Making The Offer In Compromise - Simple

Introduction

The “Offer in Compromise” is the typical way for Americans to resolve outstanding tax liabilities that they are unable to meet.¹

It is a reasonably fair process with levels of Taxpayer protections. However, it is not as is often advertised, a procedure that produces the miracle of reducing $50,000 in tax liability to $5,000 without extraordinary circumstances. Right now, any Taxpayer that has the ability to meet a portion of their outstanding tax liabilities, if they have a breathing period of several years, should give an Offer in Compromise serious consideration. Offer in Compromise settlements are based upon the Taxpayer’s assets and overall financial situation. The worse the Taxpayer’s financial situation looks, the better the settlement with the I.R.S. The bad economy is one reason why now is the time to consider an Offer in Compromise.

Offers in Compromise

The IRS has the authority to accept less than full payment and to compromise a taxpayer’s tax liabilities if it is unlikely that the IRS can collect the tax liability in full.

The basis for a settlement for less than the full amount of the liabilities by the I.R.S. must be either

(1) There is a dispute as to the amount that the taxpayer owes (Doubt as to Liability);

(2) There is doubt that the liability can be collected in full. (Doubt as to collectability); or

(3) If a settlement of a tax liability will promote effective tax administration.

Doubt as to Collectability

The IRS will accept an offer in compromise if it achieves the collection of an amount that is potentially collectible at the earliest possible time and at the least cost to the government. In order to accomplish the goal, the Internal Revenue Code provides the offer in compromise as the exclusive method for compromising all taxes, penalties, and interest for the periods and taxes covered by the offer.

An offer is legally sufficient to be accepted due to doubt as to collectability of the full tax liability if it closely approximates the amount that the IRS could reasonably collect by other means, including through an administrative or judicial proceeding. The I.R.S. will consider four components in determining doubt of collectability (i) net equity in assets, (ii) present and future income, (iii) amounts collectible from third parties, and (iv) amounts that the taxpayer should reasonably be expected to raise from assets available to the taxpayer but beyond the reach of the IRS.

In calculating the maximum collectible amount from a taxpayer, the IRS determines if the taxpayer’s assets and present and future income are less than the full amount of the assessed liability. In determining ability to pay, the IRS permits taxpayers to retain sufficient funds to pay basic living expenses. Basic living expenses are based upon an evaluation of the individual facts and circumstances of each case, taking into account published guidelines on national and local living expenses standards.

Effective Tax Administration

If there are no grounds for compromise based on doubt as to liability or doubt as to collectability, the IRS may accept an Offer to Compromise to promote effective tax administration. Generally, this means that the I.R.S. will settle for a compromised tax liability if the collection of the full liability is possible, but will create economic hardship.

The following are examples of this category:

Economic Hardship: Long-term Illness

• Taxpayer has assets sufficient to satisfy the tax liability. The Taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the Taxpayer will need to use the equity of her assets to provide for adequate basic living expenses and medical care for her child. The Taxpayer’s overall compliance history does not weigh against compromise.

Economic Hardship: Liquidation of Assets

• The Taxpayer is retired and his only income is from a pension. His only asset is a retirement account and the funds in the account are sufficient to satisfy the liability. However, the liquidation of the retirement account would leave the Taxpayer without an adequate means to provide for basic living expenses. His overall compliance history does not weigh against compromise.

The Proposal to Compromise

The Form 656 is the starting point for an offer in compromise. The taxpayer must indicate the facts and reasons why the IRs should accept the offer and which of the three categories, (doubt as to liability, doubt as to collectability, or effective tax administration); apply to the Taxpayer’s situation.

A Taxpayer seeking to compromise a liability based on doubt as to collectability or effective tax administration must also submit a Form 433-A (Financial Statement for Individuals) and any other financial statement prepared by the Taxpayer signed under a penalty of perjury.

Taxpayers that submit an offer to compromise individual income tax liabilities and who also have substantial business interests may also be required to submit a Form 433-B for the business.

The taxpayer may make a cash offer or a deferred payment offer.

