Structuring – Case Study Example of How the IRS Audits & Investigates
Structuring Transactions To Evade Reporting Requirements (FBAR, IRS Form 8300) is a common and sometimes easily misunderstood crime.
In the typical scenario, an individual or company does not want to report a financial transaction received from overseas.
It does not have to be because the transaction was illegal or from illegally sourced money – it may literally be an innocent attempt to reduce paperwork and reporting of foreign transactions (aka transactions from overseas, abroad or offshore).
Common Questions involving Structuring:
- How much can I deposit?
- What if it is my money?
- What is a Cash Transaction Report?
- What is FinCEN?
- What is a Suspicious Transaction Report?
Yes, under 31 U.S. Code § 5324, the International Structuring of International Cash Transactions to avoid IRS reporting is Fraud.
Structuring violates FinCEN, BSA and general IRS laws — which is a crime.
Structuring is the illegal transferring of money to (and from) overseas in a manner designed to avoid detection — and minimize offshore reporting requirements.
Structuring is a crime which the IRS is actively pursuing due to the high penalties the IRS is authorized to issue against anyone caught structuring.
What is Structuring?
The concept of structuring, is when a person specifically structures the transfers of money to another country, and/or into the United States in a way to avoid detection — and minimize offshore reporting disclosure rules
This used to be a much more prevalent and easy crime to commit, but ever since the introduction of FATCA (Foreign Account Tax Compliance Act) it is becoming a much more difficult crime to commit.
Structuring Related Definitions
Bank Secrecy Act is an act designed to facilitate compliance by Foreign Financial Institutions to assist the U.S. Government in detecting Money Laundering and related crimes.
For Structuring purposes, it means the transfer of money from overseas and into the United States, without meeting the FinCEN and other reporting thresholds.
IRS Reporting (aka Offshore or Foreign Account)
The required reporting of transfers pursuant to FinCEN, BSA and IRS laws in general.
FBAR (FinCEN 114)
Report of Foreign Bank and Financial Accounts
Foreign Account Tax Compliance Act.
The Crime of Structuring – Case Study Example
This is the type of situation which may be best explained through example.
Scott resides in the United States. He’s a U.S. citizen who has significant amounts of funds offshore. The money is legal, but it has never been reported to the Internal Revenue Service.
Scott has never disclosed the information on his tax return or FBAR and is now itching to get the money back to the United States so he can use it to put a down payment on a new house.
Scott wants to transfer the money back to the United States, but understands that under increased offshore compliance regulations he cannot simply take $700,000 and transfer it back to the United States like his dad used to do several years ago, before the introduction and enforcement of all these international tax laws; it’s too risky.
Structuring the Transfers
Scott decides he is going to first transfer the money in short spurts. Previously, the money was in his girlfriend’s name, but he does not want to file a Form 3520, or bring anyone else into the mix; Scott knows he is committing “Structuring.”
Step 1: Scott opens an Account in Hong Kong, so that now the money is under his name. Scott researched the location, and believes the bank is a Branch of a U.S. Institution — which he purposefully picked to avoid FACTA Reporting. (Scott believes he never had an FBAR Reporting requirement prior, since the money was not under his name — but since the money was his, the IRS would disagree).
Step 2: Scott transfers money in small increments in order to try to avoid detection. Typically, most banks will report a transaction if it is more than $10,000.
Step 3: Scott begins transferring the $700,000 directly to himself in increments. He starts making $9500 transfers consistently over the next two years in order to receive before $700,000. He then closes the Foreign Account.
**Scott considered traveling with amount of less than $10,000 on his person, but since this is a physical transfer instead of a bank transfer, it would spark FinCEN 105 reporting issues.
Scott’s Plan is Flawed
The Foreign Bank knows Scott is a U.S. Person. In addition, Scott completed and submitted a W-9 at the time he opened the account, and the account earns interest.
Therefore, even though the transfers are below most reporting requirements for both Scott and the FFI, the FFI will still report Scott because:
- The Country entered into a FATCA IGA (Intergovernmental Agreement) with the U.S.
- The FFI knows Scott is a U.S. Person
- The Account has more than $50,000 (FFI reporting Threshold)
- The Account generates Interest Income
Scott’s Reporting Requirements
Scott misses several reporting requirements of the next two years, all of which may result in significant Fines and Penalties.
FBAR (FinCEN Form 114)
This Form must be reported by any individual who has an annual aggregate total of more than $10,000 in foreign accounts on any day of the year.
FATCA Form 8938
It turns out that this particular institution is not a Foreign Branch, but a wholly owned subsidiary of the parent bank and therefore, the FATCA exception would not apply.
The Bank Account is actually in the name of a Hong Kong Private Ltd., which is held by a BVI. Scott owns both companies and therefore is required to report the companies on a Form 5471 (as well as the Passive Income generated). He is the only owner of the businesses, which makes them CFCs (Controlled Foreign Corporations) which may lead to Subpart F and immediate tax liabilities.
The businesses are corporations which do not perform any actual business, but rather earns all of its income via distributions of Passive Interest Income from the FFI.
Tax Evasion & Tax Fraud
Due to the high balance in Scott’s account (and other accounts Scott owns), the count is generating interest income. Interest income amounts to about $45,000 a year.
This compounds Scott’s criminal activity, because Scott is aware of the foreign interest income, but has proactively decided not to report it on his tax return. As a result, Scott could be facing some significant fines and penalties, including a criminal investigation by the IRS Special Agents.
If Scott was found be willful and intentionally misrepresented or omitted information to IRS, he may be subject to extremely high fines and penalties beyond what you may have already paid.
The following is a summary of penalties as published by the IRS on their own website:
A penalty for failing to file FBARs. United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A penalty for failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048. This return also reports the receipt of gifts from foreign entities under IRC § 6039F. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
A penalty for failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b). The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.
A penalty for failing to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A penalty for failing to file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.
A penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.
A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.
Underpayment & Fraud Penalties
Fraud penalties imposed under IRC §§ 6651(f) or 6663. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.
A penalty for failing to file a tax return imposed under IRC § 6651(a)(1). Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.
A penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2). If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.
An accuracy-related penalty on underpayments imposed under IRC § 6662. Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty.
Even Criminal Charges are Possible…
Possible criminal charges related to tax matters include tax evasion (IRC § 7201), filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322. Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).
A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000. A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000. A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.
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