IRS Reverses Decision; Readmits Bank Leumi Customers Into OVDP

When making a voluntary disclosure pursuant to the IRS Offshore Voluntary Disclosure Program (OVDP), the first step involves sending a letter requesting pre-clearance to make a voluntary disclosure.  The letter includes a taxpayer’s identifying information, including the taxpayer’s name and social security number.  The IRS then runs the taxpayer’s information through an IRS database to ensure that the IRS has not already received offshore account information with respect to the taxpayer or that the taxpayer is not already under audit or investigation.  If the taxpayer’s information is not in the IRS database, the taxpayer is ordinarily preliminarily accepted into the OVDP.  The taxpayer then must complete a questionnaire, and absent extenuating circumstances (e.g., non-compliance with the terms of the program, such as the funds in the offshore accounts being derived from criminal activity), the taxpayer’s matter is transferred from the IRS Criminal Investigation Division to the IRS Civil Division for processing.

Several dozen taxpayers who were prior customers of Bank Leumi in Israel completed this process and, in many cases, were both pre-cleared to make a voluntary disclosure and transferred from the IRS Criminal Investigation Division to the IRS Civil Division.  These taxpayers were apparently fully compliant with the terms of the OVDP.

Last March, however, the IRS abruptly kicked out these taxpayers from the OVDP.  Practitioners believe that the IRS had received information from Bank Leumi with respect to the taxpayers but had yet to update its database.  As a result, the IRS preliminarily accepted the taxpayers into the OVDP, despite the fact that the IRS was already in receipt of their offshore account information.

The IRS actions caused an uproar among (1) practitioners, who were advising their clients that they had cleared a huge hurdle in being preliminarily accepted into the OVDP, and (2) taxpayers, who were faced with the possibility of the severe civil (and perhaps criminal) penalties that the taxpayers originally sought to avoid by entering into the OVDP. 

Perhaps as a response to this uproar, the IRS last week reversed its decision, and readmitted the taxpayers into the OVDP.  The OVDP has been a huge success for the IRS, with the IRS collecting approximately $5.5 billion through the program.  However, abruptly kicking taxpayers out of the program likely jeopardized the continued success of the OVDP because taxpayers were more hesitant to enter the program knowing that the IRS may remove taxpayers from the program at any time.  The IRS actions last week should provide taxpayers with some measure of comfort that they will be treated fairly within the OVDP.

IRS Releases Key Statistics on Audit Rates and Enforcement Activity

The Internal Revenue Service has released its annual data book, which it describes as a “snapshot of agency activities for the fiscal year.”  The time period covered in the FY 2012 Data Book is October 1, 2011, through September 30, 2012. 

Among the data presented in the FY 2012 Data Book are audit rates for the past year.  The overall audit rate for individual tax returns was 1.03 percent, which is generally consistent with prior years.  The audit rates for wealth taxpayers, however, saw a slight decrease.  The following chart nonetheless illustrates that the audit risk dramatically increases for taxpayers reporting large amounts of adjusted gross income:

IRS Audit Rates FY 2010 FY 2011 FY 2012
All returns 1.11% 1.11% 1.03%
No AGI 3.19% 3.42% 2.67%
AGI $1 to $25,000 1.18% 1.22% 1.05%
AGI $200,000 to $500,000 1.92% 2.66% 1.96%
AGI $500,000 to $1 million 3.37% 5.38% 3.57%
AGI $1 million to $5 million 6.67% 11.80% 8.90%
AGI $5 million to $10 million 11.55% 20.75% 17.94%
AGI over $10 million 18.38% 29.93% 27.37%

The overall audit rate for estate tax returns is nearly 30 percent, with 12,582 estate tax returns filed during calendar year 2011.  The audit rate for estate tax returns where the size of the gross estate is between $5 million and $10 million is 58.6 percent.

On the enforcement front, the IRS assessed nearly $26.9 billion in civil penalties during FY 2012, and initiated 5,125 new criminal tax investigations.  2,466 taxpayers were convicted of a tax crime during FY 2012, and 2,009 of those individuals (or 81.5 percent) received a sentence of incarceration.  The number of IRS Special Agents (who are responsible for conducting criminal investigations) employed by the agency is down, from 2,730 in FY 2011 to 2,657 in FY 2012.

On the international enforcement front, Acting Commissioner Steven T. Miller offers the following assessment:

The IRS in 2012 made significant progress on international enforcement, specifically in our efforts against the practice of illegally hiding assets and income in offshore accounts.  We have continued our two-pronged approach: offering a voluntary disclosure program for those who want to come in and get right with the government, while at the same time pursuing tax evaders and the promoters and banks assisting them.

Although not discussed in the FY 2012 Data Book, the IRS Offshore Voluntary Disclosure Program remains open and provides a mechanism for taxpayers with undisclosed foreign bank accounts and unreported income from such accounts to obtain amnesty from criminal prosecution through the payment of back taxes, interest, and penalties.  To date, more than 35,000 individuals have enrolled in the OVDP since 2009 and more than $5 billion in additional revenue for the U.S. Treasury has been generated.  Details on how to enroll in the OVDP are available here.