A tale of OVDP Opt-out audit success

This is going to be a different kind of success story. I'm going to talk about what you, as the taxpayers, need to do to have success during an Offshore Voluntary Disclosure Program/Initiative (OVDP/OVDI) Opt-out audit.​


1. A thick skin

Chelsea was a personal trainer in Miami. In 2008, she was audited by the IRS for her business income. Unfortunately, she was sitting on a loss from a fitness program that didn't quite take off. She was represented by her CPA. The IRS auditor went through everything — all of Chelsea's business bank statements — and found that Chelsea was entitled to deduct the loss. The auditor closed the case with a positive result for Chelsea – "No change." This was great as it meant that the IRS agreed with Chelsea's tax return as it had been originally submitted.


2. A tolerance for idiots

Now, guess what those business bank statements, in addition to Chelsea's business expenses and income, showed? They showed her own capital contributions from a wire transfer originating from a Panamanian bank. And neither her CPA or the IRS auditor, who both saw these transfers coming inbound, asked any follow-up questions.


If they had, they would have learned that Chelsea spent a good deal of her youth in Panama where her father held a fairly prestigious job at a Panamanian bank. Chelsea had gone to college and spent most of her time in the US, but she also took trips and traveled extensively to Panama to take care of her parents and their financial affairs. He parents gifted money to Chelsea over the years and she never suffered from want.


Now, if either her CPA or auditor asked what kind of account this was, Chelsea would have said that yes, it was a foreign account that earned interest in which she had a signatory authority, and yes, this account, along with her other accounts exceeded $10,000 US in the aggregate by a bit – about $800,000. But no one thought to question it. The auditor closed the audit, her CPA continued doing her tax returns, and neither asked Chelsea about her foreign accounts; the Schedule B issue was something Chelsea, nor her CPA, ever looked into.


In early 2012, Chelsea was reading something about FBAR requirements and the horrific penalties. Worried about potential issues in the future, she started investigating legal counsel in an effort to disclose her accounts. In January of 2012, right after the 2012 OVDP/OVDI was announced, she called us. After deciding we would be a good fit, we agreed – this was a case where she should opt-out. If her CPA and an IRS auditor weren't aware that she needs to report foreign bank accounts and interest, then what reasonable explanation could there be for the IRS to levy her with FBAR penalties?


As we do with every case, we provided Chelsea with a quote to prepare her amended returns and FBARs, complete the submission of all necessary paperwork, and perform the OVDI opt-out audit. Chelsea decided to go with a Miami law firm instead. She told us that she was more comfortable with a local firm, which had been recommended to her. Their initial retainer and estimates of total cost were lower than our quote.


We wished her the best of luck.


3. A larger tolerance for idiots

In the winter of 2013, we heard from Chelsea again. I asked her how everything was going. She was in tears as she told us, "I have paid the law firm $120,000, their CPA $40,000 and now the lawyer is telling me I better not opt-out and wants me to agree to a $200,000 offshore penalty. I don't have it. I don't have anymore."


We had Chelsea upload all of her documents to our secure server where we took a look. We realized that the attorney and/or CPA were either planning on not opting out the whole time, or they simply didn't have any idea what was going on. The way they prepared Chelsea's foreign mutual fund investments (which are considered Passive Foreign Investment Companies, PFICs) in a manner that was only possible if Chelsea was not opting-out. An opt-out would require an entirely different set of calculations.


This only made Chelsea's stomach turn more. We reiterated that she should opt-out and that we have had cases extremely like hers where we've gotten positive results. We gave her a quote to prepare the returns correctly and conduct the opt-out.


4. A tolerance for abusive inquisitors

In July of 2014, we were finally conducting the Opt-out audit. The IRS agent agreed with our PFIC calculations and we were able to prove that the taxes owed was nominal. Some years she was actually due a refund, and some years there had been additional taxes; it wasn't always the case that she owed more. The taxes were never really the big issue. Rather, it was the looming FBAR penalties or the wildly undesirable $200,000 offshore penalty.


We prepared Chelsea extensively for the opt-out interview that would be conducted via teleconference; she was very nervous. Prior to the interview, the CPA who had done her original audit was kind enough to admit, in writing, that he saw the foreign accounts and didn't think they needed to be reported. Not only that, but he never asked and never advised Chelsea to actually report them. This was a great fact to have on our side.


I would like to say that the IRS was understanding. I would like to say the IRS auditor was a real human being. I would like to say he was not condescending. But alas, he was a government know-it-all, who was probably jealous of Chelsea and wanted to punish her just for being her.


We told her to stay strong. His nastiness was only to get her to crack so that he would have some justification to retaliate. She sucked it up and stayed 100% professional even when the IRS examiner was not. We kept our cool and told Chelsea she could not have done a better job. Again, she had a completely reasonable cause!


In October, we heard from the auditor. Like we were hoping, there were no FBAR penalties! All she got was an FBAR warning letter.


We explained to Chelsea that it isn't the auditor who decides, even though some of them like to pretend they wield all of the power. But really, it's the auditor who collects the facts and then the district counsel decides whether or not FBAR penalties should be imposed. Thanks to our research and preparation, the record we created convinced district counsel NOT to impose FBAR penalties.


5.  A relative definition of success

Even though we achieved the best possible result for Chelsea during her opt-out, there is no way she can deny these facts:

  • She was let down by two IRS employees. The first auditor, who didn't correct Chelsea in 2008, allowed her to continue to make mistakes. Secondly, the abusive auditor seemed to have a personal beef with Chelsea and attacked her verbally and emotionally.
  • She was let down by two CPAs. The first didn't seem to understand FBAR reporting requirements and universal tax jurisdiction, and the second prepared the return incorrectly while charging an inflated — and exorbitant — fee.
  • She was let down by a law firm who tried to push her into a settlement she didn't want and wasn't fair, and who also vastly under-estimated the total legal fee they would charge Chelsea.


Sometimes, success is only possible in relation to other possibilities. Had Chelsea continued down the path she was on, the other law firm would probably have found more hourly time to bill and Chelsea would have seen her bank account take an additional $250,000 hit between the IRS and her Miami-based law firm.


Yet, that's just the monetary aspect. I think the worst thing for Chelsea was the regret. If she didn't fight so bravely and didn't stand up for herself, I am convinced that she would have spent the rest of her life letting this episode eat away at her. How could she ever forgive herself for being pushed around by a law firm and the IRS?  How would she avoid letting some of this entire nightmare be internalized, making her fearful of the world?


Instead, she handled the blows, she kept her integrity, hung on until the end, and now she can keep her head held high.


Note: If your name is Chelsea and you live in Miami and you are a personal trainer and have parents in Panama, I assure you this a coincidence. Certain aspects of this story have been changed to protect our client's privacy. Also, so a certain government employee won't realize we were talking about their lovely, truly lovely, demeanor.