IRS & THE FBAR: International Focus For U.S. Tax Compliance

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1 IRS & THE FBAR: International Focus For U.S. Tax Compliance INTRODUCTION By Sandra R. Brown i While the laws dealing with the disclosure of foreign bank or financial accounts took effect in 1970, nearly four decades ago, only recently has the United States ( US ) government taken steps to publicly express its expanding concerns in the area of tax compliance as implicated by the use of foreign bank accounts by US citizens. In large part, the concerns have been noted in connection with increased efforts to root out offshore tax evasion via the use of secret foreign bank accounts. By way of example, in June 2008, the Internal Revenue Service ( IRS ) issued a press release reminding those who use foreign bank accounts not only of their federal reporting obligations, but also of the consequences for violations of the reporting laws. In July 2008, the Senate Permanent Subcommittee on Investigations held hearings on proposed legislation designed to stop the use of by US taxpayers of offshore tax haven banks to evade taxes. At the same time, the Department of Justice filed civil and criminal cases relating to foreign bank accounts held by US citizens in countries such as Switzerland and Liechtenstein, both historically known for the almost absolute protection of their clients information under bank secrecy laws. So how did a non-tax law, originally enacted to uncover laundering of drug

2 money, turn into what may be one of the most valuable tools of the IRS in uncovering tax abuses by wealthy US citizens? BACKGROUND In 2003, in an effort to raise the FBAR compliance rate (estimated to be less than 20 percent in the year 2001) ii, the Financial Crimes Enforcement Network ( FinCEN ) delegated its enforcement authority for the FBAR to the IRS by means of a Memorandum of Agreement between FinCEN and the IRS. iii The agreement marked a significant step in the IRS s efforts to seek out people with undisclosed overseas accounts. Included among the reasons cited for the delegation of enforcement authority are the greater resources available to the IRS to devote to FBAR compliance. iv Such delegation afforded the IRS the authority to assess and collect civil penalties for noncompliance with FBAR requirements, investigate possible violations, employ summons power, issue administrative rulings and take any other action reasonably necessary for enforcement of these provisions, including pursuit of injunctions. v While in the more recent past, criminal and civil enforcement activity relating to persons failing to comply with FBAR reporting requirements has been rare vi, a number of public actions by the federal government would suggest that pattern will not continue in the future. On June 17, 2008, the IRS Commissioner issued a press release, headlined IRS Reminds Taxpayers to Report Certain Foreign Bank and Financial Accounts by June 30." vii And on July 1, 2008, the IRS Internal Revenue Manual ( IRM ) section addressing examination procedures was updated to provide guidance for use in civil

3 compliance examinations for FBAR. viii On June 19, 2008, the Justice Department announced the guilty plea of former UBS banker Bradley Birkenfeld to charges that he had conspired to defraud the IRS by assisting UBS clients in evading US reporting requirements on income in Swiss bank accounts. ix On June 30, 2008, the Justice Department announced that it had filed papers seeking an order from a federal court in Miami, Fla., authorizing the IRS to request information from Zurich, Switzerland-based UBS AG about US taxpayers who may be using Swiss bank accounts to evade federal income taxes. x The following statements from the Department of Justice and the IRS were contained in the June 30, 2008 press release xi : We will work hand-in-hand with the IRS to vigorously enforce the tax laws against those taxpayers who use offshore accounts to evade taxes, said John A. DiCicco, Deputy Assistant Attorney General for the Justice Department s Tax Division. Offshore accounts harbor billions of dollars, and people should take notice that the secrecy surrounding these deals is rapidly fading, said IRS Commissioner Doug Shulman. The information we gather from this action will help us detect wealthy individuals who don t pay their taxes as well as provide details about how advisors facilitate this abuse. On July 1, 2008, the US District Court in Florida approved the John Doe summons and authorized the IRS to issue summons to UBS for the production of

