“High” Risk or “Low” Risk Classifications

The intensity of Internal Revenue Service review for “low” risk taxpayers will be low. For these taxpayers, the IRS will NOT assert any penalties nor will the agency pursue any follow-up actions. The skeletal information provided by IRS indicates that in order to be “low risk”, the taxpayer will have tax owing of $1500 or less for each year and his tax returns will be simple ones. To date, we do not know exactly what the IRS means by “simple” returns, but high levels of income or assets, or significant amounts of income from US-sources will render a return not “simple”. I believe that the taxpayer’s involvement in foreign entities (e.g., CFC, foreign partnership or trust) will do the same thing.

“Higher” risk taxpayers will be subject to more intensive IRS scrutiny and can be asked for additional information or documentation. Such taxpayers will be subject to the ordinary tax penalties unless they can establish “reasonable cause”. Unfortunately there is no clear, bright-line rule as to what constitutes “reasonable cause”, and all the facts and circumstances will be examined. The IRS has given some broad guidance on this topic in the December 2011 Fact Sheet, referenced above. For example:

“Reasonable Cause”

Reasonable cause relief may be granted by the IRS when you demonstrate that you exercised ordinary business care and prudence in meeting your tax obligations but nevertheless failed to meet them. In determining whether you exercised ordinary business care and prudence, the IRS will consider all available information, including:

• The reasons given for not meeting your tax obligations;

• Your compliance history;

• The length of time between your failure to meet your tax obligations and your subsequent compliance; and

• Circumstances beyond your control.

Reasonable cause may be established if you show that you were not aware of specific obligations to file returns or pay taxes, depending on the facts and circumstances. Among the facts and circumstances that will be considered are:

• Your education;

• Whether you have previously been subject to the tax;

• Whether you have been penalized before;

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

• The level of complexity of a tax or compliance issue.

You may have reasonable cause for noncompliance due to ignorance of the law if a reasonable and good faith effort was made to comply with the law or you were unaware of the requirement and could not reasonably be expected to know of the requirement. Similar considerations are given in the case of FBAR non-filings.

What Should YOU Do?

In many cases, the taxpayer’s facts do not fit neatly into one option or the other. It is at such times that the professional advice of a competent tax advisor should be sought. The taxpayer should obtain a full understanding of the implications and possible penalties under each option. It is advisable that the matter is first discussed with an experienced US tax attorney. Discussion with legal counsel would be protected by attorney-client privilege. This is particularly important if the taxpayer ultimately decides not to make the disclosure to the IRS. In contrast, a consultation with a non-attorney (for example, with the taxpayer’s accountant) is not protected by the privilege. If the IRS discovers the foreign financial accounts or assets, the taxpayer’s accountant or other non-attorney could become a witness for the IRS against the taxpayer or be required to turn over records and documents. This would not be the case if an attorney had been consulted.

In accordance with Circular 230 Disclosure