Is FATCA chasing a leprechaun and his pot of gold?

FATCA was enacted into law by section 501(a) of the Hiring Incentives to Restore Employments (HIRE) Act 2010 as a revenue offset to help pay for the continuation of unemployment benefits for workers laid off during the 2008-2010 financial crisis.

In July 2008, the U.S. Senate Permanent Subcommittee on Investigations held a hearing and issued a report entitled “Tax Haven Banks and U.S. Tax Compliance.”

The critical underlying justification for FATCA as a substantial revenue offset ultimately rested on a single statement and its footnote in that 2008 Report: Each year, the United States loses an estimated $100 billion in tax revenues due to offshore tax abuses.

In a follow up report four years later, the Subcommittee jumped the U.S. tax revenue loss by fifty percent, stating: “Contributing to that annual tax gap are offshore tax schemes responsible for lost tax revenues totaling an estimated $150 billion each year.”

However, upon review of the estimated revenue for the offset, the Congressional Joint Committee on Tax (JCT) in 2010 substantially reduced the Subcommittee estimate to only $8.7 billion of tax revenue over the ten years of 2010 to 2020, an average revenue of $870 million per year. That’s a stark difference of more than $99 billion to $149 billion annually.

Moreover, the actual annual tax revenue generated since 2009 from offshore voluntary disclosure initiatives and from prosecutions of individual’s tax evasion is running significantly lower than the JCT’s estimated annual average, at less than $400 million, and will probably result in less than that over the decade 2010 to 2020.

The substantial portion of revenue raised since 2009 has resulted from Foreign Bank Account Reporting (FBAR)-like penalties imposed upon banks (nearly $5 billion) and from FBAR penalties imposed upon their clients (also nearly $5 billion). FBAR falls under the provisions of US Code Title 31, Money and Finance, and addresses financial crime prevention including tax evasion. FBAR penalties are not Title 26, Internal Revenue Code tax revenues and tax penalties.

Regardless, these FBAR fines resulted from current IRS investigatory protocols and procedures, such as whistle blowers, John Doe summons, plea deals, and voluntary compliance initiatives.

This article addresses two questions: What was the statistical methodology used by the Subcommittee to estimate the figures of $100 billion and $150 billion lost U.S. tax revenue each year from ‘offshore tax abuses’ and ‘schemes’? And has Congress been trying to catch a leprechaun and his pot of gold?

IRS testimony about lost tax revenue from offshore tax evasion

The answer is to be found in a Congressional Research Service (CRS) Memorandum of July 23, 2001 referencing an inquiry made by the House Majority Leader as to the method used by attorney Jack Blum, an IRS contract consultant, to construct the then estimate of $70 billion of illegal tax evasion losses due to tax havens. This figure was contained in his affidavit submitted in support of the government’s request from the federal court for a John Doe summons for records from MasterCard and American Express.

According to the CRS: “Mr. Blum’s estimate was contained in a declaration filed in connection with a petition the Internal Revenue Service filed with the U.S. District Court for the Southern District. In response to your request, we contacted Mr. Blum and discussed his estimate; he was not able to send us a written discussion of his estimating procedure … We did not discuss these particular aspects of the estimating process in our initial conversation with Mr. Blum and our attempts to contact Mr. Blum on a follow-up basis have not been successful.”

In 2002 testimony, Mr. Blum provided the same estimate of $70 billion. When asked about that estimation during a Miami Offshore Alert conference, he admitted that the estimate was simply a “guess”.1

On March 4, 2009 the IRS Commissioner Charles Shulman testified before the Subcommittee that there is no credible estimate of lost tax revenue from offshore tax abuse.

According to the IRS, underreporting and underpayment of tax liabilities account for more than 90 percent of the $450 billion tax gap dollars. While the IRS has not estimated the size of the international tax gap, the Treasury Inspector General for Tax Administration reported in 2012 that estimates range from $40 billion to $123 billion annually. In 2000, the U.S. State Department estimated that assets secreted in offshore jurisdictions totaled $4.8 trillion. In 2007, the OECD estimated the total at $5 trillion to $7 trillion.

Information from the bank non-prosecution agreements

The UBS scandal was ‘the straw that broke the camel’s back’ and became the key driver for FATCA’s enactment. The Subcommittee noted over 52,000 U.S. persons with suspicious Swiss UBS bank accounts, with an estimated $20 billion under assets. “John Doe” summons were issued by the Justice Department against the UBS bank, requiring information on the U.S. accountholders. UBS settled with Justice for a $780 million fine and the details of 4,500 U.S. accountholders of the group of 52,000. The origin of the funds and lost tax revenue held by the 52,000 accounts originally requested in the UBS case remains unknown.

On February 26, 2014 Credit Suisse appeared before the Subcommittee and testified that it had a maximum 22,000 potentially suspicious accounts with U.S. beneficiaries, totaling roughly $10 billion and $12 billion in assets under management. The total fines derived from the ten Swiss based non-prosecution agreements announced by the Justice from UBS in 2009 to the most recent four on May 28, 2015 thus far approximate $4.8 billion, including: MediBank ($826,000), LBBW ($34,000), Scobag ($1,090), Finter (approximately $5.4 million), Vadian ($4,250,000), BSI ($211 million), Bank Leumi ($400 million), Credit Suisse ($2.6 billion), Wegelin ($57.8 million) and UBS ($780 million).

Information from IRS taxpayer prosecutions and the OVDP

The IRS reported that between 2009 and 2014 it charged more than thirty banking professionals and 71 accountholders with tax violations. By example, in 2013, a former UBS client pled guilty to two criminal counts of filing false tax returns for failing to report her offshore accounts left to her by her deceased husband for seven years (2001–2007).