The taxpayer is responsible for initiating the first specific proposal for compromise. A taxpayer must make partial payments to the IRS while the taxpayer’s offer is being considered. For lump sum offers, taxpayers must make a down payment of 20% of the offer with the application. For these purposes, a lump sum offer includes single payments as well as payment made in five or fewer installments. If the taxpayer proposes to pay in installments, the first installment must accompany the offer, and the taxpayer must comply with the proposed payment schedule while the offer is being considered (or the IRS will consider the offer withdrawn).

Application Process

The Taxpayer wants to make sure the offer is in an acceptable form or it will be rejected if it cannot be processed. In such instances, the IRS will contact the taxpayer to indicate and request the information that is missing or needs to be corrected.

Some items to double check before an offer in compromise is submitted are:

• The taxpayer must identify the tax liabilities and years to be compromised;
• The taxpayer must make a financial offer; and the
• Payment terms must be specified;
• The pre-printed terms of the Form 656 must not be altered and it must fully disclose assets and liabilities owed jointly and owned individually;
• The taxpayer’s taxpayer identification number must be correctly stated;
• The offer must be signed;
• Necessary financial statements – Form 433-A and/or 433-B – must be completed and signed.

When the offer is submitted by a person who shares household expenses, disclosure of the non-liable individuals’ financial information can be required to determine the taxpayer’s share of the household expenses.

Collection Proceedings During Offer

Once the offer in compromise is received, the IRS will not automatically withhold collection activity. Generally, collection activity is suspended if the offer is not frivolous and if the tax liability that the taxpayer seeks to compromise is not in jeopardy.

The IRS will not make any levies to collect the liability that is the subject of the compromise during the period the IRS is evaluating whether such offer will be accepted or rejected, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals.

The IRS directs the examining officer to determine processibilty of the offer as soon as possible, but within 14 days, and to then contact the taxpayer. If the IRS determines that the offer is processible but needs to be perfected, the IRS may communicate with the taxpayer by letter or by personal contact or request the additional information needed to perfect the pending offer. If the taxpayer does not respond timely, the IRS closes the offer as a return.

The IRS’s goal is to collect the tax liability a quickly as possible. In other words, immediate resolution of the liability is desired. To this end, the IRS will analyze the taxpayer’s assets to determine ways of liquidating the account. If the taxpayer has cash to pay the tax liability, the IRS will demand immediate payment. Otherwise, the IRS will consider if there are other assets which may be pledged or readily converted too cash; unencumbered assets; equity in encumbered assets; interest in estates and trust; lines of credit; and the taxpayer’s ability to obtain an unsecured loan. If there are assets with value and the taxpayer is unwilling to raise money from them, the IRS will consider enforced collection (i.e., levy and distrait). On the other hand, if the taxpayer has no borrowing power, the IRS will request that the taxpayer defer payment of certain other debts if this would allow payment of the tax liability.

Determining Maximum Collectability

Determining Equity in Assts: As part of its financial analysis, the IRS first examines the taxpayer’s equity in assets as the existence of equity may militate against the granting of an installment agreement.

When analysis of the taxpayer’s assets does not provide any obvious collection solutions, the IRS will turn to analyze the taxpayer’s income and expenses to determine the amount of disposable income available to apply to the tax liability. The IRS’ policy is that expense analysis is necessary only if it is unable to collect the liability from available assets. The taxpayer’s expenses must be reasonable in amount for the size of the family, the geographic location, and any unique individual circumstances. In some cases, the IRS will allow more than a reasonable amount on a substantiated expense if the tax liability, including projected accruals, can be fully paid within five years.

