U.S. citizens and residents are taxed on their worldwide income, subject to certain very specific exemptions, whether they live inside or outside of the United States. Foreign income must be reported on a U.S. tax return whether or not the person receives a Form W-2, Wage and Tax Statement, a Form 1099 (information return) or the foreign equivalent of those forms. Foreign source income includes but is not limited to earned and unearned income, such as wages and tips, interest, dividends, capital gains, pensions, rents, and royalties. Generally, certain U. S. persons are required to file Form TD F 90-22.1, the Report of Foreign Bank and Financial Accounts (FBAR) with the government if they have a reportable interest in one or more financial accounts in a foreign country having an aggregate value exceeding $10,000 at any time during the calendar year.
The IRS has been aggressively attempting to uncover tax-avoidance schemes involving the use of domestic or offshore financial accounts and arrangements. Most individuals wrongly believe that prior tax indiscretions can somehow be routinely resolved in a purely civil manner, without a criminal investigation or prosecution. However, within the past few years, at least 40 U.S. taxpayers and another 20 advisors (bankers, lawyers, consultants, etc.) have been criminally indicted for activities associated with U.S. persons holding undeclared interests in foreign financial accounts. Untold others are targets or subjects of ongoing federal criminal investigations.[i] In July 2010, various individuals around the country received a letter from the U.S. Department of Justice, Tax Division stating, in part:
Re Investigation of undeclared Foreign Financial Accounts.
The Department of Justice is conducting an investigation of U.S. taxpayers who may have violated federal criminal laws by failing to report they had a financial interest in, or signature authority over, a financial account located in a foreign country. We have reason to believe that you had an interest in a financial account in India that was not reported to the IRS on either a tax return or FBAR, Department of Treasury Form TD F 90-22.1, report of Foreign Bank and Financial Account. You are advised that the destruction or alteration of any document that may relate to this investigation constitutes a serious violation of federal law, including but not limited to obstruction of justice . . .. You are further advised that you are a subject of a criminal investigation being conducted by the Tax Division [of the Department of Justice].
Few individuals are able to emotionally survive receipt, at home, of the foregoing type of letter advising them that they are the “subject of a criminal investigation being conducted by the Tax Division” of the U.S. Department of Justice. If the initial taxpayer contact is from the IRS, a purely civil tax resolution is no longer certain and the likelihood of substantial civil penalties is significant. If the initial taxpayer contact regarding an undisclosed potential interest in a foreign financial account is from the Department of Justice, a purely civil tax resolution is anything but certain and is perhaps unlikely. Waiting is not a viable option for taxpayers having an undisclosed interest in a foreign financial account. They should immediately pursue a course of compliance designed to avoid criminal prosecution and substantial civil penalties. Actions designed to avoid detection by the government will surely increase the potential for criminal prosecution. Taunting a tiger having eleven active aircraft carriers and Seal Team Six simply doesn’t make any sense . . .
Overview of FBAR Reporting Requirements and Civil Penalties. Under the Bank Secrecy Act[ii], a resident or citizen of the United States and a person in, and doing business in, the United States must file an FBAR if: (i) the person has a financial interest in, signature authority, or other authority over one or more accounts in a foreign country, and (ii) the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year[iii]. The FBAR must be filed by June 30 of each year for the prior calendar year. Extensions of time to file federal income tax returns do not extend the time for filing FBARs – there is presently no statutory or regulatory provision granting an extension beyond June 30 to file an FBAR.
Taxpayers are required to acknowledge their interest in the foreign financial account and identify the foreign country where the account is maintained on Schedule B, Line 7 of their income tax return. Line 7a of Schedule B of Form 1040 generally asks the taxpayer for a somewhat unsophisticated “yes” or “no” answer to the question: “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? See instructions on back for exceptions and filing requirements for Form TD F 90-22.1.” The instructions to Schedule B provide a general description of the FBAR and how to obtain a copy of the FBAR[iv].
A “financial account” includes bank, savings and checking accounts, time deposits, securities accounts; mutual funds, brokerage and securities derivatives accounts; accounts where the assets are held in a commingled fund and the owner holds an equity interest in the fund; any other account maintained in a foreign financial institution or with a person doing business as a financial institution; and a foreign insurance policy having a cash surrender value.[v] The term does not include individual bonds, notes, or stock certifications in the physical possession of the U.S. Person. The FBAR is not required for an account maintained with a branch, agency, or other office that is located in the U. S. even though the financial institution itself may be foreign.
