The Internal Revenue Service has notified tax attorneys around the country that their clients have been disqualified from participation in the Offshore Voluntary Disclosure Program, even after they had initially been accepted in the program.

The IRS offered the OVDP as a way to encourage taxpayers with previously undisclosed bank accounts, particularly at Swiss banks like UBS, to come forward voluntarily, pay their back taxes and avoid heavy penalties.

In some cases, the clients and their tax practitioners had filed amended returns and paid the back taxes and interest on previously undisclosed accounts at foreign banks after receiving assurances that they had been accepted in the program. Now some are concerned that they will face stiff penalties and even the possibility of prison sentences after coming forward voluntarily.

Many of the clients had bank accounts with Bank Leumi, according to Forbes.

The Israeli bank has been under investigation by the IRS (see Bank Leumi Said to Help California Man Cheat IRS and Tax Preparers Charged with Hiding Funds in Israeli Banks). On Monday, the bank said it would take a charge of 340 million shekels, or about $91 million, to cover the costs of an investigation into its U.S. taxpayer customers for 2002 to 2010.

Bob McKenzie, a partner with the Chicago law firm Arnstein & Lehr, said he received a faxed letter about one of his clients from the IRS on Wednesday. “The letters said that you are not eligible to be in the program,” he said in an interview Friday. “We had been admitted. We’d received an official letter admitting us six months ago, and we had been cooperating fully. And then, after the fact, now they’ve sent us letters saying we were mistakenly admitted into the program. And I’m not alone. It’s happened to attorneys all over the country.”

McKenzie posted a query in an email “listserv” group that he participates in with other attorneys who represent clients with foreign assets and heard that others had also received faxes and letters. “It was mainly Bank Leumi in the last few days, but after I put this up on the listserv, I’ve had responses from other attorneys where they’ve had other banks where this has occurred. But the majority have been Bank Leumi, including one attorney who the day before yesterday received five recissions.”

On Friday morning, he said he had talked to another attorney in Baltimore with Bank Leumi clients who also received letters from the IRS rescinding their acceptance in the Offshore Voluntary Disclosure Program.

The letter sent to McKenzie simply states, “Although your clients were informed they were accepted into the voluntary disclosure program, on or about August 14, 2012, upon further review it has been determined that your clients are disqualified from the OVDP.” The letter then adds that if they have any questions, they should call the phone number of the national coordinator of the OVDP.

“We’re not receiving an explanation,” said McKenzie. “We’re not being told what this means. Are they now going to try to prosecute our clients who confessed everything on the belief of a letter from the IRS that they had been admitted into the program, or are they merely going to try to impose very harsh penalties under the program?”

The IRS issued the following statement in response to a question about the letters: “Federal law prohibits the IRS from commenting on specific cases. There are a number of reasons why a taxpayer may be disqualified from participating in the IRS's offshore disclosure program. For example, a taxpayer may be disqualified if he/she fails to make a timely, truthful and complete disclosure.”

McKenzie doubts the IRS would succeed in prosecuting a client on the basis of evidence the client has voluntarily produced after being accepted in the program.

“If they were to try to prosecute my client who confessed after they represented to them that he could participate in the program, I don’t think that any judge would find that to be good conduct on the part of the government,” he said. “But I don’t know whether it would in fact prevent them from imposing the harsh penalties allowed by law.”

He and his client followed a careful procedure when they came forward voluntarily to the IRS as part of the OVDP program. As usual, his firm faxed the client’s name and Social Security number to the IRS, asking whether they were eligible to participate in the program. A disqualifying event would be if the IRS already knew the client had an undisclosed foreign bank account, and the IRS would then send back a letter or fax saying the request was not timely and they had already found out about the account. If the client were eligible, the IRS would then notify the attorney.

The tax attorney and client then submit a formal written application, listing all the details of the client’s offshore accounts. Once they receive a formal letter from the IRS informing them they have been accepted in the program, the tax attorney and client file several years of amended tax returns and foreign bank account report, or FBAR, forms.

“The attorneys around the country relied on the IRS’s letters saying, ‘Yes, you’re eligible,’” said McKenzie. “Obviously we disclosed a lot more, giving them all the details of our clients’ life and amending all their returns. Then the IRS sends us letters saying, essentially, ‘You’re not eligible. Your clients are disqualified from the OVDP.’”

McKenzie speculates that it may have been an error by the IRS in not forwarding the information on the bank accounts that its investigators had already discovered on their own in time to the OVDP officials. But other tax attorneys view it as a trap by the IRS.

“My view is that the IRS had heard about these Bank Leumi clients already from the cooperation of Bank Leumi, but had not really put it in their database,” said McKenzie. “But that doesn’t justify this. It wasn’t my client’s mistake. My client in good faith had an attorney verify he could participate. We had the official approval in August, and it’s already seven months later. Once they’re in and qualify, the IRS revokes it.”

It will be difficult for attorneys to tell their clients about the rescinded letters, and McKenzie believes it will lead to a lack of trust in the value of coming forward under the program. “You can’t truly trust them because they’ll send you a letter later saying, ‘We didn’t mean it. Oh, never mind.’”

There is now an effort underway among the tax attorneys to get some clarification of what their clients face and the reasons for the disqualifications. Some of the leaders of the tax attorney email group have sent an email to several high-level leaders at the IRS seeking a resolution, McKenzie noted.

“Those of us who are doing a lot of these are attempting to go through some back channels within the IRS to try to find out why this occurred and what will happen to our clients, but right now we’re not being told anything,” he said. “The approach is to request a meeting with the officials to try to find out what will happen to our clients. Is this some exception or should we expect this in the future? What should we tell our clients? My client has already written very large checks. He paid every dollar of tax and every dollar of interest.”

The question is whether the client will also be facing stiff penalties or worse.