Debunking the Theory in the Context of International Tax Enforcement

Taxes/February 2005

You Can Catch More Flies with Honey: Debunking the Theory in the Context of International Tax Enforcement

Hale E. Sheppard examines the accomplishments and By pitfalls of international tax enforcement. Hale E. Sheppard I. Introduction noncompliant taxpayers elected to take part in the initiative—so much Conventional wisdom dictates for the honey. that you can catch more ﬂ ies with Armed with a significant honey than with vinegar. This may amount of information concern- be true as a general notion, but its ing offshore tax-avoidance schemes validity in the context of interna- and the U.S. taxpayers involved in tional tax enforcement is suspect. them, the IRS recently decided to Based largely on information resort to the vinegar. Not surpris- gathered from former promoters ingly, this vinegar consists of civil of offshore tax shelters, reports by and criminal penalties, many of assorted governmental agencies which are quite severe. Lest there and recent congressional hearings, be any doubt about the IRS’s will- the IRS has become acutely aware ingness to use vinegar, it signed, of various offshore tax avoidance and then greatly expanded, a strategies and structures. In an tax information-sharing alliance effort to thwart these tax abuses, with state tax authorities. There the IRS, adhering to conventional is no ambiguity regarding the wisdom, initially offered honey as message that the federal and state an inducement to noncompliant governments intend to send to taxpayers to disclose their prior noncompliant taxpayers with this behavior and then start anew. new partnership. In the words of This honey primarily came in the IRS commissioner, “We’re clos- the form of the Offshore Volun- ing in on you from all sides.”1 tary Compliance Initiative, under which the IRS agreed to waive or signiﬁ cantly reduce penalties for Hale E. Sheppard, J.D., LL.M., is an acquiescent taxpayers. Despite attorney specializing in international ©2005 H.E. Sheppard the IRS’s optimism, relatively few taxation and tax controversies.

37 International Tax Enforcement

Given the present circumstanc- firm or financial management cal management company that es, it appears that noncompliant company) offi cially control the handles all of the investment ac- taxpayers have three main options entity. These nominees typically tivities, and the promoter agree to at this time: execute an agreement clarifying institute discreet billing methods. 1. Do nothing and hope that the that they hold the shares of the Such cautious billing practices or- IRS fails to discover them foreign corporation on behalf of dinarily include not sending any 2. Wait for the IRS to send a the U.S. taxpayer, who is referred documentation to the taxpayer in letter under the so-called Last to as the “benefi cial owner.” In the United States.5 Chance Compliance Initiative this manner, the U.S. taxpayer’s In the past, it was widely believed and comply with the terms of ownership of the foreign corpora- that tax avoidance schemes, espe- the letter tion is not mentioned in any of cially those involving foreign 3. Immediately come clean the offi cial corporate documents entities and fi nancial accounts, with the IRS pursuant to the or government fi lings. Next, the were used primarily by the ultra- standard voluntary disclosure offshore promoter aids the taxpay- rich and the ultra-sneaky. Now, program er and/or the foreign corporation however, it is clear that this mo- Each of these options has its in establishing local fi nancial ac- dus operandi has been adopted by disadvantages; nevertheless, it is counts, such as interest-bearing the masses. As one commentator extremely important that noncom- savings accounts, certifi cate of artfully explains: pliant taxpayers consult a qualifi ed deposits, and security accounts and trusted tax advisor, review the through which the taxpayer can Policymakers who wonder pros and cons of each option and trade stocks, bonds, etc.3 how far down-market the make a decision before being sub- After the foreign corporation tax shelter phenomenon jected to that IRS vinegar. and foreign financial accounts has gone need only consult are established, the offshore the IRS’s latest list of sum- promoter then works with the monses, which reads like II. The New Breed of U.S. taxpayer in identifying sur- a chronicle of an everyday Offshore Investors reptitious methods to transfer shopper’s preferred vendors. money or other assets to the new Leona Helmsley’s admonition The manner in which certain corporation and accounts.4 Once that “only little people pay U.S. taxpayers conduct offshore this is accomplished, the promoter taxes” is being turned inside fi nancial activities seems to be an designs techniques through which out as a substantial number open secret these days. According the taxpayer can access the funds of little people appear to have to articles by tax practitioners, and accounts without alerting the offshore accounts they access IRS reports and congressional IRS. One of the most common with credits cards. The people hearings, abusive offshore ar- tactics for doing so involves the suspected of cheating the tax rangements commonly develop use of an offshore credit and/or system use their offshore in the following manner.2 A self- debit card (such a MasterCard, credit cards to buy things proclaimed offshore expert (i.e., Visa or American Express) issued off of eBay, services from Ya- a promoter) approaches a U.S. by the foreign fi nancial institution hoo!, and books, music, and taxpayer offering an assortment at which the taxpayer maintains movies from Amazon.com ... of offshore possibilities with sup- an account. As with domestic They use the credit cards to posed tax benefi ts. Once hired, credit/debit cards, whenever the pay their BellSouth and AT&T the offshore promoter’s fi rst step U.S. taxpayer wants to access the phone bills. They charge their is to help the U.S. taxpayer orga- funds in the foreign accounts, he/ plane tickets from Delta and nize a corporation in a country she simply makes cash withdrawals American Airlines on these with two main characteristics: or purchases an item on credit. credit cards, along with the little or no income tax and strict To further insulate the taxpayer Hammacher Schlemmer financial secrecy. This foreign from IRS scrutiny of the offshore catalog products they buy corporation does not appear to activity, the foreign fi nancial insti- in-fl ight and the Hertz and be owned by the U.S. taxpayer tution that issued the credit/credit Avis Rent A Car charges they since various nominees (who are card, the law fi rm that established ring up after they land. These usually employees of a local law the foreign corporation, the lo- offshore bank customers stay

