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Just How Serious Is IRS Asserting FBAR Penalties?

The IRS has authority to assert FBAR civil penalties.  Before delving into the FBAR abyss, this is a good time to debunk some FBAR myths.  First, there is no such thing as an FBAR penalty within the Offshore Voluntary Disclosure Initiative (“OVDI”).  The FBAR penalty exists only outside of the OVDI framework.  However, there is a penalty within OVDI that is often considered to be the equivalent of the FBAR penalty.  That penalty is commonly referred to as the offshore penalty.  Generally, it is 27.5% of the highest aggregate balance of all foreign accounts during the disclosure period but lower rates are available.

Where a taxpayer does not come forward into OVDI and has now been targeted by IRS for failing to file FBAR’s, the IRS may now assert FBAR penalties that could be either non-willful or willful.  Both types have varying upper limits, but no floor.  The first type is the non-willful FBAR penalty.  The maximum non-willful FBAR penalty is $ 10,000.  The second type is the willful FBAR penalty.  The maximum willful FBAR penalty is the greater of (a) $ 100,000 or (b) 50% of the total balance of the foreign account.  In addition the IRS can pursue criminal charges with the willful FBAR penalty.

For the non-willful penalty, all the IRS has to show is that an FBAR was not filed.  Whether the taxpayer knew or did not know about the filing of this form is irrelevant.  The non-willful FBAR penalty is $10,000.00 per account, per year and so a taxpayer with multiple accounts over multiple years can end up with a huge penalty.

But if the IRS attempts to assert a willful FBAR penalty, the IRS has the burden of proving willfulness.  Willfulness has been defined by courts as “an intentional violation of a known legal duty.”

While the standard for proving willfulness in the context of a criminal tax case is relatively clear, just the opposite is true in the context of asserting a civil FBAR penalty.  For FBAR violations the standard is that a person had knowledge that he has a reporting requirement.  And if a person has that requisite knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR.  The latter is referred to in legal circles as the theory of “willful blindness”.

4th Circuit Court Established Low Standard For Proving Willfulness

In one fell swoop, the 4th Circuit Court Of Appeals, which is one of eleven in the United States and ranks right below the United States Supreme Court, lowered the burden of proof needed by IRS to show that the failure to file an FBAR was intentional.

The 4th Circuit ruled that a taxpayer’s signature on his tax return was “prima facie evidence that he knew the contents of the return” and that the instructions in Schedule B, which refers to whether the taxpayer has any foreign accounts put U.S. taxpayers on “inquiry notice” of the FBAR filing requirement. It does not matter that the taxpayer never read his tax return or looked at the FBAR form.  The Court went on to say that this was enough to demonstrate a “conscious effort to avoiding learning about reporting requirements… meant to conceal or mislead sources of income or other financial information… that constitutes willful blindness to the FBAR requirements”. U.S. v. J. Bryan Williams, No. 10-2230, July 20, 2012 (unpublished).

In other words, the instructions in Schedule B for Form 1040, which refers to the FBAR, puts every taxpayer on “inquiry notice” of the filing requirement and so a taxpayer by simply signing his tax return or authorizing the filing of his tax return is presumed to be cognizant of the FBAR requirement.

The practical effect of this opinion is nothing short of mind blowing.  First, instead of having to prove a specific intent to “violate a known legal duty” which other tax cases have upheld as the standard for willfulness, the opinion suggests that a taxpayer’s presumed understanding of the FBAR requirement may be enough to make him liable for penalties for willful violations.  In other words, whether a person actually knew about the FBAR reporting requirements is meaningless.

Second, it gives a major boost to the IRS’s current intensive pursuit of overseas tax evasion by making it easier for the IRS to prove willfulness in the context of a willful FBAR penalty.  Very simply, the IRS now has enormous leverage to collect the hefty penalties that accompany the willful FBAR penalty.  Indeed, the civil penalty for willfully failing to file an FBAR may reach $100,000, or 50% of the value of the offshore account, whichever is greater.  This result is likely to be the start of a wave of FBAR audits for the IRS because of the sheer sums the IRS stands to collect by ramping up civil FBAR enforcement.

Offshore Voluntary Disclosure Initiative (“OVDI”)

This program was first created in 2009 as the Offshore Voluntary Disclosure Program (“OVDP”) but in 2011 was renamed to OVDI.  Generally, the miscellaneous offshore penalty under the OVDI program (the “OVDI penalty”) equals 27.5% of the highest aggregate balance in the foreign assets or entities during the years covered by the OVDI program, but may be reduced in limited cases to 12.5% or 5%.  Certain taxpayers may qualify for even greater savings through a reduction of the offshore penalty.

Taxpayers participating in the ongoing 2012 OVDI generally agree to file amended returns and file FBARs for eight tax years, and in addition to paying pay the OVDI penalty (which is assessed in lieu of all other potentially applicable penalties associated with a foreign financial account or entity) taxpayers would pay the appropriate taxes and interest together with an accuracy related penalty equivalent to 20% of any income tax deficiency

Taxpayers whose highest aggregate foreign account balance is less than $75,000 for each of the years in the OVDI disclosure period may qualify for a reduced 12.5% OVDI penalty.

Taxpayers who fall into one of three specific categories may qualify for a reduced 5% OVDI penalty.  The first category includes taxpayers who inherited the undisclosed foreign accounts or assets.  Second, taxpayers who are foreign residents and who were unaware that they were U.S. citizens may qualify for a reduced 5% OVDI penalty.  Finally, U.S. taxpayers who are foreign residents may also qualify for the reduced 5% OVDI penalty in certain circumstances.

What Should You Do?

Don’t wait for the IRS to find you.  If you have never reported your foreign investments on your U.S. Tax Returns or even if you have already quietly disclosed, you should seriously consider participating in the IRS’s 2012 Offshore Voluntary Disclosure Initiative (“OVDI”). Once the IRS contacts you, you cannot get into this program and would be subject to the maximum penalties (civil and criminal) under the tax law. Taxpayers who hire an experienced tax attorney in Offshore Account Voluntary Disclosures should result in avoiding any pitfalls and gaining the maximum benefits conferred by this program.

Protect yourself from excessive fines and possible jail time. Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Francisco, San Diego and elsewhere in California qualify you for OVDI.

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