201612.23
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FBAR Reckless Disregard Standard for Willfulness | Increased IRS Penalty

IRS Offshore Voluntary Disclosure Lawyers - Golding & Golding Worldwide

IRS Offshore Voluntary Disclosure Lawyers – Golding & Golding Worldwide

While many individuals and Expat websites downplay the importance of reporting foreign bank accounts and other offshore/foreign accounts, it is important to understand that there can be serious penalties in failing to report foreign accounts — especially if a person was willful in their failure to comply with Offshore/Foreign Account reporting.

Most recently, the Ninth Circuit held that the burden of proving a person was willful is met when a person is found to be in reckless disregard of filing FBAR forms, and the government’s burden is less than the standard of showing clear and convincing evidence (which is the evidence required in a Criminal Matter)

Thus, even though the willful penalty is equivalent to a criminal penalty, the IRS does not need to meet the standard required in a criminal case (Clear and Convincing) to prove it.

What is an FBAR?

An FBAR is a report of foreign bank and financial account form. It is a form that is required to be filed by any individual that has more than $10,000 overseas in foreign bank accounts on any day of the year. There are a few important factors to consider, which many people do not realize:

  • It is not $10,000 per account, but more than $10,000 in aggregate for all accounts combined.
  • It does not matter if a person owns the foreign money, is a joint account holder, or was merely a signatory.
  • It does not matter if the account is an individual account, investment account, retirement account, or business account.
  • Once you break the $10,000 total, you have to report all of the accounts.
  • The IRS does issue penalties for failing to report the account information.

9th Circuit – Lower Standard of Proof Makes it Easier to Penalize You

Recently, in the Ninth Circuit, the District Court issued a ruling that held the standard of willfulness is not the same standard that is required in criminal cases — even though the penalty is essentially a criminal penalty — the standard is less than Clear and Convincing evidence.

At the outcome of a criminal case, a person may suffer a loss of the freedom — so the court system wants to do its best to ensure that the defendant is guilty before placing a person in jail or prison and removing their freedoms from them. Therefore, in criminal proceedings the court must meet a Clear and Convincing standard. While there is no numerical amount of evidence proof that needs to be used, the general understanding is that it is pretty high and should hover around 95%.

In the recent Ninth Circuit case of U.S. v. Bohanec, the District Court held that the burden of proving a person was willful for financial penalties is met when a person is found to be in reckless disregard of filing FBAR forms (less than intent or deliberate actions taken), and the government’s burden is less than clear and convincing evidence.

The FACTS of the CASE

The case is U.S. v. Bohanec (United States v. August Bohanec et al, USDC CD Ca., No. 2:15-cv-04347).  The Taxpayers at issue had multiple accounts (three in total) – split between Mexico, Austria, and UBS Switzerland. It should be noted that UBS is considered a “Bad Bank” (aka Foreign Financial Facilitator) but not at the time when Defendants had attempted to enter OVDP (See below).

The accounts were actively being used by Taxpayers in order to move business profits offshore. The following facts were stipulatd between Plaintiffs and Defendants:

– Even though Taxpayers were not U.S. born citizens, they did become naturalized citizens many years ago.

– The Bohanecs knew that they had to file tax returns for the camera shop business and that if they earned money, they had to pay taxes.

– In addition to the Leitz Canada commission deposits, the Bohanecs directed their international customers, on at least a few occasions, to deposit money directly into the Swiss UBS account. 34. The Bohanecs did not report the commission income they received from Leitz Canada on their federal income-tax returns.

– The Bohanecs would occasionally withdraw money from their UBS account.

–  In June 2003, the Bohanecs transferred $10,000 from their UBS account in Switzerland to their daughter, Yolanda Reischer-Bohanec. Exhibit 11 is a copy of the UBS notice regarding this transfer.

– In July, 2003, the Bohanecs transferred $25,000 from their UBS account in Switzerland to August Bohanec’s account at Steiermärkische Bank in Austria. Exhibit 12 is a copy of the UBS notice regarding this transfer.

