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by: Anthony Parent 2017-02-18
No doubt, the uncertainty of being assessed willful FBAR penalties is a terror that many people are attempting to cope with. Some have entered into a Voluntary Disclosure program, some have created their own "soft-disclosure," and some are wondering if they should do anything at all. In this article, I will explain the process by which willful FBAR penalties are assessed, so hopefully, you will gain an understanding, an understanding that will give you some optimism and knowledge on how you can take control.
In order to sustain a willful penalty, the IRS must prove that
What the government likes to argue is that through the process of "willful blindness" the government can impute knowledge of the FBAR filing obligation to a taxpayer. A factual leap is then made to prove that someone acted willfully and had the specific intent to not file FBARs. But this argument falls apart under scrutiny.
Why? Someone could have actual knowledge of the FBAR yet not have a specific intent to commit a violation. In this was the case, no penalty could be assessed legally as both knowledge and specific intent are necessary to prove. For instance, if someone knew about the FBAR yet didn't think they needed to file one every year...or thought one was filed...or was assured by a legal expert they were exempt...or knew about the FBAR but forgot to file. While yes, there is a failure to file, there is no specific intent not to file. Thus, no Willful FBAR penalties should be assessed.
So if specific intent can be lacking where there is actual knowledge, then why is the government allowed to conjure specific intent where the government has imputed knowledge via its willful blindness mechanism?
"You're a smart guy, you must have known about the FBAR" is a common paraphrase of the accusations levied against taxpayers who didn't file. But this alone cannot sustain a Willful FBAR penalty. In addition, there must be a specific intent not to file. Even if a taxpayer knows about an FBAR and does not file an FBAR the government still has not met its burden in assessing FBAR penalties. We need to know why the taxpayer did not file one. Forgetting to file, or not thinking you need to file does not rise to specific intent.
Even in its own Internal Revenue Manual, the IRS appears to be confused, or at best seriously hedging its bets. First it claims willfulness might mean not checking "yes" on Part III line 7 of Schedule B:
An example that might involve willful blindness would be a person who admits knowledge of and fails to answer a question concerning signature authority at foreign banks on Schedule B of his income tax return. This section of the return refers taxpayers to the instructions for Schedule B that provide further guidance on their responsibilities for reporting foreign bank accounts and discusses the duty to file Form 90-22.1. These resources indicate that the person could have learned of the filing and recordkeeping requirements quite easily. It is reasonable to assume that a person who has foreign bank accounts should read the information specified by the government in tax forms.
I have written in the past why this Schedule B oversight does not, on its own, constitute willful blindness. Even the IRS agrees: the IRM then states "The mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness."
So how are revenue agents supposed to interpret this? They interpret what they can do, not what is fair.
Before the government has a federal case, as in the case of FBAR penalty litigation, it must first follow its administrative rules. It is imperative that you take this administrative portion absolutely serious. If the government does not follow its rules, it "should" lose in federal court. The best type of litigation is the type that never happens. Here, at the administrative level, you have that opportunity. It is critical you present the best possible story to the IRS and the most helpful evidence to demonstrate that you did not possess any willful intention.
The rules the IRS examiner, or auditor, must follow are located in the Internal Revenue Manual (IRM).In Section 22.214.171.124.5.3 of the IRM "FBAR Willfulness Penalty - Willfulness," we find some relevant criteria:
Willfulness is whether there was a voluntary, intentional violation of a known legal duty.
A finding of willfulness under the BSA must be supported by evidence of willfulness.
The burden of establishing willfulness is on the Service.
If it is determined that the violation was due to reasonable cause, the willfulness penalty should not be asserted.
Willfulness is shown by the person’s knowledge of the reporting requirements and the person’s conscious choice not to comply with the requirements. In the FBAR situation, the only thing that a person need know is that he has a reporting requirement. If a person has that knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR.
IRM 126.96.36.199.5.3.8 then gives some examples about where willful FBAR penalties should and should not be imposed. The IRM willful FBAR penalties examples are italicized with my commentary below each example.
A person admits knowledge of, and fails to answer, a question concerning signature authority over foreign bank accounts on Schedule B of his income tax return. When asked, the person does not provide a reasonable explanation for failing to answer the Schedule B question and for failing to file the FBAR. A determination that the violation was willful likely would be appropriate in this case.
Answers that could likely avoid willful FBAR penalties are that the software defaulted to "no," or that the taxpayer had no idea that unlike every other country, their foreign income was taxable. Why would they think that had to examine Schedule B, or even think there was any place on a tax return to put foreign income? A bad strategy is offering no explanation. Even though the IRS has the burden of proof, we can see in this example they are instructed to use your silence against you.
A person files the FBAR, but omits one of three foreign bank accounts. The person had closed the omitted account at the time of filing the FBAR. The person explains that the omission was due to unintentional oversight. During the examination, the person provides all information requested with respect to the omitted account. The information provided does not disclose anything suspicious about the account, and the person reported all income associated with the account on his tax return. The willfulness penalty should not apply absent other evidence that may indicate willfulness.
In this example, don't you notice something strange? The unreported bank account had no unreported income. Yet still, if there were evidence that the failure to file an FBAR was suspicious; the examiner is instructed that they can look to assess willful FBAR penalties. Does this seem completely insane? Well, actually this part isn't the insane part. Remember, the BSA was passed to deter international crime syndicates from using international banking as havens to keep their money and transfers safe from the prying eye of the US Treasury. So in fact, a penalty imposed where an account was used for criminal purposes but had no unreported income, well a penalty in that case would be more in line with the actual intent of FBAR.
But using unpaid Federal taxes to support a willful FBAR penalties seems odd where no claim of tax evasion charge was levied. That is, the argument is that a person negligently did not report all their income, yet they intentionally did not file an FBAR?
A person filed the FBAR in earlier years but failed to file the FBAR in subsequent years when required to do so. When asked, the person does not provide a reasonable explanation for failing to file the FBAR. In addition, the person may have failed to report income associated with foreign bank accounts for the years that FBARs were not filed. As with example a. above, a determination that the violation was willful likely would be appropriate in this case.
Sometimes you need to be absolutely sure that you have not overlooked any positive aspects to your reason you did not file. In this case, even a plausible reason is better than no reason. A plausible reason while it may not avoid all FBAR penalties, you may be assessed with less serious, and far smaller non-willful penalties or some sort of other FBAR penalty mitigation may apply. Again, the IRS will have to sue you in court to collect FBAR fines. So do you think there might be room for negotiation?
A person received a warning letter informing him of the FBAR filing requirement, but the person continues to fail to file the FBAR in subsequent years. When asked, the person does not provide a reasonable explanation for failing to file the FBAR. In addition, the person may have failed to report income associated with the foreign bank accounts. As with examples a. and c. above, a determination that the violation was willful likely would be appropriate in this case.
This is a very difficult, but not impossible, set of facts to overcome. As with our FBAR audit and OVDP opt-out clients, an FBAR warning letter is actually the result we hope to obtain. But after this FBAR warning letter is issued, it is safe to say that you are now aware that you have an obligation to report your foreign bank accounts and your worldwide income.
No doubt, the way the IRM is written and the way that many court decisions have gone, many people who have unreported FBARs are absolutely scared that the worst possible thing will happen --- that they will be assessed willful FBAR penalties whether in an OVDP opt-out or civil examination. And during this intimidation-induced panic, they fail to mount a defense to properly document and argue why they were not willful. Something we have always learned is to never give up hope. IRS agents do their best to follow the IRM and the actual law, and not appreciating the constraints they operate under leads people to bungle a case that was winnable. True, not every case can be 100% winnable, but every bad set of facts can be made better.