The Tax Wars Blog

“Beware of false knowledge; it is more dangerous than ignorance.”

– George Bernard Shaw

Shaw’s admonition is applicable to both fling delinquent returns using the Streamlined Filing Compliance Procedures or through normal filing channels with a Reasonable Cause Statement attached.   .    Calls I’ve received from both accountants and perspective clients demonstrate that many are aware of these alternatives but are ignorant of the nuances, complexities and risks of attempting to choose which path to employ to bring a taxpayer into compliance. 

The chart below is intended to assist attorneys and CPAs in understanding the important distinguishing features that separate the Streamlined Compliance Procedures and Filing amended returns through normal IRS channels with a Reasonable Cause Statement attached.  These two very different paths are the most commonly employed for bringing delinquent taxpayers with offshore income into compliance. 

COMPARISON CHART – REASONABLE CAUSE VERSUS STREAMLINED↓

Deciding how to proceed in offshore cases depends entirely on the specific facts of each taxpayer and requires both knowledge of the law and sound judgment in applying it.  Given that, one can still state some obvious and general advantages and disadvantages of these alternatives to the OVDP as related to U.S. citizens or residents. 

Major Advantages of Streamlined Process:

• Three year income tax filing period in lieu of 6 year Reasonable Cause period.
  • There is no offshore penalty for taxpayer’s residing outside of the U.S.Lower tax and interest due to fewer returns amended.Lower legal and accounting fees due to less work required.No 20% accuracy related penalty on the income tax reported in the disclosure unless an examination shows fraud or willfulness.
  • No automatic audit – rather return processed like any other return and selected for audit under normal IRS procedures ( but see disadvantages below)

Major disadvantages of Streamlined Procedures:

• The Streamlined filer must certify under penalties of perjury (Form 14654 for persons residing within the U.S. and Form 14653 for persons residing outside of the U.S.) that:
  • “My failure to report all income, pay all tax, and submit all required information returns, including FBARS, was due to non-willful conduct. I understand that non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of good faith misunderstanding of the requirements of the law.’
  • “I recognize if the Internal Revenue Service receives or 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 Criminal Investigation.”
  • IRS has stated that submissions under the Streamlined Process may be subject to verification procedures in that the accuracy and completeness of submissions may be checked against information received from banks, financial advisors and other sources. Therefore, “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 advisors.”
    • Certification is a confession or at least an admission of all of the facts regarding opening and operation of the offshore account.
    • If willful other penalties may apply, e.g., civil fraud penalty.
  • Not available for delinquent returns of taxpayers residing within the U.S.
  • No simplified PFIC rules available as under former Offshore Voluntary Disclosure Program FAQ 10.

Major problems with filing with Reasonable Cause Statement

• Reasonable Cause Statement is also made under penalties of perjury.
• Automatic Assessment – When return is filed at an IRS Service Center with a delinquent foreign reporting form or when such form is filed separately (as required for Form 3520), the IRS has been automatically assessing penalties.  No one at the Service Centers is reading or considering the Reasonable Cause Statement and request for waiver of the penalties.  The IRS Commissioner has advised professionals to have clients resubmit the return and / or foreign reporting form.  This usually does not solve the problem and client has to deal with attempts by IRS to collect the assessments.  Usually, IRS, when contacted, will postpone collection action; but, this does not stop automated collection actions such as applying overpayments   from another year to the tax assessment. The IRS Taxpayer Advocate office has lately not been very helpful in solving these matters which can go on for many months, even more than a year.

Cautions about non-willful certification and Reasonable Cause affidavits

Clients often have fuzzy, or worse, inaccurate recollections of details pertaining to opening their account or accounts, what was discussed and what was written in emails or other communications. IRS or DOJ may obtain information from banks that differs from what the client remembers.  Thus, the statement must distinguish between what is known from documents and what is remembered.

Perspective clients are searching the internet and some will attempt to feed the attorney facts that they have learned point to non-willfulness.  The attorney must voir dire the client regarding the veracity of non-willful statements.

