EVALUATING RISK OF PROSECUTION OUTSIDE OF THE OVDP

An article authored by Edward Robbins, Jr. Steven Toscher and Dennis Perez, “What’s Your Client’s Criminal Exposure on His Undeclared Foreign Bank Account? (Journal of Tax Practice, October – November 2012 pp 67-74), astutely summarizes the most likely charged tax crimes in an offshore bank account case and what the government must prove to obtain a conviction.  The article was written for tax attorneys but I shall summarize the lessons to be gleaned from the analysis and some not discussed in the article.

From the article:

The two elements that must be present before the Department of Justice will authorize a criminal tax prosecution in an offshore bank account case are a substantial tax deficiency (informally at least $40,000 cumulatively for all years); and, sufficient ‘badges of fraud” to indirectly prove that the taxpayer knew he or she had an obligation to file an FBAR, answer the bank account question on Form 1040 truthfully,  and/or report all offshore income; and, knowingly failed to file, or falsely filed and/or failed to report all offshore income.  The evidence must be weighty enough to satisfy the Department of Justice that the case has a reasonable probability of conviction.

Criminal tax cases require intensive IRS investigations and arduous gathering of proof.  But, once evidence is gathered the cases are not difficult to convict on.

My analysis of risk:

Taxpayers who enter the OVDP obtain certainty that they will not be prosecuted if they comply with the terms of the OVDP process.  Some taxpayers, however, decide to go outside of the OVDP and assume the risk of being found-out, being indicted and going to jail, no less paying a draconian FBAR penalty.  These taxpayers may choose to:

  • Do nothing. They file no amended returns and, do not enter the OVDP. Essentially, they stick their heads in the ground and hope they are not found-out. These are the real gamblers who choose to play the audit lottery. There are so many fish in the barrel, they tell themselves, that IRS will choose another fish. They have a high risk-tolerance and can sleep at night even if the house has faulty electrical wires and may burn down at any moment. But, what if they are the unlucky fish that gets hooked?
  • Make a quiet disclosure by filing amended returns directly with the IRS Service Center instead of going through the OVDP or Streamlined Process. These taxpayers want to hedge their bets a bit. They think if I am caught at least filing returns may mitigate their criminal exposure and civil penalty. Maybe so for some, but then again, maybe not.
  • Certify their non-willfulness and make a Streamlined Process filing. These taxpayers are attracted to the 5% Miscellaneous Offshore Penalty but overlook the risk of making a certification under penalties of perjury and of being rejected from the Streamlined Process. If the worst occurs they will be left out in the criminal and FBAR-penalty cold without an overcoat.

In all of these instances a tax lawyer may be able to give an opinion as to the likelihood of prosecution but no lawyer can give assurances.  There is always the risk of the unlikely indictment. What troubles is that in making these decisions, people often miss the boat in attempting to understand risk.  The make critical strategic mistakes in:

  • Focusing on “risk-tolerance” and not understanding that “risk-tolerance” or a willingness to assume great risk will not earn them a star in the offshore school. They may be willing to live with danger but can they afford to?
  • Not focusing on “risk-capacity” or their ability to withstand the hit should the unlikely come to pass as do all unlikely events with regularity (Chaos Theory).
  • Undervaluing the benefit of having certainty about a prospective result.

Some examples may help to shed light on these concepts:

