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.

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.

Quiet Disclosures. 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) – 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. 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 – The Complaint. 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.

The Complaint 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 (it would have been due June 30, 2008 and an extension of time to file is not available), 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, 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 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.

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 willfulness determination should 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.

Zwerner Responds. Many had been wondering what facts may have led the government to pursue what many believe to be unconstitutionally excessive multiple year, 50 percent FBAR penalties against Mr. Zwerner. On August 12, 2013, current tax counsel for Carl R. Zwerner filed an Answer responding to the Government’s allegations set forth in the Compliant. Mr. Zwerner is an 86 year old man who authorized other 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. Even though there was no OVDP type program in place to mitigate penalties at the time of his initial, traditional, voluntary disclosure, Mr. Zwerner apparently made those disclosures in the traditional manner of submitting amended returns and filing delinquent FBARs. 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. The Answer asserts that the agent conducting the audit ignored numerous mitigating facts and circumstances surrounding Mr. Zwerner’s voluntary disclosure and misinterpreted his statements about them. Further, it appears that at some point during the audit the agent expressed some desire to expand the audit back to tax year 1992 – a most unusual effort, especially for a taxpayer who timely filed amended returns correcting a prior tax indiscretion before any Government contacts.

While the IRS audit was proceeding, the 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI) began. It specifically allowed taxpayers who had made a voluntary disclosure under the prior rules to participate in the 2011 OVDI. Mr. Zwerner, made a timely application for the new 2011 OVDI. However, the IRS refused to allow Mr. Zwerner to participate in the 2011 OVDI because he then was under audit, even though the audit did not begin before he made his traditional voluntary disclosure and even though the audit occurred as a result of his traditional voluntary disclosure.

It is uncertain whether Mr. Zwerner could have attempted to participate in the 2009 Offshore Voluntary Disclosure Program (that was available from March 26, 2009 to October 15, 2009). However, assuming no prior government contact, had Mr. Zwerner not attempted a traditional voluntary disclosure prior to February 8, 2011 (the commencement of the 2011 OVDI) he arguably could have participated in the 2011 OVDI and would have been subject to a single 25 percent FBAR-related penalty for only the single tax year in which the offshore account had the highest balance. Had he waited to participate in the 2012 OVDI, the penalty would have increased to 27.5 percent. 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 being subjected to multiple year, 50 percent FBAR penalties asserted in the Complaint. 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.

In announcing the 2009 OVDP, then IRS Commissioner Doug Shulman stated, in part,

“My goal has always been clear — to get those taxpayers hiding assets offshore back into the system.

. . . we draw a clear line between those individual taxpayers with offshore accounts who voluntarily come forward to get right with the government and those who continue to fail to meet their tax obligations. People who come in voluntarily will get a fair settlement.

. . . Those who truly come in voluntarily will pay back taxes, interest and a significant penalty, but can avoid criminal prosecution.

. . .

At the same time, we have also provided guidance to our agents who have cases of unreported offshore income when the taxpayer did not come in through our voluntary disclosure practice. In these cases, we are instructing our agents to fully develop these cases, pursuing both civil and criminal avenues, and consider all available penalties including the maximum penalty for the willful failure to file the FBAR report and the fraud penalty.

We believe this is a firm, but fair resolution of these cases.  . . . For taxpayers who continue to hide their head in the sand, the situation will only become more dire. They should come forward now under our voluntary disclosure practice and get right with the government.”

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. However, statements by former Commissioner Shulman appear to have enticed many, possibly including Mr. Zwerner, to “come forward . . . under our voluntary disclosure practice and get right with the government” believing they would receive a “fair settlement” (certainly believed to be less than multiple 50 percent FBAR penalties!).

In his Answer, Mr. Zwerner asserts that he believed he had made a voluntary disclosure in reliance upon the advice of his then tax lawyer; he is not receiving fair and equitable treatment under the Government’s own policies; he acted reasonably to comply with the law when he became aware of it and did not willfully disobey the law; he was not willful nor a “bad actor”; has no history of FBAR penalty assessments; has no history of criminal tax or BSA convictions; did not even know what an FBAR was until after he consulted with lawyers in order to file the voluntary disclosure; the funds in the offshore account were not from an illegal source or used for a criminal purpose; that he and his representatives have been very cooperative with the IRS, have properly filed and paid all tax, and promptly provided all documents and attended meetings with the IRS; 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.

The Excessive Fines Clause. 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.

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 asserts 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.

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. Undoubtedly, the Government recognizes that this action is about much more than Mr. Zwerner and should not likely represent the battleground to test applicability of the Excessive Fines Clause in the context of multiple year 50 percent FBAR penalties.