TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

For violations involving the non-willful failure to report the existence of a reportable interest in a foreign financial account, the maximum amount of the FBAR penalty that may be assessed under Title 31, Section 5321(a)(5)(B) shall not exceed $10,000, per year, for up to six calendar years. However, no penalty shall be imposed if such non-willful violation was due to reasonable cause and the amount of the transaction or the balance in the account at the time of the transaction was properly reported [see 31 U.S.C. § 5321(a)(5)(B)(ii)]. The reasonable cause exception does not apply to willful FBAR violations. [see 31 U.S.C. § 5321(a)(5)(C)(ii)].

“Reasonable cause” is not defined in the Bank Secrecy Act (31 U.S.C.) or in the regulations interpreting it. However, the term is fairly well defined in regulations and cases interpreting the Internal Revenue Code.[i] In 1985, in Boyle v United States[ii], the Supreme Court noted that the meaning of the terms “reasonable cause” and “willful neglect” “ha[d] become clear over the near-70 years of their presence in the statutes” and that the term “willful neglect” may be read as meaning a “conscious, intentional failure or reckless indifference” while “reasonable cause” calls on the taxpayer to “demonstrate that he exercised “ordinary business care and prudence”[iii]

MOORE v. UNITED STATES. Recently, in Moore v. United States, a federal District Court determined that “a person has ‘reasonable cause’ for an FBAR violation when he committed that violation despite an exercise of ordinary business care and prudence.”[iv] In 1989, Mr. Moore moved to the Bahamas and subsequently opened an account at Bank of Bahamas in Nassau with $300,000 of after tax funds. In early 1990s these funds were transferred from Bank of the Bahamas to the Bahamas branch of United Bank of Switzerland (UBS) purportedly as a result of advice from the money manager of Bank of Bahamas.

Through 2005, Mr. Moore prepared his own returns and did not report income from the foreign account (apparently believing it was held in an entity that was separate from Mr. Moore for reporting purposes). In some years, Mr. Moore did not respond on his return to the question on Line 7 of Schedule B to the effect “At any time during (tax year), did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?” In some years, a Schedule B was not attached to the return.

A return preparer provided a tax organizer and prepared the returns for tax years 2006-2008. Apparently, Mr. Moore responded “No” on the organizer with respect to the question “Did you have an interest in or signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?” which response was also reflected in the returns. The return preparer was not otherwise advised of the existence of a possible reportable foreign account.

Mr. Moore had apparently failed to timely file FBARs regarding a foreign financial account having a high balance in 2005 of $440,070; in 2006 of $471,098; in 2007 of $517,893 and in 2008 of $408,990. Within a month of learning about FBAR filing requirements, Mr. Moore took action to come into compliance with his filing and reporting obligations for 2003 to 2008. In 2009, Mr. Moore entered the then applicable IRS OVDP and submitted amended returns setting forth additional tax liabilities for 2005 were $2,878; for 2006 were $3,205; for 2007 were $3,443 and for 2008 were $2,728. In 2010, as part of disclosing the UBS account to the IRS, Mr. Moore filed FBARs for the years 2003 through 2008.

Mr. Moore ultimately opted out of the OVDP because he did not agree to the miscellaneous offshore penalty assessed on the highest aggregate balance of his UBS account and was later subjected to an IRS examination that included tax years 2005, 2006, 2007 and 2008. During the post-OVDP examination, Mr. Moore asserted, in part, that reasonable cause existed on the basis that he “established a Bahamian Corporation, Dornlas Hardick Ltd[.,] through Graham Thompson Ltd. and capitalized it with $300,000 previously taxed in the United States. [I] believed the establishment of a legal Bahamian Corporation was sufficient to isolate the corporate assets from [my] personal assets, and that [I] was not required to disclose it on [my] personal tax return.” Ultimately, the IRS assessed the maximum non-willful penalty under Section 5321(a)(5)(B) of $10,000 for each of tax 2005, 2006, 2007 and 2008.[v]

The federal District Court held that Mr. Moore did not, as a matter of law, have reasonable cause for his failure to file FBARs prior to 2009 noting:

• “No fact finder could conclude that ignoring the question on Schedule B of his 2003 tax return was an exercise of ordinary business care or prudence.”
• “The Schedule B question asked if he had ‘signature or other authority over a financial account in a foreign country . . . .’ That phrase is not difficult to understand. As a matter of law, it placed Mr. Moore at least on notice that he should inquire further as to whether his corporation’s foreign account was subject to disclosure. His decision to avoid further inquiry is not an exercise of ordinary business care or prudence.”
• “Even when Mr. Moore employed a tax preparer, a person whose expertise clearly exceeded his own in terms of determining his legal obligations to the IRS, Mr. Moore declined to disclose the existence of his foreign account.”
• “That he did not inquire further into his legal obligations is evidence that he did not have reasonable cause for his FBAR violations, not that he was too old to know better.”
• “Evidence that a taxpayer ignored relevant questions on Schedule B and in tax organizers is evidence of willful conduct. In this court’s view, it suffices as a matter of law to demonstrate a lesser FBAR violation – one made without ‘reasonable cause.’