  1. Consider John Chen, attorney at law. He inherited a $2 million offshore bank account from his grandfather 12 years ago and has not reported the account. He did not inform his tax return preparer of the account and answered “No” to the Form 1040 bank account question. The cumulative unreported income was $100,000. He only visited the bank in Singapore once but did make some wire transfers to the U.S. for the college education of his children. John believes IRS will not discover the account because it is not in Switzerland, the Bahamas, Israel or India, focus countries of the Department of Justice. John wants to repatriate the funds and wait-out the IRS hoping the criminal statute of limitations and civil FBAR penalty will run. He will explain the transfers to his long-term banker and friend as an inheritance so that the bank will not file a suspicious activity report. John has enough other assets so that the OVDP 27.5% penalty would not impact his lifestyle. Is John being smart? The answer is no, John is not being smart. If found-out, indicted and convicted, John would be disbarred and lose his livelihood apart from losing his freedom for a while. John should enter the OVDP which is private, not disclosed to the state bar, and averts the public humiliation of media coverage.
  2. Alfonso Ortiz has a U.S. Green card. He is 72 years old. The facts are similar to that of Mr. Chen but the account is located in Mexico. Alfonso should also enter the OVDP because of his age and also because conviction of a tax crime could result in his deportation from the U.S.
  3. Mac Brown, 83, is a U.S. citizen with $50 million in liquid assets within the U.S. and another $10 million cash stashed away in the Bahamas and titled in the name of Hidden Cash Ltd. Mac loves to go to Las Vegas and is a big-time gambler. He has no problem with rolling the dice over his offshore indiscretions. But, Mac is not thinking clearly. Betting he’s the longshot here would be a large error of judgment. He can well afford the OVDP toll-charge. The $2,750,000 penalty (or, even a 50% penalty if his bank has been publicly spotlighted by the DOJ) would not impact his lifestyle. On the other hand, he would greatly benefit from the certainty of knowing he will not be prosecuted for tax or FBAR violations. At his age, he wants to spend his remaining years enjoying his grandchildren and having something to leave them, not by commiserating with fellow inmates.

For offshore clients, the most valued asset of a tax attorney is wisdom and good judgment.  All can recite the law; but, not all have the maturity and good judgment to constructively advise their client to a sound decision about how to proceed in an offshore matter where the cost of poor or ill-conceived advice may prove devastating.

© 2014 by Robert S. Steinberg, Esquire
All rights reserved

Posted in 214 OVDP, FBARS, OFFSHORE BANK ACCOUNTS, TAX, VOLUNTARY DISCLOSURE | Tagged , , , , , , , , , , , | Leave a comment

THERE’S NOTHING CIVIL ABOUT THE STREAMLINED FILING PROCESS

Many believe that you can bifurcate the Streamlined Process between the criminal aspect and civil aspect.  That once you have a non-willful opinion from the criminal tax lawyer, the process becomes civil and any competent civil tax lawyer or tax return preparer can by himself or herself complete the filings.  I believe this view to be mistaken.

First of all, the willful non-willful determination can only be made when all of the foreign financial statements and sometimes U.S. bank statements have been reviewed.  Only then will the tax attorney fully understand where all of the tentacles lead and what other communications or even entities may have been forgotten.  Even then, the non-willful opinion is unfortunately just an opinion.  IRS can reject the certification and find the taxpayer ineligible for the Streamlined Process.  There is no appeal from that determination.

Then, where it the taxpayer?  Right back in the criminal or quasi-criminal FBAR penalty soup. Obtaining the criminal tax lawyer opinion will not even necessarily insulate the taxpayer from perjury charges because, unless the lawyer reviews the underlying documents, facts will be taken as given by the client.  In my experience, clients often have a very tenuous grasp of past events relating to their offshore accounts.  Thus, there may be incriminating email or written communications that the client has forgotten about but which can be obtained by IRS directly from the foreign financial institution.

In the event of rejection of the non-willful certification, how the returns have been prepared and submitted may influence whether IRS chooses to indict and/or whether the reviewing agent decides that a draconian FBAR penalty is appropriate.  The returns themselves if carelessly prepared may be viewed as indicating that there is continuing criminal conduct.   In other words, these are not normal, run of the mill tax returns and must be prepared with a different and protective mindset.  Therefore, a lawyer experienced in criminal tax matters should not only determine the willful / non-willful issue but oversee the entire Streamlined submission just as in the case of an OVDP submission.