Mary Estelle Curran, uneducated beyond high school, was 79 at the time of her plea, and owed $667,716 in taxes plus interest and penalties over the seven years, thus on average $95,388 lost tax revenue per year including the 40 percent understatement penalty and interest on the understatement. Her imposed penalty for failure to report the foreign bank accounts on her FBAR form, which is a Bank Secrecy Act/FinCEN violation constituting an anti-money laundering penalty instead of a tax penalty, was $21,666,929, comprised of 50 percent of the high balance of the accounts.

Criminal tax attorney, Charles Rettig, reported in the June/July 2014 Journal of Tax Practice & Procedure that various taxpayers who have opted out of the IRS’ offshore voluntary disclosure program (OVDP) have already received notices asserting multiple, cumulative, FBAR penalties of 50 percent for each year under audit. Rettig also described the finding of a trial jury against Carl Zwerner. Zwerner, at 87 more elderly than Mrs. Curran, through his tax attorney, made voluntary disclosures to the IRS Criminal Investigation in 2009 before the OVDP was established, for 2004 through 2006, 2007 having been timely filed.

Although the Tax Court and IRS appeals abated a 75 percent civil income tax fraud penalty imposed by the IRS, a jury upheld a 150 percent cumulative FBAR penalty, equaling $3,488,609.33 for an account with a high balance of $1,691,054 during the relevant time period.

In its June 2014 press announcement, updated as recently as May 15, 2015, the IRS reported that its OVDPs have produced $6.5 billion since 2009 from 45,000 taxpayers from “back taxes, interest and penalties.” But like with Mary Estelle Curran and Carl Zwerner, the substantial majority of this $6.5 billion revenue is neither tax revenue nor tax penalty, but instead from FBAR anti-money laundering penalties.

According to the Government Accountability Office Report of 2013, for small accounts of less than $100,000 that over a six year period had only an average of $103 tax owing ($17 a year additional tax revenue), the IRS imposed a FBAR penalty of $13,320 (i.e. $2,220 a year FBAR penalty on average for $17 dollar tax understatement, in additional to the tax penalty and interest). The twenty-fifth percentile paid on average a $5,945 FBAR penalty for an average annual $277 tax understatement. The median paid a FBAR penalty $17,991 a year for $2,125 a year tax understatement.

The GAO analysis found that the offshore penalties paid by taxpayers with the smallest accounts (i.e., those in the tenth percentile with accounts of $78,315 or lower) were disproportionate ─ at least 575 percent of the actual tax, interest, and tax penalty owed for their unreported income. The offshore penalties were also disproportionately greater for taxpayers with small foreign balances than the amount paid by those with the largest accounts (i.e. those in the ninetieth percentile with accounts of more than $4 million) who paid 86 percent or less.

On its face, the OVDPs look to be batting an average of approximately 9,000 taxpayers a year with approximately $1.3 billion revenue.

However, just at the beginning of 2014 Treasury reported that OVDIs have led to 43,000 taxpayers paying back taxes, interest and penalties totaling $6 billion to date. Thus, the OVDIs slowed down considerably to only 2,000 additional disclosures and $500 million additional revenue over the first half of the 2014 year. One may reasonably speculate that the OVDI, at least for high net wealth disclosures, is petering out.

Have these disproportionate FBAR fines at least produced a corresponding higher rate of FBAR compliance? The IRS does not know the answer to this question, and cannot know with its current allocation of internal resources for its Office of Service-wide Penalties (OSP).

The Taxpayer Advocate noted in its 2014 Report to Congress that two decades prior Congress recommended that the IRS “develop better information concerning the administration and effects of penalties” to ensure they promote voluntary compliance. Yet, the IRS Office of Service-wide Penalties (OSP) is “an office of six analysts buried three levels below the Small Business/Self-Employed Division Commissioner [that] cites insufficient resources, insufficient staffing, employees with the wrong skillsets, and a lack of access to penalty-related data as barriers to conducting penalty research.”

In 2002, the IRS reported to Congress that the FBAR compliance rate was less than 20 percent because it had received fewer than 200,000 FBARs when one million taxpayers may have been required to file. The 2013 Taxpayer Advocate Report, replying on State Department statistics, cited that 7.6 million U.S. citizens reside abroad and many more U.S. residents have FBAR filing requirements for foreign accounts, yet the IRS received only 807,040 FBAR submissions as recently as 2012. The Taxpayer Advocate noted that in Mexico alone, more than one million U.S. citizens reside, and many Mexican citizens reside in the U.S. Given only 807,040 FBARs from a potential class of eight to ten million FBAR filers that have breached the non-inflation adjusted $10,000 FBAR filing threshold, compliance with FBAR filing appears to be declining.

Conclusion

As of 2009, 125,000 to 150,000 U.S. taxpayers were probably criminally evading tax through offshore accounts. Their assets under management reasonably totaled $200 billion to $300 billion. In that the median non-compliant taxpayer had $12,748 tax understatement for the period 2003 through 2008, it is also likely that if 50,000 taxpayers currently remain non-compliant, with inflation and interest, another approximate $1.4 billion of tax revenue may be collected by 2020.

Thus, from tools already at Treasury’s disposal before FATCA, the period 2010-2020 will probably produce an annual average of approximately $250 million tax revenue, penalties and interest, excluding FBAR and FBAR like penalties on banks. With only a reasonable maximum of $300 billion of non-compliant offshore assets, Congress has probably forced the Treasury to chase a Leprechaun. Capturing a Leprechaun’s pot of gold requires BEPS, not FATCA.