4 records identifying US taxpayers with accounts at UBS in Switzerland who elected to have their accounts remain hidden from the IRS. xii On November 12, 2008, the Justice Department announced the filing of charges against Raoul Weil, a senior executive of a large Swiss bank with offices worldwide serving some 20,000 U.S. citizens, alleging conspiracy to defraud the United States. xiii Such public action benefits the public by educating and reminding tax professionals and their clients of the FBAR reporting requirements. It also suggest that the IRS is gearing up to investigate and prosecute willful violators. Such increased public emphasis and coordinated effort with the Department of Justice, together with the IRS s ever increasing ability to obtain secret information from foreign jurisdictions, indicates that we could be seeing more investigations and prosecutions with a focus on FBAR violations. THE FBAR The FBAR reporting requirements are grounded in the Bank Secrecy Act ( BSA ) of The Act resulted from Congressional concern that foreign financial institutions located in jurisdictions that had secrecy laws with respect to bank activity were being extensively used to violate or evade domestic criminal tax and regulatory requirements. xiv Pursuant to the Act, the Treasury promulgated regulations under which provided that: (a) Each person subject to the jurisdiction of the United States (except a foreign subsidiary of a U.S. person) having a financial interest in, or signature or other

5 authority over, a bank, securities or other financial account in a foreign country shall report such relationship to the Commissioner of the Internal Revenue for each year in which such relationship exists, and shall provide such information as shall be specified in a reporting form prescribed by the Secretary to be filed by such persons... The Department of Treasury form is known as the Report of Foreign Bank and Financial Accounts TD F (revised in October 2008) (otherwise referred to as FBAR ) and is available on the IRS website at The FBAR reporting requirement is separate from an individual s obligation to indicate on a Federal income tax return (Form 1040, Schedule B) whether the individual has an interest in a financial account in a foreign country by checking Yes or No in the appropriate box. xv The Schedule B directs the taxpayer to Form TD F for the FBAR filing requirements. xvi The FBAR is not a tax return, but an annual report filed with the Secretary stating that the person filing has a financial interest in, or signatory authority over, financial accounts in a foreign country with an aggregate value exceeding $10,000 at any time during the taxable year. xvii The deadline for filing an FBAR for each calendar year is on or before June 30 th the following year - and this date cannot be extended. xviii The instructions to the FBAR explain how compliance with the statute is achieved and sets forth in detail the required information and those person obligated to comply with the FBAR reporting requirements.

6 Within the IRS, responsibility for monitoring FBAR compliance rests with the Small Business/Self-Employed Division ( SB/SE ). In further recognition of the importance of the IRS s role in the fight against terror and money laundering, SB/SE established the Office of Fraud/BSA, which reports directly to the Commissioner of SB/SE. xix The IRS has responsibility for processing and warehousing all BSA documents into the Currency Banking and Retrieval System (CBRS), including FBARs, Currency Transaction Reports, Forms 8300 (Report of Cash Payment of $10,000 Received in a Trade or Business), and Suspicious Activity Reports (SARs). xx The IRS considers the currency information in the CBRS extremely important for tax administration and law enforcement. The information provides a paper trail or roadmap for investigations of financial crimes and illegal activities, including tax evasion, embezzlement, and money laundering and for identifying cases for potential examination. xxi FBAR - Civil Penalties In recognition of the need to improve FBAR compliance, in 2004 Congress strengthened the penalties for individuals who fail to comply with the FBAR reporting requirements. xxii Under 31 USC 5321, an individual who fails to comply with the reporting requirements, regardless of whether his action was willful, can be subject to a penalty of up to $10,000 per violation. xxiii Civil penalties for a willful violation can range from the greater of $100,000 or 50 percent of the amount in the account at the time of the violation. xxiv Criminal penalties for violating the FBAR requirements while also

