TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

The Internal Revenue Service recently announced significant changes in IR-2014-73[i] regarding their offshore voluntary compliance programs, providing new options to help both resident and non-resident U.S. taxpayers whose failure to disclose their offshore financial accounts was non-willful.

The expanded 2014 streamlined procedures are available to a wider population of U.S. taxpayers living outside the country and, for the first time, to certain U.S. taxpayers residing in the United States. The changes include:

1.   Eliminating a requirement that the taxpayer have $1,500 or less of unpaid tax per year;

2.   Eliminating the required risk questionnaire;

3.   Requiring the taxpayer to certify that previous failures to comply were due to non-willful conduct.

For eligible U.S. taxpayers residing outside the United States, all penalties will be waived. 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 (all income tax related penalties will be waived).

Eligibility for the Streamlined Procedures. Taxpayers currently participating in an IRS Offshore Voluntary Disclosure Program (OVDP) who meet certain eligibility requirements can request a transition to the new streamlined procedures. Taxpayers using either the Streamlined Foreign Offshore Procedures[i] or the Streamlined Domestic Offshore Procedures[ii] will be required to certify, in accordance with the specific instructions set forth below, that the 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.

Certification of “Non-Willful” Conduct. Taxpayers who are concerned that their failure to report income, pay tax, and submit required information returns was due to willful conduct and who therefore seek assurances that they will not be subject to criminal liability and/or substantial monetary penalties should consider participating in the OVDP and should consult with their professional tax or legal advisers. The streamlined procedures offer no protection from whatever consequences might arise in a later civil examination and/or criminal tax investigation.

The government carries the burden of proving willfulness into the courtroom where “willfulness” has generally required demonstrating that the government prove the taxpayer’s actions were as a result of a “voluntary, conscious and intentional” act by the taxpayer. Taxpayers considering the streamlined procedures 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).

Further,on May 29, 2014 in United States v. Carl R. Zwerner, Case # 1:13-cv-22082-CMA (SD Florida, 2014), 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 three of the four years at issue. 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.

While post-trial arguments were pending in Zwerner, the case settled with Mr. Zwerner agreeing to 50% FBAR penalties assessed against him for 2004 and 2005 in the amounts of $723,762 and $745,209 respectfully, plus interest of $21,336.11 and $20,947.52 respectively, plus statutory penalties that accrued under 31 U.S.C. Section 3715(e)(2) on the FBAR penalty assessments for 2004 and 2005 of $128,016.64 and $125,685.11 respectively.

The jury verdict in Zwerner represents a significant win for the government in their efforts to encourage certain U.S. persons having undisclosed interests in foreign financial accounts to come into compliance with the applicable filing and reporting requirements.

Coordination with the OVDP.  Once a taxpayer makes a submission under either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures, the taxpayer may not participate in the OVDP.  Similarly, a taxpayer who submits an OVDP voluntary disclosure letter pursuant to OVDP FAQ 24 on or after July 1, 2014, is not eligible to participate in the streamlined procedures.

A taxpayer will be considered to be currently participating in an OVDP for purposes of possibly receiving transitional treatment if: (1) before July 1, 2014, he has mailed to IRS Criminal Investigation his OVDP voluntary disclosure letter and attachments as described in OVDP FAQ 24, and (2) as of July 1, 2014, he has either: (a) remained in OVDP but not yet completed the OVDP certification process where a Form 906 Closing Agreement has been fully executed by the IRS, or (b) opted out of OVDP, but not yet received a letter initiating an examination and enclosing a IRS Notice 609.

A taxpayer who, as of July 1, 2014, has completed the OVDP certification process where a Form 906 Closing Agreement has been fully executed by the IRS will not be considered currently participating in an OVDP and thus will not be eligible for transitional treatment. A taxpayer whose case has been removed from OVDP by the IRS is no longer participating in OVDP and thus is not eligible for the transitional treatment described in the Transition Rule FAQs.

Each request for transitional treatment from the OVDP to the Streamlined Procedures will be reviewed by an IRS examiner, their Manager and, perhaps, by a central review committee (to assure consistent treatment) to determine whether the taxpayer is eligible for transitional treatment, the taxpayer’s certification of non-willfulness is complete, and the available information is consistent with the certification.