38 Taxes/February 2005

at Hyatts and Ramada Inns words of Senator Max Baucus dur- Credit Card Program (OCCP).13 As and Omni Hotels. They read ing a recent congressional hearing, part of the OCCP, the U.S. govern- Time Life publications. They if tax evasion through offshore tax ment obtained a federal court order shop at Nordstrom and Old shelters persists, “the average tax- in October 2000 to serve so-called Navy. They charge Micro- payer who is playing by the rules John Doe summonses on American soft computers, Earthlink and paying his or her share will Express and MasterCard, two of the memberships, and AT&T feel like a chump [and] support companies that had presumably is- wireless telephones on these for our system based on a largely sued offshore credit/debit cards to credit cards. ... The times have voluntary system of reporting will numerous U.S. taxpayers. A “John clearly changed from when deteriorate if not collapse.”7 Doe summons” is essentially an primarily “rich guys” would, order to a third party to relinquish for example, use the cards to information concerning U.S. tax- hide assets from their ex-wives. III. Locating the Flies payers whose precise identity is While the rich guys stashed In attempt to prevent further unknown to the IRS.14 These ini- their money away and forgot injury to the IRS, law-abiding tial summonses were designed to about it, the new offshore taxpayers and the federal tax sys- acquire information regarding the card customer clearly uses his tem as a whole, or her account for current, the U.S. govern- everyday consumption and ment has taken living expenses.6 several steps. In The manner in which certain U.S. 1996, John Mat- taxpayers conduct offshore financial As for the benefi ts of using this thewson, the activities seems to be an open secret offshore arrangement, the U.S. former president taxpayer earns income such as in- of Cayman- these days. terest, dividends and capital gains based Guardian without paying any taxes whatso- Bank and Trust, ever. The taxpayer also enjoys a was convicted of bank fraud, tax identities and fi nancial activities of certain degree of asset protection evasion and money laundering.8 U.S. taxpayers holding credit/debit by placing his/her funds beyond In exchange for leniency with cards issued by banks in Antigua, the reach (and the knowledge) of respect to his punishment, Mr. Barbuda, the Bahamas and the Cay- the U.S. court system. Simply Matthewson purportedly pro- man Islands.15 Later, in March 2002, stated, creditors have a diffi cult vided the IRS with encrypted the IRS obtained another federal time accessing the taxpayer’s computer files containing the court order to serve a John Doe offshore funds when they do not identities (or at least detailed summons on Visa International. even know they exist. While the account information) of over After a certain degree of haggling, U.S. taxpayer participating in the 1,000 U.S. taxpayers involved in the credit card companies complied offshore arrangement obviously offshore arrangements.9 The data with the summonses.16 derives economic benefi ts, this provided by Mr. Matthewson have As a further component of the is not the proverbial victimless been described as a “goldmine” of OCCP, the IRS next turned its at- crime. Indeed, such offshore information that will keep the IRS tention to the businesses at which arrangements are detrimental busy for years10 and “a bonanza the U.S. taxpayers used their off- to (1) the IRS, which suffers an for federal prosecutors.”11 As for shore credit/debit cards. In August incalculable amount in lost rev- Mr. Matthewson personally, he 2002, the IRS persuaded seven fed- enues and expends tremendous has been called the “the most eral courts to allow it to serve John resources in its attempts to stop valuable source of information Does summonses on more than these offshore activities; (2) law- U.S. enforcement agencies have 40 businesses, including airlines, abiding U.S. taxpayers, who are ever had” regarding the manner hotels, car rental companies and forced to pay additional taxes to in which offshore fi nancial insti- Internet retailers.17 In October cover the shortfall occasioned by tutions facilitate tax evasion.12 2002, the IRS again convinced the offshore schemes; and (3) the Based on the leads obtained from 11 federal courts to authorize the U.S. tax system as a whole, which Mr. Matthewson and other sources, issuance of John Doe summonses suffers a loss of integrity. In the the IRS launched the Offshore to over 70 additional businesses.18

