Willfulness And The Offshore Voluntary Disclosure Program v. The Streamlined Procedures: The Most Important Of Decisions

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1 Willfulness And The Offshore Voluntary Disclosure Streamlined Procedures: The Most Important Of Decisions By Danish Meherally, J.D., LL.M., International Tax Associate, Cherry Bekaert LLP, Atlanta Nearly 45 years ago, the United States Congress passed the Financial Recordkeeping and Reporting of Currency and Foreign Transactions Act, commonly referred to as the "Bank Secrecy Act" or "BSA." 1 The BSA required US citizens, residents or those doing business in the US to keep records and file reports of their non-us ("foreign") accounts. 2 The reporting specified that particular individuals that held either a financial interest in, or signature authority over a foreign bank account are required to file a form with the Internal Revenue Service ("IRS"). 3 This reporting is known as foreign bank account reporting, commonly referred to as "FBAR." While this law has been on the books for several decades and many people have accounts that would require reporting, few of these people have, until recently, actually reported those accounts. The IRS estimates that there may be as many as one million US taxpayers who have signature authority or control over a foreign bank account and may be required to file FBARs. Thus, the approximate rate of compliance with the FBAR filing requirements based on this information could be less than 20 percent. 4 This lack of reporting has "miffed the US government in general and IRS in particular " and as such the IRS has levied large penalties for non-compliance. 5 In addition to criminal penalties, civil penalties for non-compliance can range between USD25,000 and USD100,000 per violation. 6 In 2004, the BSA was amended to delineate penalties between those individuals who willfully and non-willfully violated FBAR reporting. The differentiation in penalties was, presumably, purposed to increase compliance with the reporting rules. This differentiation in penalties has, over the years, been furthered by several programs that allowed for those who had been non-compliant to come forth and become compliant with their reporting obligations with less fear of criminal prosecution and a smaller civil penalty. These programs have often been known as offshore voluntary disclosure programs ("OVDP") and have been offered in various incarnations since The IRS has gone further to promote compliance by offering "Streamlined" procedures for compliance. The Streamlined procedures were first offered in 2012 and continue to be offered currently. Even with the IRS pursuing increased compliance and offering various programs that reduce penalties, compliance has been hard to come by. In contrast to the above described civil penalties, the OVDP penalty is less burdensome, i.e., up to 50 percent of the highest aggregate value of OVDP assets for the period covered by the OVDP. 7 The OVDP allows for individuals that are willfully non-compliant to greatly reduce both their criminal and civil penalty exposure. While the OVDP is an attractive program for those willfully non-compliant individuals, those that are non-willful have an even more attractive program the Streamlined procedures. While the OVDP program allows for a shield from criminal prosecution along with reduced civil penalties, the Streamlined procedures limit the civil penalties to 5 percent of the aggregate balance of the covered assets for the covered time. 8 Also, because only those taxpayers that are non-willful may engage the Streamlined procedures, they are also not subject to criminal penalties due to their non-willful non-compliance. The stiff penalties combined with the programs that lessen the criminal and civil penalties have not led to significant compliance in the past. However, the decades long frustration fueled, in part, by the US Government's lack of ability to identify those individuals who either refuse to or do not know of the requirement to report their foreign accounts is likely coming to an end with the passage and implementation of the Foreign Account Tax Compliance Act ("FATCA"). FATCA was enacted in 2010 as part of the Hiring Incentives to Restore Employment Act ("HIRE"). FATCA requires foreign 1