There are no appeal rights within OVDP, including the determination of whether the taxpayer qualifies for transitional treatment. If the IRS does not agree that the taxpayer is entitled to transitional treatment, the case remains governed by the terms of the OVDP in which the taxpayer is participating.  In these circumstances, if the OVDP miscellaneous offshore penalty is unacceptable to the taxpayer, the taxpayer may then opt out of the OVDP and choose to have the case resolved in an examination process.

For OVDP participants who receive transitional treatment, all other terms of the OVDP in which the taxpayer is currently participating will continue to apply, including, but not limited to, the OVDP disclosure period (currently 8 tax years) remains the same; execution of a Form 906 Closing Agreement is required; payment of accuracy-related, failure-to-file, and/or failure-to-pay penalties, if applicable, are required; and the alternative mark-to-market PFIC resolution will continue to be available.

Note that non-OVDP participants eligible for the streamlined procedures would only be required (1) to file delinquent or amended tax returns, together with all required information returns (e.g., Forms 3520, 5471, and 8938) for their most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed,  and (2) for each of the most recent 6 years for which the FBAR due date has passed, file any delinquent FBARs (FinCEN Form 114, previously Form TD F 90-22.1). Further, they would avoid all applicable accuracy-related, failure-to-file, and/or failure-to-pay penalties whereas transitional OVDP participants would have to file returns for the additional 5 years and their returns for all eight years would remain subject to applicable accuracy-related, failure-to-file, and/or failure-to-pay penalties.

OVDP Opt Out vs. Transition to the Streamlined Procedures? Taxpayers currently participating in an OVDP who meet the eligibility requirements for the streamlined procedures should consider requesting transitional treatment if they are comfortable and have a sufficient factual basis to certify their “non-willful” status. They are not required to affirmatively opt out of the OVDP and will retain the ability to resolve their issues within the OVDP or opt out at a later date if the IRS does not agree with their non-willful certification.

Taxpayers not currently participating in an OVDP who meet the eligibility requirements for the streamlined procedures should likewise consider requesting streamlined treatment if they are comfortable and have sufficient factual basis to certify their “non-willful” status.

If there are material possibly intentional misstatements set forth in the non-willful certification, the taxpayer might anticipate exposure to the extensive civil and criminal enforcement powers of the U.S. government. Often, the difference between a civil resolution and a criminal tax prosecution can be found within the misstatements of a taxpayer or their representative.

All relevant facts and circumstances must be carefully analyzed before making a determination regarding the submission of a “non-willful” certification requesting transition to the recently announced Streamlined Filing Compliance Procedures. The source of funds held in the foreign account may be an important factor. If the source of funds in the account was from unreported income, the situation can become somewhat problematic. However, having inherited funds in a foreign financial account, without more, might not be considered deserving of non-willful status by the IRS. The IRS has expressed an intention to treat taxpayers consistently and numerous individuals having inherited funds in an undeclared foreign account have been subjected to the stated OVDP penalty.

Deposits and withdrawals to the foreign account can reveal intentions and knowledge of various individuals involved. In reviewing the “non-willful” certification, the government can be expected to inquire about 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 of each withdrawal/deposit; 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 when a deposit/withdrawal occurred (i.e. receipt, credit memo, debit memo, etc.)?

Additional considerations regarding someone being “non-willful” often include whether the existence of the account was disclosed to the return preparer or others; whether the account was at some point moved to another foreign financial institution; whether the taxpayer’s advisors had some degree of knowledge about the account; the perceived degree of financial and business sophistication and education of the taxpayer; whether foreign entities were involved as accountholders; documents provided to open the account [i.e. U.S. or foreign passport(s), identification card, etc. – note that it might not be a good fact for a taxpayer having dual passports to open an account with their non-U.S. passport]; communications, if any, with others that occurred regarding bank secrecy, taxation, and/or disclosure of any foreign accounts; failure to seek independent legal advice about how to properly handle the foreign bank account and instructions or advice received regarding holding or receiving mail from the bank, etc. Further questions often lay within the responses to each of the foregoing questions.

Lastly, in reviewing the non-wilful certification under the streamlined procedures, taxpayers should anticipate the government inquiring as to whether the foreign accounts remain open and if not, where the funds were transferred when the account(s) were closed. Some taxpayers closed accounts and transferred the funds directly to a domestic account. Others closed accounts and transferred the funds through various means to other foreign accounts. Further questions often lay within the responses to each of the foregoing questions.

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[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