The Importance of an Offshore Reasonable Cause Submission

Mastering IRS Reasonable Cause is More Important Than Ever

The Art & Science of an IRS Offshore Reasonable Cause Submission

When a U.S. taxpayer faces a potential offshore fine or penalty from the IRS, they may have various options available to them to minimize or avoid penalties. One of the most common mechanisms the taxpayer may use to avoid or minimize penalties is to establish a reasonable cause defense (or offense). While the IRS agents should use an objective standard to determine if reasonable cause is met, IRS agents are only human. Thus, the Internal Revenue Service examiner’s own life experiences will impact their assessment of the taxpayer’s facts – and ultimately impact their decision as to whether the taxpayer established reasonable cause. There are many components to reasonable cause, depending on the totality of the circumstances for the non-compliance. For example, reliance on a tax professional is one of the more common scenarios in which a taxpayer will utilize a reasonable cause defense, but this is only one of several strategies the taxpayer may use.

Let’s look at how reasonable cause works and the different options that taxpayers may have when it comes to establishing a reasonable cause defense or offense.

First, Reasonable Cause on Defense or Offense?

It is important to note that reasonable cause can be used both to avoid penalties before they are assessed and to seek a penalty waiver or abatement after they have been assessed. For example, if a taxpayer realizes that they are out of compliance for unreported foreign accounts, assets, and investments, they may consider making a reasonable cause submission at the time they file their late forms. Alternatively, if the taxpayer has already been penalized, they may also make a reasonable cause submission to abate or waive penalties that have already been issued against them.

Reasonable Cause Before Penalties Are Assessed

When a taxpayer submits a late international/amended information reporting form, they may be able to avoid penalties altogether by establishing reasonable cause before the IRS assesses penalties. This is done by submitting the late reporting form along with a reasonable cause letter. Unlike amnesty programs such as the streamlined procedures, there is no specific certification or other forms used when submitting a reasonable cause statement.

Reasonable Cause After Penalties are assessed

Alternatively, if the taxpayer has already been assessed penalties, they may be able to have those penalties waived or abated by submitting a reasonable cause statement after the penalties have already been issued.

Establishing Reasonable Cause can be Challenging

To establish a reasonable cause, the taxpayer utilizes all the facts and circumstances involved with the missed filing or reporting and requests that penalties be avoided or waived. There are many components to establishing reasonable cause, and the taxpayer’s specific facts and circumstances will dictate where the taxpayer should focus their submission. In general, the taxpayer must show that they used ordinary business care and prudence to determine what was required to be filed — and that even though the taxpayer did not make the correct filing, nevertheless, IRS penalties should be avoided. It is also important to note that reasonable cause cannot be used in all circumstances. In other words, just because the taxpayer is noncompliant does not automatically mean reasonable cause is an option.

Ordinary Business Care and Prudence

The Internal Revenue manual is a great resource for taxpayers to learn how the Internal Revenue Service examiners and agents determine whether the taxpayer has established reasonable cause.

Some of the key concepts explained in the IRM include:

• • • What is the specific penalty that is being imposed?

    • Has the taxpayer been in compliance for the past several years?

    • How much time has passed since the non-compliance and the taxpayer learning about the non-compliance?

    • What, if anything else, could the taxpayer have done to avoid making the mistake or error they did?

Different Ways to Establish Reasonable Cause

While there are many different categories of reasonable cause that the taxpayer may be eligible for, in general, when it comes to international reporting, penalties come with the main categories, including:

• • • Mistake Was Made

    • Erroneous Adviser Reliance

    • Ignorance of the Law

Let’s look at each category as set out in the IRM

• • • Mistake Was Made

    • Erroneous Adviser Reliance

    • Ignorance Of The Law

The following are direct excerpts from the Internal Revenue Manual”

A Mistake Was Made

While the general rule is that simply making a mistake is not sufficient to establish reasonable cause, there are some nuances and exceptions to that strict rule. More specifically,

1. 1. 1. The taxpayer may try to establish reasonable cause by claiming a mistake was made. Generally, this is not in keeping with the ordinary business care and prudence standard and does not provide a basis for reasonable cause.

