TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

Numerous 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 filing and reporting obligations. Many U.S. taxpayers 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. Under the 2009 OVDP, the FBAR-related penalty was 20 percent and under the 2011 OVDP the FBAR-related penalty was 25 percent of the highest account value during the prior six tax years. The 2012 OVDP is ongoing and does not have a stated expiration date but it can be terminated by the IRS at any time either entirely or as to specific classes of taxpayers.

As of December 2012, the combined OVDPs apparently resulted in more than 39,000 disclosures by taxpayers and over $5.5 billion in revenues received. Recently, the Government Accountability Office (GAO) issued a report based on a review of the 2009 OVDP. See IRS Has Collected Billions of Dollars, but May be Missing Continued Evasion, GAO-13-318 (March 27, 2013). See <a href=”http://www.gao.gov/products/GAO-13-318″>http://www.gao.gov/products/GAO-13-318</a>

The GAO Report recommended that going forward the IRS should (1) use offshore data to identify and educate taxpayers who might not be aware of their reporting requirements; (2) explore options for employing a methodology to more effectively detect and pursue “quiet disclosures” and implement the best option; and (3) analyze first-time offshore account reporting trends to identify possible “attempts to circumvent tax, interest and possibly penalties that might be due” and take action to help ensure compliance. The IRS agreed with the foregoing GAO recommendations. GAO also reported that almost all of the 2009 OVDP participants received the maximum offshore penalty (equivalent to 20 percent of the high account balance during the 2009 OVDP time frame), almost half had accounts in Switzerland, and about half of the revenue collected came from a small percentage of high penalty cases.

Despite various potential risks of not coming into compliance through the OVDP, some taxpayers choose to disclose their offshore accounts outside the OVDP. According to the GAO Report, in a “quiet disclosure”, taxpayers file 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. GAO identified 10,595 potential “quiet disclosures” that occurred during the pendency of the 2009 OVPD. The GAO Report asserts that a failure by the IRS to identify and pursue “quiet disclosures” will undermine the incentive of others to participate in the offshore programs.

Taxpayers pursuing a quiet disclosure or a prospective filing are often aware of the OVDP but believe they would be unduly punished by the “one size fits all” approach under the OVDP. Although possibly economically oppressive for some, the OVDP avoids exposure to numerous additional penalties associated with the income tax returns and various required foreign information reports, the potential for what might be a difficult examination, and limits the number of tax years at issue while also providing certainty with respect to the avoidance of a referral for criminal tax prosecution.

The government continues to assert that those who are discovered disclosing offshore accounts outside of the OVDP risk more significant civil penalties, depending on the facts and circumstances of their cases. Certainly, all taxpayers are anything but equally culpable with respect to issues relating to the filing and reporting requirements involving foreign financial accounts. Overall, IRS examinations of taxpayers outside the confines of the OVDP have progressed in a somewhat reasonable manner. The fairness in the resolution often depends on the actual facts involved.

Many have been wondering whether the IRS will pursue examinations of quiet disclosures of taxpayers residing in the United States in some manner. It remains uncertain whether the IRS would or could effectively pursue those residing outside the United States in any realistic manner. It should also be acknowledged that there remain viable 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)], 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.

BSA Filing Requirements. Under the Bank Secrecy Act, U.S. residents or a person in and doing business in the United States 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 U.S. government filed a Complaint to collect multiple civil FBAR penalties in the amount of $3,488,609.33 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. See United States v. Carl R. Zwerner, Case # 1:13-cv-22082-CMA (SD Florida, June 11, 2013). According to the Complaint, from 2004 through 2007, Mr. Zwerner, a U.S. citizen, had a financial interest in an account at ABN AMRO Bank in Switzerland (hereinafter, “the Swiss bank account”).

The Complaint alleges that the balance of the Swiss bank account from 2004-2007 was at all times greater than $10,000 and that, as such, on or before June 30, 2005, 2006, 2007, and 2008, Mr. Zwerner was required to file an FBAR reporting his financial interest in the Swiss bank account for each year from 2004, 2005, 2006, and 2007, respectively. However, the Complaint also asserts that prior to October 2008, Mr. Zwerner had never reported his financial interest in the Swiss bank account on an FBAR, nor had he reported income he earned from that account on his federal income tax returns.

To many, pursuing multiple year, maximum penalties following submission of amended returns and delinquent FBARs appears punitive. The nature of the underlying actions, if any, that may have led to the filing of the Complaint are unknown. However, the Excessive Fines Clause of the Eighth Amendment and relevant Supreme Court caselaw 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 Complaint in Zwerner further alleges that on or about October 13, 2008, Mr. Zwerner filed a delinquent FBAR reporting his financial interest in the Swiss bank account during 2007, along with an amended income tax return for 2007; on or about March 27, 2009, Mr. Zwerner filed amended income tax returns and delinquent FBARs for 2004, 2005, and 2006. The basis of the Complaint is that Mr. Zwerner’s alleged failure to timely report his financial interest in the Swiss bank account for 2004-2007 was willful. Apparently, Mr. Zwerner did not hold the Swiss bank account in his own name. The Complaint alleges that from 2004 to 2006 he held the account in the name of any entity called the Bond Foundation and that, in January 2007, he transferred the account to an entity called the Livella Foundation. However, the Complaint asserts that at all times, however, Mr. Zwerner was the beneficial owner of the account.