Is this overkill?  No. When dealing with potential criminal exposure, it is wise to be extraordinarily cautious than to later be regretful for not having been.  For the return preparer the regret may include angst from becoming a witness against his or her client and being sued by the client. Now, there may be some very vanilla cases at the non-willful end of the Bell Curve that do not require such close scrutiny by a criminally informed tax lawyer.  But, few cases are completely straightforward.  In most cases the old trusted saying will prove true: “discretion is the better part of valor.”

Personally, I do not accept engagements to give a willful/ non-willful opinion unless I am to oversee the Streamlined submission.

© 2014 by Robert S. Steinberg, Esquire
All rights reserved

 

Posted in 214 OVDP, FBARS, OFFSHORE BANK ACCOUNTS, TAX, VOLUNTARY DISCLOSURE | Tagged , , , , , , | Leave a comment

SOME CLARIFICATION FROM IRS ON THE STREAMLINED FILING COMPLIANCE PROCEDURES.AND DEINQUENT INTERNATIONAL INFORMATION RETURN SUBMISSIONS.

The IRS has updated its Streamlined Filing Compliance Procedures and Delinquent International Information Return pages (October 9, 2014) and issued Frequently Asked Questions with regard to each.

The FAQs for U.S. Taxpayers residing in the U.S. clarify that:

  1. The 5% penalty for non-willful submissions does not apply to accounts over which the taxpayer had only signature authority but no financial interest.
  2. The penalty base includes only unreported assets that would have been reported on an FBAR or Form 8938. Thus, real estate, even with unreported income, is not included.
  3. Assets not reported on Form 8938 because they were reported on a delinquent Form 3520 or Form 5471 for the same year are included in the penalty base whereas assets reported in a timely filed Form 3520 or Form 5471 are not included in the base.
  4. Stock in a foreign corporation is included in the penalty base unless it is a disregarded entity in which case its reportable underlying foreign financial assets are included.
  5. Stock in a foreign corporation may be valued using any reasonable method including using the balance sheet on its Form 5471. No valuation discounts are permitted.
  6. The 5% penalty should be calculated as explained in FAQ #6, as follows
    1. Begin the computation by identifying the assets included in the penalty base for each of the last six years.  These assets include:
      1. For each of the six years in the covered FBAR period, all foreign financial accounts (as defined in the instructions for FinCEN Form 114) in which the taxpayer has a personal financial interest that should have been, but were not reported, on an FBAR;
      2. For each of the three years in the covered tax return period, all foreign financial assets (as defined in the instructions for Form 8938) in which the taxpayer has a personal financial interest that should have been, but were not, reported on Form 8938.
      3. For each of the three years in the covered tax return period, all foreign financial accounts/assets (as defined in the instructions for FinCEN Form 114 or IRS Form 8938) for which gross income was not reported for that year.
    2. Once the assets in the penalty base have been identified for each year, enter the value of the taxpayer’s personal financial interest in each asset as of December 31 of the applicable year on the Certification by U.S. Person Residing in the United States for Streamlined Domestic Offshore Procedures (Form 14654).
    3.  For any year in which a foreign financial account was FBAR compliant and (for the most recent three years) in which a foreign financial asset was both Form 8938 and Form 1040 compliant, the amount entered on the form will be zero.
    4. Once the asset values have been entered on the form, add up the totals for each year and select the highest aggregate amount as the base for the 5-percent penalty.
  7. A taxpayer who has been properly filed returns and reported all foreign financial assets for the past three years but who had unreported foreign financial assets in years 4 through 6 may make a Streamlined submission.   The penalty will be calculated as under FAQ 6 above.

Only one FAQ has been posted for U.S. Taxpayers Residing Outside the United States

  • FAQ 1 clarifies that non-residency for purposes of qualifying for the Streamlined process is not governed by IRC Sec. 911(b) (3) and Treas. Reg. Sec. 1.911-2(b) but is solely determined by the rules described on the Streamlined IRS page.