Valuation of Taxpayer Assets

Quick Sale Value: In determining whether the taxpayer’s offer is adequate in a doubt as to collectability situation, the IRS starts with the value of the taxpayer’s assets. This analysis begins with the value of the taxpayer’s assets minus the encumbrances having priority over the federal tax lien, i.e., the assets’ net realizable equity. The value assigned to these assets generally is the quick sale value (i.e., the amount that a taxpayer under financial pressures would realize on selling the assets in a short period of time). Quick sale value is defined as a value less than fair market value and greater than forced sale value, with forces sale value being no less than 75% of the asset’s fair market value

The IRS’s position in doubt as to collectability situations is that the taxpayer must offer an amount equal to the realizable equity in assets plus the value of future ability to pay, i.e., the reasonable collection potential. Thus, all assets – even those with no fair market value or those that the IRS would not attempt to collect should the offer be rejected – must be considered in determining the amount that is collectible form the taxpayer. However, if a taxpayer is not able to offer this amount due to special circumstances, the IRS may review the offer using the same factors as are used for economic hardship under effective tax administration.

The IRS examiner, therefore, conducts an investigation of the Taxpayer’s assets and income to determine if the amount offered reasonably reflects collection potential.

Allowable Expenses

Allowable expenses include necessary and conditional expenses. Necessary expenses are allowable if they are reasonable in amount.

Conditional expenses are allowable if the tax liability can be fully paid within five years through an installment agreement.

There are three types of necessary expenses: National Standards, Local Standards and Other Expenses.

Necessary Expenses – National Standards:

These establish standards for reasonable amounts for five necessary expenses: food, housekeeping, supplies, apparel and services, personal care products and services, out-of-pocket medical expenses and miscellaneous. The National Standards are available on the IRS’s website and are updated periodically.

A taxpayer who claims more than the total allowed by the National Standards must substantiate and justify as necessary each separate expense of the total. For instance, a taxpayer claiming more for food than is allowed can justify this expense if there are special prescribed or required dietary needs.

Finally, if the taxpayer can fully pay the tax liability, including projected accruals, within five years, the taxpayer may be allowed more than the amount allowed by the National Standards. To obtain the additional amount, the taxpayer must substantiate all the expenses that constitute the National Standards.

Necessary Expenses – Local Standards:

The National Standards do not adequately capture certain expenses. Housing and transportation are two such expenses. This also includes utilities and telephone expenses. Transportation includes car insurance and public transportation. Local standards for housing and utilities, and transportation may be found on the IRS’s website.

Necessary Expenses – Other:

The IRS recognizes that there are expenses other than those listed in National Standards or Local Standards that nevertheless may be necessary expenses. If the liability can be fully paid within five years, the IRS generally will allow excessive necessary and conditional expenses. If the liability cannot be fully repaid within five years, such expenses may be allowed for up to one year to give the taxpayer time to modify or eliminate the expense.

Examples of other necessary expenses include:

• Taxes;
• Charitable contributions;
• Education;
• Health care;
• Court ordered payments;
• Involuntary deductions;
• Accounting and legal fees for representing a taxpayer before the IRS;
• Secured or legally perfected debts (minimum payments); and
• Accounting and legal fees other than those for representing a taxpayer before the IRS which meet the necessary expense test of health and welfare and /or production of income.

Where other expenses are claimed as necessary, the taxpayer may have to substantiate the amounts and justify the expenses. The IRS’ general rule is that unless the tax liability will be fully paid, including projected accruals, within three years, such other expenses must be reasonable in amount. The IRS considers the following non exhaustive list of expenses under this category.

• Life Insurance;
• Disability insurance for a self-employed individual;
• Union dues;
• Education;
• Child care;
• Dependent care – elderly, invalid, or disabled; Charitable contributions;
• Repayment of loans made for payment of Federal taxes;
• Secured or legally perfected debts;
• Internet provider/email;
• Professional association dues;
• Accounting and legal fees other than those for representing a taxpayer before the IRS which meet the necessary expense test of health and welfare and/or production of income; and

Negotiating an Acceptable Offer:

Generally the amount of an acceptable offer equals: (1) the value of the taxpayer’s equity in assets subject to the IRS’s tax lien; plus (2) the present value of the taxpayer’s ability to make monthly installment payments over a five year period

If the amount offered by the taxpayer does not meet what is determined to be an acceptable offer, the taxpayer can request a conference with the IRS to discuss the amount that is acceptable as a compromise.

