The Internal Revenue Service has persuaded U.S. taxpayers to disclose hidden offshore bank accounts but then sometimes failed to cap the penalties, as promised, an agency watchdog said on Wednesday, accusing the IRS of "bait and switch."
The Taxpayer Advocate Service, an oversight arm of the IRS, wrote in its annual report to Congress that a series of IRS voluntary disclosure programs allowing wealthy Americans to come forward and disclose their hidden accounts in exchange for reduced penalties had caused some taxpayers to pay more than they had been led to believe was required.
Such taxpayers are typically those who have inherited accounts or work overseas.
"The IRS's offshore voluntary disclosure program bait and switch may undermine trust for the IRS and future compliance programs," Nina Olson, the national taxpayer advocate who heads the service, wrote in the report.
On Monday, the IRS said it was reopening a voluntary disclosure program for taxpayers hiding money in offshore bank accounts, many in Switzerland, the global capital of offshore wealth.
Previous IRS programs, in 2009 and 2011, brought in more than $4.4 billion in unpaid taxes and penalties from 33,000 taxpayers. Tax lawyers see the renewal of the program as a sign that the agency is again preparing to receive scores of names of wealthy Americans who are clients of Swiss banks, under a broad investigation of the Swiss banking industry.
Olson wrote that ordinarily the penalty on taxpayers for nonwillful, meaning accidental, failure to file a record of foreign bank and financial accounts, or FBAR, was capped at $10,000.
By contrast, willful failure to file an FBAR ordinarily carries a draconian penalty, of 50 percent of the highest account balance for each year covered.
During the first voluntary disclosure program in 2009, the IRS offered a break, capping the maximum penalty at 20 percent. A program in 2011 raised the cap to 25 percent.
The problem, Olson wrote, is that in 2009, in a written comment known throughout the tax world as "FAQ 35," the IRS also said it would never assess a penalty greater than what the law would permit. Then in February 2011, the IRS said it would no longer entertain arguments from taxpayers that their compliance was not willful.
There was no immediate response from the IRS to the watchdog's report.
Scott Michel, a tax lawyer at Caplin & Drysdale, said many tax lawyers representing Americans with hidden accounts had interpreted the original comment to mean that if a taxpayer argued that he had not willfully, or intentionally, violated the law, he would not have to pay even the reduced penalties of 20 percent or, later, 25 percent but instead would pay the maximum of $10,000.
Scores of taxpayers, many with inherited Holocaust-era accounts, made the argument, he said. But the February 2011 provision halted that activity, he said.
"IRS agents would even tell you that if you raised the non-willfulness argument, you were in substance dropping out of the program, leaving them free to impose maximum penalties," Michel said. "So pretty much from the beginning, practitioners viewed FAQ35 as an empty promise."
Probe of Swiss Banks
The U.S. Justice Department is probing 11 Swiss and Swiss-style banks suspected of selling offshore tax evasion services to tens of thousands of wealthy Americans. The investigations are widely expected to involve a disclosure by the Swiss of scores of American client names, a move that reveals their identity to the IRS.
The IRS is generally more sympathetic to taxpayers who come forward before their names are disclosed.
In 2009, UBS turned over 255 American client names as part of a $780 million deferred prosecution agreement with the Justice Department; it later turned over 4,450 American client names. The moves were a watershed breach in Swiss bank secrecy, which protects client confidentiality under law and does not consider tax evasion a crime.
The investigations, growing out of scrutiny of Swiss financial giant UBS AG, are focused on Wegelin & Co. — Switzerland's oldest private bank — Credit Suisse AG and Basler Kantonalbank, among others.
Wegelin said this week that it was unfazed by any possibility of indictment.
Credit Suisse said in July its offshore private banking practices were under investigation and that it would "continue to cooperate with the U.S. authorities." Basler Kantonalbank confirmed a year ago that it was under investigation and in contact with U.S. authorities.
Tax lawyers still view the disclosure program as the best option for taxpayers.
"The evolving nature of the programs has certainly made it more difficult on both taxpayers and practitioners," said Robert Katzberg, a white-collar criminal defense lawyer in New York who represents many U.S. clients of Swiss banks.
"Unfortunately for the many still non-compliant taxpayers, with many thousands of secret Swiss accounts about to be sent to the U.S. by 11 banks, an informed voluntary disclosure decision better be made real soon."
Olson's report also criticized the IRS's increased use of automated enforcement assessments to collect unpaid taxes from delinquent taxpayers of all stripes, saying that the use was ineffective in collecting the delinquent revenue or in promoting the future compliance affected taxpayers.
Olson also faulted what she termed inadequate congressional funding for the IRS — a perennial.
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