With respect to Delinquent International Information Returns, the IRS clarified that unlike the 2012 OVDP FAQ 18, eliminated from the 2014 FAQs, there is no automatic penalty relief for taxpayers who were fully compliant. Rather:

  • Taxpayers should use these procedures when they believe they have reasonable cause for the delinquency.
  • Taxpayers with unreported income, or unpaid tax may use these procedures, subject to the reasonable cause requirement mentioned above.
  • Penalties may be imposed if the IRS rejects the taxpayer’s reasonable cause explanation; and,
  • The taxpayer must follow the IRS procedures for establishing reasonable cause, including the requirement that the taxpayer provide a statement of facts made under penalties of perjury. (Referring to Treas Regs. Sections 1.6038-2(k) (3), 1.6038A-(4) (b), and 301.6679-1(a) (3).

What the IRS did not clarify is how aggressive it will go about determining if a taxpayer’s failure to report was non-willful as the taxpayer is required to certify (see Tax Wars Blog posts Bloomberg BNA Samples Attorney Views on Streamlined Process (9/20/14 and Will-O-The Wisp Willfulness in the Streamlined Process (9/1/14)). On this important aspect of the Streamlined process the IRS continues to be coy, telling taxpayers to ask their lawyers. As recently as October 16, an IRS senior attorney speaking at the American Law Institute program was quoted in BNA Bloomberg report to have said as to why the IRS has been vague about what it means by non-willful, “It’s intentional, and I really think it’s to the collective benefit…, because these are human stories and human circumstances.”  At the University of San Diego School of Law-Procopio International Tax law Institute, the IRS supervisory trial attorney for the IRS Office of Chief Counsel also stated that there is no need to further define non-willfulness (as reported in Tax Analysts Tax Notes Today on 11/3/14)

The IRS acting director of International Business Compliance also emphasized at the ALI program that under the delinquent foreign form submission procedures reasonable cause explanations will be viewed very positively where all foreign income has been reported.

While the new FAQs are welcome and helpful some guidance on the most important question of whether certain factors rule out non-willfulness in the eyes of the IRS and how the agency will apply the willful blindness standard would be appreciated by the tax bar.

© 2014 by Robert S. Steinberg, Esquire All rights reserved www.steinbergtaxlaw.com

 

 

Posted in 214 OVDP, COMPLIANCE, FBARS, OFFSHORE BANK ACCOUNTS, TAX | Tagged , , , , , , , , | 1 Comment

PRO SE TAXPAYERS OFTEN DON’T SEE THE BUS THAT HITS THEM: SELF-REPRESENTATION CAN BE DANGEROUS

I receive many calls from taxpayers considering how to bring their unreported offshore accounts into compliance. Sometimes and often with respect to expatriates, these individuals will have prepared their own returns and even attempted to represent themselves through some of the tangled web of rules concerning the OVDP, Streamlined Filing Compliance Procedures, Transitional Rules or opting out of the OVDP. Likewise, many calls originate from people who’ve divorced and have represented themselves in innocent spouse disputes with IRS. Usually, they call when something very bad and unforeseen to them happens in their case.

I always tell them that their self-representation likely has made more difficult the professional’s job of representing them. One client recently asked, “Why do you think that representation by a professional is often made more difficult when clients have represented themselves initially?”

I thought others might benefit from my response which is reprinted below.

While representing himself or herself, the client may:

  • Admit facts government would otherwise have to prove.
  • Waive Fifth Amendment rights against self-incrimination.
  • Tell IRS too much which results in more questions being asked and other issues being raised.
  • Give up documents that don’t have to be produced resulting in more questions being asked and more issues being raised; or, worse, incriminating themselves in a tax crime.
  • Overlook procedural requirements that results in options that might have been available being ruled out.
  • Misunderstand the law and make the wrong arguments because even lawyers who are not tax lawyers lack the tax background to fully grasp and appreciate many tax issues.   Also, cases do not always stand for what a lay person thinks they stand for.  This is one reason why CPAs sometimes misadvise clients on tax issues. They don’t know how to read a case.  They are not lawyers and certainly not tax lawyers.  No matter how much a client may read, he or she cannot make up for the training and experience of one who has lived with this mind twisting stuff for over 40 years.  There is also an underlying conceptual framework to the tax law, although it might not seem so, that a tax lawyer has at his or her recall in evaluating facts and law, but which a client does not have to draw on.
  • Finally, clients representing themselves don’t understand the process or how to deal with IRS at any level, agent, appeals or collections.