39 International Tax Enforcement

The IRS publicly labeled the underpayment.23 Furthermore, in tax evasion31 and signing false OCCP a successful program, one cases where the taxpayer underpays documents under penalties of yielding “promising” results. In the amount of taxes owed because perjury.32 Many of these crimi- support of this favorable charac- of negligence or intentional dis- nal penalties involve signifi cant terization, the IRS stated that as regard of U.S. tax law, the IRS fi nes, lengthy prison sentences of July 2003 approximately 2,900 may impose an accuracy-related or both. tax returns had been audited, penalty equal to 20 percent of more than $3 million worth of the underpayment.24 The IRS A. The Offshore Voluntary past-due taxes were collected, and may also impose a fi ve-percent- Compliance Initiative dozens of cases were referred for per-month penalty to the amount Despite the availability and scope criminal prosecution.19 of taxes owed in situations where of these penalties, the IRS decided the taxpayer fails to fi rst test the theory that fl ies to file certain are more easily lured by honey. returns before The IRS introduced in January In the context of international tax the deadline.25 2003 a partial tax amnesty pro- enforcement, it is clear that conventional With respect to gram known as the Offshore foreign finan- Voluntary Compliance Initiative wisdom does not apply: You cannot catch cial accounts, a (OVCI).33 The IRS was eager to more fl ies with honey than with vinegar. taxpayer must recapture lost revenue, but it disclose certain limited the scope of the OVCI to accounts annu- U.S. taxpayers who (1) submitted ally on Schedule their applications before the IRS IV. Show Me B of Form 1040 (U.S. Individual (either independently or through the Honey Income Tax Return) and on Form leads from informants or other TD F 90-22.1 (Report of Foreign governmental agencies) identi- Establishing foreign corpora- Bank and Financial Accounts), fi ed them as potential tax cheats; tions, foreign fi nancial accounts which is commonly known as a (2) did not promote, solicit or in and offshore debit/credit cards “Foreign Bank Account Report” any way facilitate tax evasion by is not illegal for U.S. taxpayers.20 or “FBAR.”26 If a taxpayer violates using offshore payment cards or However, failing to report these the FBAR fi ling requirement, the offshore fi nancial arrangements; offshore activities by submitting annual penalty is $10,000, regard- (3) did not obtain the offshore in- to the IRS the required informa- less of whether the violation was come illegally; and (4) did not use tion returns and failing to pay the willful.27 This penalty is increased the offshore credit/debit cards or requisite income taxes does vio- to the greater of $100,000 or 50 offshore fi nancial arrangements late the law. The U.S. government percent of the balance of the to support or in any way facilitate taxes the worldwide income of all foreign fi nancial account in cases any illicit activity.34 “U.S. persons.”21 This ordinarily where the taxpayer “willfully” In addition to satisfying these means that all income earned fails to fi le an FBAR.28 Every U.S. eligibility requirements, the tax- by U.S. persons, whether in the person who controls a foreign cor- payer was obligated to supply the United States or abroad, must be poration must also fi le an annual IRS with many items related to reported to the IRS and subjected Form 5471 (Information Return the relevant tax years, including to U.S. income tax during the year of U.S. Persons with Respect to copies of the taxpayer’s previously in which it is earned.22 Certain Foreign Corporations).29 fi led federal income tax returns; A U.S. taxpayer who engages For each year that he/she fails to copies of any relevant powers in the typical abusive offshore do so, the IRS may assert a penalty of attorney; descriptions of off- arrangement could incur various of $10,000.30 shore credit/debit cards, foreign penalties; that is, the IRS has at its In addition to the various civil accounts and foreign assets in disposal plenty of vinegar. With penalties described above, the U.S. which the taxpayer has or had regard to civil sanctions, if a tax- government may potentially bring any ownership or benefi cial in- payer engages in fraud, then the a slew of criminal charges against terest; descriptions of any entities IRS may impose a penalty equal a taxpayer engaged in the typical and nominees through which the to 75 percent of the amount of the offshore arrangement, including taxpayer exercised control over

40 Taxes/February 2005 foreign funds, assets or invest- of honey through a program unof- the OVCI successes based on the ments; descriptions of the source fi cially known as the Last Chance fact that these initiatives yielded of any foreign funds, assets or Compliance Initiative (LCCI).43 millions in back taxes, led to investments owned or controlled The IRS did not introduce the approximately 1,200 taxpayers by the taxpayer; copies of all LCCI amid great fanfare. Instead, the “coming clean,” and identifi ed promotional materials, transac- LCCI came into existence subtly as hundreds of previously undiscov- tional materials and other related many U.S. taxpayers whose identities ered offshore promoters.44 These documentation regarding offshore the IRS had obtained thanks in large results are certainly laudable; how- credit/debit cards or offshore part to the OVCI and the OCCP re- ever, it is apparent the IRS failed fi nancial arrangements; accurate- ceived a relatively innocuous-looking to tempt the majority of non- amended or delinquent-original letter from the IRS. The letter begins compliant taxpayers with honey. federal income tax returns; com- by stating that the IRS will give the This conclusion is derived from plete and accurate Forms 5471; and taxpayer “one fi nal opportunity” to a recent report by the Treasury, complete and accurate FBARs.35 minimize his/her penalty exposure which states that “[e]xtrapolating Provided that the IRS was sat- by providing the IRS complete in- from the limited information isfi ed with these items, it agreed formation regarding any unreported available concerning the number with respect to the relevant tax offshore activity. If the taxpayer fails of foreign bank and credit card years not to impose the civil to respond affi rmatively to this let- accounts held by United States penalties for fraud,36 failure to ter within 30 days, then the IRS will citizens, the IRS estimates that fi le Forms 547137 or failure to fi le automatically subject the taxpayer there may be as many as 1 million FBARs.38 The IRS further agreed to to an examination and impose ap- U.S. taxpayers who have signature impose the failure-to-fi le penalty, propriate penalties. authority or control over a foreign the failure-to-pay penalty and/or If, however, the taxpayer decides bank account.”45 This conclusion the accuracy-related penalty only to accept the offer and provides the gathers further support from a “in appropriate circumstances.”39 IRS with all of the necessary fi nan- recent study by the U.S. Govern- Importantly, the IRS also de- cial and tax information within the ment Accounting Offi ce, which cided to treat participation in the allotted time, then certain penalties found that “[o]f the more than OVCI as a “voluntary disclosure,” could be mitigated. In particular, the 1 million taxpayers that the IRS thereby lessening the possibility of LCCI letter indicates that the IRS estimated might be involved in criminal prosecution.40 will impose the civil fraud penalty offshore schemes when it initiated According to the IRS, the for only one year, and only when the OVCI program, 861 taxpayers OVCI honey generated a “strong “warranted.” The IRS also agrees came forward.”46 Faced with the response” since over 1,200 tax- to penalize the taxpayer’s failure to magnitude of offshore activity and payers submitted applications, fi le FBARs with respect to only one the relatively meager participation the IRS collected more than $75 year. The IRS further limits itself in the OVCI, the IRS seems to million in back taxes, and more to imposing the failure-to-fi le pen- have dropped the honey in favor than 400 promoters of offshore alty, the failure-to-fi le penalty and of vinegar. arrangements were identifi ed.41 the accuracy-related penalty only “in appropriate circumstances.” A. The Abusive Tax Avoidance B. The Last Chance It is important to note, though, Transaction Partnership Compliance Initiative that the LCCI letter does not Cooperation between taxing au- The deadline for taking part in the prohibit the IRS from potentially thorities at the federal and state OVCI expired on April 15, 2003.42 pursuing criminal penalties against level is nothing new. For example, Based on the information that it the taxpayer in connection with the the IRS, the Financial Manage- acquired through the OVCI and offshore activities. ment Service Department of the the OCCP, one must assume that U.S. Treasury, and state child sup- the IRS could have immediately port agencies have collaborated pursued individual taxpayers and V. Resorting since 1981 in maintaining the promoters. Before expending all to the Vinegar Federal Tax Refund Offset Pro- of these efforts and resources, gram. Under this program, federal however, the IRS decided to offer As mentioned above, the IRS tax refunds owed to noncustodial noncompliant taxpayers another bit proclaimed both the OCCP and parents are intercepted and sent