Settlement Discretion:

The IRS has discretion to determine to what extent to compromise a tax liability. IRS settlement offers are not legally required. However, the IRS must maintain a duty of “administrative consistency” and Taxpayer equality when rejecting offers. In settlement discretion cases, courts generally apply an abuse-of-discretion standard of review.

Appeals:

The taxpayer may appeal the rejection of the proposed offer in compromise to the Appeals office within the 30-day period beginning the day after the date of the letter of rejection.

Finality of Agreement:

An offer in compromise is considered to be accepted only when the taxpayer is notified by the IRS, in writing, of the offer’s acceptance. The acceptance of an offer in compromise conclusively settles all questions regarding the liability that is the subject of the offer. The form used to make an offer in compromise states that the taxpayer no longer may be able to contest the amount of his tax liability.

A case may be reopened even though an offer in compromise has been accepted, if the following situations exist:

• A taxpayer falsifies or conceals assets on completing Form 656 or Form 433-B
• There is a mutual mistake of a material fact sufficient to cause a contract to be reformed.

Footnotes:

1. A little used procedural method that is very helpful if the taxpayer has a good case that has not been presented properly, or if the taxpayer has new documentation to present is a Request for Audit Reconsideration which differs from an offer in compromise based upon doubt as to liability. In several types of cases the IRS may make arbitrary adjustments, usually involving the denial of the deductions or exemptions that were the subject of an audit. If there is significant new or additional convincing information not previously seen that will prove a taxpayer’ point, the taxpayer may request “audit reconsideration”. The taxpayer must provide additional information or there is no basis for reconsideration.

Do you have an unreported foreign bank account and you missed the Amnesty Program?

Are you afraid to enter into the I.R.S Voluntary Compliance Program?

You are not alone. Richard Lehman, a Florida tax lawyer, specializing in the amnesty and voluntary compliance areas of tax law is organizing a class of people for the purpose of approaching I.R.S. to force it to apply the “Doctrine of Tax Payer Equality” and extend equal treatment to all taxpayers so that taxpayer(s) can continue to take advantage of long standing policies by the I.R.S. that allow them to clear their records without facing confiscatory civil penalties or criminal violations.

Lehman believes that a well represented large group of taxpayers is the taxpayers’ best chance of fairness and equal treatment. Learn how to become part of this group contact Richard Lehman Today!

Are you going to wait until more information is supplied to the I.R.S. from foreign banks and face criminal tax charges when you can still avoid them right now?

Mr. Lehman has spent years as an attorney with the I.R.S., in addition he has over 35 years of private practice experience representing clients dealing with the I.R.S. Please contact him today to help guide you through the process of determining the best choice available for you, without waiving valuable rights.

Richard S. Lehman, Esq.
2600 N. Military Trail, Suite 270
Boca Raton, FL 33431
561-368-1113 Telephone
561-998-9557 Fascimile

Americans With Foreign Bank Deposits And Unreported Income – A Stay Out Of Jail Card From The I.R.S.

[This IRS Amnesty Program terminates on September 23, 2009. Schedule a confidential appointment with Richard S. Lehman, P.A. today to discuss your individual situation.]

Richard S. Lehman, P.A.
2600 N. Military Trail, Suite 270
Boca Raton, Florida 33431
Telephone: (561) 368-1113
Facsimile: (561) 998-9557

The most recent headlines include a controversy between the United Bank of Switzerland and the Swiss government versus the Internal Revenue Service of the United States. The U.S. is seeking the names of approximately 50,000 Americans with offshore bank accounts at U.B.S.

The headlines are a result of very strong efforts by the United States in recent years to stop the use of “tax havens” where Americans were depositing unreported income that had not been taxed and were doing so with anonymity and impurity.

Those efforts have started to bear fruit for the U.S. tax collectors. Since knowingly not reporting income on your Federal income tax return is a crime, many U.S. individuals were put in a hard place with important choices to make about taxes.

The Internal Revenue Service has very intelligently made that choice easier.

