guidance" outside the traditional Revenue Rulings, Notices and other official documents.
Details about the 2011 Offshore Voluntary Disclosure Initiative, for example, were provided almost exclusively in FAQs posted on the IRS website. IRS officials have explained that FAQs and other online materials enable the agency to provide information quickly to taxpayers. Additional guidance is expected by the end of January.
The dual citizen VDP
In December 2011, the IRS issued a fact sheet (FS-2011- 13) outlining information for U.S. citizens or dual citizens residing outside the U.S. In it, the IRS clarified the basis for avoiding the penalties under the Foreign Bank Account Reporting (FBAR) Rules, stating that penalties would not be imposed in all cases on non-compliant persons.
Taxpayers who owe no U.S. tax (e.g., due to the application of the foreign earned income exclusion or foreign tax credits) will not be subject to penalties for failure to file or failure to pay. In addition, no FBAR penalties apply to violations that the IRS determines were due to reasonable cause, based on a consideration of the facts and circumstances.
Reasonable cause relief generally is granted when taxpayers can demonstrate that they exercised ordinary business care and prudence in meeting their tax obligations but nevertheless failed to meet them. In determining whether a taxpayer exercised ordinary business care and prudence, the IRS will consider all available information, including:
- Reasons given for not meeting the obligations
- Taxpayer's compliance history
- Length of time between the failure to meet the tax obligations and the subsequent compliance
- Circumstances beyond the taxpayer's control.
Reasonable cause may be established if the taxpayer shows that he or she was unaware of the specific obligations to file returns or pay taxes. Among the facts and circumstances that will be considered are:
- The taxpayer's education
- Whether the taxpayer has previously been subject to the tax
- Whether the taxpayer has been penalized before
- Whether there were recent changes in the tax forms or law that the taxpayer could not reasonably be expected to know
- The level of complexity of a tax or compliance issue
It is not clear if the IRS plans to administer taxpayers' submissions under the 2012 VDP in a similar manner as the dual citizen submissions where no U.S. tax is owed. Given the IRS position on what constitutes reasonable cause under the 2012 program, guidance is required and expected shortly.
Foreign Bank Account Reporting
Reporting generally is required by June 30 of each year. During 2011, however, the Treasury Department and the IRS postponed certain FBAR-related deadlines. They announced a one-year extension, to June 30, 2012, for filing the FBAR by certain financial professionals with only signature authority over foreign financial accounts.
Tune in to the Spring issue of Tax Alert for more discussions about the notable developments in U.S. tax affairs in 2012. Contact your Collins Barrow adviser for more information.
Joseph E. Sardella, CA, CPA, is a Tax Partner in the Toronto office of Collins Barrow.
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