Original documents may or may not be available.

The willful versus non-willful characterization is a partly subjective analysis that depends to a large extent on the “eyes of the beholder.” Thus, IRS may view as willful that which the taxpayer and even the best counsel may have perceived as non-willful.

Can a taxpayer still qualify as non-willful?

A Tax Analysts Tax Notes article (Richman, Nathan J., “International Tax Enforcement Efforts Include Civil Tools”) quoted Acting Assistant Attorney General of the Department of Justice Tax Division, Caroline Ciraolo who was speaking at the March 4^th Federal Bar Association Section on Taxation annual meeting. Ms. Ciraolo stated:

After three very well-publicized voluntary disclosure programs, nearly 200 criminal prosecutions, ongoing criminal investigations and the increasing assessment and enforcement of substantial civil penalties for failure to report foreign financial accounts, a taxpayer’s claims of ignorance or lack of willfulness in failing to comply with disclosure and reporting obligations are, quite simply, neither credible nor well-received.

The Acting Assistant Attorney General suggests that it would seem extraordinary at this late date that anyone with an unreported offshore bank account could convince IRS that a lack of knowledge on their part was the cause of their non-compliance with the tax filing and reporting obligations.

Her statement, not unreasonable on its face, seems to me to overstate and oversimplify the determination of willfulness versus non-willfulness.

For one thing, the publicity to which the Assistant Attorney General refers, while widespread is not part of the mass media news that most regular people digest. FBAR news and prosecutions is not usually mentioned on the nightly local TV news or reported with great fanfare in the non-financial daily newspapers.

Her statement is most appropriately related to those who opened accounts in tax havens with funds originating in the U.S. and who employed all sorts of devious means to hide their identity from the IRS. These people are not your average ordinary person but are the tax criminals who should have entered the Offshore Voluntary Disclosure Program.

For those in this category who have yet to come forward, the bell is tolling loudly. The IRS having concluded its Swiss Bank Settlement Program with almost 100 banks is shifting its focus to banks in other countries that have assisted U.S. persons with evading tax. These countries of new emphasis include, but are not limited to: The Bahamas, The Cayman Islands, Australia, India, Singapore and Israel.

But, those not committing overt acts in an attempt to evade U.S. tax are not home free. For, civil willfulness does not necessarily require overt acts of commission and the civil FBAR penalty may apply to one who is not a tax criminal. When present, overt acts often represent the nails in the coffin of willfulness, if not establishing a tax crime.

Willfulness for purposes of assessing the draconian FBAR civil penalty can be established by showing knowledge of the obligation to file and intentionally not filing; or, in intentionally burying your head in the sand (willful blindness).

The Streamlined Filling Non-willful certification is all about stating facts that show negligence, even gross negligence, or ignorance, but do not indicate knowledge of the reporting and filing rules and intentionally ignoring them. This analysis is both legal and factual and must delve into all of the facts surrounding the opening and operation of the offshore account – the why, from what source, how, when, where, who, and for how long.

Some examples of facts relating to the non-compliant-non-tax-criminal person, which, if present, might tend to evidence lack of knowledge and intentional non-reporting are:

1. The person has no post-secondary school education.
2. The person has a BS and Master’s Degree in Biology or other technical field and not one in taxation or finance with courses in taxation.
3. The person inherited the account from a parent who lives in the foreign country.
4. The person did not transfer funds offshore; but, rather the funds in the account originated offshore.
5. The person has a close connection to the foreign country with family there with frequent visits.
6. The person works as an IT specialist and has no background or contact with tax issues and international finance.
7. The person works as a department store clerk or in another non-skilled job.
8. The person prepared his or her own tax returns and misunderstood the program instructions. I’ve seldom reviewed a self- prepared return with offshore activities reported correctly.
9. The person is an expatriate living in a high tax country and owes little tax to the U.S.
10. The person living out of the U.S. has bank accounts only in his or her country of residence which are not viewed by him or her as foreign but as their local bank account.
11. The person has recently immigrated to the U.S. and has been preoccupied with adapting to the new country, culture, lifestyle, language or a new spouse.
12. The person who recently immigrated to the U.S came from a country that does not tax its citizens on world-wide income.
13. The person living in the U.S. or outside of the U.S. has during the filing period suffered severe emotional, medical, family or business hardships.
14. The person is not a sophisticated investor whose investments consist solely of an employer 401(k) and IRA.
15. The person’s tax return preparer was a store-front operator who did not inquire about offshore bank accounts or provide a tax organizer to clients.
16. The person’s return had no Schedule B.