On March 23, the Internal Revenue Service came up with a six month “Amnesty Program” to allow U.S. taxpayers with unreported income to disclose their foreign bank accounts without fear of any criminal tax penalties. The price is to pay the income tax, the interest on the income tax and two specific penalties on unreported income and foreign bank accounts for the years 2003 through 2008. The Amnesty Program terminates six months after its March 23, 2009 announcement, on September 23, 2009.

This Article will discuss the I.R.S. Amnesty Program, its requirements, pitfalls and its procedures.

The I.R.S. Amnesty Program for foreign bank deposits is a modification of a long standing I.R.S. Voluntary Disclosure Policy that for decades has provided for a waiver of criminal charges against a taxpayer that has “Voluntarily Disclosed” all of his or her unreported income to I.R.S. and met several other required standards.

This long standing policy governing Voluntary Disclosures has its weaknesses from a taxpayer standpoint, the most crucial of which was that the I.R.S. honored their policy but has always taken the position that there were no guarantees of Amnesty. Furthermore, the numerous civil tax penalties that might result from the disclosures of previously untaxed income remained uncertain.

The Amnesty program seems to add more certainty to the ordinary Voluntary Disclosure policy in both of these areas. The Amnesty Program appears to grant amnesty from both civil and criminal tax charges, for a taxpayer’s previous undisclosed and unreported taxable income, so long as the taxpayer meets the following Amnesty Program requirements and meets all of the requirements of the general Voluntary Disclosure policy.

The I.R.S. manual spells out the principal requirements of the Voluntary Disclosure which must be truthful, timely and complete. This occurs under the following circumstances

1. The undisclosed income has not come from an illegal source.
2. The taxpayer shows a willingness to cooperate (and in fact does cooperate) with the I.R.S. in determining his or her correct tax liability; and
3. The taxpayer makes good faith arrangements with the I.R.S. to pay in full, the tax, interest and any penalties determined by the I.R.S. to be applicable.
4. The disclosure must be timely which means it must be received before:

(a) The I.R.S. has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation.

(b) The IR.S. has received information from a third party (e.g., informant, other governmental agency or the media) alerting the I.R.S. to the specific taxpayer’s noncompliance.

(c) The IR.S. has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or

(d) The I.R.S. has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g. search warrant, grand jury subpoena)

The Amnesty Program

It is first important to see what requirements have been added to the general Voluntary Disclosure rules to meet the Amnesty Program.

Under the Amnesty Program, the taxpayer’s voluntary disclosure will be forwarded to the local Criminal Investigation Office that will determine if the disclosure is voluntary and has been truthful, timely, complete and is therefore eligible for the Amnesty Program.

Assuming eligibility for the Amnesty Program, first the taxpayer must file amended income tax returns and Treasury Department Forms TD F 90-22.1, Report of Foreign Bank and Financial Accounts (“FBARs”), for each of the prior six years (or for each year since the foreign bank account(s) in question were opened), whichever is less.

The cost of Amnesty is calculated based upon the disclosures in the Amended Returns of 2003 through 2008. The taxpayer will be responsible for:

A. Unpaid income taxes for each of the last six years.

B. Interest calculated on the unpaid taxes.

C. An accuracy-related penalty of 20% or delinquency penalty of 25% on all income tax liability for the six year period.

D. A penalty equal to 20% of the highest value of each undisclosed bank account during the six year reporting period. This can be reduced to 5% for certain bank deposits that represented income that was previously reported to the U.S.

These guidelines, like the Voluntary Compliance guidelines also need some further explanation. However, it should be pointed out that the I.R.S. has supplied helpful guidance in the form of a series of questions and answers that can be located on the I.R.S. website at I.R.S.gov under the words “offshore bank deposits – Amnesty”.

An example of the calculation for the cost of the Amnesty Program described above is found at Question and Answer No. 12 of the I.R.S. publication which reads as follows:

Q.12. How does the penalty framework work? Can you give us an example?

A12. Assume the taxpayer has the following amounts in a foreign account over a period of six years. Although the amount on deposit may have been in the account for many years, it is assumed for purposes of the example that it is not unreported income in 2003.