7 violating certain other laws can range up to a $500,000 fine or 10 years imprisonment or both. xxv Civil and criminal penalties may be imposed together. xxvi The civil penalty imposed under 31 USC 5321 for failure to file the FBAR is not a tax penalty under Title 26 xxvii and therefore is not subject to the notice of deficiency procedures. xxviii Absent a notice of deficiency, the US Tax Court has no jurisdiction to hear disputes involving the IRS s assessment of the FBAR penalty. xxix Enforced collection of the FBAR penalty is, by statute, the subject of a civil action to recover a civil penalty. xxx Further, once assessed, liability for the FBAR penalty should fall within the exception to discharge in bankruptcy as found under Title 11,523(a)(7). xxxi It is also important to remember that in addition to the FBAR penalty, an individual may also be subject to a variety of tax penalties if they have not properly reported the income from their foreign accounts on their tax return. Tax practitioners, who may have stuck their head in the sand and allowed their tax return preparation software to automatically mark the no box in relation to foreign bank accounts unless the client affirmatively provided information to the contrary, may also be subject to penalties under 26 USC Section 6694, as recently amended by Congress in the Emergency Economic Stabilization Act of 2008, P.L , imposes penalties on practitioners who fail to meet certain standards when preparing tax returns. Liability under Section 6694 arises from the practitioner s failure to properly report the foreign accounts of the taxpayers return, not from the failure to comply with the FBAR procedures. If a preparer chooses not to disclose a position taken on a return, they must have substantial authority for choosing not to disclose. xxxii If a

8 practitioner discloses a position on a return, they must have a reasonable basis for taking that position. xxxiii Section 6694 provides that any preparer who prepares a return that does not meet specified standards will be required to pay a penalty equal to the greater of $1,000 or 50% of the income derived or to be derived by the preparer with respect to the return. xxxiv The standards set forth in Section 6694 require the preparer to establish that he or she did not know or should not reasonably have known that the return includes an erroneous position with respect to an item reported therein. xxxv In addition to civil or criminal penalties that may be imposed on a practitioner who fails to comply with the rules for properly reporting foreign accounts, a practitioner may also be subject to discipline by the IRS Office of Professional Responsibility (OPR). Circular 230 sets forth the obligations of tax practitioners who engage in practice before the IRS. xxxvi To the extent that a practitioner fails to exercise due diligence in providing advice, or provides false or misleading advice or information regarding the FBAR reporting obligations, OPR may propose sanctions including censure, suspension, or disbarment from practice before the IRS. Tax practitioners who continue to employ a don t ask, don t tell philosophy with respect to a client s foreign bank accounts do so at the risk of facing both financial and professional penalties. FBAR Criminal Penalties The Jobs Act made no changes to criminal FBAR penalties under 31 USC Criminal violations of the FBAR rules can result in a fine of $250,000 and 5 years of imprisonment. xxxvii If the FBAR violation occurs while violating another law or as part of a pattern of illegal activity the penalties are increased to $500,000 in fines

9 and/or 10 years of imprisonment. xxxviii Additionally, the assessment of a civil penalty does not preclude the imposition of a criminal penalty or prosecution, as the penalties may be imposed together. xxxix Part S of the federal sentencing guidelines generally governs sentencing for criminal FBAR violations, and provides for a base offense level of 6 plus the number of offense levels from the table in 2B corresponding to the value of the funds... xl An offense level reduction is available under 2S1.3(b)(3) if the defendant did not act with reckless disregard, the funds were the proceeds of lawful activity, and the funds were to be used for a lawful purpose. xli Recent history, where data is available, suggests that criminal prosecution for FBAR violations have been rare. xlii Most of the criminal prosecutions with respect to foreign bank accounts have arisen with respect to non-fbar criminal statutes. For example, a taxpayer who provides a false answer to the foreign bank question on Schedule B of the Form 1040 can be prosecuted pursuant to Internal Revenue Code ( IRC ) 7206(1). That section punishes a taxpayer who willfully makes and subscribes any return under penalties of perjury which he does not believe to be true and correct as to every material matter. A person who knowingly answers no on the Schedule B when the answer is yes runs the risk of facing prosecution under this provision. Moreover, a person may not avoid criminal prosecution by failing to provide an answer to the foreign bank account question. Also, a taxpayer s omission from his income tax return of income from a foreign bank account in the form of interest, dividends or capital gains can result in criminal exposure under IRC 7201 and IRC 7206(1).