The above list represents but a handful of illustrative facts that combined with other facts might help establish that the non-compliant person’s conduct was not willful. The analysis and determination of what these individual facts collectively mean is a job for a tax attorney experienced in these matters. CPAs, however competent in preparing tax returns, are not trained to decipher this difficult and consequential legal question: Whether a client’s conduct is criminal, willful or negligent. The consequences of getting this determination wrong can be disastrous.

There is no one size fits all solution to offshore noncompliance issues.  There are cases in which it is clear that the client has committed tax or other crimes which would likely be charged if uncovered.  These individuals cannot file Streamlined or use Reasonable Cause; but, should use the IRS Voluntary Disclosure procedures.  In other cases the facts may clearly indicate willful conduct or willful blindness that falls short of criminal conduct.  Often the facts are ambivalent, somewhere between reckless which the IRS views as willful and grossly negligent which IRS views as non-willful for purposes of Streamlined Filings.  Sorting out these variable fact patterns and suggesting how to proceed is impossible without possessing a full understanding of the available options for mitigating the potential consequences from the client’s non-compliance.  The chart above compares Reasonable Cause with Non-willful conduct under the Streamlined Procedures.

The Streamlined Filing Compliance Procedures (Streamlined process or filing)represent a very attractive process by which certain non-compliant taxpayers can come into compliance without penalty (for those living outside of the U.S. who meet a non-residency test) or with a 5 percent miscellaneous offshore penalty for those residing inside the U.S. (that is, who fail to meet the non-residency test).

The Streamlined Process is a special program under which IRS provides a relatively simpler route by which U.S. taxpayers can potentially resolve past tax oversights and become compliant with U.S. tax reporting rules regarding income, foreign bank accounts or other required foreign reporting forms.  Basically, the returns and foreign forms are filed with a special Streamlined unit of the IRS who review the package for adequacy on its face and if found adequate are put through for normal return processing with penalty relief.

Eligibility for Streamlined Filing

The program is aimed at taxpayers who are not tax criminals and who meet the following eligibility requirements.

1. Meet or fail to meet a non-residency test for one of the three streamlined years.
2. Have filed returns for the past three years for which the due date has passed. Those qualifying as non-residents can file delinquent returns under the program.
3. Have failed to report the income from a foreign financial account or other foreign source income as required by U.S. tax law and / or failed to file correct FBARs or other foreign reporting forms.
4. Certify that the failure to report all income, pay all tax and submit all required information returns was due to non-willful conduct. The courts and IRS have defined willfulness as “the intentional violation of a known legal duty.”  That phrase is easier to recite than to clarify and IRS has been coy about how aggressively it will review taxpayer certifications of non-willfulness.  The test turns on both factual analysis and legal conclusions from those facts. Recently, several courts have held that willfulness includes reckless disregard of the law and IRS rules and return instructions referred to on Form 1040, Schedule B. With regard to eligibility for the Streamlined Process, IRS has the final say.  For a fuller discussion of willfulness see my blog post on the-tax-wars.net  “Will-O-The Wisp Willfulness in the Streamlined Process “(9/1/14)).  This affidavit is the tricky-as-a-maze part of the Streamlined process that requires great care, thought and legal skills to navigate without subjecting the filer to enhanced risks of criminal charges.