41 International Tax Enforcement

to the proper state child support The ATAT Partnership was on more than 28,000 taxpayers.58 agency to pay the noncustodial welcomed by federal and state Based on these “promising early parent’s delinquent child support tax offi cials. IRS Commissioner results,” the IRS and the states re- debt. As of 2002, the program had Mark W. Everson, for instance, la- vealed their intention of further collected more than $15 billion in beled the agreement “a milestone expanding the ATAT Partnership past-due child support payments.47 in state and federal cooperation” by introducing three joint enforce- The federal and state governments designed to enable various levels ment initiatives: (1) State Income have worked together in other ways, of government to jointly and Tax Reverse Filing Match, under too. Although state tax authorities aggressively pursue tax evaders.52 which the IRS will compare the audit taxpayers, they rely to a cer- Other IRS offi cials also praised information provided by taxpayers tain extent on federal tax audits the Memorandum of Understand- on state income tax returns with for enforcement. Since state tax ing, calling it a “testament to the federal data to identify nonfi lers liability is often calculated based positive impact that partnering and those taxpayers underreport- on federal tax liability, “states rely between the IRS and the State ing the amount of their income; extensively on federal examination tax organizations can have on (2) the Federal-State Offshore Pay- activities for verifi cation of the tax good tax administration”53 and ment Card Matching Initiative, base and the appropriate treatment “an important new partnership” which contemplates increased use of various transactions.”48 This rela- in the fi ght against abusive tax of state databases by the IRS to tionship is not one sided. Indeed, scams.54 State revenue agencies help identify taxpayers who have the IRS has historically used lists of also expressed their support of participated in offshore credit/ registered state taxpayers to identify the new relationship with the IRS. debit card abuses; and (3) the Title potential federal nonfi lers and to Case in point: the California State 31 Money Servicing Businesses cross-check reported income and Controller recently categorized Memorandum of Understand- activities. State driver’s license fi les the situation as a “win-win” for ing that establishes a framework also constitute a good source for state governments and the federal for the federal-state information the IRS of current taxpayer ad- government, and a “lose-lose” for exchange to increase compliance dresses and potential assets to seize tax cheats.55 Similarly, Stephen M. by particular businesses in the in cases of tax defi ciencies.49 Cordi, deputy comptroller for the fi nancial services industry.59 This traditional federal-state state of Maryland and president teamwork was dramatically of the Federation of Tax Admin- B. Recent Civil strengthened in September 2003 istrators, welcomed the ATAT and Criminal Enforcement when the IRS and most states Partnership given the dire state The U.S. Department of Justice signed a Memorandum of Under- of fi scal affairs. According to Mr. (DOJ), working in conjunction standing aimed at detecting and Cordi, “Abusive tax avoidance with the IRS, has demonstrated its penalizing U.S. taxpayers involved transactions have become a threat willingness to fully use the informa- in abusive tax avoidance transac- to the fi scal health of our states. tion that it receives from the ATAT tions (“the ATAT Partnership”).50 It’s hard to overstate the size of Partnership and related sources. In Under the ATAT Partnership, the problem, or the diffi culty of the words of Eileen J. O’Connor, the IRS and state tax authorities dealing with it in an effi cient and Assistant Attorney General for the agreed to periodically exchange systematic way.”56 Tax Division, “People who engage lists of participants in ATATs, Approximately four months in, facilitate or promote tax fraud share audit results from ATAT cas- after the ATAT Partnership was in- are increasingly likely to be on the es, inform one another regarding troduced, the IRS announced that receiving end not only of civil newly discovered ATATs , jointly it had begun sharing leads on over enforcement actions, but also of participate in ongoing ATAT 20,000 taxpayers.57 Five months criminal prosecution.”60 training and other educational after that, it was announced that With regard to criminal issues, activities, appoint members to under the ATAT Partnership the the DOJ announced that in 2003 the cross-functional ATAT coun- IRS and the states had identifi ed it referred approximately 1,130 cil, and initiate communications certain tax-avoidance schemes taxpayers to the U.S. Attorney’s on an as-needed basis in order that cost the government “tens Offi ce for prosecution of assorted to facilitate the purposes of the of millions of dollars” in tax tax violations.61 In making these ATAT Partnership.51 revenues and had shared leads referrals the DOJ focused on