2 financial institutions to report holders of accounts that are US citizens or residents to the US Government. If a report is not made then any payment made to such a foreign financial institution is subject to a 30 percent withholding. 9 This reporting is beginning to go into effect through various intergovernmental agreements signed between the US and governments around the world that allows for exchange of information related to US account holders. As such, many individuals that were previously non-compliant have been alerted to the fact that their identity as a US person and account holder will be disclosed to the US government and as a result they will be subject to the onerous criminal and civil penalties of the BSA. The effect of FATCA has therefore been for individuals to come forward voluntarily and disclose their assets held outside the US. The decision to voluntarily disclose and the method for doing so is a complex decision that could result in large civil penalties even in the absence of criminal penalties, and as a result the distinction between willful compliance and non-willful compliance is an important one. This is particularly true because once an individual files through the Streamlined procedures they may not then apply for the OVDP.10 Thus it is of utmost importance that an individual that is voluntarily disclosing assets be sure that they are non-willful before filing through the Streamlined program. Willfulness is a concept that US courts have dealt with for many decades. US jurisprudence has held that the term willfulness means a "voluntary, intentional violation of a known legal duty." 11 Knowledge of the willfulness standard is of paramount importance to tax professionals in this context because failure to appropriately assess the client's status can result in failure to be able to engage the Streamlined program and result in much more severe penalties. There are however recent cases that provide some specific guidance. The Fourth Circuit Court of Appeals, in 2012, decided US v. J. Bryan Williams. In this case, Williams, the taxpayer, failed to report his interests in two foreign bank accounts. The IRS brought an action pursuant to 31 U.S.C for a willful failure to report his interest in those bank accounts. 12 The issue in the case was whether or not Williams was willful in his noncompliance. In 2001 Williams completed a "tax organizer" for tax year 2000 which was provided to him by his accountant. Among the questions asked in that organizer the taxpayer answered "No" to whether or not he had "an interest in or signature or other authority over a bank account, or other financial account in a foreign country." 13 Moreover, in response to IRS Form 1040, line 7a in Part III of Schedule B for tax year 2000, the taxpayer answered "No" to the question: "At any time during 2000, 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?" Subsequently, the taxpayer fully disclosed the foreign accounts in 2002 to an IRS agent upon advice from legal counsel. The taxpayer also filed his 2001 federal tax return on which he indicated his interest in the Swiss accounts. Also, as part of an application to participate in an Offshore Voluntary Compliance Initiative, the taxpayer noted his interest in the Swiss accounts. At the time of submitting that application the taxpayer also amended his 1999 and 2000 returns and disclosed the Swiss accounts at that time. In 2003, the taxpayer pled guilty to criminal charges of defrauding the IRS and criminal tax evasion in connection with the amounts held in the Swiss accounts. As part of his plea deal, the taxpayer agreed to "allocute to all of the essential elements of the charged crimes, including that he unlawfully, willfully and knowingly evaded taxes by filing false and fraudulent tax returns on which he failed to disclose his interest in the (Swiss) accounts." 14 Thereafter, in 2007, the taxpayer, filed his FBARs for each year between 1993 and 2000 and the IRS assessed two USD100,000 penalties against him. The District Court ruled that the taxpayer's non-compliance was not willful because the taxpayer: "lacked any motivation to willfully conceal the accounts from authorities" because they were already aware of the accounts and his failure to disclose the accounts "was not an act undertaken intentionally or in deliberate disregard for the law but instead constituted an understandable omission given the context in which it occurred." 15 On appeal, the Fourth Circuit Court of Appeals noted that "[w]illfulness may be proven through inference from conduct meant to conceal or mislead sources of income or other financial information," and it "can be inferred from a conscious effort to avoid learning about reporting requirements." 16 The Fourth Circuit went on to note that "willful blindness may be inferred where a defendant was subjectively aware of a high probability of the existence of a tax liability, and purposefully avoided learning the facts point to such liability." 17 The Court also noted that in cases where willfulness is a condition for 2

