“A will-o’-the-wisp is an atmospheric ghost-light seen… at night, especially over bogs, swamps or marshes. It resembles a flickering lamp and is said to recede if approached, drawing (sojourners) from the safe paths.”(Wilkipedia). Most clients with unreported offshore accounts who contact me these days want to enter the new IRS Streamlined Filing Compliance Program and insist that their conduct was and is non-willful. They are moved by the lower 5% penalty for U.S. persons, much less severe than the OVDP 27.5% penalty or 50% penalty for those having accounts with banks on the DOJ’s under investigation list. But, non-willfulness like the will-o-the-wisp is a fickle fire. You may see it but IRS may not, for non-willfulness or willfulness to a great extent is in the eyes of the beholder. There is significant uncertainty about how IRS and the courts will apply the willfulness element of FBAR civil violations. Two court decisions have implied there may be strict liability when a return is signed without reporting a foreign financial account. IRS has not provided guidance on what specific factors will influence it to accept or reject a Certification of Non-Willfulness. At a June Tax Controversy Forum John McDougal, special trial attorney and division counsel, IRS Small Business and Self-Employed Division, was quoted to have remarked: “The concept of willfulness is well documented in the case-law…. We’re depending on the practitioners to help clients work their way through what the risk is of criminal prosecution and significant penalties.”
In light of this uncertainly and ambiguity in IRS’s position on willfulness, the Streamlined Process could become a swamp some will come to rue having entered. Why? Because those entering the new Streamlined Process must certify under penalties of perjury that their conduct was non-willful, that sly will-o-the-wisp again.
In determining non-willfulness, one must, in effect, rule out willfulness. The rule of law is easy to state. Conduct is willful when there is a voluntary, intentional violation of a known legal duty.
To decide that the failure to file an FBAR was willful, a court must find:
- That there was a legal duty to file imposed on the taxpayer.
- That the taxpayer had knowledge of the legal duty to file, and
- That the taxpayer voluntarily and intentionally did not file as required.
In the case of an FBAR, the Bank Secrecy Act Sec. 5314 broadly imposes a duty to file on those U.S. persons having an interest in or authority over one or more foreign financial accounts the aggregate value of which exceeds $10,000 at any time during the calendar year. The report is due by June 30 of the following year to which it relates. This question of whether one has a financial interest in a foreign account can, itself involve a complex web of tax and foreign law, but I shall not discuss that question in this post.
Knowledge of legal duty
The next question is did the person know of that obligation? The Fourth Circuit Court of Appeals (Williams case) and District Court for the Southern District of Utah (McBride case) on facts replete with evidence of willfulness, held that a taxpayer is presumed to have read his or her return and is charged with knowledge of the information contained in the return. Thus, the taxpayer is charged with knowledge of the FBAR requirement because Schedule B asks “do you have an interest in a foreign financial account,” and refers taxpayers to the instructions that explain the FBAR filing requirement.’’ This is the concept of “willful blindness,” that is, taking steps to prevent acquiring knowledge of the filling requirement (in the case discussed, failing to read the return and instructions). These two decisions found that willful blindness not only established knowledge but willfulness as well because the conduct of signing a return without reading explicitly referenced instructions about the FBAR requirements showed a reckless disregard that establishes willfulness.. But, both Williams and McBride had so many overt acts of bad intent that the court did not need to base its decision on the Schedule B question alone; and, it is uncertain whether the suggested strict liability proposed in those two cases will apply on more innocent facts.
Putting aside the Schedule B question for the moment, in analyzing willfulness or whether the violation was intentional, it is helpful to think of the bell curve. Conduct at the two extremes is easy to characterize, but conduct in the middle of the bell curve is more difficult. Usually, one begins to add up overt acts indicative of willful conduct until the pile of willful acts becomes a mass, which taken together convinces that the failure to file was volitional. These acts could include:
- Using a coded or numbered account.
- Using a structured investment with a nominee title holder.
- Using an intermediary who has been indicted or is under investigation.
- Using a bank under DOJ criminal investigation, has been indicted or has entered into a non-prosecution agreement or deferred prosecution agreement.
- Using a bank in a country with strict bank secrecy laws.
- Making systematic withdrawals of cash just under $10,000.
- Instructing the bank to hold mail and not send statements to the U.S. address.
- Having a very large account balance.
- Having large unreported income compared to reported income on your U.S. return.
- Telling your tax return preparer who asks about foreign bank accounts, that you have none (whether asked in person or in a tax organizer provided by the preparer).
- Lying to or evading questions posed by a Revenue Agent or attempting to impede the examination.
- Checking the “No” box as to the foreign bank account question on Form 1040, Schedule B (But, may require some of the above other acts evidencing willfulness in addition).