Thus, in my experience, coming into a case when the client has been proceeding without counsel is almost always problematical.  That is not to say that such problems will be encountered in every case.  But, it is common and reading Tax Court decisions in which the taxpayer has appeared pro see very cogently illustrates why.

Moreover, it is one thing for a client to self-prepare his or her tax return which may be perceived as straightforward, even though very little in current tax law is simple. The consequences of a mistake on a Form 1040 involve penalties that, although painful, will not destroy most taxpayers. It is quite another thing, for a client to self-represent when very serious consequences, possible jail time and draconian civil penalties, are at stake. These kinds of outcomes can destroy a person financially and emotionally.

 

© 2014 by Robert S. Steinberg, Esquire

All rights reserved

Posted in 214 OVDP, DIVORCE, EQUITABLE RELIEF, INNOCENT SPOUSE, NEW OVDP, TAX | Tagged , , , , | 1 Comment

WHEN NOT TO REQUEST INNOCENT SPOUSE TREATMENT

The case of Kimberly A. Sorentino v Commissioner (Summary Opinion 2014-99, September 24, 2014) illustrates what can happen when a taxpayer doesn’t get the relief she needs because she’d asked for the wrong relief. Although the Court’s Summary Opinion may not be cited as precedent, it is instructive.

The case involved taxes owned on a putative joint return filed for the year 2007. The joint return filed had reported an overpayment and requested a refund. IRS determined that to the contrary taxes were owing on the joint return and sought to collect from Kimberly. Some of the facts are summarized as follows:

Kimberly and her husband George, who intervened in the case in opposition to her innocent spouse request, were divorced in 2008. Their marriage had been dysfunctional and volatile. They were married in 2005 after having met the year before. They separated in 2006 and initiated divorce proceedings then but later reconciled.  Kimberly testified that George had:

  • Physically assaulted, offended and humiliated her on numerous occasions.
  • Objected to her work-related travel.
  • Harassed her at work by calling frequently and showing up unannounced.
  • Caused her work performance to suffer resulting in her losing her job.
  • Caused her to lose two successive jobs with the same harassing behaviors.

Further, she testified that following a heated argument she packed up her belongings and left George. Her sister had to rush to pick her up after receiving a phone call from her that she was contemplating suicide.  As a result, Kimberly was admitted to a mental health facility for treatment which lasted from March 15 to March 20, 2008 and as an outpatient from March 21 to March 29, 2008.

On March 24, 2008 George sent a draft of a Marital Dissolution Agreement to Kimberly. Kimberly did not take part in drafting the agreement, was not represented by counsel, but signed the agreement on April 9, 2008.  The dissolution agreement did not address the 2007 tax but did state that the parties would file separate tax returns for 2008 and later years.

The case does not summarize all of the income items of each spouse for 2007 but states that during 2007 Kimberly received retirement plan distributions of $79,114 and $15,970 which she deposited into her bank account. George apparently had little income because he was a former police officer with failing health.

Kimberly did not file a separate return for 2007 and believed (albeit erroneously) she had sufficient withholding tax taken out of her retirement distributions to cover the tax liability. Before 2007 Kimberly and George had filed jointly for each year of their marriage. Still, Kimberly testified that she did not know that George intended to file a joint return and did not meet with the return preparer regarding the filing of a joint return or otherwise authorize the filing of a joint return.

The joint return was e-filed by the return preparer even though only George had signed Form 8879, IRS e-File Signature Authorization, which the preparer is required to obtain before transmitting an e-filed return.

When IRS assessed and attempted to collect taxes due from Kimberly, she retained counsel and filed Form 8857, Request for Innocent Spouse Relief. She claimed that she’d been a victim of spousal abuse in 2007, was not involved in preparing the joint return or in handling household finances, did not sign the joint return, and, was filed she was suffering a mental breakdown at the time the joint return was filed.