42 Taxes/February 2005 various tax-avoidance schemes it had successfully enjoined a offshore activities being detected by involving, among other things, promoter who was commingling the IRS has increased dramatically. shifting assets and income to the funds of over 250 customers Noncompliant taxpayers, therefore, hidden offshore accounts, fail- in various bank accounts held in have three main options at this junc- ing to fi le returns and not fully the promoter’s name in order to ture: Do nothing and hope that the reporting income.62 Along with make it diffi cult for the IRS and IRS fails to discover them; Wait for making general announcements the DOJ to trace the income, as- the IRS to send an LCCI letter and regarding the recent increase in sets, expenditures and identities comply with this initiative; or Im- criminal tax enforcement, the of the customers. This scheme mediately come clean with the IRS DOJ also provided details of allowed the customers to avoid pursuant to the standard voluntary particular cases. For instance, the paying approximately $24 mil- disclosure program. The pros and DOJ announced in April 2004 lion in federal taxes.68 cons of each of these three options that two taxpayers pled guilty to are examined below. fi ling fraudulent tax returns, a C. Complement crime that carries with it a fi ne of to the ATAT Partnership A. Option 1—Do Nothing up to $250,000, three years of im- Identifying noncompliant taxpay- Although tax practitioners may be prisonment, or both.63 According ers will also be facilitated by a new ethically restrained from suggesting to the DOJ announcement, the state initiative designed to comple- such a strategy, taxpayers could opt taxpayers made payments to cer- ment the ATAT Partnership. In for complete inaction and simply tain domestic shell corporations February 2004, the California hope that the IRS fails to discover (i.e., ones without any employees Franchise Tax Board, the Federa- them.71 Those considering this op- or business activity), fraudulently tion of Tax Administrators, the tion may take comfort in a recent deducted these payments as profes- Multistate Tax Commission, and study by the U.S. Government Ac- sional fees, ultimately deposited representatives of 11 state taxing counting Offi ce (GAO) regarding these payments in offshore bank authorities met to develop strat- the challenges facing the IRS in accounts that they controlled, and egies regarding how the states combating ATATs. According to the accessed these untaxed funds by could better cooperate to combat study, the IRS has encountered vari- using offshore credit/debit cards.64 abusive tax shelters.69 Shortly ous staffi ng and resource problems In a similar announcement the thereafter, the Federation of Tax in its attempt to implement a new DOJ explained that several more Administrators announced the enforcement strategy. The study taxpayers pled guilty to tax fraud signing of the Memorandum states, in particular, that the: in April 2004.65 Like the previous Agreement Pertaining to Abu- case, the taxpayers here admitted sive Tax Avoidance Transactions, IRS has begun shifting, to using shell corporations, unre- which is intended to supplement although more slowly than ex- ported foreign fi nancial accounts the ATAT Partnership. Whereas pected, and plans to continue and offshore credit/debit cards to the ATAT Partnership centers on shifting, signifi cant resources circumvent U.S. tax laws.66 information sharing between the into addressing schemes, but The DOJ has also proclaimed IRS and the states, the new Memo- the potential volume of ad- its readiness to use information randum focuses on information ditional work that may be partially obtained through the sharing between and among the identifi ed and inexperience ATAT Partnership in the civil states regarding ATATs.70 with the rate at which staff context. In a recent release, the can close cases makes it un- DOJ stated that it fi led lawsuits clear whether the additional in 2003 to halt the activities of 35 VI. Assessing resources and the caseloads promoters of abusive tax schemes, Taxpayer Options will match each other.72 and managed to enjoin 28 of these promoters.67 As was the case in As a result of the information ac- With respect to offshore credit/ the criminal arena, the DOJ did quired by the IRS under the OCCP, debit card abuses, the GAO study not limit itself to generalizations the OVCI, the growing ATAT Part- reveals that as of July 2003 the concerning civil tax enforcement. nership and the burgeoning state IRS had managed to close only Instead, the DOJ issued a release complement thereto, the probabil- 18 percent of these cases that it had in March 2004 explaining that ity of a U.S. taxpayer involved in anticipated closing by that date.73