Amount of Interest Account
Year Deposit Income Balance

2003 $1,000,000 $50,000 $1,050,000

2004 $50,000 $1,100,000

2005 $50,000 $1,150,000

2006 $50,000 $1,200,000

2007 $50,000 $1,250,000

2008 $50,000 $1,300,000

(NOTE) This example does not provide for compounded interest, and assumes the taxpayer is in the 35 percent tax bracket, files a return but does not include the foreign account or the interest income on the return, and the maximum applicable penalties are imposed).

If the taxpayer comes forward and has their voluntary disclosure accepted by the IRS, they face this potential scenario:

They would pay $386,000 plus interest. This includes

• Tax of $105,000 (six years at $17,500) plus interest
• An accuracy-related penalty of $21,000 (i.e., $105,000 x 20%, and
• An additional penalty in lieu of the FBAR and other potential penalties that may apply, of $260,000
  (i.e., $1,300,000 x 20%)

The I.R.S. Questions and Answers publication is very helpful to answer many of the questions that will arise under these policies. To mention a few:

1. Can a Taxpayer qualify for the Amnesty Program if he or she no longer has the ability to pay?

Q27. If I don’t have the ability to pay can I still participate in the IRS’s Voluntary Disclosure Practice?

A27. Yes. The March 23, 2009 guidance requires the taxpayer to fully pay all taxes and interest for all years covered, and the Voluntary Disclosure penalty, as well as all other unpaid, previously assessed liabilities, when the signed closing agreement is returned to the Service. However, it is possible for a taxpayer who is unable to make full payment at that time to submit a request that includes other payment arrangements acceptance to the IRS.

The burden will be on the taxpayer to establish inability to pay, to the satisfaction of the IRS, based on full disclosure of all assets and income sources, domestic and offshore, under the taxpayer’s control. Assuming that the IRS determines that the inability to fully pay is genuine, the taxpayer must work but other financial arrangements, acceptable to the IRS to resolve all outstanding liabilities, in order to be entitled to the penalty relief set forth in the March 23, 2009 guidance.

2. What assets may be subject to the Amnesty Program?

The answer to the question of what asset may be subject to the Amnesty Program actually required two Questions and Answers, not one. The I.R.S. issued one set of Questions and Answers in May and recently updated those Questions and Answers on June 24th. It seems the May Questions and Answers on this subject needed clarification in the form of a second question in June which is Question and Answer NO. 37.

The two answers make it clear that the assets that may be subject to the 20% penalty include more than just bank deposits. They include tangible assets such as real estate or art, intangible assets such as patents or stocks or other interests in a business.

Question 37 clarified that there was no 20% penalty for non income producing assets that had no reporting obligation to disclose their existence at this point. The tax on gain in any of these assets should be paid to the U.S. when the gain is realized.

Q20. Does the twenty percent penalty apply to entities? Does the twenty percent penalty apply only to cash and securities held in foreign accounts or entities or to tangible and intangible assets as well?

A20. The twenty percent penalty applies to entities. The twenty percent penalty applies to all assets (or at least the taxpayer’s share) held by foreign entities (e.g., trusts and corporation) for which the taxpayer was required to file the information returns, as well as all foreign assets (e.g. financial accounts, tangible assets such as real estate or art and intangible assets such as patents or stock or other interests in a U.S. business) held or controlled by the taxpayer.

Q37. Re: Q & A 20. A taxpayer owns valuable land and artwork located in a foreign jurisdiction. This property produces no income and there were no reporting requirements regarding this property. Must the taxpayer report the land and artwork and pay a 20 percent penalty?

A.37 Q&A 20 related to income producing property for which no income was reported. Under those circumstances, no distinction is made between assets held directly and assets held through an entity in computing the 20 percent offshore penalty. However, if the taxpayer owns non income producing property in the taxpayer’s own name, there has been no U.S. taxable event and no reporting obligation to disclose. The taxpayer will be required to report any current income from the property or gain from its sale or other disposition at such time in the future as the income is realized. Because there has as yet been no tax noncompliance, the 20 percent offshore penalty would not apply to those assets. If the foreign assets were held in the name of an entity such as a trust or corporation, there would have been an information return filing obligation that may need to be disclosed. See Q&A 42.

