The National Taxpayer Advocate (NTA) has issued a Taxpayer Advocate Directive (TAD), followed by ensuing correspondence between IRS and the NTA, alleging unfair treatment of certain participants in the 2009 offshore voluntary disclosure program (OVDP). According to the NTA, a memo issued by IRS on March 1, 2011 was inconsistent with earlier guidance from 2009 regarding examiners' discretion to settle cases and the applicability of the 20% offshore penalty for nonwillful violations.
The NTA characterized the memo as essentially presuming that all taxpayers who avail themselves of the OVDP are tax cheats, and thus was a switch from IRS's more nuanced original position. According to the NTA, this left those who were merely trying to correct honest mistakes, who were perhaps encouraged to participate in the program based on the earlier guidance, effectively unable to pursue a reasonable cause defense.
Background on the OVDP. The first OVDP was announced by IRS in 2009 and applied to those that voluntarily and timely disclosed unreported offshore income for 2003 - 2008. In February of 2011, IRS unveiled a second OVDP to give taxpayers with undisclosed income from hidden offshore accounts for the 2003 - 2010 period the chance to get current with their taxes. The 2011 OVDP was originally available through Aug. 31, 2011 but was extended through Sept. 9, 2011. It carried higher penalties than the original disclosure program but the penalties could be mitigated under certain circumstances (see Federal Taxes Weekly Alert 09/01/2011 for details.) IRS also recently announced a new program that carries a slightly higher penalty (see article in yesterday’s Newsstand e-mail about the reopening of the latest offshore voluntary disclosure program).
If the taxpayer enters into the OVDP, and finds the offshore penalty to be unacceptable, that he must indicate in writing the decision to withdraw from or opt out of the program. Once made, this election to opt out is irrevocable, and the taxpayer's case will be handled under the standard audit process. The opt-out option may reflect a preferred approach in instances where the results under the applicable voluntary disclosure program appear too severe given the facts of the case. To the extent that issues are found upon a full scope examination that were not disclosed by the taxpayer, those issues may be the subject of review by Criminal Investigation (see article on 2011 Offshore Voluntary Disclosure Initiative FAQ #51, covered in Federal Taxes Weekly Alert 02/10/2011.)
Background on Taxpayer Advocate Directives. The National Taxpayer Advocate (NTA) has the power to issue Taxpayer Advocate Directives (TADs) to mandate changes in IRS administration or procedure. This authority is intended to resolve any potential disagreements with other IRS operations. (IR 98-30)
The authority to issue TADs applies to changes recommended to improve operations or grant relief to groups of taxpayers, or to all taxpayers. The action must be needed to protect taxpayers' rights, prevent undue burden, ensure equitable treatment, or provide an essential service. A TAD will not be issued to interpret tax law.
Generally, the NTA first issues a Proposed TAD to the chief of the responsible area, with a set response date. That chief may agree to the proposed action, submit a counterproposal, or explain why the action cannot take place. The NTA may accept the response or work with the chief toward a solution. The NTA can issue a TAD if not satisfied with the outcome. The only way to appeal a TAD is for the Chief Officer of the function involved to go to the IRS Deputy Commissioner. The NTA can also issue an expedited TAD without first giving a proposed directive if it determines that a problem is immediate and has a significant impact on taxpayers. (IR 98-30)
The issue. FAQ #35, which was released by IRS in June of 2009 in association with the 2009 OVDP, asks whether examiners will have any discretion to settle cases. The answer reads as follows:
“Voluntary disclosure examiners do not have discretion to settle cases for amounts less than what is properly due and owing. These examiners will compare the 20 percent offshore penalty to the total penalties that would otherwise apply to a particular taxpayer. Under no circumstances will a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes. If the taxpayer disagrees with the IRS's determination, as set forth in the closing agreement, the taxpayer may request that the case be referred for a standard examination of all relevant years and issues. At the conclusion of this examination, all applicable penalties, including information return penalties and FBAR penalties, will be imposed. If, after the standard examination is concluded the case is closed unagreed, the taxpayer will have recourse to Appeals.”
On Mar. 1, 2011, an IRS memo limited the instances in which examiners should exercise discretion in imposing a less-than-20% penalty. According to the NTA, this shifted position effectively negates the consideration of whether “taxpayers in the 2009 OVDP would pay less under existing statutes on the basis of non-willfulness or reasonable cause.” Rather, such taxpayers could either agree to pay more than they believed they owed, or withdraw from the program and potentially face stiff civil penalties and seek criminal prosecution.