      2. However, the reason for the mistake may be a supporting factor if additional facts and circumstances support the determination that the taxpayer exercised ordinary business care and prudence but nevertheless was unable to comply within the prescribed time.

      3. Information to consider when evaluating a request for an abatement or non-assertion of a penalty based on a mistake or a claim of ignorance of the law includes, but is not limited to the following:

         • When and how the taxpayer became aware of the mistake.

         • The extent to which the taxpayer corrected the mistake.

         • The relationship between the taxpayer and the subordinate (if the taxpayer delegated the duty).

         • If the taxpayer took timely steps to correct the failure after it was discovered.

         • The supporting documentation.

Erroneous Advice or Reliance

1. 1. 1. Each request for penalty relief should be reviewed thoroughly to determine the exact basis of the taxpayer’s request.

      2. Is the taxpayer claiming they did not comply due to specific advice they received from someone, whether orally or in writing, or

      3. Is the taxpayer claiming they relied on someone else to comply on their behalf?

      4. Certain sections of the IRC and Treasury Regulations provide relief from certain penalties based on erroneous advice. See IRM 20.1.1.3.3.4, Advice, to first determine if a statutory exception or administrative waiver applies.

      5. If the taxpayer states they relied on written or oral advice from the IRS but does not qualify for relief in accordance with the criteria in IRM 20.1.1.3.3.4.1, Written Advice From the IRS, or IRM 20.1.1.3.3.4.2, Oral Advice From the IRS, refer to IRM 20.1.1.3.2.2, Ordinary Business Care and Prudence, to determine if the taxpayer exercised ordinary business care and prudence in relying on the IRS’s advice.

      6. The taxpayer may try to establish reasonable cause by claiming they relied on another party to comply on their behalf. Generally, this is nota basis for reasonable cause, particularly for filing or paying obligations, since the taxpayer is responsible for meeting their tax obligations and that responsibility cannot be delegated. However, other factors to consider include:

         • Was the taxpayer unable to comply because they did not have access to their own records? See IRM 20.1.1.3.2.2.3, Unable to Obtain Records.

         • Was the failure to comply due to a change in the tax law the taxpayer could not reasonably be expected to know? See IRM 20.1.1.3.2.2.6, Ignorance of the Law.

         • Consider all facts and circumstances presented by the taxpayer to determine if, despite the exercise of ordinary business care and prudence, the taxpayer nevertheless was unable to comply.

Ignorance of the Law

1. In some instances, taxpayers may not be aware of specific obligations to file and/or pay taxes. The ordinary business care and prudence standard requires that taxpayers make reasonable efforts to determine their tax obligations. See IRM 20.1.1.3.2.2, Ordinary Business Care and Prudence.

Reasonable cause may be established if the taxpayer shows ignorance of the law in conjunction with other facts and circumstances. For example, consider the following:

• • • • The taxpayer’s education.

• • • • If the taxpayer has previously been subject to the tax.

      • If the taxpayer has been penalized before.

      • If there were recent changes in the tax forms or law which a taxpayer could not reasonably be expected to know.

      • The level of complexity of a tax or compliance issue.

      • Reasonable cause should never be presumed, even in cases where ignorance of the law is claimed.

      • The taxpayer may have reasonable cause for noncompliance due to ignorance of the law if either of the following are true:

      • A reasonable and good faith effort was made to comply with the law, or

      • The taxpayer was unaware of a requirem ent and could not reasonably be expected to know of the requirement.

Reasonable Cause is Crucial to IRS Penalty Management

As the IRS has recently increased enforcement of fines and penalties — especially offshore noncompliance penalties — reasonable cause becomes more important now than ever. Taxpayers should be cautious before submitting a reasonable cause application to ensure they have all of their ducks in a row.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a taxpayer misses the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.

Contact our firm today for assistance.