The IRS has some established programs available for clients that have not disclosed foreign assets or ownership interests in foreign entities (or reported income from such foreign interests). Generally, using one of these options is superior to a “quiet disclosure” for several reasons that depend upon the option used and relevant facts in the client’s particular situation. Failure to comply the Bank Secrecy Act (FBAR/FinCen Form 114) disclosure requirements, and Foreign Account Tax Compliance Act disclosure requirements, and other filing, reporting and disclosure requirements can bring substantial monetary and/or criminal penalties.
Recently, along with other fellow practitioners, I’ve seen increased IRS vigor with penalty enforcement. Penalties can generally run $10,000 per form to start with (and penalties approaching or exceeding $100,000 is quite common in situations in which fairly minor disclosure was necessary over a period of only 3 or 4 years).
Generally, while a “reasonable cause” argument can be used avoid penalties, the reasonable cause test is not an easy standard to meet and not an easy argument to make. Reasonable cause is based on all the facts and circumstances, and the taxpayer must establish that ordinary business care and prudence was used to meet filing obligations, but the taxpayer was nonetheless unable to do so. Generally, the taxpayer must demonstrate circumstances existed beyond the taxpayer’s control to meet the reasonable cause standard.
Using one of the IRS programs can mean substantially reduced or eliminated penalties (and in some cases, no criminal conviction) for a client who wishes to “catch up” and fully comply with U.S. foreign asset disclosure requirements.
Briefly, the IRS Streamlined Domestic Offshore Procedure (for taxpayers residing in the U.S.) and Streamlined Foreign Offshore Procedure (for taxpayers living outside the U.S.) are available, established programs for clients to make the necessary disclosures with minimal penalties. The Offshore Voluntary Disclosure Program (OVDP) is also available for taxpayers who wish to comply with foreign asset and income disclosure.
Each of these programs has certain qualifications that the taxpayer must meet in order to use the program and benefit from reduced or eliminated penalties. The key qualification that separates the Streamlined Procedures from the OVDP is that of willful conduct. The Streamlined Procedures are reserved for taxpayers whose failure to disclose foreign assets was a result of non-willful conduct. For taxpayers whose failure to comply with U.S. tax law in this area was willful, the OVDP may be an option.
The concept of willfulness is defined in various places by the IRS, and generally constitutes conduct that is “voluntary, conscious, and intentional” (according to the definition found in Treasury regulations. The Internal Revenue Manual defines willful conduct as “voluntary, intentional violation of a known legal duty” at IRM 4.26.16.6.5.1 (11-06-2015) in the rules associated with FBAR compliance. The "willfulness" inquiry is entirely different than that for "reasonable cause".
Distilled down to its essence, “willfulness” means that the taxpayer acted with knowledge that failing to report or disclose foreign assets or foreign income, was unlawful. Absent an admission on the taxpayer’s part, willfulness is usually established and proven by the IRS through circumstantial evidence regarding the client’s conduct.
Determining whether a noncomplying client can use the Streamlined Procedures instead of the more rigorous (and expensive) OVDP hinges upon careful assessment about whether the client’s nondisclosure was willful (including client actions, inactions, communications, and other fact-specific items and the documentation that exists that indicates whether willful conduct existed). The stakes are frequently very high in the face of penalties because a client who makes use of the Streamlined Procedures is precluded from OVDP participation. Moreover, once a client pursuing the OVDP path similarly closes the door to the Streamlined Procedures (absent very narrow circumstances).
Clearly, the willfulness inquiry is all-important in advising the taxpayer in this high-stakes area. What is less clear is what sorts of conduct may constitute willfulness. In part, this is because such conduct is typically very specific to the client’s fact pattern and what the client’s particular actions (or inactions) were. Cases vary greatly from client to client but court cases and lengthy experience with IRS Streamlined and OVDP submissions have indicated some basic “rules of thumb” regarding conduct that the IRS may construe as willful. Since a totality of facts and circumstances are taken into account in a typical case, any one of these generally won’t tip the scale to a conclusion of willfulness, but they could be indicative of such behavior.
- Failure to accurately answer (or answer at all) questions on a tax return about interests in foreign accounts, or an interest in a foreign trust. Note that these questions not only appear on Schedule B, Part III, but similar questions also exist on entity returns, too.
- Filing the required forms (FinCen Form 114, or Forms 8938, 926, 8858, 8865, 5471 or other forms) and omitting information about one or more accounts, interests, or transactions
- Filing a late FinCen Form 114 or without providing any reasonable explanation about the failure to originally file on a timely basis
- Establishing accounts or entities in known tax havens
- Opening a foreign account without a business purpose or other non-tax avoidance purpose (ie. no family or business connection with the foreign jurisdiction)
- Instructing the foreign financial institution to forego issuing or sending periodic statements regarding funds or assets within an account
- Taking regular trips to the location of the foreign account or asset that was not disclosed and/or using money for personal expenses from an unreported account through use of cash withdrawals or through issuing checks or fund transfers to other accounts
- Failure to obtain professional tax advice or reliance upon the advice of a promoter, foreign advisor or unqualified tax professional
- Using an offshore entity or a complex multi-entity “chain” to own foreign assets or establishing a nominee to own such interests
- Failure to report the income from the undisclosed foreign asset
- Other tax compliance on part of the taxpayer (and compliance with filing other required forms, such as those with the SEC or other federal agency, state agencies, and state tax forms).
- Steps taken to conceal existence of the foreign entity or assets, or communications with the foreign financial institution about the assets or accounts
- Moving the foreign account or asset, especially when a foreign financial institution falls under IRS ( or other U.S.) investigation or otherwise frequently moving assets or accounts, or moving funds among family members
- Making a “quiet disclosure” to attempt to comply with foreign asset reporting requirements
- Destroying paperwork, communications, or statements involving the establishment of the foreign account or ownership interest
- Engaging in a pattern of conduct where the pattern itself indicates deliberate action or inaction
- Having a level of education or sophistication that indicates the taxpayer knew about filing requirements but deliberately failed to file the forms (for example, an accountant who routinely files required foreign asset disclosure forms for clients, but not for his or her own foreign assets)
- Conduct indicative of “willful blindness” (ie. conduct that indicates a deliberate avoidance of learning about the relevant rules and requirements)
Given the very high civil and criminal penalties associated with failure to comply with the foreign asset disclosure requirements, careful tax practitioner due diligence with the taxpayer in determining whether willful conduct exists, and in presenting the facts to the IRS in a Streamlined or OVDP submission is very critical to the successful use of these programs and bringing the taxpayer into full compliance.
Note. If you have clients that have not properly filed FinCen Form 114, Form 8938 in connection with specified foreign financial assets, or have not filed required international information returns in connection with interests or transactions with foreign entities (such as Forms 926, 3520 and 3520-A, 8865, 8858, 5471 or 5472) or Form 8621 associated with PFIC holdings, (or if you are unsure whether a particular client should be filing these forms) contact me. I would be pleased to address any questions you may have. My direct line here in Boston is 617-761-0520 or email me at mlovell@cbiztofias.com