IRS Stealth: Delinquent Information Submission Procedure Penalties May Apply Without Considering “Reasonable Cause” Statement

On November 5, the Internal Revenue Service (IRS) made life more difficult for taxpayers who may have missed some foreign information return filings.  The IRS quietly revised one of the four options to correct for missing information returns with respect to a US taxpayer’s interest in any offshore/foreign assets and holdings (e.g., Form 8938, Form 5471, Form 3520, Form 3520-A).  The new procedure can be found here (as revised on November 5th); the IRS FAQs have not yet been updated and can be found here.

The Delinquent Information Submission Procedure (DISP), provided a somewhat comforting opportunity to US taxpayers who did not need to use the Offshore Voluntary Disclosure Program or the Streamlined Filing Compliance Procedures to file delinquent international information returns if they had “reasonable cause” for the tax noncompliance. Taxpayers wishing to use the DISP could not be under a civil examination or a criminal investigation by the IRS, and could not have already been contacted by the IRS about the delinquency. Prior to revision of the DISP on November 5, taxpayers had a bit more clarity. Even though there was no guarantee that penalties would not be asserted (since the returns would be processed through normal procedures), the IRS did not make the ominous sounds now being enunciated in the revised DISP.  Here is the concerning language from the new DISP:

  • “During processing of the delinquent information return, penalties may be assessed without considering the attached reasonable cause statement.”
  • “It may be necessary for taxpayers to respond to specific correspondence and submit or resubmit reasonable cause information.”

This new language indicates to me that there is no guarantee the reasonable cause statement will be reviewed, processed or even considered. Reporting penalties are often assessed automatically and if assessed, the taxpayer will be in the position of having to present the reasonable cause position to the IRS.  No one knows how long this may take as there is no guarantee the taxpayer will be heard in a timely manner, especially given IRS backlogs with COVID-19 issues.  Meanwhile, when a taxpayer is waiting to have the IRS make a determination on the issue of reasonable cause, the IRS may still collect the penalty.  If the number of these kinds of cases increases in volume, then involvement by the Taxpayer Advocate may be required for relief.

On the positive side, the revised DISP still provides that “information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.”

Call to Action

The window for voluntary correction of tax noncompliance in the international sphere is definitely closing.  Since January 2017, the IRS Large Business & International division started implementing so-called compliance “campaigns” that included various international tax issues where there was greater taxpayer noncompliance. (The full list of current IRS “campaigns” is here).  At the same time, the IRS launched information webinars about the campaigns so that practitioners and taxpayers would be well aware that IRS was using data analytics and technology to make the most efficient use of limited IRS resources. The IRS continues to obtain more and more information from foreign financial institutions and governments under FATCA, from altruistic reporters, from whistleblowers, and in teaming up with other countries to hunt down taxpayers who have not met their obligations.  The options available to such taxpayers to voluntarily correct and update their US tax-filings are clearly narrowing.

Currently, there are still some possibilities to address noncompliance, including the streamlined submission procedures. There is no guarantee that the IRS will not soon change the deal and all indications are that the landscape is changing quickly.  Taxpayers must take action to correct mistakes while the opportunity exists.

 

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