File a Protective Claim for Refund for Possible OVDP Opt Out Cases

In 2009, the IRS had introduced an Offshore Voluntary Disclosure Initiative/Program (OVDI/OVDP). In following years, the program was reintroduced and revised. When it comes to addressing offshore filing deficiencies, several issues exist in connection with the statute of limitations, the nature of the error/omission, and the taxpayer’s intent. Many clients have been receiving conflicting advice and as result are often confused. This discussion attempts to clarify the measures associated with addressing and correcting these foreign tax reporting matters.

Opting Out:

If the client did not carry the indicia of willful intent, then the decision to opt out of the voluntary disclosure program (and seek a regular examination with lower penalties) should be given serious consideration. After all, not every offshore account was secretly and intentionally established in Switzerland. In facts, most cases in our office have no evidence of concealment or intent to violate the law.

Many practitioners fear that opting out would invite criminal exposure or retribution. But based upon the National Taxpayer Advocate’s report to Congress, the IRS had not initiated any criminal proceedings against those who had opted-out of the 2009 program at all. And the average penalty asserted on 2009 OVDP opt-outs was a mere $15,737, far less than the hundreds of thousands that were often imposed and consented to under advice of counsel in the OVDP.

When a taxpayer opts out, the IRS agent assigned will typically conduct an in depth interview with the taxpayer (or taxpayer’s representative). There are always risks, but unlike the OVDP program, which imposes rigidity on its examiners, opt-out auditors are given more discretion in the assessment of the foreign reporting penalties. In fact, they are expected to take facts and circumstances into account. This is not something mentioned when the client gets the threatening letter saying that opting out puts all available penalties (including willful) back on the table. In fact, penalty “mitigation” guidelines were even provided to minimize the consequences on smaller violations. If convinced, the IRS is even authorized to issue a Letter 3800 (a warning letter) that abates the foreign reporting penalties for one or many of the tax years entirely. To clarify the process, the IRS has updated its appeals procedures for the resolution of contested foreign bank account reporting (FBAR) assessments outside the OVDP (Revised IRM 8.11.6).

Protective Refund Claims:

Tax advisors should be well versed in the significant distinctions between the FBAR and income tax assessment statutes. The statute of limitations for assessment of FBAR penalties is governed by Title 31 of the U.S. Code and can be extended even after expiration. Signing the statutory extension can reopen closed years because it is considered a waiver of an affirmative defense; however, Title 26 of the US Code governs the assessment of income taxes derived from offshore activity. Once expired, the income tax statute typically stays closed, even if an extension is subsequently executed by agreement.

Taxpayers who had submitted under OVDP would have been wise to watch the timing of their submissions against the clock very closely. The OVDP mandated payment for eight years of back income taxes at the time of submission, including payments for expired tax years. These submissions often take years to run through the process and there is uncertainty in relying on an expired statutory assessment extension to preserve clients’ refund options if they choose to opt out.

The Internal Revenue Code (IRC) holds that the statute of limitations for filing a claim for refund is the later of three years from the tax return’s original filing or two years from the date the tax was paid.

If a taxpayer opts out and the IRS has posted the remittances as payments to years that, by the time of the resolution of the opt out, are closed for refund claims, the IRS takes the position that it cannot refund any tax, penalty or interest overpaid — either overpaid with the original return or the payment under FAQ 35. The reason for this position is that Code Section 6511(a) and (b), here, preclude the refund.

As a result, advisors must institute protective refund claims prior to the lapse of their two-year payment anniversary. Those who hadn’t or who had trusted the stale statutory extensions might encounter problems. When the client opts out without timely refund claims in place, the tax payments for years expired at submission face the prospect of being surrendered. This is unfortunate because those dollars could instead have been applied to any mitigated penalties, or even better, refunded.

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