43 International Tax Enforcement

What’s more, this situation may generally has three years from from pursuing criminal charges worsen in the future. The GAO the date a return is fi led during against the taxpayer.81 study indicates that thanks to which to assess tax.77 However, the OVCI and the OCCP the IRS the IRS is not restricted by any C. Option 3—Make an was able to identify hundreds of such time limit in cases where Immediate Voluntary Disclosure offshore promoters and noncom- a taxpayer fails to fi le a return, If participating in the LCCI pliant taxpayers.74 While this is fi les a false return or engages is unappealing or impossible, positive news in theory, it could in tax evasion.78 Also, if a tax- taxpayers have one remaining lead to diffi culties and uncertainty payer fi les a return, but there is option: making an immediate in terms of enforcement. As the a “substantial omission” from voluntary disclosure.82 Ac- GAO study explains, “There is the gross income (i.e., more than 25 cording to the IRS’s standard potential that the volume of cases percent of the proper amount) voluntary disclosure program could grow signifi cantly, but it is shown on the return, then the revised in December 2002, a not clear how much the caseload statute of limitations is extended submission to the IRS will qual- will grow or how quickly.”75 The to six years from the date the ify as a “voluntary disclosure” IRS’s enforcement-capability trou- return was fi led.79 The statute of when (1) it is truthful, timely bles have also been highlighted by limitations is similarly extended and complete; (2) the taxpayer high-ranking government offi cials. from three year to six years in the shows a willingness to cooper- For instance, on his way out of case of many criminal offenses.80 ate (and does in fact cooperate) offi ce, former IRS Commissioner Assuming the IRS manages to with the IRS in determining Charles O. Rossotti revealed that identify the noncompliant tax- his/her correct tax liability; 60 percent of the tax debts identi- payer, he/she could conceivably and (3) the taxpayer makes good fi ed by the IRS are never pursued, face many of the penalties de- faith arrangements with the IRS 75 percent of taxpayers who fail to scribed earlier, including those to pay in full the applicable tax, fi le tax returns do not face any en- for civil fraud, failure to fi le interest, and penalties.83 forcement action, and 79 percent timely returns, failure to file On the bright side, select- of taxpayers participating in abu- FBARs, failure to fi le Forms 5471, ing this option may save the sive schemes are never subjected perjury and tax evasion. taxpayer from criminal pros- 76 to penalties. ecution. The INTERNAL REVENUE B. Option 2—Participate Assuming that the IRS is un- MANUAL provides that although able to identify them, the pros in the LCCI making an acceptable voluntary for taxpayers of doing nothing As explained above, the IRS is disclosure does not automati- may include the avoidance of offering certain taxpayers “one cally guarantee that a taxpayer taxes, interest and penalties. final opportunity” to minimize will avoid criminal prosecution, However, the cons associated their penalty exposure by pro- the IRS will consider this, along with this inaction option out- viding the IRS with complete with all other relevant factors, weigh the pros since, despite the information regarding any unre- when determining whether staffi ng and resource problems ported offshore activity within a particular case should be that it is currently experiencing, a designated time period. recommended for criminal the IRS will ultimately identify In terms of pros, participation prosecution.84 Also, as was the most noncompliant taxpayers. in the LCCI means reduced civil case with participation in the This eventuality is supported penalties for the taxpayer, as well LCCI, making a standard vol- by the fact that the IRS has al- as preservation of taxpayer confi - untary disclosure preserves the ready identifi ed many promoters dentiality. Resolving an issue under confidentiality of the taxpayer’s and obtained offshore account the LCCI allows a taxpayer do so identity and other personal in- information under the OCCP, privately, without having his/her formation. On the other hand, the OVCI and the ATAT Partner- identity, tax violations, fi nancial making a standard voluntary ship. Perhaps more importantly, information and the like exposed disclosure does not relieve the the IRS now has essentially all as part of a court proceeding. On taxpayer from his/her obliga- the time in the world to pur- the downside, disclosing under the tion to fully pay all back taxes, sue certain taxpayers. The IRS LCCI does not preclude the IRS interest and “any penalties

