Bad Bad, Bad Penalty, Bad OVDP Policy

There are now 50 foreign financial institutions on the IRS list of “bad banks” The list is published at the following link:

http://www.irs.gov/Businesses/International-Businesses/Foreign-Financial-Institutions-or-Facilitators

If a U.S. taxpayer has or had a foreign financial account that is unreported for FBAR purposes at any of the foreign financial institutions on the “bad bank” list the IRS and Department of Justice (“DOJ” take the position that failure to come forward is “willful” conduct subjecting the taxpayer to multi-year maximum FBAR penalties of fifty percent (50%) of the highest balance per year for up to six (6) years. The Justice Department has informally announced that it will only seek two (2) years of the maximum penalty in litigation, but that could easily amount to one hundred percent (100%)of the account balance. The alternative offered by the IRS and DOJ is to come forward under the Offshore Voluntary Disclosure Program, but there is a catch.

The catch is that if a taxpayer is on the “Bad bank” list the OVDP penalty is fifty percent (50%) of the single highest year account balance in the preceding eight (8) years instead of the customary twenty-seven and one half percent (27.50%) penalty. The difference is rationalized based upon the fact that taxpayers has had numerous opportunities to come forward since 2009 and that the “bad banks” are going to turn over information that will lead to the discovery of the taxpayer’s accounts; conclusion, the conduct is presumed “willful” deserving of the greater penalty. Does this presumption make sense?

From a prosecutor’s perspective the offer may make perfect sense. After all, the taxpayer is escaping harsher penalties including possible criminal prosecution in exchange for the fifty percent (50%) single year penalty. But, from a practitioner’s standpoint, we see taxpayers for whom the passage of time was just that the passage time without “willful” intent. In our opinion the fifty percent (50%) penalty should be reserved for taxpayers who make no effort to come forward not those who are willing to come forward but are deterred by the magnitude of the OVDP penalty.

The burden of proving “willfulness” under the fifty percent (50%) OVDP penalty is unfairly shifted to the taxpayer when in fact the burden of proving “willfulness” is and should be on the government. Many taxpayers with “Bad Bank” exposure should in appropriate cases consider using alternative options to come forward and be prepared to litigate the “willfulness” issue if and when challenged by the government