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Penalized for Good Behavior? The IRS says 'Yes...'

by Fuerst on Categories: tax

Penalized for Good Behavior? The IRS says 'Yes...'

By Jennifer Correa Riera and Sunny Dhaliwal - Fuerst Ittleman PL

Every police and lawyer show on television has had the same scene at some point.  The grizzled detective or earnest lawyer counseling the suspect in the interrogation room says, “If you just confess, they’ll go easy on you.”

The IRS Seems to Have Missed that Episode

Heavily promoted by the Internal Revenue Service (IRS), the Voluntary Classification Settlement Program (VCSP) and the 2009 Offshore Voluntary Disclosure Program (OVDP) promised taxpayers considerable leniency in exchange for voluntarily disclosing and trying to remediate certain tax problems.  Instead, evidence suggests that taxpayers who have stepped forward under these programs have actually been subjected to penalties in excess of those mandated by law.

What is causing this phenomenon?  An analysis of the penalty structures applicable to the VCSP and the 2009 OVDP indicates that that the IRS is more focused on generating revenue and ultimately dissuading taxpayers from participating in “amnesty” type programs.

The VCSP provides employers partial relief from past federal employment tax obligations under the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA) related to workers who are voluntarily reclassified from independent contractors to employees.  In exchange for relief from interest and penalties, VCSP participants must pay a penalty equal to 10% of the total tax liability that would have been due had the employer properly withheld tax for his or her workers during the most recent tax year.

When announcing the program, the IRS stated that the VCSP’s goal was to increase compliance and reduce the burden for employers. However, the burden imposed upon employers under the VCSP is far more than required by Congress when it enacted Section 530 of the Revenue Act of 1978.  

As Discussed by Congress:

Section 530 of the Revenue Act of 1978 is a safe harbor for an employer who owes FICA and FUTA taxes resulting from the improper classification of an employee as an independent contractor. Thus, if a worker employee is misclassified as an independent contractor under the common-law analysis, the employer will nonetheless escape employment tax liability if the conditions of section 530 are met. . . . Section 530 should be interpreted liberally in favor of the employer.

(Present Law and Background Relating to Worker Classification for Federal Tax Purposes. Page 6. JCX-27-07. Joint Committee on Taxation. May 7, 2007)

However, because Section 530 was never codified as part of the Internal Revenue Code, most taxpayers are unaware of its existence.  Thus, by failing to address Section 530 in VCSP materials – such as the VCSP Frequently Asked Questions – the IRS has effectively diverted taxpayers from a more favorable outcome available to them.

The IRS employed a similar sleight of hand with the 2009 OVDP.  In exchange for a lesser penalty, the 2009 OVDP provided taxpayers with an avenue to voluntarily disclose their offshore financial accounts and/or foreign financial accounts over which they have signature authority. Reportable offshore financial accounts are those that exceed $10,000 at any time during the calendar year.

Ordinarily, the civil penalty imposed for willfully failing to report an applicable account on a Form TD F 90-22.1, “Report of Foreign Bank and Financial Accounts,” or “FBAR” can be as high as the greater of $100,000 or 50% of the total balance of the foreign account.  However, the penalty applicable to a taxpayer who non-willfully fails to file an FBAR may not exceed $10,000. See 31 U.S.C. § 5321(a)(5). 

Under the 2009 OVDP, participants are subject to a penalty equal to 20% of their offshore financial account’s highest balance during the period mandated by the IRS unless certain circumstances apply.  In March 2011, however, the IRS issued a memorandum to OVDP examiners examining 2009 program participants directing them to stop accepting less than a 20% penalty.  The examiners were further instructed to assume that all violations were willful unless proven otherwise.  These instructions forced several 2009 OVDP participants who committed non-willful FBAR violations to pay the 20% penalty, which often times exceeded the $10,000 cap under title 31.

As Discussed by the Taxpayer Advocate:   

With significant FBAR penalties as leverage, the IRS “strongly encouraged” people who failed to file these and similar returns and report income from foreign accounts to participate in the 2009 . . . (OVDP), rather than quietly filing amended returns and paying any taxes due. It warned that taxpayers making “quiet” corrections could be “criminally prosecuted,” while OVDP participants would generally be subject to a 20 percent “offshore” penalty in lieu of various other penalties, including the FBAR penalty. While the OVDP appeared to be a great deal for those involved in criminal tax evasion, it was a terrible deal for many whose violations were not willful or who would be eligible for reasonable cause exceptions.

(Taxpayer Advocate Directive 2011-1,4 August 16, 2011)

Taxpayers considering voluntary compliance programs, such as the VCSP and the 2009 OVDP’s successors should seek advice of counsel and become better informed of the applicable law and available options.

By Jennifer Correa Riera and Sunny Dhaliwal
Fuerst Ittleman, PL
1001 Brickell Bay Dr., 32nd Floor
Miami, FL 33131

South Florida Legal Guide - Midyear 2012 Edition

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