Washington – On December 15, 2011 (IR-2011-117), the IRS released guidance on foreign bank account reporting for income tax returns to be filed for calendar year 2011. A new annual tax form will be required for many taxpayers with foreign financial assets. Form 8938 (Statement of Specified Foreign Financial Assets) will be required to be filed by taxpayers if their foreign assets exceed certain thresholds. For example, a married couple living in the United States and filing a joint tax return would not file Form 8938 unless their specified foreign assets exceed $100,000 on the last day of the tax year or more than $150,000 at any time during the year. The new Form 8938 does not replace or otherwise effect a taxpayer’s obligation to file an FBAR (Report of Foreign Bank and Financial Accounts) or the “check the box” requirement on Form 1040, Schedule B if foreign financial assets are $10,000 or more.

 

The recent government foreign compliance initiative includes treasury regulations resulting from the Foreign Account Tax Compliance Act (“FACTA”) passed in March of 2010. FACTA was designed to identify US taxpayers avoiding their tax obligations on foreign taxable income. FACTA regulations include foreign entity tax compliance and reporting measures. Foreign banks or other foreign entities investing in US based assets or who have US residents as account holders are required to make identity disclosures. Without such identity disclosures, institutions will be required to institute a mandatory 30% income tax withholding regime on all US taxpayer income. The regulations as implemented under FACTA will result in increasing information available to the IRS as foreign institutions address ever-increasing compliance measures relating to US assets and US residents.

 

Washington – February 8, 2012, the IRS announced that it has reopened the offshore voluntary disclosure program – Amnesty III – with some changes.

 

This new voluntary disclosure program is similar to the Amnesty II program with a few key differences. For example, there is no set expiration date for Amnesty III disclosures. While Amnesty I & II had deadlines for voluntary disclosure applications, none exist for Amnesty III as we move forward into 2012 and beyond. The FBAR penalty increases to 27.5% for the highest aggregate account balance during 8 full tax years, and income tax understatement penalties continue to be assessed on Form 1040X filings. However, taxpayer eligibility exists for FBAR penalties under the maximum of 27.5% rate - some even as low as 5% of the highest account balance. See the penalty chart later in this website.

 

Form TD F 90-22.1, commonly referred to as the FBAR ("Report of Foreign Bank Account"), is the critical annual June 30^th filing for taxpayers with foreign financial accounts which include not only bank accounts and brokerage accounts but also foreign life insurance and annuity policies, as well as retirement plans.

 

The surprising truth is that it can be much more costly to fail to file an FBAR than failure to file an income tax return (Form 1040) which underreports income from foreign sources. FBARs are information returns but noncompliance can result in extremely severe civil penalties – up to the greater of $100,000 or fifty percent (50%) of the value of the account, per year - for willful failure to file an FBAR or filing a false FBAR.   

In recent years, many tax disclosure treaties have been signed including Switzerland, France, Germany, Italy, Spain, and the UK. Additional government compliance steps include lawsuits against major banks and US taxpayers as well as the passage of FACTA. The results of successful litigation, continuing legislation, and subsequent regulations have laid out a step-by-step process for account identification, information reporting, and withholding requirements for foreign financial institutions and US withholding agents.

The IRS has recently released FBAR guidance. Highlights are as follows:

Who must file? U.S. taxpayers, including U.S. citizens, non-resident aliens and business and trust entities, with foreign financial accounts with an aggregate value of more than $10,000 must file an FBAR.  

 FBAR PENALTIES LESS THAN 50%

Not well known to taxpayers or the tax practitioner community due to a lack of reported court cases is that the FBAR statute does not require the assessment of the onerous $100,000/fifty percent (50%) penalty. The following chart highlights the civil (and criminal) penalties that may be asserted under the FBAR initiative. Title 26 (Income Tax) penalties and FBAR penalties (Title 31) have different penalty structures and different government collection avenues.

 

 

It is difficult to obtain information on FBAR civil penalty cases which have been assessed in non-criminal, non-willful cases. These cases are settled/paid rather than litigated. It is clear, however, that the Treasury does make FBAR penalty assessments for less than the 50% penalty and even waives penalties based upon favorable factual circumstances. It is also clear that an FBAR penalty is not like an IRS income tax penalty. In income tax matters (Title 26 of the United States Code), upon tax assessment of a tax and penalty and the issuance of required taxpayer notices, federal statutes allow the IRS to simply issue a bank levy or wage garnishment for unpaid income taxes and penalties. No court order is required. IRS collection powers are built into the income tax statute for obvious revenue purposes.