3. How does a Taxpayer treat unreported income earned prior to 2003?

Paragraph No. 3 also requires two separate Questions and Answers for clarification. Previously in this Report, Question and Answer 12 was referred to. In Answer No. 12, there is a specific point of saying the original deposit “is not unreported income for 2003”. This answer begs the question of whether amnesty is granted for pre 2003 unreported income.

In Question 33 of the June 24th version of the Questions and Answers, the following statement is made about unreported income in a pre disclosure year (2003 – 2008). Question No. 33 appears to say that the Amnesty Program is a program that will also cover the pre amnesty years. The answer to this question continues to need clarification by the I.R.S.

Q33. If the look back period is 2003-2008, what does the taxpayer do if the taxpayer held foreign real estate, sold in 2002, and did not report the gain on his 2002 return? Does the taxpayer compute the 20 percent on the highest aggregate balance in 2003-2008? What, if anything, does IRS expect the taxpayer to do with respect to 2002?

A33. Gain realized on a foreign transaction occurring before 2003 does not need to be included as part of the voluntary disclosure. If the proceeds of the transaction were repatriated and were not offshore after January 1, 2003, they will not be included in the base for the 20 percent offshore penalty. On the other hand, if the proceeds remained offshore after January 1, 2003, and the income in the account was not reported, they will be included in the base for the penalty.

4. How to obtain records from overseas?

Q18. What should I do if I am having difficulty obtaining my records from overseas?

A18. Our experience with offshore cases in recent years is that taxpayers are successful in retrieving copies of statements and other records from foreign banks when they genuinely attempt to do so. If assistance is needed, the agent assigned to a case will work with the taxpayer in preparing a request that should be acceptable to the foreign bank.

5. What information is needed to comply with the Amnesty Program?

Q25. Besides federal income tax returns, what forms or other returns must be filed?

A25. The following forms must be filed:

• Copies of original and amended federal income tax returns for tax periods covered by the voluntary disclosure.
• Complete and accurate amended federal income tax returns (or original returns, if not previously filed) of the taxpayer for all tax years covered by the voluntary disclosure.
• An explanation of previously unreported or underreported income or incorrectly claimed deductions or credits related to undisclosed foreign accounts or undisclosed foreign entities, including the reason(s) for the error or omission.
• If the taxpayer is a decedent’s estate, or is an individual who participated in the failure to report the foreign account or foreign entity in a required gift or estate tax return, either as executor or advisor, complete and accurate amended estate or gift tax returns (original returns, if not previously filed) necessary to correct the underreporting of assets held in or transferred through undisclosed foreign accounts or foreign entities.
• Complete and accurate amended information returns required to be filed by the taxpayer, including, but not limited to, Forms 33520, 3520-A, 5471, 5472, 926 and 8865 (or originals, if not previously filed) for all tax years covered by the voluntary disclosure for which the taxpayer requests relief, and
• Complete and accurate Form TD F 90.22.1. Report of Foreign Bank and Financial Accounts, for foreign accounts maintained during calendar years covered by the voluntary disclosure.

6. What are the civil and criminal penalties a Taxpayer might face if they do not join the Amnesty Program?

Q.14 What are some of the criminal charges I might face if I don’t come in under voluntary disclosure and the IRS finds me?

Possible criminal charges related to tax returns include tax evasion (26 U.S.C. § 7206(1) and failure to file an income tax return. The failure to file an FBAR and the filing of a false FBAR are both violations that are also subject to criminal penalties,

A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.

What are some of the civil penalties that might apply if I don’t come in under voluntary disclosure and the IRS finds me?