Attractiveness of Streamlined Process

The program beneficial for most who qualify because the Streamlined Process:

• Allows one to come into compliance by filing only three years of returns and six years of FBARS instead of six years of returns required under the existing Voluntary Disclosure Procedures (VDP).
• Avoids the VDP harsher penalty regime which would be inappropriate for those who are not tax criminals or reckless or willful violators and in all fairness should not be subject to the maximum FBAR penalties or, for willful violations or harsh penalties for failure to file Form 3520. Instead, the Streamlined Process for U.S. persons allows you to come into compliance by paying a reduced miscellaneous offshore penalty of 5 percent of the highest balance of noncompliant foreign financial assets (required to be reported in an FBAR or on Form 8938 or reported but income not reported) during a six year look back period but no other penalties such as the accuracy-related penalty (can be 20%) on any increased income tax liability or 3520 penalty (can be 25% of value of unreported trust assets). Those qualifying as living outside of the U.S. pay no penalty at all.
• Removes the cloud of fear hanging over one’s head about discovery of the non-compliance and possible passport denial or revocation.
• Brings one into compliance without identifying him or her as a tax-violator and without disclosing to the public that he or she has entered the program.

Uncertainty Associated with Streamlined Filings

Unlike the VDP, one does not initially know if IRS has accepted him or her into the Streamlined Process. While an IRS audit of Streamlined returns will not be automatic, returns may be selected for audit under normal IRS audit guidelines and IRS may determine that one’s conduct, in its eyes, was not non-willful.  In that case, IRS could go back further than three years and could assert an FBAR penalty at the conclusion of the audit process.  The IRS would have to act within the period allowed under law for making income tax assessments, normally three years unless large amounts of income (more than 25% of all income reported) are found to have not been reported in your returns.  This limitations period on making assessments would start to run from the filing date of your original or delinquent returns. These limitations periods, however, do not apply to a year for which IRS successfully proves that fraud was committed in filing the return.  The limitations period for IRS assessing the FBAR civil penalty is six years from the due date of the particular FBAR.  For a fuller discussion of the impact of limitations periods, read my blog post on www.the-tax-wars.net  “Statutes of Limitations and Streamlined Filings or File Forward Strategies” (8/10/15).

Linchpin of Safely Filing under Streamlined Process

Streamlined filings are safe provided the following rules are strictly observed:

1. Provide only truthful and accurate information in the required Non-willful statement or affidavit.
2. Make the affidavit (i.e., it is filed under penalties of perjury) completely transparent, including facts all relevant known facts, even those that may suggest willfulness, with an explanation, if required.
3. Distinguish between facts that are known from documents and memory or recollections of past events.
4. Have an experienced tax attorney prepare the non-willful affidavit and make the decision whether conduct described is non-willful conduct.
5. Remember that statements in the non-willful affidavit are legal admissions. Do not inadvertently and ignorantly admit to a chargeable crime or you may find yourself so charged.

Dangerous Streamlined Filing

Whether a taxpayer’s conduct is non-willful requires a factual and legal analysis to determine where the taxpayer’s conduct falls on an imaginary ladder of culpability.  The ladder shows the most culpable conduct at the top rung and the least culpable conduct at the bottom rungs.  From the top down the ladder appears:

• Criminal conduct.
• Civilly willful conduct.
• Reckless disregard conduct.
• Non-willful conduct.
• Grossly negligent conduct.
• Negligence
• Ignorance of the law

A taxpayer will qualify for Streamlined filing relief if they are ignorant of the law, negligent, grossly negligent or non-willful.  Only an experienced tax attorney has the training and experience to distinguish between the categories of conduct listed above. Often a taxpayer’s conduct will fall in the cracks between categories of grossly negligent, non-willful, reckless or willful.  Only an experienced tax lawyer will know the questions to ask the client to root out all of the relevant facts necessary to make a proper non-willful decision.

I’ve had been told that there are CPAs who are preparing non-willful affidavits for clients making Streamlined filings.  In doing so, they are subjecting their clients to unknowing risks of being charged with making a false Streamlined claim of non-willfulness or even worse of unwittingly admitting to a crime or committing perjury.  They are also inviting malpractice claims because practicing out of license (unlawful practice of law) is per se negligent.

