Some background on the IRS Pre-clearance form for Offshore Voluntary Disclosures
Submitting a Voluntary disclosure can be onerous work. But when a client wants to come clean, they want to come clean as soon as possible and not wait the months, even years it can take to get a proper voluntary disclosure completed. Thankfully and to its credit, the IRS developed a pre-clearance form. The pre-clearance form allowed us within minutes of a client hiring us, to alert the IRS that this client would be coming forward.
For the vast majority of cases, a pre-clearance would come back without a hitch. But for two of our clients, their pre-clearance came back with a phone call from a Department of Justice attorney who was investigating them. Once we informed them of the nature of the case an that they were making disclosures, the criminal investigations were stopped. We all breathed a sigh of relief.
Additionally, what we were doing was submitting pre-clearance requests even when we were pretty sure the client would be making a Streamlined Disclosure, not a full Standard Offshore Voluntary Disclosure Program (OVDP). The difference between the two is that a Streamlined submission includes three years of tax returns and at most a 5% penalty, and the Standard OVDP could be 27.5% or as high as a 50% penalty.
We continued to make pre-clearances for our streamlined cases. And yet — at least one of our clients who was non-willful was under investigation. Luckily, we got to the case quickly and the prosecutor had many other cases to choose from. If we had not filed that pre-clearance and the investigation were to proceed, it is likely that our client would be indicted!
The IRS then changed their guidance to encourage us and others not to make a pre-clearance for Streamlined Disclosures. The IRS announced they would investigate all of those who made a pre-clearance but failed to make a proper disclosure. We had no worries, as in every case a Streamlined submission or Standard OVDP was made.
Our assumption was that the IRS would be able to investigate its own database to see a submission was made. This assumption proved to be wrong — I believe it comes from a decision on how to code a Streamlined Submission. Instead the IRS has been sending out Letter 5935 and Form 15023 to taxpayers who have made proper disclosures!
Our typical responses to Letter 5935 and Form 15023
We selected option three to explain the IRS that our client is in full compliance. We are very nice about it. Again, the people who sent these letters are burdened by systems that are not telling them the things they need to know. There is no sense in taking this personal.
Other responses
If you have a Streamlined Submission ready to go, you can select option one. Option two seems very dangerous unless you have already spoken with an experienced Offshore Disclosure law firm. And option four make sense if you need some time to talk with someone to help you out.
The outlook of IRS efficiency
The IRS is not getting simpler. Be on the lookout for more errors. While the Taxpayer First Act of 2018 is working its way through Congress promises a better computer system, this has been tried many times before and has failed. While tax reform did lower taxes, it created more complexity.
The root cause of all of these headaches is that we have a tax system with a primary goal that isn’t to raise revenue, but rather, to encourage the outcomes that elected (and some unelected) officials in Washington, DC desire. These are not my words, but the words of Cordell Hull, the father of the modern income tax.
Maybe some day we will get smart enough to see through this folly. But until then, keeps your eyes open to the possibility that the IRS might get something really wrong.