George’s testimony at trial disputed Kimberly’s.   He testified that he did not abuse or harass her and that she’d visited the return preparer with him and intended to file jointly. Strangely, the return preparer did not testify at trial.

Tax Court Decision

The Court denied innocent spouse status to Kimberly because it found that no valid joint return had been filed. One of the requirements for obtaining innocent spouse relief from a joint return liability is that a joint return was indeed filed.

Generally, one must sign a joint return to be held jointly and severally liable for the tax liability related to that return. This is so because each spouse must indicate his or her affirmative election to file jointly.  But a signature of both spouses is not always required.  A joint filing will be found to have been made when the facts indicate that both spouses intended to file jointly.  Intent will be gleaned from the surrounding facts and circumstances including a history of filing jointly. In finding that no joint return had been filed, the court was influenced by evidence that showed:

  • Form 8879 was not signed by Kimberly.
  • An extremely dysfunctional marriage.
  • The absence of objective evidence contradicting Kimberly’s testimony.
  • The lack of credibility of George’s testimony which was inconsistent.
  • That the preparer did not testify.
  • That Kimberly was contemplating suicide near the time for filing the 2007 return and had been hospitalized.
  • That these facts made credible Kimberly’s testimony, that she’d decided to abandon filing jointly and did not intent to file jointly with George for 2007.

So, Kimberly was found not to have filed a joint return but was denied innocent spouse relief. Well, where does that leave her?   On the IRS books of account, she is still listed as jointly liable for a tax due on a return the Tax Court says was not a return.

An American Bar Association Tax Section practitioner forum discussed what Kimberly should do next procedurally. My suggestion was:

The mistake made in this case was asking for innocent spouse relief which the court denied as it had to since no joint return was found to have been filed. Interestingly, the tax could be higher on a MFS return. A MFS return filed now will probably be rejected by the IRS computer since a return has already been recorded under client’s SSN. You can request, as has been suggested, that IRS abate the joint assessment against client. If IRS is not cooperative, the Taxpayer Advocate should be able to help clear up the client’s account since you have the Tax Court decision that no joint return was filed. Alternatively, if client has already received her due process collection notice on this assessment Appeals consideration can still be requested.

This is not a forgery case, by the way. The former husband submitted an unauthorized putative joint return, which the court rejected. He did not forge the client’s signature, however. Another question: Why did the return preparer transmit the joint return without having in her possession a Form 8879 signed by the wife? She has a malpractice issue.

Also, I would not be surprised if the former husband goes back into family court alleging that the former wife breached the dissolution agreement, arguing that the agreement’s statement that the parties would file separate returns in 2008 implicitly means that they would file jointly in 2007. He cannot compel her to file jointly, but would seek damages for her refusal to file jointly. I don’t suggest he would be successful, only that he might try.

Conclusion:

  • The Martial Dissolution Agreement should have explicitly covered whether a joint return would be filed for 2007.
  • Ideally, Kimberly would have been advised (not the case here) about how much money filing jointly would save her over filing separately.
  • Then she could have (again, not the case here due to her mental condition) weighed the dollar savings against not being party to a joint return with violence prone George. She might have wanted to have nothing to do with him and just pay the toll charge for filing separately. Sometimes personal considerations outweigh financial ones.
  • Kimberly should have filed a married filing separately return if she did not want to file jointly. That would have prevented George from being able to claim she’d intended to file jointly.
  • Not having done that, she should have based her appeal of collection activity against her by arguing that no joint return had been filed because she did not sign the return, consent to file jointly or intend to file jointly; and, submitted a MFS return to appeals.
  • Still, the Tax Court decision will be helpful in obtaining an abatement of the joint return liability. But, she’ll have to file a separate return.
  • From a strictly financial position, Kimberly may have been misguided in objecting to the joint return liability to begin with, since it appears that most of the income was attributable to her retirement distributions and she will likely owe more tax on an MFS return.
  • Thus, it is important to understand your best option to minimize the tax liability before claiming innocent spouse status. For, in this case, even if a joint return had been found to have been filed, Kimberly would not have been relieved of most of the joint return liability, as most of the income items on the joint return were her own income items.

