On April 26, 2013 the US Government Accountability Office released a report1 ("the Report") that encouraged the Internal Revenue Service ("IRS") to seek out off-shore filers who have circumvented the IRS's recent Voluntary Disclosure programs2 in favor of "quiet disclosure." While the term quiet disclosure is not a defined term, it is generally understood to mean when a taxpayer: a) files late or amended tax returns outside of the Voluntary Disclosure programs; or b) ignores past tax filing delinquencies and simply becomes compliant prospectively.
The IRS has agreed with the Report's recommendations and, as a result, those taxpayers who have or plan to engage in quiet disclosure likely face significantly increased risk of IRS examination. While typical IRS processes for collecting penalties occur in an orderly and measured fashion, the draconian penalties that can apply for failing to file timely returns are not eligible for these procedural niceties. As a result, the taxpayer can find himself in the position of owing tens of thousands of dollars of penalties after receiving only a single letter from the IRS.
Most of the penalties for failing to file a timely tax return are subject to the statutory defense of "reasonable cause." In other words, if the taxpayer had "reasonable cause" for not filing on time, the penalties can be eliminated entirely. However once a penalty has been assessed, the taxpayer may argue "reasonable cause" only after taking the following steps: first, paying the penalty in full; second, filing a claim of refund and, if denied; third suing in Federal Court. The US Taxpayer Advocate Nina Olson was correct when she said "Bad things happen to people who ignore IRS correspondence."3
I. IRS Views Quiet Disclosures with Suspicion
Rightly or wrongly the Report and the IRS view skeptically those who make quiet disclosures. This skepticism is based on three factors: first, those taxpayers who make quiet disclosures circumvent the Voluntary Disclosure programs and this undermines the incentives to participate in those programs. Second, the taxpayers who are able to circumvent the Voluntary Disclosure programs pay fewer penalties than participants, which results in lost revenue for the US Treasury.4 Third, it is antithetical to principles of fairness that those who do not follow the rules (by using quiet disclosures) may receive more favorable treatment than those who do follow the rules.
For practitioners with experience in this area, the IRS's disdain for quiet disclosure is not news. The 2012 OVDP frequently asked questions include the following two admonitions:
Taxpayers are strongly encouraged to come forward under the OVDP to make timely, accurate, and complete disclosures. Those taxpayers making "quiet" disclosures should be aware of the risk of being examined and potentially criminally prosecuted for all applicable years.5
The IRS is reviewing amended returns and could select any amended return for examination. The IRS has identified, and will continue to identify, amended tax returns reporting increases in income. The IRS will closely review these returns to determine whether enforcement action is appropriate. If a return is selected for examination, the 27.5 percent offshore penalty would not be available. When criminal behavior is evident and the disclosure does not meet the requirements of a voluntary disclosure under IRM 220.127.116.11, the IRS may recommend criminal prosecution to the Department of Justice.6
Further, some practitioners have noted that advising a client to participate in a quiet disclosure may be a violation of section 10.51(4) of Circular 2307 and thereby subject the practitioner to professional sanction by the IRS's Office of Professional Responsibility.
Section 10.51(4) of Circular 230 precludes practitioners from engaging in conduct that "in any way gives false or misleading information" to the IRS. Admittedly, it might require a stretch of logic to find an ethical violation when the Code clearly allows filing late or amended returns. However, it is not inconceivable that the IRS would, given the right facts, seek to pillory a practitioner for advocating quiet disclosure when it has such a clear policy against such.
II. Quiet Disclosures Likely Face Increased Risk of Examination
The Report made several recommendations to the IRS to identify those using quiet disclosure: first, the IRS should: a) "explore options for employing a methodology to more effectively detect and pursue quiet disclosures and implement the best option;" and b) "analyze first-time offshore account reporting trends to identify possible attempts to circumvent monies owed and take action to help ensure compliance."8
Acting IRS Commissioner Steven Miller agreed with the recommendations set forth in the Report and, in comments attached to the Report, stated appropriate action will be taken including examinations, if warranted."9
Using the methodology described below, the Report identified 10,595 potential quiet disclosures, which was much higher than the potential quiet disclosures identified by the IRS.10
The Report identified these potential quiet disclosures by looking at taxpayers who, for the tax years covered by the 2009 OVDP (2003 – 2008): a) filed amended or late returns; and b) filed amended or late FBARs.11 The Report does not appear to have included taxpayers who have recently filed FBARS and indicated on Schedule B of the form 1040 that they possess a foreign bank account, though the Report indicates that this combination of factors might indicate a quiet disclosure.
The IRS went on record way back in 2009 that it did not approve of quiet disclosures. With the release of the Government Accountability Office report it is clear that other branches of the federal government share this disdain. It remains to be seen what steps the IRS will take to catch taxpayers who have engaged in quiet disclosures and the vigor with which it will pursue them. Because the failure to file penalties can be assessed with very little notice to the taxpayer, it is important for those who made quiet disclosures to closely watch their mail box and respond to any IRS correspondence immediately. As Ms. Olson said "Bad things happen to people who ignore IRS correspondence."
1 Offshore Tax Evasion: IRS Has Collected
Billions of Dollars, but May Be Missing Continued
Evasion, GAO-13-318, March 27, 2013. http://www.gao.gov/assets/660/653369.pdf
2 i.e., 2009 Offshore Voluntary Disclosure Procedure ("2009 OVDP"); 2011 Offshore Voluntary Disclosure Initiative ("2011 OVDI"); 2012 Offshore Voluntary Disclosure Program ("2012 OVDP").
3 National Taxpayer Advocate Nina is credited with this quote. See, Yablon, "101 Tax Quotes for Tax Day," Tax Notes, April 15, 2013, p. 323 at 324.The quote is substantially similar to the first sentence in Chief Justice Roberts's opinion in Hink v. U.S., 99 AFTR 2d 2007-2814 (127 S. Ct. 2011) in which he stated: "Bad things happen if you fail to pay federal income taxes when due."
4 Supra note 2 at p. 23.
5 2012 OVDP FAQ 15
6 Id. At FAQ 16
7 Mopsick, "Tax Justice for Americans Abroad" Tax Notes, July 9, 2012, p. 189 at 191.
8 Supra, note 2 at p. 29.
9 Id., at p. 61.
10 Supra, note 2 at p. 24.
11 Id. at p. 25.
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