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 taxpayers with foreign 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. Thresholds for U.S. citizens who reside abroad need not file Form 8938 unless the value of specified foreign assets exceeds $400,000 on the last day of the tax year or more than $600,000 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.

Washington – On September 15, 2011, IRS Commissioner Shulman, in an IRS newswire referencing the completed 2009 and 2011 IRS amnesty programs for FBAR noncompliance, made the following comments. Commissioner Shulman said:

 “My goal all along was to get people back into the U.S. tax system. Not only are we bringing people back into the U.S. tax system, we are bringing revenue into the United States Treasury and turning the tide against offshore tax evasion. … We have changed the risk calculus. Americans now understand that if they try to hide assets overseas, the chances of being caught continue to increase.” 

Amnesty I, which ended on October 15, 2009, and Amnesty II, which ended on September 9, 2011, led to 30,000 voluntary disclosures. The two amnesty programs provided the IRS with a wealth of information from various foreign banks and identified advisors assisting taxpayers with offshore tax evasion schemes. The IRS is currently using this information to continue its international enforcement efforts. Amnesty I and Amnesty II may be over, but IRS enforcement efforts relating to unfiled or incorrect FBARs continues. FBAR refers to that crucial annual June filing for taxpayers with foreign financial accounts which include not only bank accounts and brokerage accounts but also foreign life insurance and annuity policies, and retirement plans.

The surprising truth is that it can be more damaging 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.   

By way of historical background, UBS AG (Union Bank of Switzerland) agreed in 2009, pursuant to a federal lawsuit in Florida, to continuing disclosures of foreign account information to settle a U.S. lawsuit against UBS seeking the names of U.S. residents (both citizens and resident aliens) suspected of evading U.S. income taxes through 52,000 UBS accounts. UBS has been making continuing Swiss account information available to the IRS since late 2009. The controlling case is U.S. v. UBS AG, 09 cv 20429, U.S. District Court, Southern District of Florida.

Other foreign banks, including Credit Suisse, Clariden Leu, HSBC and banks in Liechtenstein are currently caving in to U.S. authorities in a continuing pattern of disclosure of foreign accounts held by U.S. residents. Many Department of Justice lawsuits have been filed.

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. 

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 for not complying with FBAR requirements. 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. It is also clear that an FBAR penalty is not like an IRS income tax penalty. In income tax matters (Title 26), upon tax assessment of a penalty and the issuance of required taxpayer notices, federal statutes allow the IRS to simply issue a taxpayer 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 government collection of general 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 IRS Title 26 (income tax) 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 an 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). Any executive branch of the government first must give the debtor notice that the 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 must first 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 collection administrative procedure after an FBAR penalty has been assessed but remains unpaid.

Therefore, 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). 

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 judgment against the debtor. There is no so-called FBAR tax lien or FBAR judgment before the rendering of an order from a federal court.

This statute confers government discretions in that Treasury shall decide whether the non-tax claim be “collected, or compromised, or collection action therefore 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 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.

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 that FBAR civil penalty collection authority does not have the teeth of Title 26 Internal Revenue matters dealing with income tax, Social Security tax, Medicare tax, gift tax, estate tax, excise tax and a variety of other taxes under Title 26 of the United States Code. Several comments are in order when the government, under its discretion, decides to file an action for judgment on an FBAR penalty in a United States District Court within two years of the date of the penalty assessment.

Let me bring to your attention a recent court case which highlights the lengthy process of government efforts 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 the assessed FBAR penalty. The suit was filed in 2009. In 2010, the government filed a motion for summary judgment on the pleadings. The judge, by order dated February 24, 2011, that pursuant to a hearing on the matter, denied the government’s motion for summary judgment on the FBAR penalty. A preponderance of evidence is not the appropriate judicial standard. 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 trial will be the taxpayer’s willfulness in not filing FBARs.

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

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

A post amnesty voluntary disclosure by taxpayers generally will not result in criminal prosecution. Over the years this office has seen that taxpayer voluntary disclosures of past tax avoidance/tax evasion normally does not result in criminal prosecution. Often, an IRS criminal investigation does not result in a criminal recommendation 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 amnesty programs of 2009 and 2011. 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. This type of disclosure is used by taxpayers who are concerned about possible criminal charges.

 

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 disclosures which started in 2009 – if the government 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 consult with IRS attorneys on all voluntary disclosure cases coming to their attention. Taxpayers must make their voluntary disclosure before foreign banks or criminal subjects 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 who 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 offshore voluntary disclosure protection.

Normally, civil income tax assessments and civil FBAR penalties become the issue with a successful voluntary disclosure. No criminal charge – but civil penalty issues are on the table.

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 outcome of taxpayer foreign account issues.

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.

Amnesty I and Amnesty II were only two attempts by the government to fight the foreign account compliance battle. Note the Form 8938 requirements for attachments to 2011 income tax returns as mentioned above.

Effective January 1, 2013, the Jobs Act, Public Law 111-147, passed on March 18, 2010, contains additional provisions in the government’s quest to combat offshore tax evasion. Generally, a foreign financial institution will be subject to a 30% U.S. withholding tax on the income of their U.S. resident taxpayer accounts unless the foreign financial institution agrees to required reporting. The foreign institution must agree to annual reporting of information with respect to its U.S. accounts, including name, address, tax identification number, account balance, and Form 1099 like information.

In addition, effective January 1, 2013, 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 and voluntary disclosures, harm to the government through unpaid income tax dollars and the government’s burden of proof in federal district court before a FBAR penalty turns into an enforceable judgment.