10 Prosecutions of FBAR violations with other criminal violations associated with the concealment of foreign accounts, such as tax evasion, fraud, money laundering, and for false statements on a tax return for failing to check the box on Schedule B may result in sentencing under the tax tables of the federal sentencing guidelines, xliii after application of the guidelines procedures on multiple counts of conviction and the grouping rules. xliv Unlike the guidelines fraud tables, xlv the tax tables do not provide for a safety valve sentencing level reduction. While the criminal statute for failing to comply with the FBAR reporting rules has been around for quite some time, compliance - or shall we say lack of compliance, has been elevated on the IRS radar screen. This increased attention, combined with the IRS s ever- increasing ability to obtain the cooperation of, and information from, foreign jurisdictions, suggest that more civil tax investigations relating to the proper disclosure of secret foreign bank or financial accounts by US citizens as well as an increase in criminal prosecutions for willful violations of Sections 5321 and 5322 are on the horizon. End Notes i. AUSA Sandra R. Brown currently serves in the Tax Division of the United States Attorney s Office for the Central District of California. The views expressed in this article are solely those of the author and do not necessarily represent the positions of the U.S. Department of Justice. ii. US Treasury Department, Report to Congress in Accordance Act Sec. 361(b) of P.L of the USA PATRIOT Act (April 26, 2002) ( Treasury Report ), at 6.

11 iii. 68 FR 26,468 (May 16, 2003)(codified at 31 CFR (g)). iv. Final Rule (RIN 1506-AA45)(May 15, 2003). v. 31 CFR (g)). vi. Treasury Report, supra note 7, at 8. vii. IRS News Release IR , June 17, 2008 ( viii. IRM ix. Department of Justice Press Release No ( x. Department of Justice Press Release No xi. Id. xii. Department of Justice Press Release No xiii. Department of Justice Press Release No ( xiv. United States v. Clines, 958 F.2d 278 (4 th Cir. 1992). xv. US Income Tax Return Form 1040, Schedule B, Part III Foreign Accounts and Trusts. xvi. Id. xvii. Form TD F ( FBAR ) Instructions. xviii. Id. xix. Written Statement of Kevin Brown, Commissioner, SB/SE Division of IRS Before Committee on Banking, Housing, and Urban Affairs, United States Senate (September 28, 2004), ( Statement of Kevin Brown ) at note 6. xx. Id. xxi. Treasury Report, supra, note 7, at 9. xxii. American Jobs Creation Act of 2004 ( Jobs Act ), Section 821. xxiii. 31 USC 5321(a)(3).

12 xxiv. 31 USC 5321(a)(5)(C)(i), as amended by the Jobs Act. xxv. 31 USC 5322(b). xxvi. 31 USC 5321(d). xxvii. 31 USC 5321(a)(5)(A). xxviii. 31 USC 5321(b)(1); 31 CFR Sec103.56(g)(2007). xxix. Williams v. Commissioner of Internal Revenue, 131 T.C. 6, Tax Ct. Rep. (CCH) 57,547, Tax Ct.Rep.Dec. (RIA) (October 2, 2008). xxx. 31 USC 5321(b)(2). xxxi. United States v. Simonelli, Slip Copy, 2008 SL (D.Conn. Sept. 30, 2008). xxxii. 26 USC 6694(a)(2)(A), as amended by the Emergency Economic Stabilization Act of 2008 (H.R. 1424), Sec 506, effective to returns prepared after May 25, xxxiii. 26 USC 6694(a)(2)(B), as amended. xxxiv. 26 USC 6694(a)(1)(B), as amended. xxxv. 26 USC 6694(a)(3), as amended. xxxvi. Circular 230; xxxvii. 31 USC 5322(a) xxxviii. 31 USC 5322(b). xxxix. 31 USC 5321(d). xl. US Guidelines Sentencing Manual, November 1, 2007 ( USSG ) 2S1.3(a)(2). xli. United States v. Bove, 155 F.3d 44 (2 nd Cir. 1998). xlii. Treasury Report, note 7, at 8. xliii. USSG 2T1.1. xliv. USSG 3D1.1; USSG 5G1.2.

13 xlv. USSG 2B1.1.