• A Penalty for failing to file the Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”.
• A penalty for failing to file form 3520. Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.
• A penalty for failing to file Form 3520-A. Information Return of Foreign Trust with U.S. Owner Taxpayers
• A penalty for failing to file Form 5471. Information Return of U.S. Person with Respect to Certain Foreign Corporations.
• A penalty for failing to file Form 926. Return by a U.S. Transferor of Property to a Foreign Corporation.
• A penalty for failing to file Form 8865. Return of U.S. Persons with Respect to Certain Foreign Partnerships.
• Fraud penalties
• A penalty for failing to file a tax return
• A penalty for failing to pay the amount of tax shown on the return.
• An accuracy related penalty on underpayments

There are answers to these and many other questions in the I.R.S. publication and a taxpayer is urged to read it in full. The I.R.S. certainly does its job to push the taxpayer towards compliance, since it gives another example that shows how costly it could be from a civil tax payment standpoint for the taxpayer who chooses not to use the Amnesty Program but chooses to sit and wait and hope for the best.

The reader will note that the example in Question 12 of the I.R.S. publication produced a total amount of tax, not including interest equal to $386,000 as the cost of full compliance for an unreported deposit of $1 Million that earned $300,000 in income for the six year reporting period. The I.R.S. in Question 12 also published the cost to the taxpayer who chooses not to comply. This time the cost would be 600% higher than the taxpayer would pay under the potential Amnesty Program with a total of interest and penalties of $2,306,000.

If the taxpayer did not come forward and the IRS discovered other offshore activities, they face up to $2,306,000 in tax, accuracy-related penalty, and FBAR penalty. The taxpayer would also be liable for interest and possible additional penalties, and an examination could lead to criminal prosecution.

The civil liabilities potentially include:

• The tax and accuracy-related penalty, plus interest, as described above.
• FBAR penalties totaling up to $2,175,000 for willful failures to file complete and correct FBARs (2003 - $100,000, 2004 - $100,000, 2005 - $100,000, 2006 - $600,000, 2007 - $625,000 and 2008 - $600,000.
• The potential of having the fraud penalty (75 percent) apply, and
• The potential of substantial additional information return penalties if the foreign account or assets is held through a foreign entity such as a trust or corporation and required information returns were not filed.

Note that if the foreign activity started more than six years ago, the Service may also have the right to examine additional years.

Practical Solutions

This author has found on multiple occasions that when dealing with cases such as those involved in the Amnesty Program, the taxpayer is best served by making his first few steps the right ones which include hiring the right team of counsels that include both a tax lawyer and a criminal lawyer.

These two disciplines of law working together will generally come up with the best solution. Often the tax lawyer believes that certain taxpayer disclosures and presentations will be helpful in deterring an I.R.S. criminal investigation while the criminal lawyer must always keep his eyes on the taxpayer’s Fifth Amendment rights to make sure the disclosures necessary to tell the taxpayer’s story do not violate the taxpayer’s constitutional rights and do great harm. The resulting work product of the two disciplines generally seems to have outcomes that include the best of both worlds.

There is one area in particular where much more guidance is needed from the I.R.S. to make sure that potential applicants to the Amnesty Program are not driven away for fear of the requirement that their income must be from “legal sources”. There is very little information available by way of case law, contemporary writings, I.R.S. publications and other sources that provide any parameters to the term “legal” or “illegal” sources of income for purposes of the Amnesty Program. This presents a problem since the Amnesty Program will attract taxpayers in many borderline cases, that may be unnecessary scared away.

For example, assume a taxpayer is indicted for a criminal misdemeanor involving the violation of a state law while conducting his or her business. Assume all of the charges against the taxpayer are later dismissed either immediately or after exhausting the legal process.

Query: Is this illegal income?

The handling of the question of “legal source income” needs to be treated with delicacy by taxpayer and counsel alike. This author has found on many occasions that it is extremely helpful to request that counsel meet directly with the I.R.S. criminal investigator, without discussing the taxpayer’s name, for advice on dealing with gray areas of the law.

Attorney-client privilege is one of the strongest privileges available under law.

Richard S. Lehman, P.A.
2600 N. Military Trail, Suite 270
Boca Raton, Florida 33431
Telephone: (561) 368-1113
Facsimile: (561) 998-9557