3 civil liability it is present in cases of recklessness as well as unknowing. 18 In this case, the taxpayer signed his 2000 federal tax return affirming, under penalty of perjury, that he had examined his 2000 return and all schedules and statements and that all of the responses therein were true, accurate and complete. The Court notes that "a taxpayer who signs a tax return will not be heard to claim innocence for not having actually read the return, as he or she is charged with constructive knowledge of its contents." 19 The Court found that "Williams's signature is prima facie evidence that he knew the contents of the return, and at a minimum line 7a's directions to '[s]ee instructions for exceptions and filing requirements for Form TD F ' put Williams on inquiry notice of the FBAR requirement." 20 The Court points out that the taxpayer testified that he did not read line 7a of the return nor did he consult the instructions to the FBAR, and as such he made a "conscious effort to avoid learning about reporting." 21 The Court reasons that the taxpayer's untrue answers to the questions on both the tax organizer and the return itself indicates his intent to conceal or mislead sources of income. The Court specifically notes that: "[I]t is reasonable to assume that a person who has foreign bank accounts would read the information specified by the government in tax forms. Evidence of acts to conceal income and financial information, combined with the defendant's failure to pursue knowledge of further reporting requirements as suggested on Schedule B, provide a sufficient basis to establish willfulness on the part of the defendant. This conduct constitutes willful blindness to the FBAR requirement." 22 The Court deemed the fine imposed by the IRS appropriate under the willfulness standard because of the taxpayer's answer to Form 1040, line 7a, Schedule B and his signature attesting to the truth of that information. The willfulness, as the Court noted, is the result of the taxpayer's reckless non-compliance with FBAR reporting. In addition to the above detailed case, the US District Court for Utah was also presented with the issue of defining willfulness for purposes of the FBAR. In US v. McBride, USTC 5066, McBride, the taxpayer, opened and maintained four foreign bank accounts during tax years 2001 and These foreign bank accounts each carried balances in excess of USD100,000 for the tax years at issue. The taxpayer in this case did not file FBARs for the tax years at issue. Furthermore, the taxpayer responded in the negative on his 2000 tax return Form 1040, line 7a, Schedule B related to whether or not he had any interest in a foreign bank account. Form 1040 was signed by the taxpayer and properly filed. The taxpayer filed his 2001 return in a similar manner as the 2000 return as it related to the presence of any interest in a foreign bank account. In 2001 the taxpayer was also told by advisers that he must disclose any interest in foreign bank accounts on his tax returns. Moreover, during subsequent IRS examinations the taxpayer repeatedly represented to IRS examiners that he did not have any interest in foreign bank accounts. As a result of the taxpayer's failure to file FBARs for the tax years at issue, the IRS assessed the taxpayer a civil penalty of USD100,000 for each tax year at issue, 2000 and 2001, under 31 U.S.C. 5314(a). In that case, the District Court notes that "where willfulness is a condition of civil liability, it covers 'not only knowing' violations of a standard, but reckless ones as well." 23 The Court goes on to note that "willfulness may be satisfied by establishing the individual's reckless disregard of a statutory duty, as opposed to acts that are known to violate the statutory duty at issue improper motive or bad purpose is not necessary to establish willfulness in the civil context." 24 The Court further states: "The Supreme Court recently confirmed that acting with 'willful blindness' to the obvious or known consequences of one's action also satisfies a willfulness requirement in both civil and criminal contexts." 25 Expounding on the willful blindness standard, the Court goes on to state that "[w]here a taxpayer makes a 'conscious effort to avoid learning about reporting requirements,' evidence of such willful blindness is a sufficient basis to establish willfulness." 26 Having established the definition of willfulness, the Court notes that the only other case to examine willfulness in the context of an FBAR penalty is US v. Williams and goes on to affirm the proposition that a taxpayer's signature on a return is prima facie evidence that the signer knows the contents of the return. 27 The Court further states: "On the other hand, knowledge of what instructions are contained within the form is directly inferable from the contents of the form itself, even if it were a blank. If this court were to read Mohney (US v. Mohney, 949 F.2d 1397, (6th Cir. 1991)) otherwise, that result 3