With regard to non-income tax penalties such as FBAR penalties, we must look to the general statute controlling the collection of general government debt. The answer lies in reviewing Title 31, Subtitle III, United States Code § 3711, which covers United States government collection matters. The statute sets out the options of a government branch if a U.S. citizen or resident alien has not paid the government monies owed for one reason or another – including FBAR penalties.

U.S. Code § 3711 is very specific about the statute controlling all government collection matters under the law “except taxes and penalties of the Internal Revenue Code of 1986” (26 U.S.C. 1 et. seq.). It is Title 26 (income tax) and IRS collection practices which most individuals know and fear. Non Title 26 cases/collection matters do not have the teeth of the broad reaching collection authority given to the IRS, e.g., levy, garnishment, offset, foreclosure, tax lien filing, all without prior court consent. 

Section 3711 allows the head of the executive branch of government (in the case of FBARs, the Department of Treasury) to exercise certain powers to collect unpaid claims. U.S.C. § 3711(e). The executive branch must first give the debtor notice that a claim for monies is overdue and explain debtor rights. The government, in time, is authorized to disclose to a consumer reporting agency that the person is responsible for an unpaid government debt. In a written notice, the government agency must tell the debtor that he has the right “to a complete explanation of the claim, to dispute information in the records of the agency about the claim and to an administrative repeal or review of the claim.” U.S.C. § 3711(e)(iv). This is the controlling administrative collection procedure after an FBAR penalty has been assessed but remains unpaid.

Before disclosing debt information to a consumer reporting agency, the head of the executive agency shall provide, on request of a person subject to the government claim, an opportunity to “review the obligation of the person, including an opportunity for reconsideration of the initial decision on the claim.” U.S.C. § 3711(e)(ii). This section offers an administrative hearing for a taxpayer to justify FBAR non-compliance.

Finally, and perhaps most important for many taxpayers with foreign accounts, are their judicial rights under U.S.C. § 3711(g)(4)(C). At the discretion of the Secretary of Treasury, the executive branch may refer the non-tax claim to the Department of Justice for civil collection litigation. In other words, the government must file a federal lawsuit to obtain an enforceable court judgment against the FBAR debtor. There is no so-called FBAR tax lien or collectible FBAR assessment before the rendering of an order from a federal court.

The statute confers government discretions in that Treasury shall decide whether the non-tax claim shall be “collected, or compromised, or collection action suspended or terminated, in accordance with otherwise applicable statutory requirements and authorities.” Unclear is whether the Department of Treasury can make an income tax refund offset for a penalty under the FBAR statute before litigation and judgment. U.S.C. § 3711(g)(9) would suggest that a tax refund offset by Treasury is possible without a court judgment.

There is very little in the way of reported cases or information about FBAR penalties against taxpayers in non-criminal situations. There are a variety of reported civil cases in recent years where a taxpayer who has been indicted for criminal acts in the FBAR/foreign tax evasion area also has been subject to civil litigation in U.S. District Court with resulting civil judgments for penalties under the FBAR statutes (U.S.C. §§ 5321 and 5322.) The cases, with rare exception, address maximum 50% penalty issues.

Under Title 31 § 5321(b), the Secretary of Treasury may commence a civil action to recover a civil penalty assessed under Subsection (a) at any time before the end of the two year period from the date the penalty was originally assessed. There is a longer statutory period for civil actions in the case of criminal FBAR findings under U.S.C. § 5322.

It can therefore be stated unequivocally that FBAR civil penalty collection authority does not have the teeth of Title 26 Internal Revenue Service matters dealing with income tax, Social Security tax, Medicare tax, gift tax, estate tax, excise tax and a variety of other miscellaneous taxes under Title 26 of the United States Code. 

Several comments are in order when the Department of Justice files an action for judgment on an FBAR penalty in a United States District Court within the applicable two-year period from the date of the FBAR penalty assessment.

Let me bring to your attention a recent court case which highlights the lengthy process required of the government to obtain an enforceable judgment in FBAR civil penalty matters. I cite the recent case of United States of America v. Jon McBride, United States District Court, Utah, Case No. 2:09-cv-378-DB. The government filed a civil lawsuit against the defendant who had not paid an assessed FBAR penalty. The suit was filed in 2009 within a two-year limitation period (2010). The government filed a motion for summary judgment on the pleadings. The judge, by order dated February 24, 2011, pursuant to a hearing on the matter, denied the government’s motion for summary judgment on the FBAR penalty. A simple preponderance of evidence was not the appropriate judicial standard for the FBAR penalty at issue. The court did not rubber stamp the government’s request for a judgment and scheduled a pre-trial conference for May 12, 2012. The issue in the upcoming conference trial will be the taxpayer’s willfulness in not filing FBARs.