– In December 2003, the Bohanecs transferred $20,000 from their UBS account in Switzerland to their bank account in Austria. Exhibit 13 is a copy of the UBS notice regarding this transfer.

– In February 2006, the Bohanecs opened a bank account in Mexico and transferred $25,000 from their UBS account in Switzerland to Mexico for expenses related to a house they were building in Mexico. Exhibit 14 is a copy of the UBS notice regarding this transfer. (RT 18:18-23.)

–  In November 2006, the Bohanecs transferred $7,500 from their UBS account in Switzerland to their Bank of America account in Pasadena, California. Exhibit 15 is a copy of the UBS notice regarding this transfer.

– In addition, from October 2004 through October 2008, the Bohanecs made several other withdrawals from their UBS account in Switzerland. Exhibits 17 through 22 are copies of statements from UBS with notations reflecting these withdrawals.

– Between the filing of their 1998 federal income-tax return and May 19, 2011, the Bohanecs did not file any federal income-tax returns.

– On May 19, 2011, the Bohanecs executed and filed FBARs for 2003, 2004, 2005, 2006, 2007, and 2008. Exhibits 25 through 30 are copies of these FBARs.

– On May 19, 2011, the Bohanecs executed and filed federal income-tax returns for 2003, 2004, 2005, 2006, 2007, and 2008. Exhibits 31 through 36 are copies of these tax returns.

– While the FBARs filed by the Bohanecs in May 2011 for 2003, 2004, 2005, 2006, 2007, and 2008 included the UBS account, they did not include the Austrian account, which was in existence during 2003 through 2008.

– The FBARs for 2006, 2007, and 2008 filed by the Bohanecs in May 2011 did not include the Mexican account, which was in existence during 2006 through 2008.

– The Bohanecs were ultimately rejected by the IRS for the Voluntary Disclosure Program for Offshore Accounts.

– While the federal income-tax returns for 2003, 2004, 2005, 2006, 2007, and 2008 included the interest earned on the UBS accounts, they did not include the income earned by the Bohanecs from their EBay sales.

– On October 3, 2013, the IRS issued a notice of deficiency for tax year 2003 through 2010. Exhibit 37 is a copy of this notice of deficiency.

OVDP Rejection

Taxpayers had applied for OVDP and were initially approved for preclearance, but were later rejected because they had been untruthful on their OVDP application and subsequent filings. Namely, they had not reported the true nature of the foreign deposits, had not reported all of the accounts in their disclosure (aka they did not make a “Full Disclosure) and overall did not tell the truth in their OVDP application; in other words, they selectively reported the money and accounts they wanted to – which is enough to get an applicant rejected or dismissed from OVDP/OVDI.

Burden of Proof – Reckless Disregard (Without Clear and Convincing Evidence)

The IRS took a firm position against these taxpayers and issued significant willful penalties against them. While the IRS did issue (and court upheld) penalties against these taxpayers for being willful (by finding reckless disregard met the standard of willfulness and that clear and convincing evidence is not required in the noncriminal proceedings), it is important to understand that these facts were very specific. These taxpayers appeared to have intentionally sought to evade paying tax or reporting the accounts.

Nevertheless, it is important to keep in mind that the general proposition is that a person may be held to be Willful even if they did not act deliberately or with intent (aka reckless disregard) and the standard of proof needed to prove Willfulness is less than Clear and Convincing.

Thus, when a person is held to be willful, they will be penalized extensively. In fact, depending on the facts and circumstances of the case, a person could be penalized 100% value of their foreign accounts and situation, which the IRS finds them to be willful over a multiyear audit/examination. Even though a 100% penalty is equivalent to a criminal standard as opposed to a civil standard (the IRS has issued memoranda stating that willfulness should be equivalent to criminal liability – although it is a non-citable document), the government does not need to establish a criminal standard of behavior to issues these penalties.

How the Court Summarized Willfulness

Thus, for the IRS to be able to issue penalties based on an evidentiary standard that is less than clear and convincing evidence makes it very difficult fight the penalties once they are issued.