© 2014 by Robert S. Steinberg, Esquire
All rights reserved

Posted in DIVORCE, INNOCENT SPOUSE, JOINT RETURNS, TAX | Tagged , , , , , | 1 Comment

BLOOMBERG BNA SAMPLES ATTORNEY VIEWS ON STREAMLINED PROCESS

Alison Bennett of Bloomberg BNA’s article “Questions surround Standard of Willful Path Conduct under Streamlined Version of OVDP” (9/17/14), summarizes some of her interviews with tax lawyers around the country concerning the Streamlined Filing Compliance Procedures announced by IRS on June 16, 2014.

I’ve questioned the usefulness of the Streamlined Process for U.S. persons in prior blog posts and my colleagues interviewed by Ms. Bennett have similar reservations. Some of the comments are summarized below, namely:

  • The government may take a stricter view of non-willfulness for those trying to transition out of the OVDP into the Streamlined Process under the transitional rules also announced on June 16, 2014.
  • One practitioner’s experience is that most transitional applications are being rejected by IRS.
    • Apparently, as I’ve discussed in earlier posts there is no appeal of this IRS decision.
  • The IRS seems to be interpreting non-willfulness using a stomach test: Did you know in your gut that you had a legal obligation to report the foreign accounts?
    • But that test goes to knowledge of the legal obligation and should not necessarily mean per se that the failure to disclose was willful.
  • The Streamlined Process is laden with risk to the taxpayer who is going out on a limb by giving an affidavit under oath.
    • There is no guidance from IRS about how it will apply the willfulness standard under the Streamlined Process. For example:
      • Will U.S. persons be held to a tougher standard than expats? I would not be surprised if that is the case, but IRS is silent.
      • Willful Blindness: What will constitute in the eyes of IRS a conscious effort to avoid learning about the reporting requirements?
        • The IRS Internal Revenue Manual says not checking the box on Schedule B of Form 1040 will not alone establish willful blindness, but does not say what facts will?
      • Look back period for facts to establish willfulness: Though a taxpayer must only file three years of income tax returns and six years of FBARS under the Streamlined Process, will IRS go back further searching for badges of fraud or other acts indicative of willfulness?
        • IRS could go back to the opening of the account.
    • Can one, knowing the frailties of memory, make, under oath, an affirmative certification of non-willfulness?
    • I am certain that most, if completely honest with themselves, will not be able to make that assertion in good faith or with any degree of intelligent certainty.
  • All who represent clients in Voluntary Disclosure matters would like to see IRS at least publish some broad brushstroke guidance on how the view thewillfulness issues, such as
    • Will the standard be differently applied for U.S. persons versus expats?
    • Under what circumstances will willful blindness be asserted?
    • What are the largest factors in the eyes of IRS leaning towards willfulness?
    • What are the largest facts leaning towards non-willfulness?
    • Are there any safe harbors on which practitioners can rely in advising clients?
  • To date the IRS has been want to provide guidance because it says, the facts in every case are so divergent. While this is true, some broad guidance would be helpful.

Robert S. Steinberg, Esquire

www.steinbergtaxlaw.com

 

Posted in 214 OVDP, TAX | Tagged , , , , , , , , | 1 Comment

DIVORCE DECREE TRUMPS FEDERAL TAX LIEN ARISING AFTER ENTRY OF DIVORCE JUDGMENT.

A New Hampshire U.S. District Court decision U.S. v. Baker 13-cv-213-PB2014 DNH 176, August 22, 2014) highlights some important lessons about the priorities of a divorce decree against a federal tax lien on one of the spouses.

