Opting Out: The Solution forThe Non-Willful OVDI Taxpayer

By Jeffrey A. Neiman

The IRS is on the brink of completing anotherdisclosure program to bring Americans into com-pliance with their foreign bank account reportingrequirements. However, as the 2011 offshore volun-tary disclosure initiative (OVDI) ends on September9, one cannot help but think how much moresuccessful it could have been if taxpayers had beentreated with a bit more flexibility and fairness.

It’s clear that the 2009 offshore voluntary disclo-sure program (OVDP) and the 2011 OVDI werehuge successes. Tens of thousands of Americansparticipated in the programs. The IRS collectedbillions of dollars in unpaid taxes, interest, andpenalties. Undeclared assets have been reported tothe IRS and will be taxed for years to come. Thelandscape in tax enforcement has forever changed,and the Justice Department and IRS have brokenthe back of bank secrecy and obtained a treasure-trove of information that will provide fodder forcriminal and civil investigations for the next 10years.

The programs achieved their stated goals ofbringing offshore money back into the U.S. taxsystem and helping people with undisclosed in-come hidden in offshore accounts get current with

their taxes. However, had the programs treatedAmerican taxpayers more fairly, it’s possible thatthe IRS could have brought tens of thousands moreAmericans into compliance and collected billions inadditional revenue.

The programs required taxpayers to amend theirincome tax returns to report all previously unre-ported income, and in so doing, avoid criminalprosecution. They also required taxpayers to agreeto a penalty of 20 percent of the additional tax dueand to pay the tax, penalty, and interest. As far asthose aspects of the program, there is no doubt thatthe tradeoff of penalty for a sound night’s sleep wasreasonable.

The programs then required a taxpayer to agreeto a penalty for failing to file a foreign bank accountreport. Except for a few taxpayers who residedoverseas and who met other criteria, the penaltywas 20 percent of the highest value of the foreignaccounts in the OVDP and 25 percent in the OVDI.However, the ‘‘take it or leave it’’ 20 and 25 percentpenalties imposed by the IRS on all taxpayers,regardless of their underlying conduct, made it verycostly to come into compliance.

The penalty applied whether or not the taxpayerknew about the requirement to report the foreignaccount. In tax litigation parlance, the penalty wasapplied equally to both willfully, non-willfully, andnoncompliant taxpayers. The programs assume thatjust because the taxpayer had unreported overseasassets, the taxpayer knew of his legal obligation toreport the overseas accounts and to file an FBAR, aform many tax practitioners had not even heard ofbefore 2008.

An overwhelming majority of American tax-payers with unreported assets overseas are notcriminals, yet in the programs the IRS has treated alltaxpayers as if they were Al Capone. The tax systemin this country is overwhelmingly complicated.Mistakes, errors, and accidents happen and a tax-payer who failed to report assets for one of thosereasons should not be treated the same as thetaxpayer who has intentionally failed to reportforeign assets.

Willfulness is the cornerstone to any criminal taxmatter and has been defined by the courts asintentionally violating a known legal duty. In thecriminal setting, the government carries the heavyburden of having to prove beyond a reasonabledoubt that a taxpayer acted willfully. The govern-ment will spend an overwhelming majority of its

Jeffrey A. Neiman

Jeffrey A. Neiman is aformer federal prosecutorwho received national rec-ognition for handling com-plex, high-profile matters,including the prosecution ofSwitzerland’s largest bank,UBS, for helping Americancitizens commit tax fraud.Neiman now practices inFort Lauderdale, Fla., where

he specializes in white-collar criminal defense andtax litigation.

Neiman explains how the offshore voluntarydisclosure programs would have generated in-creased compliance had the IRS made a distinctionbetween the willful and non-willful violator andhow the nonwillful violator can gain penalty reliefby opting out of the program.

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case in chief trying to prove willfulness by intro-ducing evidence that the taxpayer dealt in cash,used nominees, lied to accountants, or maintained adouble set of books. Absent those circumstances,the matter will most certainly not proceed crimi-nally; instead, the taxpayer will be referred for civilexamination.

The OVDI and OVDP assume willfulness inorder to avoid devoting countless resources toindividually review thousands of taxpayer disclo-sures. While the IRS does not have unlimited re-sources, an expedited review process could havebeen established to compare the facts and circum-stances of an individual taxpayer’s overseas ac-count to a set of predetermined objective factorsthat would have allowed the IRS to assess a reason-able and fair FBAR-related penalty and avoidedhigher penalties for non-willful taxpayers.

Why does the IRS assume willfulness? Money. Ifa taxpayer was unaware of his obligation to file anFBAR and failed to file it, the maximum penaltythat can be imposed for non-willful failure to file is$10,000 per year. If a taxpayer willfully failed to filean FBAR, however, the maximum penalty that canbe imposed is 50 percent of the account balance peryear. By assuming willfulness and by threateningtaxpayers with that draconian penalty, the IRS hascreated the appearance that the OVDI and OVDPprograms are the deal of the century.

The IRS has attempted to provide relief for thenon-willful taxpayers by allowing them to opt outof the voluntary disclosure program. In fact, onJune 1 the IRS announced specific opt-out proce-dures that should be followed. The proceduresmake clear that opting out comes with a hefty price.By opting out, a taxpayer takes the chance of a fullaudit and penalties in excess of what is beingoffered in the voluntary disclosure program. Al-though the words ‘‘full audit’’ strike fear in alltaxpayers and tax professionals, those are chancesworth taking when willfulness clearly does notexist.

It is important to note that the FBAR penalty isnot like other IRS penalties. The authority for theFBAR penalty is not derived from Title 26 of thecode. Rather, its authority is derived from Title 31 ofthe U.S. Code. As a non-Title 26 penalty, the IRS canassess the FBAR penalty but it cannot collect itunder the Internal Revenue Code with liens andlevies and other IRS collection tools. Instead, theIRS is treated just like any other creditor. To collectthe FBAR penalty, the IRS must make a referral tothe DOJ’s Tax Division, which then must seek ajudgment in a U.S. district court against the tax-payer. In any proceeding to collect the FBAR pen-alty, the taxpayer may assert a lack of willfulness asa defense and thus get his day in court.

The recent efforts to combat offshore tax evasionhave been unprecedented. As new regulations gointo effect, it will become increasingly difficult forAmericans to conceal assets overseas. It is a shamethat the IRS will not view each case individuallyand receive with open arms taxpayers who want tocome into compliance.

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