A collectible court judgment on the various FBAR penalties require the government to introduce evidence from mere preponderance of evidence in the modest penalty cases to proving willfulness in more severe FBAR penalty cases.

It is clear that taxpayers have specific rights in FBAR civil penalty matters which differ from income tax matters where taxpayers face the immediate and immense collection powers of the IRS.

Not well-understood is that non-amnesty voluntary disclosures by taxpayers generally will not result in criminal prosecution. Over the years this office has witnessed that taxpayer voluntary disclosures of past tax avoidance/tax evasion normally does not necessarily result in criminal prosecution. Often, an IRS criminal investigation does not result in an IRS criminal recommendation to the Department of Justice in voluntary disclosure cases. Those cases that do go forward based upon an IRS criminal prosecution recommendation have a history of being rejected by IRS District Counsel, the local United States Attorneys Office and/or the Department of Justice. 

 

Internal Revenue Manual 9.5.11.9(4) reflects general IRS voluntary disclosure guidelines outside the historic FBAR amnesty programs. The IRS, however, may take the position that voluntary disclosure in offshore matters will not be honored for treatment as a non-criminal matter unless the taxpayer notifies the IRS Criminal Investigation Division of its voluntary disclosure. What is a non-criminal matter? When the government cannot prove willfulness beyond a reasonable doubt.

 

In general, IRS disclosures are timely if received before:

 

a.     The IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation;

 

b.    The IRS has received information from a third party (e.g., informant, a foreign government or other government agency, or the media) alerting the IRS to a specific taxpayer’s non-compliance. A good example is UBS’s widespread disclosure of foreign accounts which started in 2009. If the government already knows about you, a disclosure will not avoid a criminal investigation.

 

c.     The IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena, current criminal matters).

 

The Internal Revenue Manual encourages that Special Agents of the IRS Criminal Investigation Division to consult with IRS attorneys on all voluntary disclosure cases coming to their attention. Taxpayers must make their voluntary disclosure before foreign banks or those in plea bargaining arrangements in sentencing matters turn over information to the IRS. There are dozens of financial advisors who have been indicted/plead guilty to offshore crimes that are presently turning over taxpayer names on a regular basis. A taxpayer who has already been identified by the IRS through these sources is not eligible for voluntary disclosure protection.

Normally, only civil income tax assessments and civil FBAR penalties are on the table with a successful voluntary disclosure. There are no guarantees, however, because of increasing attention paid by the government in foreign account non-compliance matters.

In this swirling enforcement environment, tax practitioners continue to be approached by clients seeking advice on how to clean up their offshore affairs before the government comes knocking at their door. The cases range across a broad factual spectrum from criminal matters under Title 26 and Title 31 and draconian penalty concerns under the FBAR statute down to taxpayers having reasonable cause enabling them to escape FBAR penalties. Between these two bookend positions is a minefield of uncertainty as to the outcome of taxpayer foreign account issues.

Amnesty I, Amnesty II, Amnesty III, newly required disclosure Form 8938, and FACTA are continuing attempts by the government to fight the foreign account compliance battle. Note Form 8938 requirements as an attachment to individual income tax returns (Forms 1040) from tax year 2011 going forward. Treaties continue to be passed and FACTA regulations continue to place reporting and withholding requirements and possible penalties on financial institutions.

Effective January 1, 2013 (The Jobs Act, Public Law 111-147), an amended Internal Revenue Code 6662 will require a 40% penalty be assessed against taxpayers if any portion of their foreign income tax understatement is attributable to an undisclosed foreign financial asset.

A careful analysis will determine if a taxpayer had reasonable cause for his noncompliance or willfully hid assets in foreign jurisdictions to evade taxes. In between these bookends are civil penalty issues such as negligence, taxpayer cooperation, voluntary disclosures, harm to the government through unpaid income tax dollars and the government’s burden of proof in federal courts before a FBAR penalty turns into an enforceable judgment.

Filing required returns, truthfulness and cooperation all help in addressing taxpayer affairs in the foreign account area. It is clear from the statutes, Internal Revenue written procedures, and case law that voluntary disclosure before a government investigation is the indicated path for most taxpayers. The manner and means of such disclosure and the reporting positions undertaken by the taxpayer must be determined with great care based on a careful analysis of all relevant facts of a particular case.