Continued from Part I

The Risks Associated With Making A Quiet Disclosure

What happens if the IRS disagrees with Joan, Tommy, or Trevor’s explanation for filing late FBARs? In other words, what if the IRS believes that their failure to file FBARs was not inadvertent or accidental, but instead willful?

This could result in any one of a number of “parade of horribles,” the most serious of which is a referral to Criminal Investigation. While that is generally the exception and not the rule, taxpayers should be mindful of the fact that, unlike OVDP, a “quiet disclosure” does not guarantee immunity from prosecution.

At the same time, if you thought that you could “change horses in midstream” and seek shelter in the OVDP bunker the moment the IRS questions your explanation, you are sadly mistaken. Unfortunately, it is too late. At the risk of sounding crass, the message that the IRS is sending is this: “You’ve made your bed so sleep in it!”

Taxpayers looking for guidance need look no further than the eminent archaeologist, Indiana Jones. In the same way that “Indie” had to choose between the “real” Holy Grail and the “fake” Holy Grail with the latter resulting in a gruesome death (i.e., decaying into dust) and the former resulting in eternal life, you must choose “wisely.”

Outside of criminal prosecution, what other risks could a taxpayer face? None other than FBAR penalties, the 800-pound gorilla of civil tax penalties. To the extent that a penalty is warranted, there are two types: non-willful and willful.

Both types have varying upper limits, but no floor. For example, the maximum nonwillful FBAR penalty is $ 10,000. And the maximum willful FBAR penalty is the greater of (a) $ 100,000 or (b) 50% of the closing balance in the account as of the last day for filing the FBAR.

There are two critical points to keep in mind when it comes to FBAR penalties. First, FBAR penalties are determined per account, not per unfiled FBAR. And second, penalties apply for each year of each violation. Taken together, this means that FBAR penalties can be aggregated, one on top of the other, catapulting one’s liability into the stratosphere.

Those who think that the likelihood of the IRS asserting multiple FBAR penalties, let alone multiple willful FBAR penalties, is ever so slight are sadly mistaken. If recent cases are any indication, not only has the IRS shown a willingness to assert multiple willful FBAR penalties that were enough to make Warren Buffet cry “uncle,” but it has done so with impunity.

For as malicious and mean-spirited as it might be, the IRS has support for its position. Indeed, it has wrapped itself in the “invisibility cloak” (the magical garment from the world of “Harry Potter” which makes anyone who wears it invisible) of recent circuit court decisions that have diluted the quantum of proof needed to establish “willfulness.” Therefore, it should come as no surprise that the IRS has been asserting willful FBAR penalties more aggressively now than it has ever done so before.

While the IRS could theoretically assert a willful FBAR penalty for any reason whatsoever — including for something as arbitrary and capricious as a dislike for the color of your shoes — keep in mind that just because the IRS thought that it was appropriate does not make it “official.” For example, you could challenge the assertion. In doing so, you’d be putting the IRS’s feet to the fire, by holding them up to their burden of proving “willfulness” in court. As illustrated in the Zwerner case, the IRS must prove willfulness to the satisfaction of a jury. And while willfulness need only be proven by clear and convincing evidence in the civil context, the fact remains that proving the existence of a mental state is easier said than done.

Even if the IRS can make out a colorable claim of willfulness, the taxpayer can mount a defense. Such defenses are grounded in “reasonable cause.”

The authority for the “reasonable cause” exception is found in the IRS Manual. The IRM approves of the “reasonable cause” guidance provided under 26 C.F.R. §1.6664, Reasonable Cause and Good Faith Exception to the § 6662 penalties.

Whether a taxpayer’s FBAR noncompliance was due to “reasonable cause” is based on a consideration of all the facts and circumstances. Factors that weigh in favor of a determination that an FBAR violation was due to reasonable cause include the following:

• The sophistication and education of the taxpayer;

• Whether there were recent changes to the tax forms or to the law that the taxpayer could not reasonably be expected to know;

• The level of complexity of the tax or compliance issue;

• Reliance upon the advice of a professional tax advisor who was informed of the existence of the foreign financial account;

• Evidence that the unreported foreign account was established for a legitimate purpose and that no effort was made to intentionally conceal the reporting of income or assets; and

• That there was no tax deficiency related to the unreported foreign account (or, if there was a tax deficiency, it was de minimis).

Other factors, in addition to those listed here, might weigh in favor of a determination that the failure to file an FBAR was due to reasonable cause. No single factor is determinative. It is a “facts and circumstances” test.

Factors that weigh against a determination that an FBAR violation was due to reasonable cause include the following:

• Whether the taxpayer’s background and education indicate that he should have known of the FBAR reporting requirements;

• The taxpayer’s compliance history (i.e., whether the taxpayer had been penalized before);

• Evidence that the unreported foreign account was established for an illegitimate purpose (i.e., sheltering money from the U.S. government);

• That the taxpayer failed to disclose the existence of the account to his tax preparer; and

• That there was a tax deficiency related to the unreported foreign account.

As with factors that weigh in favor of a determination that an FBAR violation was due to reasonable cause, there may be other factors that weigh against a determination that a violation was due to reasonable cause.

For those who think that the meaning of “reasonable cause” is as clear and precise a term as a modern household appliance, think again. Reasonable cause is a legal term of art that has spawned a substantial amount of case law. It is for this reason that taxpayers should always consult with a tax professional before relying upon reasonable cause as a defense to a civil penalty asserted by the IRS.

The takeaway is this: Taxpayers should carefully weigh their options before deciding to enter one of the IRS’s compliance-driven initiatives or the offshore voluntary disclosure program. Because the stakes are so high, this should never be done alone, but instead by consulting with an experienced tax professional.

Those who are feeling overwhelmed and perhaps even discouraged by this process can seek comfort in the words of the famous poet, Dylan Thomas. They offer inspiration to those who have raised their masts and begun their Maiden voyage into the “choppy seas” of foreign asset reporting:

Do not go gentle into that good night.

Rage, rage against the dying of the light.

Let’s Meet On TaxConnections.

Original Post By:  Michael DeBlis