As cited by the court in the ruling:

– Although Defendants assert that “willfulness” encompasses only intentional violations of known legal duties, and not reckless disregard of statutory duties, no court has adopted that principle in a civil tax matter. The only cases Defendants cite to support their argument that “willful” means that a defendant must have knowledge and specific intent are criminal cases. See Ratzlaf v. United States, 510 U.S. 135 (1994) (structuring); United States v. Eisenstein, 731 F.2d 1540 (11th Cir. 1984) (felonious failure to file currency transaction reports).

– Where willfulness is an element of civil liability, the Supreme Court generally understands the term as covering “not only knowing violations of a standard, but reckless ones as well.” Safeco, 551 U.S. at 57.

– Recklessness” is an objective standard that looks to whether conduct entails “an unjustifiably high risk of harm that is either known or so obvious that it should be known.” Safeco, 551 U.S. at 68 (internal quotation marks and citation omitted).

– Several other courts, citing Safeco, have held that “willfulness” under 31 U.S.C. § 5321 includes reckless disregard of a statutory duty. See United States v Williams, 489 Fed.Appx. 655, 658 (4th Cir. 2012); United States v. Bussell, No. CV15-02034 SJO(VBKx), 2015 WL 9957826 at *5 (C.D. Cal. Dec. 8, 2015); see also United States v. McBride, 908 F.Supp. 2d 1186, 1204, 1209 (D. Utah 2012).

Getting into Compliance

While there is no clear-cut definition of the term willful (the IRS has declined to provide a specific definition), it is safe to say it is a totality of the circumstances test based on the facts and circumstances of an individual’s particular situation. If you have unreported foreign accounts or money, your best option for getting into compliance is to make a full and truthful IRS Voluntary Disclosure of your Foreign Accounts.

What if Offshore Voluntary Disclosure?

Offshore Disclosure is the process of coming forward and disclosing overseas assets and foreign income to the IRS in exchange for (in most cases) a waiver of prosecution by the Internal Revenue Service. Whether a taxpayer is Willful or Non-Willful will determine which Offshore Disclosure Program the taxpayer should enter — and what their penalty will be.

Whether or not an applicant will have to pay an OVDP penalty (and if so, how much they will have to pay) or qualify for a reduced penalty (or penalty waiver) under the Streamlined Compliance Procedures will depend on a few different factors – with the most important factor being whether the applicant was willful or non-willful.

Golding & Golding – Offshore Disclosure

At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.

In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.

The Devil is in the Details…

If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.

It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.

Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.

What if You Never Report the Money?

If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported —  then you are in a bit of a predicament, which you will need to resolve before it is too late.

As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.

Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).

Getting into Compliance

There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.

We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlikes the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.

After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.

If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.

Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.

1. OVDP 

OVDP is the Offshore Voluntary Disclosure Program — a program designed to facilitate taxpayer compliance with IRS, DOT, and DOJ International Tax Reporting and Compliance. It is generally reserved for individuals and businesses who were “Willful” (aka intentional) in their failure to comply with U.S. Government Laws and Regulations.

The Offshore Voluntary Disclosure Program is open to any US taxpayer who has offshore and foreign accounts and has not reported the financial information to the Internal Revenue Service (restrictions apply). There are some basic program requirements, with the main one being that the person/business who is applying under this amnesty program is not currently under IRS examination.

The reason is simple: OVDP is a voluntary program and if you are only entering because you are already under IRS examination, then technically, you are not voluntarily entering the program – rather, you are doing so under duress.

Any account that would have to be included on either the FBAR or 8938 form as well as additional income generating assets such as rental properties are accounts that qualify under OVDP. It should be noted that the requirements are different for the modified streamlined program, in which the taxpayer penalties are limited to only assets that are actually listed on either an FBAR or 8938 form; thus the value of a rental property (reduced by any outstanding mortgage) would not be calculated into the penalty amount in a streamlined application, but it would be applicable in an OVDP submission.