4 would conflict with the well-established legal principle that citizens are charged with knowledge of the law." 28 While there are other facts that lead the Court to its conclusion, the Court reasons that: "Knowledge of the law, including knowledge of the FBAR requirements, is imputed to [the taxpayer]. The knowledge of the law regarding requirement to file an FBAR is sufficient to inform [the taxpayer] that he had a duty to file a Form TD F [now FinCen Form 114] for any foreign account in which he had a financial interest. [The taxpayer] signed his federal tax returns for both the tax year 2000 and Accordingly [the taxpayer] is charged with having reviewed his tax return and having understood that the federal income tax return asked if at any time during the tax year, he held any financial interest in any foreign bank or financial account. The federal income tax returns contained a plain instruction informing individuals that they have the duty to report their interest in any foreign financial or bank accounts held during the taxable year. [The taxpayer] is therefore charged with having had knowledge of the FBAR requirement as indicated by his signature on the federal income tax returns for both 2000 and 2001." 29 Having imputed knowledge of the FBAR requirement to the taxpayer and assigning willfulness through both reckless disregard and willful blindness, the Court determines that the assessed FBAR penalties are proper. 30 The immediate conclusion of Williams and McBride is that willfulness is a broadly defined concept that encompasses a wide swath of actions but clearly includes at least a thorough examination of a taxpayer's answer to the question on Form 1040, line 7a, Schedule B that specifically asks if the taxpayer has a financial interest in a foreign bank account. Moreover, if the answer to this question is marked "No" and the taxpayer signs and files the return, then courts have upheld the proposition that those taxpayers have been willfully non-compliant with the FBAR requirement and as such they would not be eligible for the Streamlined program. They are thus exposed to a far larger civil penalty and cannot seek refuge in the OVDP. Therefore, it is of great importance that a tax professional gather all of the facts and circumstances of each individual taxpayer's previous FBAR and Form 1040 status before making an election to apply for the Streamline or OVDP program. Endnotes: 1 31 U.S.C et seq., Pub. L. No U.S.C. 5314(a) C.F.R (2005). 4 US Dep't of the Treasury, A Report to Congress in Accordance with 361(b) of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of (USA Patriot Act) 12 (April 26, 2002). 5 Hale E. Sheppard, Evolution of the FBAR: Where we were, Where we are, and Why it Matters, 7 Hous. Bus. & Tax L.J. 1 (2006) U.S.C. 5321(a)(5)(B)(ii). 7 Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers. 8 Streamlined Filing Compliance Procedures for US Taxpayers Residing in the United States Frequently Asked Questions and Answers U.S.C Supra, note Cheek v. US, 498 US 192, 201 (1991); US v. Bishop, 412 US 346, 360 (1973); US v. Sturman, 951 F.2d 1466 (6th Cir. 1991). 4

5 12 US v. J. Bryan Williams, 4th Cir. (2012) 13 Id. 14 Id. 15 Id. 16 Id. at 3, quoting US v. Sturman, 951 F. 2d 1466, 1476 (6th Cir. 1991) (noting willfulness standard in criminal conviction for failure to file an FBAR). 17 Id. quoting US v. Poole, 640 F.3d 114, 122 (4th Cir. 2011). 18 Id. 19 Id. at 4, quoting Greer v. Commissioner of Internal Revenue 595 F. 3d 338, 347 (6th Cir. 1991). 20 Id. 21 Id. quoting US v. Sturman 951 F.2d at Id. quoting US v. Poole 640 F. 3d at Id. at 15, quoting Safeco Ins. Co., 551 US at 57; cf. US v. Illinois Central R. Col., 303 US 239, (1938). 24 Id. 25 Id. quoting Global-Tech Appliances, Inc. v. SEB S.A., 131 S. Ct 2060, (2011). 26 Id. quoting US v. Williams, Case No , 2012 WL , at 4 (4th Cir. July 20, 2012). 27 Id. 28 Id. at 17. See US v. Mohney, 949 F.2d 1397, (6th Cir. 1991). 29 Id. at Id. at 22. 5