THE IRS FBAR PENALTY SUMMARY MEMORANDUM. The statutory penalty computation provides a ceiling on the FBAR penalty. The actual amount of the penalty is left to the discretion of the IRS examiner. Attachments to the pleadings filed in Moore include an internal IRS FBAR Penalty Summary Memorandum prepared by the IRS examiner reflecting the government viewpoint on “non-willfulness” and “reasonable cause”:

          Reasons for Assertion of Penalty – Mr. Moore never reported earnings in the UBS account since it was first established back in 1980s and earnings have accumulated over the years; the amount of the unreported income on the foreign account was “significant, and generated substantial tax liabilities and accuracy-related penalties” (the aggregate unpaid tax for the years at issue was $12,254); there was a “pattern” of non-compliance (schedule B response to the foreign account question was either left blank or “No”); and Mr. Moore responded “No” on the tax organizer provided by the preparer.

          Penalty Determination – For most FBAR cases, the IRS has determined that if a person meets four threshold conditions then the person may be subject to less than the maximum FBAR penalty depending on the amounts in the person’s accounts.[vi] There are four threshold conditions which vary slightly depending on the date of the violation. For violations occurring after October 22, 2004, the four threshold conditions are:

1. The person has no history of past FBAR penalty assessments; the person has no history of criminal tax or BSA convictions for the preceding ten years.

2. No money passing through any of the foreign accounts associated with the person was from an illegal source or used to further a criminal purpose;

3. The person cooperated during the examination. (Mr. Moore responded to reasonable requests for documents; meetings and interviews, etc.).

4. The IRS did not sustain a civil fraud penalty against the person for an underpayment for the year in question due to the failure to report income related to any amount in a foreign account.[vii]

There are three penalty levels depending on the highest amount in the account during the period for which the FBAR should have been filed. For violations regarding an account exceeding $250,000, the penalty per violation is the statutory maximum of $10,000.

In determining application of the maximum non-willful penalty for each year at issue, the IRS FBAR Penalty Summary Memorandum in Moore stated “multiple FBAR penalties are appropriate for this case in view of the nature of the violations, a long-history of non-compliance, and amounts involved. The taxpayer has not established reasonable cause for his failure to file, and the taxpayer’s actions indicate that certain elements of willfulness and willful blindness[viii] may exist to support application of the maximum non-willful penalties for these periods.”

Another attachment to the pleadings in Moore includes a declaration from the IRS Appeals Officer who was assigned to review the administrative appeal of the FBAR penalties stating “One of the issues discussed was reasonable cause, and whether it was applicable in this case considering Mr. Moore did not inquire or seek professional advice regarding his reporting requirements in connection with his foreign bank account.” The foregoing seems to reflect an IRS feeling that a reasonable cause determination requires a taxpayer to “inquire or seek professional advice regarding his reporting requirements in connection with his foreign bank account” or possibly at least inform their return preparer of the existence of an interest in a foreign financial account.

ARBITRARY AND CAPRICIOUS CONDUCT. On July 24, 2015, the U.S. District Court determined in Moore that the conduct of the IRS in assessing the non-willful FBAR penalties was “arbitrary and capricious” in that the IRS failed to disclose any adequate basis for its decision to assess the FBAR penalties until forced to do so in the District Court litigation. “Even after this litigation began, the IRS refused to disclose the evidence on which it now relies to demonstrate the basis for its decision to impose those penalties. With respect to the 2005 penalty, the IRS broke its own promise not to impose a penalty until Mr. Moore had an opportunity to respond to its “proposed” assessment.”

The IRS assessed the non-willful FBAR penalties against Mr. Moore on January 24, 2013. Pursuant to 31 U.S.C. § 3717, interest technically begins to accrue on such an assessment from the date of notice of the assessment and demand for payment which, in Moore, occurred on January 24, 2013. Additionally, pursuant to 31 U.S.C. § 3717(e)(2), if the FBAR penalty assessments are not paid within 90 days of notice and demand, a penalty accrues at the rate of 6% per year from the date of notice and demand on the unpaid assessments.

Ultimately, during the litigation process, the government provided a declaration from an IRS Appeals Officer “which includes the case memorandum that the IRS previously refused to disclose to Mr. Moore, discloses the basis for the IRS’s decision to assess the FBAR penalties. That memorandum leads the court to conclude that the IRS did not act arbitrarily and capriciously or abuse its discretion in determining the amount of the penalties. In particular, the court finds that the guidelines for determining the amount of FBAR penalties contained in the Internal Revenue Manual are not arbitrary or capricious, and that it was not an abuse of discretion for the IRS to follow those guidelines in this case.”

