While most of us have a vague idea that “offshore tax evasion” costs the government money and hurts the economy in the process, upon hearing the term we’re far more likely to think about Wesley Snipes, Al Capone, or some sort of abstract meeting between a shady looking billionaire and his Swiss banker on a boat somewhere. But a recent report from the U.S. Government Accountability Office revealed the IRS could be leaving billions of dollars in taxes, penalties, and interest owed by evaders on the table. Considering all the recent angst over the sequester, that’s sure to get your attention regardless of your familiarity with the income tax landscape.
According to the GAO – which is a sort of ombudsman arm of Congress – the IRS has failed to identify thousands of people who’ve made so-called “quiet disclosures” since its first Offshore Voluntary Disclosure Program (OVDP) in 2009. A quiet disclosure is when someone simply amends past years’ tax returns to note previously unreported international income, rather than formally bringing it to the IRS’s attention.
While IRS offshore programs have collectively netted 36,000 voluntary disclosures since 2009, the number of people reporting offshore income has nearly doubled to some 516,000 since 2007. By preventing those with something to hide from slipping through the cracks and educating others about tax liabilities they’re unaware of, the GAO believes the IRS could make the $5.5 billion it has recouped in the past six years through amnesty programs look like a drop in the bucket.
“IRS has not researched whether sharp increases in taxpayers reporting offshore accounts for the first time is due to efforts to circumvent monies owed, thereby missing opportunities to help ensure compliance,"the GAO report concluded. "Taxpayer attempts to circumvent taxes, interest, and penalties by not participating in an offshore program, but instead simply amending past returns or reporting on current returns previously unreported offshore accounts, result in lost revenues and undermine the programs’ effectiveness.”
The ostensible benefit of the OVDP programs is that taxpayers who come clean about offshore holdings will avoid jail time (up to 10 years is possible) as well as harsh financial penalties (potentially many times the amount of their offshore funds). However, many people clearly prefer to roll the dice since program participants still must pay not only back taxes and interest, but also a 20% accuracy penalty for taxes they should have paid on offshore holdings in prior years as well as a penalty equal to 27.5% of their highest aggregate international account balance in the past eight years.
For tax evaders, successfully flying under the radar means avoiding costly penalties altogether. For the government, it means more than $100 billion in lost revenue each year, according to an independent bipartisan report from Sens. Carl Levin (D-MI) and Tom Coburn (R-OK).
Quiet Disclosures: Costly Problem or Much Ado About Nothing?
“The offshore voluntary disclosure programs are, as I understand it, about avoiding criminal tax liability,” Patricia Brown, director of the University of Miami School of Law’s graduate program in taxation a former counsel for the U.S. Treasury Department, told WalletHub in a recent interview. “[Most of the quiet disclosers the GAO identified] are people who should not be prosecuted, probably will not be prosecuted, and the IRS knows they’re not going to be prosecuted. There probably are some people who are just playing the lottery, and those people are giving quiet disclosure a bad name.”
Brown and other tax experts believe the IRS has simply taken necessary steps to prioritize cases based on their potential return on investment in time and manpower, especially in light of the sequester’s recent impact on the organization’s budget.
“If we want to impede evasion, or address aggressive tax planning, or respond to any of the other trendy ideas for a better and more egalitarian tax system, we should do this: provide the Internal Revenue Services with the resources it needs to do its job,” David Rosenbloom, director of the International Taxation program at NYU Law, recently told WalletHub via e-mail. “That entails cessation of the practice of starving the agency, probably means refraining from giving it assignments for which it is ill prepared (health care!), avoiding the enactment of stupid laws and particularly laws that require IRS to spend vast numbers of man and woman years interpreting whatever whims have passed through the vacuous mind of some member of Congress. These are absolutely necessary first steps toward a better tax system. Oh, and trying to stop listening to the many voices complaining about the tax system and effectively demanding a reduced burden. Government costs, it needs to be paid for.”
Nevertheless, experts say significant tax evaders are indeed on the IRS’s radar and will be milked for what’s owed. Uncle Sam probably won’t get all that’s coming to him when all is said and done, but the returns should become more and more significant in the years to come.
Better Enforcement of Tax Evasion on the Horizon?
The writing has been on the wall for international tax evaders since the now-infamous 2008 case involving Swiss banking giant UBS.
“There was evidence of Swiss bankers coming to the United States and soliciting tax evasion on U.S. soil, and that just really ticked people off,” Brown said of the case in which whistleblower testimony eventually resulted in 20,000 U.S. tax evaders being identified and UBS paying $780 million in fines. “And it gave the Justice Department a way to get information they couldn’t get in any other way because UBS bankers had done enough in the United States to get the John Doe summons.”