The term “financial interest” includes accounts for which the U.S. Person is the owner of record or has legal title, whether the account is maintained on their own benefit or for the benefit of others that might include non-United States persons; accounts where the owner of record or holder of legal title is a person acting as an agent, nominee, or in some other capacity on behalf of a U.S. Person; a corporation in which a U.S. Person directly or indirectly owns more than 50% of the total value of the shares of stock; and an account where the owner of record or holder of legal title is a partnership in which the U.S. person owns interest in more than 50% of the profits or a trust in which the U.S. person either has a present beneficial interest in more than 50% of the current income.[vi]
A U.S. person has account “signature authority” if that person can control the disposition of money or other property in the account by delivery of a document containing his signature to the bank or other person with whom the account is maintained.[vii] A person with “other authority” over an account is one who can exercise power that is comparable to signature authority over an account by direct communication, either orally or by some other means, to the bank or other person with whom the account is maintained.
It is not a violation of U.S. law to have a legal or beneficial interest in a foreign financial account. However, failure to properly report the foreign account on Schedule B and to file an FBAR may be subject to civil and criminal sanctions. The two primary civil FBAR penalties are referred to as “non-willful” and “willful”[viii]. The “non-willful” penalty is up to $10,000 for each negligent violation of the FBAR filing or record keeping requirements and may be waived if “such 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.”[ix] “Willfully” failing to file an FBAR can be subject to both criminal sanctions (i.e., imprisonment) and civil penalties equivalent to the greater of $100,000 or 50% of the high balance in an unreported foreign account, per year – for each year since October 22, 2004 for which an FBAR wasn’t filed.[x] If asserted for one or more years, the penalty is not limited to the amount of funds in the account, etc. Schedule B and the instructions provide the government with what may be an important “willfulness” link between an income tax return and the FBAR filing requirements.
Willfulness. “Willfulness” is generally determined by “a voluntary, intentional violation of a known legal duty”.[xi] The Internal Revenue manual (IRM) provides that willfulness is demonstrated by the person’s knowledge of the FBAR reporting requirements coupled with the person’s conscious choice not to comply with the requirements.[xii] 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 record keeping requirements.[xiii] The IRM provides an example involving willful blindness where a person admits knowledge of but fails to answer the question concerning signature authority at foreign banks on Schedule B of his income tax return.[xiv]
To impose a willful FBAR penalty, the Government has the burden of proving that the taxpayer was “willful” in that they somehow made a “voluntary, intentional violation of a known legal duty.”[xv] In United States v. J. Bryan Williams,[xvi] even though the taxpayer acknowledged using a foreign financial account for the purpose of evading taxes in a conspiracy to defraud the government and checked “No” for Question 7a on Schedule B of his Form 1040, the district court held that his failure to file an FBAR was non-willful because the government did not meet its burden of proving that Mr. Williams knew about the FBAR requirements and nonetheless affirmatively chose to not comply. The court explained that the government “[did] not adequately account for the difference between failing and willfully failing to disclose an interest in a foreign bank account.”[xvii]
The government has acknowledged the “inherent difficulty of proving, or disproving, a state of mind (willfulness) at the time of a violation.”[xviii] A determination that there was a willful violation must generally be supported by substantial circumstantial evidence such as a combination of efforts taken to conceal the source and existence of the accounts through nominee foreign corporations or foundations having no true business or estate planning purposes[xix], lack of disclosures to the taxpayers advisors and possibly others, “hold mail” instructions to the institution, information and notes contained in the internal records of the foreign financial institution,[xx] etc. and will depend on the facts and circumstances of each case. The government might assert that the Schedule B reference to the FBAR instructions somehow supports a conclusion that the person could have learned of the FBAR filing and record keeping requirements. However, the IRM clearly states that the mere fact that a person checked the wrong box, or no box, on a Schedule B of their income tax return is not sufficient, by itself, to establish a “willful” FBAR violation.[xxi] How much more is required will surely be the subject of much future litigation.
[i] A “target” is a person as to whom the prosecutor or the grand jury has substantial evidence linking him or her to the commission of a crime and who, in the judgment of the prosecutor, is a putative defendant. A “subject” of an investigation is a person whose conduct is within the scope of the grand jury’s investigation. See United States Attorneys Manual 9-11.151
[ii] See 31 USC §§5311-5330 and 31 CFR Chapter X (Effective March 1, 2011; formerly 31 CFR Part 103 through February 28, 2011).