CPA Indicted for foolhardy Streamlined Filing Caper

CPA Brian Nelson Booker prepared his own Streamlined filing.  He should have hired legal counsel.  He would certainly have been told that his conduct was willful and therefore he should not attempt a Streamlined filing.  A Voluntary Disclosure would have been more suitable for his situation.  The rueful facts of his indictment can be found in U.S. v. Brian Nelson Booker Case O: 19 Cr. 60152 (S.D. Fla.).

Lesson:  Tax criminal cannot sneak into a lower penalty regime through the Streamlined Process. IRS is on the watch for such people.   You cannot turn bad chop-meat into a wholesome meal. And, it is not always easy to determine if the chop-meat is bad.  A CPA will not know.  He or she may have the client sail off unaware of a hidden bomb aboard the Streamlined ship.  A bomb of willfulness, which, if triggered, will take both the client and CPA to the bottom.

Robert S. Steinberg, Esquire
www.steinbergtaxlaw.com

In John Milton’s epic biblical poem “Paradise Lost,” the fall of Man is depicted. The Devil is banished to Hell.   The Modern Wealthy Man has had his own fall.  The morality-play today devolves around tax-evasion and the loss of privacy.  Keeping one’s financial affairs secret from the masses, sometimes for good cause such as to protect personal safety, but often for more shady reasons like the evasion of tax obligations, is no longer a certainty.

After the Panama Papers were disseminated, no one with a sane mind would have continued to believe that offshore financial accounts in Tax Haven jurisdictions could continue to perfectly wall-off one’s financial affairs from public scrutiny.  Now comes the Paradise Papers to reinforce that point for any remaining non-believers.

The Paradise Papers were obtained by the German newspaper Suddeutsche Zeitung which called in the International Consortium of Investigative Journalists to head the inquiry.

Like the Panama Papers the obtained documents reveal financial dealings of many wealthy political leaders, celebrities and other extremely wealthy individuals.  Even the Queen of England’s financial affairs were revealed in the leak.

What is lost in these revelations?   The Paradise Lost is privacy and secrecy.  They simply do not exist anymore for information trusted to computer networks or cloud-based applications.

Very sophisticated hacker-groups are determined to obtain such information, no less governmental tax authorities.   Does this mean we are likely to go back to paper documents stored in rusting file cabinets?  Certainly not for most transactions, although I have read that certain spy agencies are employing typewritten again in their spy-craft.

What this does mean for U.S. non-compliant taxpayers is that their foreign financial accounts long hidden away in some remote tax haven jurisdiction are no longer safely hidden away that they will never be found-out.

If such accounts beneficially owned or controlled by U.S. citizens or resident aliens, are uncovered by the IRS and Department of Justice, the resultant criminal and civil sanctions may well feel like Hell.

So, the question is: What to do?  The options are limited.

One may continue to imitate an ostrich – stick one’s head in the sand and wish for non-discovery, like those poor souls who knew they should have left Europe during World War II but waited too long and fell under Nazi occupation.  The tragic consequences of those indecisions are well known.

The consequences of tax non-compliance today are less tragic but harsh enough: at a minimum severe or draconian amounts to pay for tax, penalty and interest; and, the distinct possibility of incarceration for tax crimes committed, no less, the embarrassment and shame of reputation that goes along with becoming a felon.

The above, sounding not particularly too palatable, the question still sits on the table, “What to do?”

Fortunately, there is a course of action that both caps the adverse financial consequences of one’s tax non-compliance and affords amnesty from criminal prosecution.  This result can be accomplished by entering an IRS / DOJ amnesty program called The Offshore Voluntary Disclosure Program or OVDP.

The OVDP is a special program under which IRS settles all potential criminal and civil tax issues relating to unreported offshore financial accounts under a specified civil penalty regime that is less severe than the maximum civil penalties that could be asserted by IRS outside of the program, were you audited, but in some cases more severe than the lowest level of civil penalties that IRS would assert outside of the program.  In the OVDP, IRS also grants immunity from any criminal charges that otherwise might arise from the non-reporting.