An OVDP submission involves the failure of a taxpayer(s) to report foreign and overseas accounts such as: Foreign Bank Accounts, Foreign Financial Accounts, Foreign Retirement Accounts, Foreign Trading Accounts, Foreign Insurance, and Foreign Income, including 8938s, FBAR, Schedule B, 5741, 3520, and more.

What is Included in the Full OVDP Submission?

The full OVDP application includes:

  • Eight (8) years of Amended Tax Return filings;
  • Eight (8) Years of FBAR (Foreign Bank and Account Reporting Statements);
  • Penalty Computation Worksheet; and
  • Various OVDP specific documents in support of the application.

Under this program, the Internal Revenue Service wants to know all of the income that was generated under these accounts that were not properly reported previously. The way the taxpayer accomplishes this is by amending tax returns for eight years.

Generally, if the taxpayer has not previously reported his accounts, then there are common forms which were probably excluded from the prior year’s tax returns and include 8938 Forms, Schedule B forms, 3520 Forms, 5471 Forms, 8621 Forms, as well as proof of filing of FBARs (Foreign Bank and Financial Account Reports).

OVDP Penalties

The taxpayer is required to pay the outstanding tax liability for the eight years within the disclosure period – as well as payment of interest along with another 20% penalty on that amount (for nonpayment of tax). To give you an example, let’s pick one tax year during the compliance period. If the taxpayer owed $20,000 in taxes for year 2014, then they would also have to include in the check the amount of $4,000 to cover the 20% penalty, as well as estimated interest (which is generally averaged at about 3% per year). This must be done for each year during the compliance period.

Then there is the “FBAR/8938” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank”) on the highest year’s “annual aggregate total of unreported accounts (accounts which were previously reported are not calculated into the penalty amount).

For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all of their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.

Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe and remember that by entering the program, the applicant is seeking to avoid criminal prosecution!

                         

2. Streamlined Domestic Offshore Disclosure

The Streamlined Domestic Offshore Disclosure Program is a highly cost-effective method of quickly getting you into IRS (Internal Revenue Service) or DOT (Department of Treasury) compliance.

What am I supposed to Report?

There are three main reporting aspects: (1) foreign account(s), (2) certain specified assets, and (3) foreign money. While the IRS or DOJ will most likely not be kicking in your door and arresting you on the spot for failing to report, there are significantly high penalties associated with failing to comply.

In fact, the US government has the right to penalize you upwards of $10,000 per unreported account, per year for a six-year period if you are non-willful. If you are determined to be willful, the penalties can reach 100% value of the foreign accounts, including many other fines and penalties… not the least being a criminal investigation.

Reporting Specified Foreign Assets – FATCA Form 8938

Not all foreign assets must be reported. With that said, a majority of assets do have to be reported on a form 8938. For example, if you have ownership of a foreign business interest or investment such as a limited liability share of a foreign corporation, it may not need to be reported on the FBAR but may need to be disclosed on an 8938.

The reason why you may get caught in the middle of whether it must be filed or not is due largely to the reporting thresholds of the 8938. For example, while the threshold requirements for the FBAR is when the foreign accounts exceed $10,000 in annual aggregate total – and is not impacted by marital status and country of residence – the same is not true of the 8938.

The threshold requirements for filing the 8938 will depend on whether you are married filing jointly or married filing separate/single, or whether you are considered a US resident or foreign resident.

Other Forms – Foreign Business

While the FBAR and Form 8938 are the two most common forms, please keep in mind that there are many other forms that may need to be filed based on your specific facts and circumstances. For example:

  • If you are the Beneficiary of a foreign trust or receive a foreign gift, you may have to file Form 3520.
  • If you are the Owner of a foreign trust, you will also have to file Form 3520-A.
  • If you have certain Ownerships of a foreign corporation, you have to file Form 5471.
  • And (regrettably) if you fall into the unfortunate category of owning foreign mutual funds or any other Passive Foreign Investment Companies then you will have to file Form 8621 and possibly be subject to significant tax liabilities in accordance with excess distributions.