The facts of the case

  • Mr. and Mrs. Baker filed for divorce on 2/28/08, after ten years of marriage.
  • The Bakers owned two parcels of land in New Hampshire as tenants with rights of survivorship.
  • The two properties had been purchased by them in 2000 and a quitclaim deed recorded with the Register of Deeds reflecting their ownership rights.
  • The Massachusetts state issued a divorce judgment on 2/28/08.
  • The divorce judgment became final on 5/29/08.
  • The judgment of divorce approved and incorporated the Baker’s separation agreement.
  • The Massachusetts court found the separation agreement to be “fair and reasonable and not the product of any fraud, duress or coercion.”
  • The agreement states in part:
    • The Wife shall own solely the piece of land located at Micion Rd., Campton, New Hampshire (“Land”). Within thirty (30) days following the date of the Agreement the Husband shall execute a deed transferring and conveying to the Wife all of his right, title and interest in and to the Land, free and clear of all existing liens. The Husband hereby waives and releases any and spousal rights in the Vacation Home, which he may have or acquire under the present and future laws of any jurisdiction.
  • Neither the divorce judgment nor a deed conveying the Land to Mrs. Baker was recorded with the Register of Deeds subsequent to the divorce.
  • On May 14, 2009 the U.S. assessed unpaid income taxes against Mr. Baker.
  • On October 21, 2009 the U.S. sent a levy notice to Mr. Baker.
  • The IRS then recorded its federal tax lien in the amount of $2,458,609 on November 9, 2009.
  • The IRS later assessed additional taxes against Mr. Baker and send to him a second levy notice on 7/29/10 and on 8/9/10 recorded a second notice of federal tax lien for $1,133,687.
  • On May 1, 2013 the U.S. sued both Mr. and Mrs. Baker seeking a judicial sale of the Land transferred to the Wife under the divorce decree as partial satisfaction of Mr. Baker’s tax liability now totaling over $4 million.

Government’s Argument and Court’s decision

The government argued that the failure to execute and record the deed as required in the Separation Agreement invalidates the conveyance to the Wife. The government argued that since the deed was not recorded, a subsequent bona fide purchaser for value would have priority over the wife’s interest in the property.  The Court rejected the government’s argument.  That Mr. Baker could defeat the Wife’s interest by making a fraudulent transfer to a purchaser without knowledge of the earlier transfer who pays full value is irrelevant.  Mrs. Baker could still enforce her full title rights against Mr. Baker.

Under New Hampshire law (applied as the property is located in NH) the Separation Agreement effectuated an immediate severance of the Joint tenancy and transfer of Mr. Baker’s interest to Mrs. Baker.  The deed requirement was not intended in the Separation Agreement to be a condition precedent. The Separation Agreement  did not require that the deed be recorded before Mr. Baker ceased to have an interest in the Land.

“Mr. Baker lost his right to own, transfer or encumber the properties when the divorce judgment became final.” NH law did not give him any enforceable right to the properties after that date.

Whether one has an interest in property is determined under state law. Whether the federal tax lien attaches to such property interests is a matter of federal Law.  In U.S. v. Baker, the U.S. District Court found that Mr. Baker ceased to have any property interest in the Land conveyed to Mrs. Baker under the divorce decree upon entry of the divorce judgment.  Thus, there was no property interest of Mr. Baker against which the federal tax lien could be enforced.

RSS COMMENTS

  • The result could in this case be different for property located in a state with a race to record statute.
  • Mrs. Baker prevailed in this case, but the dispute would have been averted if she had simply made sure that the deed was recorded.
  • The Lesson: Record all divorce conveyances that can be recorded. Record both the judgment and deed or other document of transfer.
  • In this case the tax lien arose and was recorded after the divorce judgment had been entered. But, don’t assume there are no income taxes unpaid or no tax liens recorded. Spouses should obtain federal and state tax transcripts and conduct a search for tax liens before signing a Separation Agreement.
  • A tax attorney knowledgeable on federal tax liens and state property law should resolve issues of tax lien priority.   A CPA is not trained to make these legal determinations.

© 2014 by Robert S. Steinberg, Esquire
All rights reserved

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