The OVDP has several beneficial features, namely:

• Offers certainty that you will not be charged with a crime and that the civil FBAR penalty will be no more than 27.5% (50% if any account is with certain identified banks or facilitators under investigation) of the highest aggregate value in U.S. dollars of your offshore accounts during the OVDP period discussed below.
• Allows you to repatriate and use offshore funds remaining after paying the tax and penalties and / or have funds owned by your parents remitted to them.
• Removes the cloud of fear handing over you about discovery of the non-compliance.
• Does all of the above without tainting your name, identifying you as a tax-violator and without disclosing to the public that you have entered the program.

The OVDP is a process that is completed in phases:

1. Submit your name or names to the Criminal Investigation Division (CID) of IRS and CID will send notification by fax if your name or names are cleared or if you are already under audit consideration or have already been identified. In the latter instance, you will not be eligible to participate in OVDP and likely will be audited by IRS which could result in civil penalties more severe or less severe than are offered in OVDP and or criminal sanctions for all or some of you.
2. Assuming your name clears CID, you will then submit a detailed OVDP Letter and Attachment for each foreign account to CID. The information required by this letter and the attachments is quite detailed and may take some time to gather, organize and relate in a coherent, accurate narrative.  The letter must be completely truthful and submitted within 45 days of initial clearance of your name by CID   CID will then notify by mail whether you have been provisionally accepted into the program.
3. Following provisional acceptance, you will submit within 90 days, a more detailed package of amended returns with supporting documentation. Your case will then be assigned to an examiner by the IRS Philadelphia Service Center for review and certification.  This is not equivalent to a full-blown audit and usually goes smoothly but sometimes requests for clarification or additional information or documentation are made.  Checks for the FBAR penalty and for the income tax, accuracy related penalty and interest due must also be submitted at this time.
4. The additional package will include amended returns and Amended FBARs (TD Form 90.22-1 or FinCEN 114) for each year of the OVDP period (8 years). The OVDP period is determined by income tax returns delinquent or requiring amendment. If any tax returns have not yet filed, such returns, if required, will be included with the OVDP submission.
5. Once the OVDP review is complete you will sign a contract with IRS stating the income tax, accuracy related and FBAR penalties and interest owed and paid. This contract called a “Closing Agreement” is binding on IRS unless it is later found that you fraudulently misrepresented facts in your submission. The IRS can still audit your returns on domestic tax issues, but that is not a common occurrence unless controversial domestic issues are raised in the returns.  Thus, the “Closing Agreement” and payment of tax, penalty and interest should end the matter.

In addition to the OVDP penalty, there will be income tax to pay on unreported income, a substantial underpayment or accuracy related penalty of 20% of the additional tax, and a failure to pay penalty of up to 25% applied to the unpaid tax plus accrued interest.

Even if accepted into the OVDP, you have the option of opting-out of the program and seeking a lower FBAR civil penalty while preserving the OVDP criminal immunity.  Opting-out, however, can result in a higher as well as lower civil FBAR penalty and can result in higher income taxes and income tax penalties being asserted by IRS. Thus, opting-out sometimes presents potential monetary benefits but poses additional risks not present if one remains in the OVDP.

To be eligible for the OVDP one must act propitiously.  Once IRS or the DOJ has your name as being noncompliant you become ineligible for the program.

Thus, I strongly urge individuals still out of compliance with U.S. tax law regarding foreign financial accounts to consult with a tax attorney experienced in these matters.

I, of course, am available for such representation.  There are other post on this blog-site dealing with various aspects of the OVDP and Streamlined Filing Compliance Procedures, another IRS program, for taxpayers whose noncompliance was not willful.

My credentials, experience and publications may be found on my website www.steinbergtaxlaw.com

© 2017 by Robert S. Steinberg, Esquire
All rights reserved

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Source: FEATHER THEME