Many people fail to report offshore income and file related information returns for a wide variety of reasons. With few exceptions, the IRS requires them to “opt into” a punishing offshore voluntary disclosure settlement program. The combination of the reporting statute and the way the IRS administers it creates the potential for such harsh penalties that some taxpayers agree to pay unwarranted amounts to avoid the penalties.
The median penalty paid under the 2009 program by taxpayers who had the smallest accounts, and did not have legal representation, was nearly eight times the unpaid tax. It was also disproportionately greater than what the IRS extracted from those with the largest accounts; they paid a median of about three times the unpaid tax. Thus, the IRS has extracted the most extreme penalties from unrepresented taxpayers with small accounts who were voluntarily trying to correct a mistake. By contrast, IRS data suggests that those who don’t try to comply often remain undetected. Yet the IRS’s audit rate with respect to foreign financial account reporting is less than 0.25%.
The National Taxpayer Advocate has offered many common sense recommendations that would bring taxpayers into compliance and help restore confidence in the IRS, but IRS has not fully adopted them.