TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

U.S. taxpayers with previously undisclosed interests in foreign financial accounts and assets continue to analyze and seek advice regarding the most appropriate methods of coming into compliance with their U.S. filing and reporting obligations. Many are pursuing participation in the current IRS offshore voluntary disclosure program (the OVDP which began in 2012), modeled after similar programs in 2009 and 2011.

Taxpayers participating in the ongoing 2012 OVDP generally agree to file amended returns and file FBARs for eight tax years, pay the appropriate taxes and interest together with an accuracy related penalty equivalent to 20 percent of any income tax deficiency and an “FBAR-related” penalty (in lieu of all other potentially applicable penalties associated with a foreign financial account or entity) of 27.5 percent of the highest account value that existed at any time during the prior eight tax years.

QUIET DISCLOSURES. There remain alternatives to the OVDP, including the voluntary disclosure practice of the IRS set forth in Internal Revenue Manual 9.5.11.9 [see Example 6(A) – a letter from an attorney which encloses timely amended returns from a client which are complete and accurate (reporting legal source income omitted from the original returns) and which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full), Section 4.01 of the Criminal Tax Manual for the U.S. Department of Justice, and Section 3, Policy Directives and Memoranda, Tax Division of the U.S. Department of Justice. These practices and policies provide protection from a criminal investigation and prosecution but do not determine the outcome of any civil examination proceedings.

Despite various potential risks of not coming into compliance through the OVDP, some continue to disclose their offshore accounts outside the OVDP in a “quiet disclosure” by simply filing amended income tax returns for all or some of the tax years otherwise covered by an offshore program, and report previously unreported income – whether such income is associated with the previously unreported accounts or otherwise. At the same time, taxpayers attempting a quiet disclosure typically file late Forms 90-22.1, Report of Foreign Bank and Financial Accounts (FBARs), if they had not previously filed FBARs, or amended FBARs, if they had, to disclose the previously unreported offshore accounts.

BSA FILING REQUIREMENTS. Under the Bank Secrecy Act, U.S. persons must file a report with the government if they have a financial account in a foreign country with a value exceeding $10,000 at any time during the calendar year. Taxpayers comply with this law by noting the account on their income tax return and by filing the FBAR. Civil penalties for willful failure to comply with the reporting requirements of Section 5314 can be imposed under 31 U.S.C. § 5321(a) (5). For violations involving the willful failure to report the existence of an account, the maximum amount of the penalty that may be assessed under Section 5321(a) (5) is the greater of $100,000 or 50 percent of the balance in an unreported foreign account, per year, for up to six tax years.

U.S.A. vs. CARL R. ZWERNER –

On June 11, 2013, the government filed a Complaint to collect multiple civil FBAR penalties in the amount of $3,488,609.33 (as of June 13, 2013) previously assessed against Carl R. Zwerner of Coral Gables, Florida for his alleged failure to timely report his financial interest in a foreign bank account, as required by 31 U.S.C. § 5314 and its implementing regulations. [United States v. Carl R. Zwerner, Case # 1:13-cv-22082-CMA (SD Florida, June 11, 2013)].

Mr. Zwerner is an 87 year old man who authorized his tax counsel in 2008 to contact IRS Criminal Investigation and make a voluntary disclosure. Mr. Zwerner disclosed the existence of his offshore account (including income generated by the account) on his timely filed 2007 tax return and paid the tax owed.

On February 10, 2009, Mr. Zwerner’s prior tax counsel contacted IRS Criminal Investigation Division (CID) on a hypothetical basis (without disclosing the identity of Mr. Zwerner). On February 17, 2009, IRS CID issued a letter stating that no criminal action would take place, but the identity of the client had not been disclosed at the February 10, 2009 meeting. Mr. Zwerner was then advised by his tax counsel that his voluntary disclosure had occurred and he should file the amended returns for tax years 2004, 2005 and 2006. On or about March 27, 2009, Mr. Zwerner filed amended tax returns and the FBARs for 2004, 2005, and 2006, and paid the tax and interest owing.

Mr. Zwerner’s tax returns were not under audit at the time of his voluntary disclosure. Following up on this traditional voluntary disclosure, at some point in 2010 the IRS began an audit of Mr. Zwerner’s returns. In the course of that audit, Mr. Zwerner advised the IRS agent of his prior voluntary disclosure.

Mr. Zwerner appears to have come into compliance under the then applicable voluntary disclosure practice set for in the IRS’s Internal Revenue Manual 9.5.11.9, Example 6(A) at a time when there was no formal program regarding the voluntary disclosure of previously undisclosed interests in offshore financial accounts. Unfortunately, IRM 9.5.11.9 only speaks to the voluntary disclosure being a factor considered by the IRS in the determination of a referral for criminal prosecution by the Tax Division of the U.S. Department of Justice. It has no formal impact on any IRS civil penalty determination although, historically, a timely voluntary disclosure has received favorable consideration in the civil penalty arena as well.

The $3,488,609.33 (as of June 13, 2013) assessed by the government represents 50% of the high balance of his account at the time of the violations for EACH year, as follows: (a) 2004 – $723,762, assessed on June 21, 2011; (b) 2005 – $745,209, assessed on August 10, 2011; (c) 2006 – $772,838, assessed on August 10, 2011; and (d) 2007 – $845,527 assessed on August 10, 2011.

