With the IRS, procedure can mean millions

In tax matters, procedure is important. The IRS has many rules about notices, deadlines, refunds, audits and disputes. And no matter how right you are, if you don't follow the procedures, you may be out of luck. As just one example, if you don't file a refund claim in time (generally within three years), you can't get your money back, even if it is clear you overpaid.

If you receive an IRS Notice of Deficiency, there is only one way you can respond: you must file in Tax Court within 90 days. The only response that protects your rights is filing in Tax Court. And unlike most deadlines, which the IRS can and does extend, that 90 days cannot be extended, ever. And there are many other procedural rules.

Another place where procedure counts is offshore disclosures. The procedural oddity I want to discuss involves so-called opt outs. The long-running IRS Offshore Voluntary Disclosure Program (OVDP) closed to new entrants in 2018, but many remain in the pipeline. For them, the decision whether to "opt out" is still relevant. Opt-outs sound odd.

Why enter a special program, only to then exit it before completion? Some taxpayers feel by the end, that the OVDP penalties are too much. No matter how sympathetic your facts might be, the IRS agents do not have discretion to settle OVDP cases for less than the set penalties. One option is to 'opt out' after the IRS has calculated a proposed penalty and provided a closing agreement. That might be a year or two after you entered the OVDP.

Taxpayers facing the decision to pay either the 27.5% or 50% miscellaneous OVDP penalties may bristle at those amounts. Opting out allows you to request a reduced penalty based on your particular facts and circumstances. Yet in opt outs, the IRS can demand additional documents and even a phone interview, which are unpleasant thoughts for most people.

On the numbers, you might save big dollars, but could you actually end up paying more by opting out? It is theoretically possible, although it seems pretty unlikely. Still, that is one reason to look at your facts and numbers carefully before you act. If you are facing a small penalty (e.g., $50,000) in the OVDP, opting out probably cannot save you too much, especially if by opting out you end up spending money on legal fees, and maybe even with non-willful penalties. Yet larger OVDP penalties such as $500,000, $1M, or higher might make opting out hard to resist, particularly if you have good facts and no evidence of willfulness or evasion.

Some penalties can still apply in an opt out, but much will hinge on willfulness. If you aren't willful, the penalties are vastly smaller. However, even non-willful violations can add up when taxpayers have multiple accounts for multiple years. The non-willful FBAR penalties can range up to $10,000 per account per year. The statute of limitations is usually six year. Therefore, even for non-willful violations, the penalty could be $60,000 per account. If you have five accounts that you fail to list for six years, that could be $300,000.

Despite these warnings, many opt outs come out well. Remember the old consumer warnings not to try this at home, or warnings that past results are not an indication of future results? Those cautionary labels are appropriate here. But here are some real-life illustrations of the home run opt outs can be on the right facts and with a little luck.

In one opt out case, an older man moved from one bank to the next after one bank closed his accounts. He failed to report accounts accurately even after entering the OVDP, and he made inconsistent statements to the IRS when represented by prior counsel. We submitted medical records showing he was experiencing memory loss, and emphasized that he had made significant efforts to come into compliance. The IRS's opt out exam resulted in penalties under $200,000 compared to the nearly $2 million penalty he would have paid under the OVDP formula.

In another case, an older expatriate moved money from one country to another after her accounts were closed. She had even used a shell company. However, we emphasized that her late husband had controlled the accounts, and that she had little understanding of U.S. reporting. She paid less than $200,000 after an opt out exam, compared with more than a $1.5M penalty under the OVDP.

An even more striking comparison was a formulaic OVDP penalty of over $3M, which ended up whittled to less than $50,000 in an opt out. In two other cases, OVDP penalties of $1.5M were cut below $75,000. In one more, a $2M OVDP penalty landed under $100,000 via an opt out. A less dramatic comparison was an opt out result of about $45,000, down from the OVDP formula of more than $200,000. Still, even this reduction can be worth the trouble.

In all of these, the facts matter, and the judgment and handling of the case by the IRS does as well, no matter how sympathetically one presents the taxpayer. If you opt out hoping for a home run, you might end up unhappy. So, a sober discussion with any opt out candidate is a good idea. The OVDP is predictable, and opting out is clearly much less so, so think about your facts. If you have no evidence of willfulness, the sheer numbers may make opting out awfully hard to resist.

Ask whether the potential risks of opting out offset the potential rewards. Individual advice about the particular facts and the taxpayer's conduct is important. Using a different passport, moving banks, or giving a FATCA certification to a bank that turns out not to be true in some cases might be explainable. But these kinds of acts can raise eyebrows so must be thought through carefully.

It can be hard to turn away from certainty in favor of something that could be better or worse. Examining your numbers and risk profile is wise, and be careful. For those with the right facts and a willingness to endure some risk, opting out can sometimes save vast dollars. On this and all else with the IRS, procedure really counts.. 