The NTA argues that, under FAQ #35, “total penalties that would otherwise apply” should mean the total penalties that would be imposed after a standard examination; otherwise, taxpayers could be possibly subjected to excessive civil penalties and criminal prosecution and perhaps be worse off than if they hadn't entered the OVDP.
The TAD and its progeny. In Taxpayer Advocate Directive 2011-1, dated Aug. 16, 2011, the NTA directed that the Commissioners of the Large Business and International (LB&I) and the Small Business/Self-Employed (SB/SE) divisions take the following actions within 15 business days and, within 10 business days, provide the NTA with a written response describing the planned actions and any intent to appeal:
1. Disclose the Mar. 1, 2011 memo for OVDP examiners that addresses the use of discretion in 2009 OVDP cases on irs.gov (whether or not it is revoked, see (2), below).
2. Revoke the Mar. 1, 2011 memo and disclose such revocation.
3. Direct all examiners that, when determining whether a taxpayer would be liable for less than the offshore penalty under “existing statutes” as required by FAQ #35, they should not assume the violation was willful unless the taxpayer proves it was not. Direct them to use standard examination procedures to determine whether a taxpayer would be liable for a lesser amount under existing statutes (e.g., because the taxpayer was eligible for the reasonable cause exception) without shifting the burden of proof onto the taxpayer.
4. Commit to replace the Mar. 1, 2011 memo and all OVDP-related FAQs on IRS.gov with guidance published in the Internal Revenue Bulletin, incorporating comments from the public and internal stakeholders (including the NTA). It should reaffirm that taxpayers accepted into the 2009 OVDP will not be required to pay more than the amount for which they would otherwise be liable under existing statutes, as currently provided by FAQ #35, and direct OVDP examiners to use standard examination procedures to make this determination.
5. Allow taxpayers who agreed to pay more under the 2009 OVDP than the amount for which they believe they would be liable under existing statutes the option to elect to have IRS verify this claim (using standard examination procedures), and in cases where IRS verifies it, offer to amend the closing agreement to reduce the offshore penalty.
In other words, the NTA asserted that IRS failed to properly implement FAQ #35, which practitioners had interpreted as suggesting that an examiner could consider a taxpayer's argument that his noncompliance was not willful or was otherwise deserving of reduced or no penalties. In turn, this resulted in inequitable treatment of taxpayers, in that it fails to distinguish between true tax evaders and those who made honest mistakes.
In their response dated Aug. 30, 2011, Heather C. Maloy and Faris R. Fink, the respective Commissioners of the LB&I and SB/SE divisions, agreed to disclose the Mar. 1, 2011 memo referenced in (1) but otherwise appealed the TAD. In contrast to the NTA's characterization of “total penalties that would otherwise apply,” the Commissioners argued that the relevant comparison should only involve “issues that can be resolved using the information available during the certification of the voluntary disclosure.” They claimed that the OVDP language makes clear that otherwise applicable mitigation standards weren't intended to apply during a verification exam.
In her Sept. 22, 2011 response to the appeal, the NTA re-asserted her primary concerns with the 2009 OVDP. She stated that, without FAQ #35, the OVDP penalty structure essentially assumes that all participants are tax evaders hiding money overseas, and doesn't account for those who are seeking to correct honest mistakes. She further expressed skepticism at IRS's “opt-out” option described in a June 11, 2011 memo, which provides that those who opt out will be subject to a complete examination of all relevant years and issues, then subject to all applicable penalties. In the end, the NTA characterized IRS's actions as a miscommunication and called on IRS to create a “fair process” to evaluate willfulness and reasonable cause, with the burden of proof on IRS.
On Oct. 14, 2011, Steven T. Miller, Deputy Commissioner for Services and Enforcement, sent a memorandum to the NTA agreeing to request (1) and rescinding actions (2) through (5). He stated that the relief generally sought by the NTA was provided in the existing opt-out procedures, which expressly state that it may be preferable for certain taxpayers to opt out of the 2009 or 2011 OVDP.
Decision now lies with the Commissioner. Deputy Commissioner Miller's memorandum now elevates the issue to IRS Commissioner Doug Shulman. It remains unclear how he will respond, although his public pronouncements on the OVDP have been overwhelmingly positive to date, including the recently issued IR 2012-5.
Documents related to this article can be accessed at the following links:
Source RIA Newsstand 1/11/2012.