Burden of proof
The burden of proof has two elements:
- Who must sustain the burden as to the level of proof required? and,
- What level of proof is required to establish willfulness?
Who must prove willfulness?
In determining eligibility for the Streamlined Process, it is the taxpayer who must establish the facts supporting non-willfulness or that his conduct was due to negligence, inadvertence, mistake or conduct that is the result of a good faith misunderstanding of the requirements of law. In the end, however, the government to convict in a criminal case or successfully collect the FBAR penalty will have the burden of proof. If that is the case, what difference does it make that the taxpayer must establish non-willfulness for eligibility under the Streamlined Process? For one thing, the failure to file, failure to pay, and accuracy-related penalty will be in play even if the result of a trial is that the taxpayer is found to have been non-willful. A court will not likely second guess the IRS on its decision to reject a taxpayer from the Streamlined Process because the IRS did not have to offer the relief and the taxpayer did not have to apply. Thus, a low threshold is likely to apply to IRS actions on eligibility questions.
On the other hand, the burden of proof is on the government in all criminal cases, in penalty cases under the Internal Revenue Code, and in FBAR penalty actions under the Bank Secrecy Act.
Level of Proof
The District Courts in both Williams and McBride held that the government must prove willfulness by only a “preponderance of the evidence”. This means that the greater weight of the evidence must indicate that the taxpayer’s conduct was willful. These were cases in which the penalty was assessed and the government sued the taxpayer to obtain a judgment for the debt on which it could then seek to collect. “Preponderance of the evidence” is a much lower standard than “beyond a reasonable doubt” required in criminal prosecutions or even “clear and convincing evidence”, as required in civil fraud penalty cases under the Internal Revenue Code. “Clear and convincing” proof falls in between a “preponderance of the evidence” and “beyond a reasonable doubt:”
A 2006 IRS Chef Counsel’s Memorandum and its Internal Revenue Manual indicate that IRS believed “clear and convincing evidence” was necessary to establish willfulness in an FBAR collection suit. Now, however, IRS is arguing that the lower “preponderance of the evidence” burden applies. Since only two district courts have ruled on this issue, uncertainty will prevail until higher courts rule.
When will I know if IRS has accepted my “Certification of Non-willfulness?”
Unlike the OVDP, IRS will not acknowledge your Streamlined submission or enter into a closing agreement (Form 906) with you. Thus, you will not initially know if IRS has accepted you submission under the Streamlined process. Rather, you will wait. Wait for what? For the statute of limitations on assessment to run. IRS normally has three years from the filing date to assess additional tax but this time limit is increased to six years if gross income is understated by more than 25%. Fraudulent returns have no time limit after which IRS cannot assess tax. IRS can assess a fraudulent return at any time.
This seems unfair. IRS should at least notify a taxpayer if he or she has been accepted or rejected under the Streamlined Process as to non-willfulness.
Suggestion: for a deceased taxpayer, file a Request for Prompt assessment under IRC Sec. 6501(d) on Form 4810 after filing your Streamlined submission to shorten the statute of limitations to 18 months. Nothing says that you cannot and this may be an excellent idea.
What happens if IRS says my conduct was willful?
Bad things can happen and apparently there is no appeal from the IRS determination about one’s eligibility for the Streamlined Process. What happens then if you are kicked out of Streamlined? Some consequences:
- Your returns for all open years under the statute of limitations may be audited, not just the three-years filed. If fraud found, all years are fair game for audit. Thus, you may be assessed substantial additional income tax.
- You have no criminal protection for FBAR and income tax violations. Thus, you can go to jail and expect IRS to make some examples out of some filing frivolous non-willful certifications.
- You may be assessed the maximum income tax penalties including late payment, late filing, accuracy related and/ or civil fraud penalty..
- You will have appeal rights with regard to the income tax penalties proposed or assessed upon examination.
- IRS may assess the FBAR penalty but will have to sue you within two years of assessment to collect as the income tax levy procedures do not apply.
- You may be charged with perjury for your false certification of non-willfulness.
The linchpin of the Streamlined Process is the willful / non-willful determination. This is a very complex issue, made more difficult by uncertainly about how the IRS will determine willfulness and what burden of proof will be applied. An attorney experienced in criminal tax matters should conduct the analysis of whether the client’s conduct was willful or non-willful. A CPA, accountant or enrolled agent, apart from having no communications privilege, is not trained to make such legal determinations.
This post is intended to provide the lay reader with a basic understanding of some of the willfulness / non-willfulness issues and is not intended as an exhaustive or scholarly dissertation on the subject. Thus, citations by and large are not included and the discussion is general in scope. This summary is not intended as legal advice and should not be relied upon for any specific solution to an FBAR problem.
© 2014 by Robert S. Steinberg, Esquire
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