The Internal Revenue Service (IRS) currently offers non-compliant US taxpayers several different relief programs in which to report foreign assets and/or income and become compliant with US rules related to the disclosure of foreign assets. One option is the Offshore Voluntary Disclosure Program (OVDP). Another is the Streamlined Filing Compliance Procedures (SFCP). SFCP is further bifurcated into two sub-programs—one for US residents (Streamlined Domestic Offshore Procedures or “SDOP”) and one for non-US residents (Streamlined Foreign Offshore Procedures or “SFOP”). Each program has its own set of tailored procedures and eligibility requirements.
The critical differences between OVDP and SFCP are: (1) the non-willfulness requirement; (2) the look-back period; and (3) the amounts of penalties the US taxpayer must pay. Specifically, OVDP does not require the US taxpayer to certify that his or her failure to disclose foreign assets was non-willful. On the other hand, SFCP requires the US taxpayer to certify that his or her failure to disclose foreign assets was non-willful and to also include a narrative explaining such non-willful conduct. The incentive to demonstrate non-willfulness can be significant. In general, US taxpayers who enroll in OVDP must pay a 27.5 percent penalty (and in some cases a 50 percent penalty) of the highest aggregate value of undisclosed foreign assets for the OVDP disclosure period (eight years). However, US taxpayers who enter SDOP must only pay a five percent penalty of undisclosed foreign assets during the disclosure period (three years), and US taxpayers who enter SFOP pay no penalty.
OVDP pre-dated SFCP. Consequently, taxpayers who non-willfully failed to disclose foreign assets were only eligible to enter OVDP to become compliant under the IRS’ disclosure program. The IRS recognized that OVDP did not adequately account for these taxpayers’ circumstances and made SFCP available to US taxpayers starting on June 18, 2014. Contemporaneously with announcing SFCP, the IRS also created transitional rules for US taxpayers who qualified for SFCP to transition from OVDP to either SDOP or SFOP. According to the IRS, the purpose of the transitional treatment is to provide certain taxpayers an “opportunity to remain in the OVDP while taking advantage of the favorable penalty structure” of SFCP (see Transition Rules: Frequently Asked Questions). In announcing the transitional rules, the IRS made clear that a US taxpayer is not entitled to automatic transitional relief and that the US taxpayer must meet certain eligibility requirements and adhere to specific procedures. Further, the IRS did not provide for an appeal process if it denied a US taxpayer transitional treatment.
On July 25, 2016, in Maze v. IRS, 1:15-cv-01806, a consolidated action, the US District Court for the District of Columbia ruled in favor of the IRS with respect to the validity of the transitional rules. Specifically, three separate taxpayers had entered OVDP before June 18, 2014, and sought to transition to SFCP. The IRS denied each taxpayer’s request based on the position that in order to transition from OVDP to SFCP, the taxpayer must strictly adhere to the transition rules provided by the IRS.
The taxpayers filed suit and alleged that the IRS’ failure to permit them to transition into SFCP resulted in higher penalties, additional penalties, increased filing burdens, a disparate standard of review and a longer case review time as compared to other similarly situated taxpayers. Based on these alleged injuries, the taxpayers claimed the IRS’ actions violated two provisions of the Administrative Procedure Act (APA): (1) the transition rules were arbitrary, capricious, an abuse of discretion or otherwise not in accordance with the law; and (2) the transition rules were procedurally defective because they were contrary to the APA’s notice-and-comment requirements. The taxpayers sought various remedies, including a judgment that the transition rules violated the APA; a judgment that the taxpayers may enter SFCP; and an injunction prohibiting the IRS from enforcing the transition rules.
The court was persuaded by the IRS that the Anti-Injunction Act and the tax exception to the Declaratory Judgment Act deprived it of jurisdiction to hear the case. The court concluded that the case fell within the purview of the Anti-Injunction Act’s provision that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.” (26 U.S.C. § 7421(a); The Declaratory Judgment Act likewise prohibits most declaratory suits with respect to US federal income taxes).
The taxpayers relied on four different arguments, each of which the court rejected.
Firstly, the taxpayers claimed that because they paid the three years of taxes required by SFCP, there was nothing to assess or collect. The court rejected this argument, in part, because under SFCP the taxpayers would pay reduced disclosure penalties (five percent vs. 27.5 percent) and would not be subject to additional penalties such as accuracy-related penalties (which the court concluded constituted taxes for the purposes of the Anti-Injunction Act).
Secondly, the taxpayers argued that the transition rules were “procedural rules” and the Anti-Injunction Act does not bar a challenge to procedural rules. The court rejected this argument because the rules challenged in the suit pertain wholly to the assessment and collection of unpaid taxes, and not to any unrelated regulatory goals.
Thirdly, the taxpayers asserted that the requested relief would not bar the IRS from seeking tax payments for the five earlier years covered by OVDP that were not covered by SFCP. The court rejected this argument because it believed allowing the taxpayers to transition would constitute a restraint on the assessment and collection of taxes, and it further believed the taxpayers had no legal basis for this argument.
Finally, the taxpayers argued that the Anti-Injunction Act is inapplicable because the taxpayers had no alternative remedy. The court similarly dismissed this argument because according to the court, the taxpayers had two alternative remedies—pursue a settlement with the IRS or pay the taxes and penalties and seek a refund through a refund suit.
On a separate note, in United States v. Greenfield, 2d Cir., No. 15-543 (Aug. 1, 2016), the IRS was rebuked in an attempt to require a US taxpayer to disclose documents related to offshore accounts. Specifically, the IRS sought documents from an individual taxpayer following a widely-publicized leak of information related to certain Liechtenstein financial institutions. The taxpayer refused to comply and asserted his Fifth Amendment right against self-incrimination. The Second Circuit held for the taxpayer with respect to a certain sub-set of documents the IRS sought. This holding may increase the IRS’ burden for compelling the disclosure of certain offshore account information.
Lastly, Tax Notes recently published an article speculating that OVDP and SFCP may be discontinued in the foreseeable future. The article cites various reasons the IRS may have for discontinuing the programs (e.g., decreased participation over the past five years). The article also surveys practitioners to solicit their perspective on the effectiveness of the voluntary disclosure programs and whether the IRS should adopt new, alternative procedures if OVDP and SFCP are discontinued so that US taxpayers may still have an adequate mechanism for becoming compliant. The IRS has yet to officially comment on terminating OVDP or SFCP.
Taxpayers who have failed to comply with their US tax filing and information reporting obligations should be aware of these recent developments and seek appropriate advice regarding whether, and which, disclosure program to pursue. As noted above, the IRS may terminate the disclosure programs at any time, reducing the ability for non-compliant taxpayers to enter a structured program to seek to achieve finality with respect to their compliance.