“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↓

CHARACTERISTIC OR FACTS SHOWING	QUALIFIES AS REAS. CAUSE	QUALIFIES AS NON-WILLFULFOR STREAMLIED
Defined as	Having exercised ordinary business care and prudence	Not having intentionally violated a known legal duty to file or acted recklessly.
Negligent conduct	NO	YES
Grossly negligent conduct	NO	Yes
Reckless conduct in failing to read instructions referred to on Schedule B of Form 1040 regarding foreign bank accounts	NO	Courts have treated as Willful Blindness but might still qualify under exceptional circumstances.
Extent of Due diligence required	Did all that you could, given education and experience, but still could not timely file.	Lower bar – duty to file unknown or failure to file not intentional or conscious act.
Years included	Generally must go back at least six years – both returns and FBARS	3 for which due date of 1040 passed; 6 for which due date of FBAR passed. .
Reliance on return preparer Reliance on return preparer – Foreign reporting Forms	Generally, No RC for 1040 May provided RC due to complexity	Yes Yes
Income tax penalty	Waived if Reasonable. Cause found	• Outside US  None for amended or delinquent returns. • Living inside US None – for amended returns. • If audited  None for reported assets or income as long as original return not fraudulent & FBAR not willful.  Any additional deficiency subject to all penalties. • Previously assessed penalties – not abated.
Misc. Offshore Penalty	None if Reasonable Cause Found.	Living out of U.S. – none Living in U.S. – 5% of non-compliant assets(if non-willful)
Escapes criminal tax liability?	NO – Unless deemed Voluntary Disclosure.  Safer to use IRS Voluntary Disclosure Procedures if possible tax crimes indicated	Same as for Reasonable Cause
Certainty of result – civil?	NO	NO – return might be selected for audit just as any return might be.
Time to complete	Open ended – IRS will assess penalty requiring a resubmit or appeal	Complete upon submission of Streamlined Filing unless audited.
Automatic audit?	No	No
Public disclosure?	No	No
Cost	Need tax attorney and qualified return preparer but more expensive than Streamlined	Expensive – Need tax attorney and qualified return preparer
Submission problems	IRS Service Centers are automatically assessing foreign reporting form penalties without	File returns with Non-Willful Certification – No automatic assessment of penalties.
Conscious decision not to file	No	No
Taking care of other matters and not filing tax return	No	No
Serious job, family, health issues	Yes	Yes
Simply forgetting	No	Possibly if forgetting due to serous job, family, heath distractions.

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.