44 Taxes/February 2005 determined by the IRS to be You cannot catch more fl ies with remain for noncompliant U.S. applicable.”85 honey than with vinegar. It is also taxpayers. Although each has clear that the IRS is now knowledge- its downsides, it is essential that able about offshore tax avoidance noncompliant taxpayers consult a VII. Conclusion strategies, highly motivated to stop qualifi ed and reliable tax advisor, In the context of international tax them and willing to use vinegar to review the pros and cons of each enforcement, it appears that con- do so. Under these circumstances, option and make a decision before ventional wisdom does not apply: it seems that three main options experiencing that IRS vinegar. ENDNOTES 1 Mark W. Everson, Everson Comments on 15 U.S. Internal Revenue Service, IRS Issues Sec. 821 of the American Jobs Creation Antishelter Agreement Between IRS, State Chronology on Credit Card Tax-Avoid- Act of 2004 (P.L. 108-357). Agencies, 2003 TNT 180-12 (Sept. 17, ance Schemes, John Doe Summonses, 28 Id. 2003). 2003 TNT 10-12 (Jan. 15, 2003); See 29 Code Sec. 6038(a). 2 Thomas W. Ostrander, The Offshore also U.S. General Accounting Offi ce, In- 30 Code Sec. 6038(b). Credit Card and Financial Arrangement ternal Revenue Service: Challenges Re- 31 Code Sec. 7201. Probe: Fraught with Danger for Taxpay- main in Combating Abusive Tax Schemes, 32 Code Sec. 7206. 33 ers, 99(2) J. TAX’N 114 (2003); U.S. In- GAO-04-50 (Nov. 2003), at 10–12. Rev. Proc. 2003-11, 2003-1 CB 311 ternal Revenue Service, Full Text: Publica- 16 Id. (Jan. 27, 2003). tion 1150, Tax Havens and Their Use by 17 Id. 34 Id. United States Taxpayers—An Overview, 18 Id. 35 Id. 93 TNT 119-22 (June 6, 1993); Dale 19 U.S. Internal Revenue Service, Offshore 36 Id. Hart, IRS Small Business Testimony at Fi- Compliance Program Shows Strong Re- 37 Id. nance Committee Hearing on Tax Scams, sults, IR-2003-95 (July 30, 2003); Amy 38 Id. 2003 TNT 63-24 (Apr. 2, 2003); U.S. Hamilton, IRS Collects $75 Million in 39 Id. Senate, Committee on Finance, Taxpayer Taxes Through Offshore Amnesty, 2003 40 Id. Beware: Schemes, Scans and Cons, Hrg. TNT 147-2 (July 31, 2003). 41 Internal Revenue Service, Offshore Com- 107-77 (Apr. 5, 2001). 20 Dale Hart, IRS Small Business Testimony pliance Program Shows Strong Results, 3 Id. at Finance Committee Hearing on Tax IR-2003-95 (July 30, 2003). 4 Id. Scams, 2003 TNT 63-24 (Apr. 2, 2003). 42 Rev. Proc. 2003-11, 2003-1 CB 311 5 Id. According to this IRS offi cial, “[w]hile it is (Jan. 27, 2003). 6 Amy Hamilton, Profi le of Offshore Bank not illegal to have a credit card issued by 43 See Testimony of Nina E. Olson, Na- Customers Emerges in Latest IRS Filings, an offshore bank, there is ample basis for tional Taxpayer Advocate, before the 2002 TNT 169-1 (Aug. 30, 2002). believing that many people are using off- Senate Committee on Finance on the 7 U.S. Senate, Committee on Finance, shore credit cards to repatriate funds hid- Tax Gap and Tax Shelters, 2004 TNT supra note 2, at 3. den offshore to evade paying U.S. taxes. 141-44 (July 21, 2004) (attaching the 8 Michael Allen, Murky World of Offshore Use of an offshore credit care, trust, or Abusive Schemes Tipping Point Study, Banking Emerges in U.S. Tax-Fraud Probe, other arrangement to hide or underreport which examines the OCCP, OVCI, WALL ST. J., Aug. 3, 1999, at A18. income or to claim false deductions on a LCCI, and ATAT Partnership); Minutes 9 Senate Panel Presses Large U.S. Banks on federal tax return is illegal.” from the South Texas IRS/Tax Practitioners 21 Abuses, Airs New Findings, 12(6) MONEY Reg. §1.1-1(b); Code Sec. Council Meeting, Oct. 30, 2003 (stating LAUNDERING ALERT 1 (April 2001). 7701(a)(30). that Susan Graham, SBSE Compliance 10 Id. 22 There are certain limited exceptions to Chief, announced the launch of the “Last 11 Beth Piskora and Jesse Angelo, Pay No these rules. See, e.g., Code Sec. 911. Chance Compliance Initiative”), available Attention to the Man in the Booth, N.Y. 23 Code Sec. 6663. at www.texastaxsection.org; Caplin & 24 POST, Aug. 8, 1999, at 59. Code Sec. 6662(b). Drysdale, Foreign Bank Accounts—Last 12 25 Supra note 9. Code Sec. 6651(a)(1). This penalty Chance for Taxpayers TAX ALERT, July 2004, 13 U.S. Internal Revenue Service, Offshore increases to 15 percent of such tax per at 2 (explaining the OVCI and the LCCI), Credit Card Program (OCCP), available month, not exceeding a maximum of 75 available at www.caplindrysdale.com; at www.irs.gov/newsroom. percent, if the failure to timely fi le a return Thomas W. Ostrander, The Offshore 14 Any summons that does not identify the is due to fraud. Code Sec. 6651(f). Credit Card and Financial Arrangement person with respect to whose liability the 26 Under the Bank Secrecy Act, a U.S. per- Probe: Fraught with Danger for Taxpay- summons is issued may be served only son with a fi nancial account in a foreign ers, 99(2) J. TAX’N 114 (2003) (explaining after a court proceeding in which the IRS country with a value exceeding $10,000 and distinguishing the OVCI and LCCI); establishes that (1) the summons relates at any time during the year must fi le an Steven Toscher and Michael R. Stein, to the investigation of a particular per- FBAR. Previously, the authority to enforce FBAR Enforcement Is Coming! available son or ascertainable group or class of the FBAR penalties resided with the U.S. at www.taxlitigator.com/articles/fbar.htm persons, (2) there is a reasonable basis Treasury Department’s Financial Crimes (describing the LCCI and the potential for believing that such person or group Enforcement Network. This power, how- hazards for taxpayers participating in it); or class of persons may fail or may have ever, was recently delegated to the IRS. INTERNAL REVENUE MANUAL §5.3.1.2.4, Code failed to comply with any provision of See IRS and FinCEN Announce Latest Cases with Case Codes and Subcodes U.S. tax law, and (3) the information Efforts to Crack Down on Tax Avoidance (Nov. 1, 2004) (explicitly referring to the sought and the identity of the person(s) is Through Offshore Accounts, IR-2003-48 program as the “Last Chance Compliance not readily available from other sources. (Apr. 10, 2003). Initiative” and the “LCCI”). Code Sec. 7609(f). 27 31 USC §5321(a)(5), as amended by Act Please note that the IRS has not of-