The IRS asserted a 75% civil income tax fraud penalty for tax years 2004, 2005 and 2006. Following the audit, the income tax civil fraud penalty was abated in the U.S. Tax Court for 2006, by IRS Appeals for 2004 and 2005, and was not even asserted by the IRS for 2007.

BURDEN OF PROOF. The government carries the burden of proving willfulness into the courtroom. Taxpayers should carefully review the recent court decisions in United States v. Williams, No. 10-2230 (4th Cir. 2012) and United States v. McBride, No. 2:09-cv-00378 (D. Utah 2012) on the issue of determining “willfulness” for assertion of the more significant “willful” FBAR penalties (of up to 50% of the account balance, per year). Although the underlying facts in each case were not the best, the courts might not lightly view those with considerable financial resources who fail to inquire about their potential reporting requirements associated with various interests in foreign financial accounts.

JURY DETERMINES 150% FBAR PENALTY APPLIES. The jury trial in Zwerner began on May 19, 2014 in the Federal District Court for the Southern District of Florida. Today, the jury returned a verdict finding Mr. Zwerner “willful” and thus liable for an FBAR penalty equivalent to 50% of the high balance in his foreign financial account for each of the years 2004, 2005 and 2006 years as previously assessed by the government. The jury determined Mr. Zwerner was not “willful” as to the year 2007.

Essentially, the assessed FBAR penalties upheld by the jury aggregate $2,241,809 on an offshore account that had an apparent high balance of $1,691,054 during the years at issue.

Many have been wondering what unique facts may have led the government to pursue what many believe to be unconstitutionally excessive multiple year, 50 percent FBAR penalties against Mr. Zwerner. Heightened tax enforcement efforts and increased penalties for non-compliance must be coupled with ongoing efforts to encourage taxpayers to voluntarily come into compliance. The perception of fairness (or unfairness) in the process can have a significant impact on the decisions of millions of other U.S. taxpayers presently contemplating whether to come into compliance with their filing and reporting requirements.

By previously trying to voluntarily come into compliance through the filing of amended returns and original FBARS, he was subjected to an IRS audit, then became ineligible for the 2011 OVDI and is now subjected to multiple year, 50 percent FBAR penalties. It should be noted that taxpayers entering a criminal plea in matters involving FBAR violations typically receive a single year 50 percent FBAR penalty based on the highest account value for the applicable tax years.

This is a significant win for the government in their efforts to encourage certain US persons having undisclosed interests in foreign financial accounts to come into compliance with the applicable filing and reporting requirements . . .

THE EXCESSIVE FINES CLAUSE TO THE RESCUE? To many, pursuing multiple year, maximum penalties following submission of amended returns and delinquent FBARs appears punitive. The Excessive Fines Clause of the Eighth Amendment and relevant Supreme Court case law support a conclusion to the effect that a civil penalty or forfeiture is unconstitutional if the penalty or forfeiture is at least in part “punishment” and such punishment is grossly disproportionate to the conduct which the penalty is designed to punish. The touchstone of the constitutional inquiry under the Excessive Fines Clause is the principle of proportionality – the amount of the penalty must bear some relationship to the gravity of the offense that it is designed to punish.

The judge in Zwerner will hear arguments on June 6 whether the penalties violate the constitutional prohibition against excessive fines. Many will continue to watch U.S.A. vs. Carl R. Zwerner before making any decision to pursue any form of voluntary disclosure regarding previously undisclosed interests in a foreign financial account.

MOVING FORWARD. Recent events support the conclusion that the system is far more important than any single U.S. taxpayer; the IRS and those representing the IRS must remain objective and conduct themselves with the highest degree of integrity at all times.

The case involving Mr. Zwerner represents more than an effort to collect civil FBAR penalties from Mr. Zwerner. The Answer filed on behalf of Mr. Zwerner asserted instances where the IRS agent conducting the audit attempted to “mislead and bolster his position for the FBAR penalty,” displayed an “unrealistic aggression” towards Mr. Zwerner, and asserts that Mr. Zwerner signed a letter dated August 9, 2010 admitting to “willful misconduct” in failing to file FBARs but neglected to disclose that the letter was actually dictated by the agent coercing Mr. Zwerner into signing it as “the only way he would be able to obtain a reduction of the penalties that might otherwise apply.” If any of the foregoing allegations of agent misconduct are true, the Government is pursuing the wrong person involved in the underlying audit.

Worldwide respect for the integrity of the U.S. system of tax administration depends, at least in part, upon how the Government continues to treat those who pursue some type of timely and truthful voluntary compliance with the filing and reporting requirements associated with their foreign financial accounts. A system of tax administration based in large part on voluntary compliance cannot ignore the potential impact associated with the manner in which those who voluntarily comply, even if in a somewhat awkward fashion (but before any contacts by the Government), are treated.

Heightened tax enforcement efforts and increased penalties for non-compliance must be coupled with ongoing efforts to encourage taxpayers to voluntarily come into compliance. The perception of fairness (or unfairness) in the process can have a significant impact on the decisions of millions of other U.S. taxpayers presently contemplating whether to come into compliance with their filing and reporting requirements.