Reporting Foreign Income

If you are considered a US tax resident (which normally means you are a US citizen, Legal Permanent Resident/Green-Card Holder or Foreign National subject to US tax under the substantial presence test), then you will be taxed on your worldwide Income.

It does not matter if you earned the money in a foreign country or if it is the type of income that is not taxed in the country of origin such as interest income in Asian countries. The fact of the matter is you are required to report this information on your US tax return and pay any differential in tax that might be due.

In other words, if you earn $100,000 USD in Japan and paid 25% tax ($25,000) in Japan, you would receive a $25,000 tax credit against your foreign earnings. Thus, if your US tax liability is less than $25,000, then you will receive a carryover to use in future years against foreign income (you do not get a refund and it cannot be used against US income). If you have to pay the exact same in the United States as you did in Japan, it would equal itself out. If you would owe more money in the United States than you paid in Japan on the earnings (a.k.a. you are in a higher tax bracket), then you have to pay the difference to the U.S. Government.

                           

3. Streamlined Foreign Offshore Disclosure

What do you do if you reside outside of the United States and recently learned that you’re out of US tax compliance, have no idea what FATCA or FBAR means, and are under the misimpression that you are going to be arrested and hauled off to jail due to irresponsible blogging by inexperienced attorneys and accountants?

If you live overseas and qualify as a foreign resident (reside outside of the United States for at least 330 days in any one of the last three tax years or do not meet the Substantial Presence Test), you may be in for a pleasant surprise.

Even though you may be completely out of US tax and reporting compliance, you may qualify for a penalty waiver and ALL of your disclosure penalties would be waived. Thus, all you will have to do besides reporting and disclosing the information is pay any outstanding tax liability and interest, if any is due. (Your foreign tax credit may offset any US taxes and you may end up with zero penalty and zero tax liability.)

*Under the Streamlined Foreign, you also have to amend or file 3 years of tax returns (and 8938s if applicable) as well as 6 years of FBAR statements just as in the Streamlined Domestic program.

                      

4. Reasonable Cause Statement

When a Person, Estate, or Business is out-of-tax compliance for failing to report Foreign Income and/or Foreign Assets, the applicant has relatively few options for timely and safely getting into tax and foreign reporting compliance — before fines and penalties are issued.

While the most common options include the Offshore Voluntary Disclosure Program or the Streamlined Offshore Disclosure Program, there is another alternative. It is called making a Reasonable Cause submission.

Reasonable Cause Process

An individual should never attempt offshore disclosure without the assistance of a qualified attorney. With that said, it is even more important to ensure that if you are even considering a reasonable cause submission, that you do so only with the help of an attorney. That is because only with an attorney do you receive the benefit of the attorney-client privilege.

Unlike the Streamlined Program or OVDP where there are strict procedures to be followed, a reasonable cause submission is different. It should be noted that a person can submit a reasonable cause application for any number of different reasons; it is not limited only to offshore money and reporting foreign accounts. It should also be noted that there are potentially high risks and penalties associated with this Reasonable Cause process, so you have carefully weigh your options. 

With a reasonable cause submission, the attorney will carefully evaluate and analyze the facts and circumstances of your case in detail. He or she should sit down with you either in person or via teleconference if you are non-local and assess the pros and cons of the potential submission in order to determine what the benefits and detriments may be to a reasonable cause disclosure. Thereafter the attorney will amend the returns, prepare the necessary forms, and draft a persuasive Reasonable Cause Letter.

At Golding & Golding, we are Tax Attorneys (with Masters of Tax Law) and Enrolled Agents credentialed by the IRS (Highest Credential awarded by the IRS), so we can handle your entire submission (Taxes, Legal, and Audit Defense) in-house, for a flat-fee.

Reasonable Cause Examples

If you were completely non-willful in your failure to disclosure and were unaware that there was any reporting requirement, then the thought of paying any penalty may sound absurd and you may consider Reasonable Cause as an alternative option.

Reasonable Cause is determined on a Case by Case basis in accordance with your specific facts and circumstances.

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