According to the Complaint, Mr. Zwerner’s original tax returns for 2004 to 2007 did not report any income earned from the Swiss bank account; that the first time he reported such income was when he amended those returns; and that Mr. Zwerner represented on Schedule B of his original tax returns for those years that he did not have an interest in a foreign financial account. The Complaint asserts that Mr. Zwerner “expressly represented to the accountant who prepared his original tax returns for 2006 and 2007 that he had no interest in or signature authority over a financial account in a foreign country.” Further, it asserts that in a “letter dated August 9, 2010, Mr. Zwerner admitted to the IRS that he was aware that he should have reported both the existence of the account and the income he earned from it.”

The government carries the burden of proving wilfulness 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.

The Internal Revenue Manual suggests that “willfulness may be attributed to a person who has made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements.”  However, the wilfullness determination should continue to be based on the actual facts and the context in which statements are made (or not) rather than assertions in a legal pleading.

The Complaint alleges that due to Mr. Zwerner’s willful failure to file FBARs reporting his financial interest in the Swiss bank account during 2004-2007, a delegate of the Secretary of the Treasury of the United States assessed penalties against him under 31 U.S.C. § 5321(a)(5) in the amount of 50% of the 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. According to the Complaint: (a) on June 21, 2011, a delegate of the Secretary of the Treasury of the United States gave notice of the penalty assessment for 2004 to Mr. Zwerner and made demand for payment thereof; (b) on September 8, 2011, a delegate of the Secretary of the Treasury of the United States gave notice of the penalty assessments for 2005-2007 to Mr. Zwerner and made demand for payment thereof; (c) despite the notices and demands for payment, Mr. Zwerner did not pay the penalties assessed against him. As of June 6, 2013, the Complaint alleges that Mr. Zwerner owes the United States $3,488,609.33 in penalties assessed under 31 U.S.C. § 5321, including interest and other additional amounts which accrued and continue to accrue as provided by law.

The road that led to the filing of the Complaint seeking collection of multiple year FBAR penalties against Mr. Zwerner is as uncertain as the potential outcome of the litigation that is forthcoming. It is not known whether there are additional facts that may have caused the government to be pursue the filing of the Complaint or whether this might reflect a new beginning in the offshore enforcement arena.

Time will tell the extent, if any, to which the filing in Zwerner may impact others who similarly attempt to come into compliance outside the OVDP. The government will not and can not pursue such actions against everyone. Many factors likely come into play in the exercise of government discretion on which matters to pursue, or not.

Given the complexities of the Internal Revenue Code, other relevant statutes and life in general, many of the indiscretions associated with an income tax return or FBAR are anything but willful or intentional and definitely not fraudulent in nature. It is also likely that long-term residents of the U.S. might be deemed to have a higher degree of knowledge and will be treated differently than long-term non-residents of the U.S. In each situation, the actual facts and circumstances of each matter must be carefully reviewed before anyone can determine the appropriate method of coming into compliance with the various filing and reporting requirements associated with offshore financial accounts.

The Way Forward. The OVDP may not be for everyone. The decision whether to participate in the ongoing 2012 OVDP as opposed to possibly pursuing a quiet or prospective disclosure must take into account all relevant facts and circumstances as well as the possibility of expansive IRS discretion to perform examinations over a lengthy period of time. Having inherited funds in a foreign financial account, without more, might not be considered deserving by the IRS of some lesser penalty regime. Other considerations often include the U.S. residency status of the taxpayer, the source and amount of funds, how long the account has been maintained, whether there were withdrawals or deposits into the account or the account was moved to another foreign financial institution at some point, whether the taxpayer’s advisors had some degree of knowledge about the account, the sophistication and education of the taxpayer, whether foreign entities were involved as accountholders, etc.

Deposits and withdrawals to a foreign account by U.S. residents can reveal intentions and knowledge of various individuals involved. Those residing in the U.S. who do not participate in the OVDP should likely consider their responses to government inquiries regarding the manner in which deposits and/or withdrawals were made to/from the foreign account(s); the mechanics of how deposits/withdrawals were made; the form in which deposits/withdrawals occurred (i.e. cash, check, wire, travelers’ check, etc.); amounts that were withdrawn/deposited each time; when such deposits/withdrawals occurred; where such deposits/withdrawals occurred; whether there were there limitations on the amounts that could be deposited/withdrawn; and documents received a deposit/withdrawal occurred (i.e. receipt, credit memo, debit memo, etc.)?

There will also be inquiries as to whether the foreign accounts remain open and if not, where the funds were transferred when the account(s) were closed. Some U.S. residents closed accounts and wire transferred the funds directly to a domestic account. Others closed accounts and transferred the funds through various means to other foreign accounts. Decisions regarding something other than OVDP participation should be carefully considered depending upon the taxpayers responses to each of the foregoing questions. If discovered before any form voluntary disclosure submission, the potential resolution is uncertain.

Zwerner may represent more than an effort to collect civil FBAR penalties. 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 can not ignore the potential impact associated with the manner in which those who voluntarily comply, even if in a somewhat tardy fashion (but before any contacts by the government), are treated.