Rogin Nassau LLC Offshore Voluntary Disclosure Survey

Proving Willfulness in FBAR Reporting – Checking “No” Ain’t Apropos

 

 

Daniel L. Gottfried

 

September 20, 1010

Please click here to participate in the Rogin Nassau LLC Offshore Voluntary Disclosure Survey

 

Once ignored, but now the focus of headlines across the spectrum of tax publications, Form TD F 90-22.1, the Report of Foreign Bank and Financial Accounts (FBAR) is used by U.S. persons to report a financial interest in or signature authority over certain foreign financial accounts.  In 2003, the Internal Revenue Service was delegated FBAR enforcement authority in an attempt to improve abysmal FBAR compliance rates, estimated for 2001 to be less than 20 percent.[1]  

 

The information provided on the FBAR is required to be disclosed under the Bank Secrecy Act.  The Bank Secrecy Act is essentially a criminal statute which has been used by government authorities to apprehend and prosecute money launderers, drug dealers and terrorists, in addition to those who purposefully evade taxes.[2] 

 

Considering the seriousness of the criminal activities which the Bank Secrecy Act aims to address, it is not surprising that violations in FBAR reporting can carry steep penalties – the steepest of which are reserved for “willful” violations.[3]  In this context, willfulness means that the U.S. person actually knew of his or her FBAR obligations but intentionally failed to fulfill those obligations.[4]

 

Generally, a taxpayer is only given notice of possible FBAR reporting obligations on a single line of the income tax return, which inquires: “At any time during [the tax year], did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?”[5]  The Service takes the position that checking “no” to this question when the taxpayer in fact should have filed an FBAR, is evidence of willfulness, which in turn, warrants increased penalty assessments for FBAR violations.[6] 

 

The Service seems to believe that checking “no” is the smoking gun that can be used to prove that a taxpayer should have known about the FBAR.  With this lens, virtually any failure in FBAR reporting can be viewed as willful.  Given the severe consequences associated with a willful FBAR violation, if the government is to legitimately maintain a presumption that checking “no” establishes willfulness, then that presumption should at least reflect the realities of return preparation practice.

 

Perhaps nothing is more illustrative of the realities of industry practice than the experience and observations of the tax attorneys whose clients have participated in the Service’s recent offshore voluntary disclosure initiative.  Under the terms of this initiative, which ended on October 15, 2009, participants must file amended income tax returns for the past six years, pay back-taxes, interest and penalties for those years, and generally pay a hefty “miscellaneous” penalty equal to 20% of the highest account value during the six year look back period.

 

The experience of tax practitioners who have navigated their clients through the mire of the program sheds light upon two important realities of return preparation that are disregarded by the Service’s checking “no” presumption.  First, a general observation made early on by the author and colleagues in other firms around the country is that while some of the program’s participants had purposefully engaged in tax evasion, at least as many were innocent of “willful” noncompliance.  These were immigrants or persons with international ties who had financial interests outside the U.S., and who were not aware of the proper way to report those interests.  Of course, ignorance is not a defense to tax underpayments and certain penalties.  However, ignorance can be a defense to any penalties that are based on a showing of willfulness, because the definition of “willfulness” presupposes that the person knew of their legal obligation and chose not to fulfill it.[7]

 

A second and perhaps more singular observation is that as program participants have been coming clean and filing amended returns to correct unreported foreign income, it is being observed that many return preparers are still continuing to check “no” to the existence of a foreign account.  This is even more striking considering that these return preparers were aware of the existence of the foreign accounts and the only reason for preparing the amended returns was to report the income from the foreign accounts.

 

In order to quantify the prevalence of this occurrence, in July of 2010, we conducted a survey of tax attorneys who regularly assist clients with offshore tax compliance matters.  (The survey questions and answers are shown below.)  There were twenty-eight respondents to the survey, all of whom were members of the American Bar Association and attorneys in good standing with their state bar associations.  A full 60% of the respondents represent twenty-six or more clients that have made voluntary disclosures of unreported foreign assets.  In fact, 21% of the respondents represent more than 100 such clients.

 

The survey showed that 43% of respondents believed that at least half of the amended returns that were prepared to report a previously unreported foreign account checked “no” to the question asking whether the taxpayer had a foreign account, even though the return preparer was specifically advised that the purpose of preparing the amended return was to disclose the existence of previously unreported income from foreign accounts.  More staggering, a full 86% of respondents found that this question was answered incorrectly even when the same tax return preparer was the person preparing past-due FBARs for the taxpayer.

 

While there is no universal answer as to why this is occurring, many return preparers are explaining that their tax return preparation software automatically checks “no” to this question, and many others are explaining that missing this question was simply an oversight.  Regardless of the specific reason in a particular case, the fact remains that checking “no” is hardly evidence of intentional wrongdoing in any of these cases. 