“The IRS’s refusal to disclose anything about the basis for its decision until this litigation, and in particular its decision to withhold Agent Batman’s memorandum until after the court ordered it produced, was arbitrary and capricious. The IRS did not simply fail to disclose Agent Batman’s memorandum, it opposed Mr. Moore’s motion to compel its disclosure. Once the Government determined that it could point to no other evidence justifying its decision to impose the maximum penalties, the Government produced the memorandum. The IRS has offered no explanation for its apparent policy not to explain the assessment of FBAR penalties to citizens, and in particular for its apparent policy not to put that explanation in writing. It has also offered no explanation for its steadfast refusal to disclose Agent Batman’s memo in this litigation until it was left with no other options. No citizen should have to sue his own Government to find out why he is being fined, or to find out why he is being fined $40,000 as opposed to a smaller amount. And once a citizen has sued, he should not have to fight over the most basic disclosures.”

In its Order of July 24, 2015, the federal District Court upheld the $40,000 FBAR penalty assessment. However, to prevent “the IRS from profiting by imposing penalties without explaining them. The court voids the IRS’s assessment of interest and other charges on top of its previously unexplained penalties.” Instead, interest and penalties were to begin accruing on top of the $40,000 FBAR penalty assessment on the date of the courts Order (July 24, 2015).

IRS STREAMLINED PROCEDURES FOR NON-WILLFUL VIOLATIONS. In addition to the OVDP, the IRS maintains other more streamlined procedures designed to encourage non-willful taxpayers to come into compliance. Taxpayers using either the Streamlined Foreign Offshore Procedures (for those who satisfy the applicable non-residency requirement) or the Streamlined Domestic Offshore Procedures are required to certify that their failure to report all income, pay all tax, and submit all required information returns, including FBARs (FinCEN Form 114, previously Form TD F 90-22.1), was due to “non-willful” conduct.

For these Streamlined Procedures, “non-willful conduct” has been specifically defined as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law”. For eligible U.S. taxpayers residing outside the United States, all penalties will be waived under the Streamlined Foreign Offshore Procedures. For eligible U.S. taxpayers residing in the United States, the only penalty will be a miscellaneous offshore penalty equal to 5 percent of the foreign financial assets that gave rise to the tax compliance issue under the Streamlined Domestic Offshore Procedures.

Even if returns properly filed under the Streamlined Procedures are subsequently selected for audit under existing IRS audit selection processes, the taxpayer will not be subject to failure-to-file and failure-to-pay penalties or accuracy-related penalties with respect to amounts reported on those returns, or to information return penalties or FBAR penalties, unless the examination results in a determination that the original tax noncompliance was fraudulent and/or that the FBAR violation was willful. Any previously assessed penalties with respect to those years, however, will not be abated. Further, as with any U.S. tax return filed in the normal course, if the IRS determines an additional tax deficiency for a return submitted under these procedures, the IRS may assert applicable additions to tax and penalties relating to that additional deficiency.

[i]  See U.S. Taxpayers Residing Outside the United States, Eligibility for the Streamlined Foreign Offshore Procedures,  http://www.irs.gov/Individuals/International-Taxpayers/U-S-Taxpayers-Residing-Outside-the-United-States

[ii] U.S. Taxpayers Residing in the United States, Eligibility for the Streamlined Domestic Offshore Procedures, http://www.irs.gov/Individuals/International-Taxpayers/U-S-Taxpayers-Residing-in-the-United-States

[i] For example, 26 U.S.C. § 6664(c)(1) prohibits penalties for any portion of an underpayment of tax “if it is shown that there was reasonable cause for such portion and that the taxpayer acted in good faith with  respect to such portion.” Another statute, applicable to foreign trusts, prohibits penalties for “any failure  which is shown to be due to reasonable cause and not due to willful neglect.” 26 U.S.C. § 6677(d). And, in the statute that the Government identifies as an analogue, Congress prohibited monthly penalties for failing to file tax returns where “such failure is due to reasonable cause and not due to willful neglect . . . .” 26 U.S.C. § 6651(a)(1).

[ii] United States v. Boyle, 469 U.S. 241, 245 (1985).

[iii] Id. See also Internal Revenue Manual (IRM) 20.1.1.3.1 (August 20, 1998).

[iv] Moore v. United States, Case No. C13-2063RAJ (April 6, 2015, USDC Western District of Washington).

[v] Note that the aggregate $40,000 in penalties was far less than what would have been determined under the 2009 OVDP – $103,578, likely representing 20% of  the $517,893 account value that existed in 2007.

[vi] IRM 4.26.16. Many have wondered whether these mitigation guidelines had any continuing effect following the OVDP and Streamlined Procedures but, in Moore  the IRS was applying the FBAR mitigation guidelines in determining the appropriate penalty in November 2011.

[vii] Id.

[viii] Under the concept of “willful blindness”, willfulness may be attributed to a person who has made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements.