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National Taxpayer Advocate Nina Olson says that criminal tax evaders are receiving a sweetheart deal from the IRS through its voluntary offshore bank account disclosure initiative. Although those who are intentionally hiding assets can come forward and pay a set penalty to avoid criminal prosecution, the system is often unfair to California taxpayers who unknowingly shielded assets from taxation, Olson says.

In cases of innocent taxpayers, there are times when not participating in the voluntary disclosure program could result in lower penalties but also trigger a vigorous audit.

There are two very common situations in which California residents may be unintentionally shielding assets abroad. The first situation involves dual citizens who may not know that accounts in their second country of citizenship need to be disclosed to the IRS. The second case involves individuals who inherit offshore accounts which turned out to be undisclosed.

The imposition of penalties on OVDI participants also appears unfair in some instances. One lawyer says that he has a client who unintentionally failed to disclose offshore income which resulted in a tax bill of $4,000. The IRS wanted to smack an additional $550,000 in penalties on this particular client which seems grossly disproportionate to the amount of tax that was outstanding.

The reason why the IRS wants to assess such a large penalty is the fact that the penalty is levied against the taxpayer’s largest bank account or most expensive asset, which means that a small tax bill can turn into a massive penalty headache even if it is unrelated to the large account which the penalty is based off of.

In our next post we will discuss additional concerns that Nina Olson raised about the administration of the OVDI programs.

Source: Bloomberg, “IRS Called Easy on Criminal Tax Evaders in Watchdog’s Critique,” Jan. 17, 2012