[iii] 31 U.S.C. § 5314; 31 C.F.R. §§103.24 and 103.32
[v] IRM 126.96.36.199.2 (07-01-2008)
[vi] IRM 188.8.131.52.4 (07-01-2008)
[vii] IRM 184.108.40.206.5 (07-01-2008)
[viii] 31 U.S.C. § 5321(a)(5)
[ix] 31 U.S.C. § 5321(a)(5)(B)
[x] 31 U.S.C. § 5321(a)(5)(C)
[xi] IRM 220.127.116.11.3 (07-01-2008)
[xv] See CCA 200603026 (September 01, 2005); IRM 18.104.22.168.5.3 (07-01-2008); See also United States v. J. Bryan Williams, 106 A.F.T.R. 2d 2010-6150, 2010-2 USTC 50,623 (E.D. Virginia, September 1, 2010).
[xvii] Williams, supra at *7 (emphasis in original). See also Ratzlaf v. United States, 510 U.S. 135 (1994), a Supreme Court case that addressed the standard for willfulness in the context of a criminal violation of a structuring provision of the Bank Secrecy Act (BSA). The standard applied in Ratzlaf, at 141, was “a voluntary intentional violation of a known legal duty” – the government had to prove that the defendant had acted with knowledge that his conduct was unlawful in order to establish he had willfully violated the anti-structuring law. It was not enough that he knew the bank had a duty to report the transactions. In CCA 200603026 (September 1, 2005), the IRS concluded that “in order for there to be a voluntary intentional violation of a known legal duty, the account holder would just have to have knowledge that he had a duty to file an FBAR, since knowledge of the duty to file an FBAR would entail knowledge that it is illegal not to file the FBAR. A corollary of this principle is that there is no willfulness if the account holder has no knowledge of the duty to file the FBAR.”
[xviii] See CCA 200603026 (September 1, 2005) “The burden of proof for criminal cases for establishing willfulness is to provide proof ‘beyond a reasonable doubt.’ Although the same definition for willfulness applies (‘a voluntary intentional violation of a known legal duty’), the Service would have a lesser burden of proof to meet with respect to the civil FBAR penalty than the criminal penalty. We expect that a court will find the burden in civil FBAR cases to be that of providing ‘clear and convincing evidence,’ rather than merely a ‘preponderance of the evidence.’ The clear and convincing evidence standard is the same burden the Service must meet with respect to civil tax fraud cases where the Service also has to show the intent of the taxpayer at the time of the violation. Courts have traditionally applied the clear and convincing standard with respect to fraud cases in general, not just to tax fraud cases, because, just as it is difficult to show intent, it is also difficult to show a lack of intent. The higher standard of clear and convincing evidence offers some protection for an individual who may be wrongly accused of fraud.”
“The burden of proof the Service has with respect to civil tax fraud penalties represents an exception to the general presumption of correctness that the courts have afforded to tax assessments (where the taxpayer, who is in the best position to provide supporting documentation, would ordinarily have the burden to show that taxes and tax penalties assessed are incorrect). There is a presumption of correctness in tax cases because the courts recognize the importance of the government’s ability to efficiently collect taxes, which are ‘the life-blood of government.’2 Because the FBAR penalty is not a tax or a tax penalty, the presumption of correctness with respect to tax assessments would not apply to an FBAR penalty assessment for a willful violation—another reason we believe that the Service will need to meet the higher standard of clear and convincing evidence.”
[xix] See “Entity Classification of Liechtenstein Anstalts and Stiftungs”, CCA AM2009-012 (October 16, 2009) differentiating the U.S. tax treatment between Lichtenstein Anstalts (typically classified as business entities under Treas. Reg.§ 301.7701-2(a) and not as trusts under Treas. Reg. §301.7701-4(a) because, in most situations, their primary purpose is to actively carry on business activities) and Stiftungs (generally treated as trusts under Treas. Reg. § 301.7701-4(a) having the primary purpose to protect or conserve the property transferred to the Stiftung for the Stiftung’s beneficiaries and is usually not established primarily for actively carrying on business activities.).
A “target” is a person as to whom the prosecutor or the grand jury has substantial evidence linking him or her to the commission of a crime and who, in the judgment of the prosecutor, is a putative defendant. A “subject” of an investigation is a person whose conduct is within the scope of the grand jury’s investigation. See United States Attorneys Manual 9-11.151
[xx] See In re: Grand Jury Investigation M.H. (Case No. 11-557712, (9th Cir August 19, 2011) for a discussion regarding whether foreign account information required to be maintained under 31 U.S.C. § 5311 and the regulations thereunder is protected by the 5th Amendment privilege or must be disclosed under the “Required Records Doctrine”espoused in United States v Doe, 465 US 605, 611-612 (1984) and Fisher v United States, 425 US 391, 409-10 (1967).
[xxi] IRM 22.214.171.124.3 (07-01-2008)