TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

The IRS recently announced Streamlined Filing Compliance Procedures in an effort to encourage U.S. taxpayers to come into compliance with their reporting and filing requirements associated with varying interests in foreign financial accounts and assets. The streamlined procedures require the filing of original (for non-residents) or amended (for residents) tax returns. Such tax returns must not only report whatever foreign source income was generated in each of the applicable tax years but must also properly report any U.S. source income and deductions for each of the applicable tax years. 

For eligible U.S. taxpayers residing outside the United States, all penalties will be waived under the streamlined procedures. For eligible U.S. taxpayers residing in the United States, the only penalty under the streamlined procedures 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 associated with the non-U.S. source income will be waived).

Feel Lucky? The streamlined procedures do not limit the civil penalties otherwise associated with the reporting of U.S. source income. IRS Offshore Voluntary Disclosure Program (OVDP) Frequently Asked Question 7.1 provides “The offshore penalty structure only resolves liabilities and penalties related to offshore noncompliance. Domestic portions of a voluntary disclosure are subject to examination.”

Further, the streamlined procedures do not provide protection from a possible criminal prosecution referral. However, the IRS Voluntary Disclosure Practice set forth in IRS Internal Revenue Manual (IRM) 9.5.11.9 would seem to provide a pass from a criminal referral if the appropriate “bells and whistles” set forth in IRM 9.5.11.9 are followed (a “truthful, timely, complete” disclosure, “willingness to cooperate”, “taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable,” etc. ).

IRM 9.5.11.9 further provides:

1. It is currently the practice of the IRS that a voluntary disclosure will be considered along with all other factors in the investigation in determining whether criminal prosecution will be recommended. This voluntary disclosure practice creates no substantive or procedural rights for taxpayers as it is simply a matter of internal IRS practice, provided solely for guidance to IRS personnel. Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution.
2. A voluntary disclosure will not automatically guarantee immunity from prosecution; however, a voluntary disclosure may result in prosecution not being recommended. This practice does not apply to taxpayers with illegal source income.

Am I “non-willful”? For purposes of the streamlined procedures, non-willful conduct is 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.

The vast majority of taxpayers having previously undisclosed interests in a foreign financial account or asset likely believe they are more “non-willful” than not. The issue is whether the IRS will agree. Be cautious when certifying non-willful status to the government.

The government may have or subsequently receive information that does not support such status. All relevant facts and circumstances must be carefully analyzed before making a determination regarding the submission of a “non-willful” certification requesting participation in the Streamlined Filing Compliance Procedures.

Will They Actually Inquire Regarding the “Non-Willful” Certification? The IRS has indicated it will review each certification of non-willful status seeking participation in the streamlined 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-willful certification under the streamlined procedures, resident 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 resident 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.

Will the IRS Interview the Taxpayer? Further questions often lay within the responses to each of the foregoing questions. An interview by an IRS examiner (in person or by phone) should be anticipated in most cases and are more likely with respect to resident taxpayers.

Those directly involved in creating and maintaining the foreign account and assets are the only ones capable of determining whether determining non-willful status. If such status is not supported by sufficient objective facts, consider other methods of coming into compliance, including the OVDP.

Civil vs. Criminal Resolution? Certainly the overwhelming majority of tax disputes result in a civil resolution. However, taxpayers frequently ask about the difference between a civil vs. criminal tax case. Often, the difference between a civil resolution and a criminal tax prosecution can be found within the misstatements of a taxpayer or their representative.

If there are material possibly intentional misstatements set forth in the non-willful certification, the taxpayer might anticipate exposure to the extensive criminal enforcement powers of the U.S. government. The IRS form certification required to be signed by the taxpayer under the streamlined procedures provides “I recognize that if the Internal Revenue Service receives of discovers evidence of willfulness, fraud, or criminal conduct, it may open an examination or investigation that could lead to civil fraud penalties, FBAR penalties, information return penalties, or even referral to [IRS] Criminal Investigation.”

Resolution of a civil case may be limited to a payment to the government of taxes, interest and possibly penalties. Resolution of a criminal case may include a period of incarceration (affectionately referred to as “Club Fed”) followed by a payment to the government of taxes, interest and possibly penalties.

A lengthy criminal tax investigation often destroys families and businesses. Looking back, every criminal tax defendant at some point asks themselves why they didn’t previously do things appropriately when they had the opportunity to avoid the criminal process.

What to Do ? Now is the time to take a deep breath, carefully analyze all relevant facts and available information. Once a taxpayer makes a submission under either the Streamlined Filing Compliance Procedures, the taxpayer may not participate in 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.

Taxpayers currently participating in an IRS OVDP who meet the eligibility requirements for the Streamlined Filing Compliance 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.

Non-resident taxpayers might be better positioned to achieve their goal of a non-willful, no penalty resolution under the streamlined procedures. Their “foreign” account is actually in their own neighborhood; it is only “foreign” in the sense that it is located outside the territorial boundaries of the United States. The existence of the account does not, by itself, somehow represent an acknowledgment of tax non-compliance by the non-resident taxpayer. The streamlined procedures seem to represent the first attempt by the government to acknowledge that at some point, non-resident taxpayers become residents of their home state, emotionally even if perhaps not technically.

If there are any uncertainties or potentially difficult factual scenarios involved, consult with experienced counsel. Taxpayers will sleep better if they get it right, somehow get into compliance and move on in life . . .