 

Again, these amended returns are being filed in the context of a voluntary disclosure program in which the taxpayer is generally admitting to unreported foreign income and FBAR noncompliance with full knowledge and participation of the IRS.  Nevertheless, in a significant portion of cases, the taxpayers would still check “no”, if not for the intervention of a careful lawyer who is reviewing the amended returns with this issue in mind.

 

One survey respondent commented: “In some cases the tax preparer reported foreign bank account one year and not on others.”  Another commented that many return preparers “did not even know what [an FBAR] was before we brought it to their attention [and many] knew their client had foreign accounts, but only thought to bring in the income, not file FBARs.” 

 

This experience illustrates that checking “no” cannot be universally cited as evidence of intentional wrongdoing.  Foreign tax reporting is a complex web of overlapping rules, and compliance is no easy task.  A large number of taxpayers with foreign tax compliance problems are not purposeful tax evaders, but are merely unaware of these complex rules.  This also applies to a large number of tax advisors and tax return preparers, who may be well-versed in domestic tax rules but not as familiar with international tax compliance issues.  Therefore, sweeping the innocent (albeit, perhaps ignorant) subset into the same box that holds the real tax evaders is not sound tax policy.  In the words of one survey respondent, “the indiscriminate assertion of penalties is not only expensive for both taxpayers and the Service, but it also undermines confidence in the IRS and the fairness of the tax system in general.”  So long as our country operates based on a system of voluntary tax reporting, the taxpaying community needs to have faith that innocent mistakes will be dealt with fairly and reasonably.  Hopefully the insights gained from this survey will help to illustrate that a system with complex rules needs a carefully reasoned, case-by-case, approach to resolving problems that arise.

 

The most concise summary comes from a survey respondent who stated:  “There is no conclusion that can be drawn about client intent from the ‘No’ box being checked on Schedule B.…”

 

 

Offshore Voluntary Disclosure Practitioner Survey Report

 

Question One:  How many clients do you represent that have made voluntary disclosures of unreported foreign assets?

 

 

More than 100

6

21%

26 - 100

11

39%

11 - 25

8

29%

1 - 10

3

11%

 

28

100%

 

 

Question Two:  In offshore voluntary disclosure cases where a taxpayer is filing amended income tax returns to report income from a previously unreported foreign account approximately what percentage of such amended returns are initially prepared by the tax return preparer by checking "no" to the question asking whether a taxpayer has a foreign account on Part III to Schedule B of Form 1040 even though the preparer has been specifically told that the purpose of filing the amended return is to disclose the existence of previously unreported income from foreign accounts?

 

 

Less than 25%

11

39%

25% - 50%

5

18%

50% - 75%

7

25%

75% - 90%

3

11%

90% or More

2

7%

 

28

100%

 

 

Question Three:  Do you find that tax return preparers incorrectly complete Part III to Schedule B of Form 1040 even though the very same tax return preparer is preparing an FBAR for that taxpayer?

 

 

No

4

14%

Yes

24

86%

 

28

100%

 

 

Question Four:  In cases where the preparer incorrectly answered the question on the amended Part III to Schedule B of Form 1040 how did the preparer explain the error when it was pointed out to him/her?

 

 

The tax return preparation software automatically checks “no” to this question

20

71%

They are unaware of the proper reporting method for foreign accounts

3

11%

They do not consider the question material because it does not impact the tax liability

0

0%

It was an oversight

16

57%

Not sure

3

11%

Other

2

7%

 

44

157%*

 

 

 

*The total amount exceeds 100% because respondents were not limited to a single answer

 

 

Daniel L. Gottfried is a tax partner at Rogin Nassau LLC in Hartford, Connecticut.  The views expressed in this article are those of the author only, and do not necessarily reflect the views of Rogin Nassau LLC or its clients.  I would like to thank David J. Buckley for his assistance in the preparation of this article and Dennis Brager for his insightful comments.  Any errors or omissions are solely the author’s responsibility.

 

Readers are invited to participate in the survey discussed in this article.  Please click on this link to participate in the survey.

 

 

 

[1] U.S. Treasury Department, “Report to Congress in Accordance with § 361(b) of the USA Patriot Act” (April 26, 2002).

[2] E.g., John K. Villa, “Banking Crimes: Fraud, Money Laundering, and Embezzlement” (Thompson/Reuters West 2009).  

[3] 31 U.S.C. § 5321.

[4] E.g., I.R.M. § 4.26.16.4.5.3.

[5] Line 7a, Schedule B to Form 1040.  See also Line 10, Schedule B to Form 1065.

[6] I.R.M. § 4.26.16.4.5.3(8)(a).

[7] The IRS may take the position that willfulness may be attributed to a person who intentionally avoids learning about FBAR requirements.  See IRM 4.26.16.5.3(6).

 

 




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