A John Doe summons is basically a subpoena for records about people who meet a certain criteria, but whose specific identities are yet unknown. And as Brown recounted an IRS official telling her back in 2008, “‘‘There’s nothing that focuses the mind quite like seeing bankers in orange jumpsuits.’”
But the threat of prosecution is nothing new. What the IRS really needs is more funding because “there is the potential for a very small cost of IRS auditors to get a lot of money,” according to Frank Doti, director of the tax law program at the Chapman University School of Law. Professor Michael McIntyre of Wayne State University Law School agrees, saying "It is foolish to cut the IRS budget when a dollar added brings in many dollars."
A resolution to the sequester would help in that regard. But that, it seems, would only be a start.
Political Pressure Fostering More Effective Evasion Regulation?
Additional funding or not, we can all take solace knowing that fallout from the UBS case has fostered a fundamentally sound worldwide enforcement landscape. It just needs to mature a bit logistically.
You see, the UBS case helped politicize the issue by providing stark evidence of its scope at a time of significant worldwide economic turmoil. This helped spark effective new information-sharing agreements between governments, which may have been previously hesitant to accommodate the world community ahead of domestic constituents and/or unsavory motives. “There are instances where bank secrecy is an important constitutional constraint, preventing corrupt regimes from getting information about assets of private citizens -- information that would be put to ill use,” says Mitchell Kane, a professor at NYU Law. “There are other instances where bank secrecy is used by non-residents to hide assets from home jurisdictions, with the host jurisdiction turning a blind eye. There is no obviously correct balance to strike here.”
Steven Dean, a professor at Brooklyn Law School, adds: "There are profound differences among countries on the causes of and cures for offshore tax evasion. ... In some ways the obstacles are political. Global taxpayer IDs, for example, could help enormously, but make a lot of people uncomfortable. The political capital the US has invested in FATCA is enormous, but in some ways it remains just a gesture."
Even so, many of the previous impediments to international tax transparency have fallen by the wayside in light of recent events, sending a clear message to any would-be tax criminals in the process.
“With the aggressive enforcement by the IRS and the DOJ’s Tax Division, and the coming implementation of FATCA, we are rapidly approaching the point where anyone who wants to ‘game the system’ has to take significant risks that their money won’t be there when they want it,” Scott Michel, president of the tax law firm Caplin & Drysdale, said. “Surely there are countries that will not bow to the will of the US on this issue, but one should fairly ask whether they provide a safe financial climate for the holding of substantial assets.”
The risk involved with tax evasion will also increase moving forward, as the global community improves the efficiency of information sharing. “One of the problems you have with automatic exchange of information is that the governments have not been able to use the information,” Brown said. “Even if you had standardized forms to provide the information from one country to the other country, if the financial institutions were using a different form to report it to the government, you had problems translating the information.” However, the OECD has been working on a common form that allows “the government sending the information to simply slice and dice it and send it to the resident’s country” since 2010, and Brown expects that it is close to completion.”
In other words, regulators, lawmakers, politicians, and even the general public are catching up to the issue of tax evasion. We’re just waiting on logistics now. Maybe it’s time to give UPS a call?
While the IRS, the U.S. government, and the rest of the international community certainly have some work to do in further curbing offshore tax evasion, signs of improvement are clearly in evidence. And that’s good news for the economy moving forward.
“The evidence is contentious on the scale of the problem, but it seems to be widely agreed that there is a problem. Obviously there will be losers from any changes, as some low tax areas benefit from the current set up, so change needs international agreement and that is why the G8 and G20 are looking at this for the future,” Judith Freeman, a professor of taxation law at Oxford University, told WalletHub. “There seems to be a will to increase controls, but how effective all the action will be remains to be seen. I think the net is tightening somewhat.”
Increasing political pressure has indeed led to better information sharing, and that will only become more and more significant as technological logistics improve. That’s a good thing too because much like the Great Recession was amplified by a crisis of confidence among investors, the U.S. tax system depends upon acceptance by the masses.
“The U.S. system is a voluntary-compliance system. So, to the extent that high-profile people evade taxes, that’s a problem because then everybody else wonders why they’re paying taxes,” Brown said, noting that advancements in the regulation of offshore tax evasion have reduced its effect on the taxpayer’s psyche. “You’d have to be a real adrenaline junkie to do it now. I think most banks are being really careful."