45 International Tax Enforcement

ENDNOTES fi cially labeled this new program as the 2003 TAX NOTES INT’L 180-13 (Sept. 17, (Mar. 2004). “Last Chance Compliance Initiative,” 2003). 69 Franchise Tax Board, California FTB and that this program is referred to as 55 States, D.C. Comment on Agreement Meets with States to Discuss Combat- the LCCI in this article solely for the sake to Fight Abusive Tax Transactions, 2003 ing Abusive Tax Shelters, 2004 STATE TAX of simplicity. TNT 180-32 (Sept. 17, 2003). TODAY 22-4 (Feb. 3, 2004). 44 U.S. Internal Revenue Service, Offshore 56 Shafroth, supra note 56. 70 Hawaii Department of Taxation, State Compliance Program Shows Strong Re- 57 U.S. Internal Revenue Service. IRS, States Signs Agreement to Share Abusive Tax sults, IR-2003-95 (July 30, 2003). Move Forward in Fight Against Abusive Shelter Information, 2004 STATE TAX TODAY 45 U.S. Treasury Department, A Report to Tax Avoidance, IR-2004-19 (Feb. 10, 53-14 (Mar. 18, 2004). 71 Congress in Accordance with § 361(b) 2004); Allen Kenney, IRS, States Share JEROME BORISON, EFFECTIVELY REPRESENT- of the Uniting and Strengthening America Leads on Tax Avoidance Schemes, 2004 ING YOUR CLIENT BEFORE THE “NEW” IRS by Providing Appropriate Tools Required STATE TAX TODAY 28-2 (Feb. 11, 2004). (2001–2002), at 2-20 and 2-21 to Intercept and Obstruct Terrorism Act of 58 U.S. Internal Revenue Service, IRS and (discussing rules contained in Circular 2001 (USA Patriot Act), Apr. 26, 2002, State Partnership Moves Forward to Im- 230, American Bar Association Formal at 6. prove Compliance and Service, IR-2004- Opinion 314, and various statements 46 U.S. Government Accounting Offi ce, 77 (June 7, 2004); Internal Revenue of the American Institute of Certified Taxpayer Information: Data Sharing and Service, IRS Announces Partnership with Public Accountants regarding appro- Analysis May Enhance Tax Compliance States Producing Early Results, 2004 TNT priate behavior in cases of taxpayer and Improve Immigration Eligibility Deci- 110-23 (June 8, 2004); Allen Kenney, noncompliance error or omission). sions, GAO-04-972T (July 21, 2004), IRS Commissioner: Service to Increase 72 U.S. General Accounting Offi ce, Internal at 31. Information Sharing with States, 2004 Revenue Service: Challenges Remain in 47 Frank Shafroth, The Tax Doctor: Reason STATE TAX TODAY 111-3 (June 9, 2004). Combating Abusive Tax Schemes, GAO- to Love Refunds, 2004 State Tax Today 59 Id. 04-50 (Nov. 2003), at 15. 70-4 (Apr. 12, 2004). 60 U.S. Department of Justice, News 73 Id., at 20. 48 Id. Release—Justice Department Notes 74 Id., at 22. 49 Id. Increase in Tax Enforcement: Civil and 75 Id. 50 U.S. Internal Revenue Service, Small Criminal Enforcement Against Tax Cheats 76 Jonathan Weisman, GAO Finds Increase Business/Self-Employed Division, IRS on the Rise (Apr. 6, 2004). in Tax Evasion; report Says IRS Needs 61 SB/SE Releases Memo of Understand- Id. More Resources, WASH. POST, Dec. 19, ing on Abusive Transactions, 2003 TNT 62 Id. 2003, at E1. 180-27 (Sept. 17, 2003). See also 63 U.S. Department of Justice, News Re- 77 Code Sec. 6501(a). Federal and State Tax Authorities Initi- lease—Two Businessmen Plead Guilty 78 Code Sec. 6501(c)(1), (2) and (3). Each ate Partnership to Combat Tax Shelters; to Tax Fraud in Offshore Credit Card of these provisions states that “the tax Pledge More Information Sharing, Vol. Scheme: Credit Cards Were Used to may be assessed, or a proceeding in 90(43) STANDARD FEDERAL TAX REPORTS 1-2 Spend Untaxed Income Stashed in For- court for the collection of such tax may (Sept. 25, 2003). eign Accounts (Apr. 13, 2004). be begun without assessment, at any 51 Id. 64 Id. time.” (Emphasis added.) 52 U.S. Internal Revenue Service, IRS and 65 U.S. Department of Justice, News Re- 79 Code Sec. 6501(e). States Announce Partnership to Target lease—Third Promoter of Offshore Tax 80 Code Sec. 6531. Abusive Tax Avoidance Transactions, Fraud Scheme Pleads Guilty in Oregon: 81 Thomas W. Ostrander, The Offshore IR-2003-11 (Sept. 16, 2003); See also Prosecutions Also Snared Clients Who Credit Card and Financial Arrangement U.S. Internal Revenue Service, IRS and Used Scheme to Cheat (Apr. 2004). Probe: Fraught with Danger for Taxpay- 66 States Announce Partnership to Target- Id. ers, 99(2) J. TAX’N 114 (2003). ing Abusive Tax Avoidance Transactions, 67 U.S. Department of Justice, News Re- 82 Internal Revenue Service, IRS Revises 2003 TNT 180-10 (Sept. 17, 2003). lease, supra note 69. Voluntary Disclosure Practice, IR-2002- 53 Dale R. Hart, SB/SE Commissioner 68 U.S. Department of Justice, News 135 (Dec. 11, 2002). 83 Highlights Provisions of Agreement to Release—Justice Department Sues INTERNAL REVENUE M ANUAL, at §9.5.3.3.1.2.1, Fight Tax, 2003 TNT 180-11 (Sept. 17, to Shut Down Alleged “Warehouse Voluntary Disclosure Practice (Dec. 2003). Banking” Scam: Complaint Alleges 2002). 54 Pamela F. Olson, New Partnership Will Los Angeles-Area Man Helps Custom- 84 Id. Restore Faith in Tax System, Olson Says, ers Hide Income and Assets from IRS 85 Id.

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