navigating the choppy seas of the streamlined procedures

The Streamlined Procedures

Major Changes

• On June 18, 2014, the IRS overhauled the Offshore Voluntary Disclosure Program while expanding and modifying the streamlined filing procedures in order to accommodate a broader group of U.S. taxpayers.

• These changes amount to the IRS’s latest effort to promote tax compliance and to crack down on offshore tax evasion, which has been an agency priority for years.

• Experts predict that these programs will ease the financial and legal pain for almost six million expatriate Americans who live and work abroad, many of whom were utterly naïve about FBAR-reporting.

Major Changes

• Major changes to the streamlined procedures include the following:

(1) expansion of eligibility to a wider population of U.S. taxpayers, namely those residing in the U.S.;

(2) elimination of the $ 1,500 tax threshold; and (3) elimination of the risk assessment process associated with the 2012 streamlined filing

compliance procedures.

Fundamental Tenet of Streamlined

They relax the penalties that a taxpayer with an overseas account might otherwise face for

failing to disclose a foreign account.

Two Types

(1) Streamlined Domestic Offshore Procedures(2) Streamlined Foreign Offshore Procedures

Streamlined Foreign

• Overview– U.S. taxpayers living abroad (or their estates) who

disclose their foreign accounts and settle their U.S. tax bills under the Streamlined Foreign Offshore Procedures won’t be charged any penalties. Instead, they will simply owe back taxes and interest.

Streamlined Foreign

– Right about now, you might be asking yourself the question, “Did I hear you right? There is no miscellaneous penalty under the Streamlined Foreign Offshore Procedures? You must be pulling my leg!” No, you heard right.

– Also eliminated was the requirement that the unpaid tax be $ 1,500 or less a year – a low ceiling that most people exceeded. There will now be no limit.

Streamlined Domestic

• Overview:

– At the same time, the IRS extended an olive branch to Americans living in the U.S. with undisclosed foreign accounts (or their estates), who previously were ineligible from participating in the streamlined procedures.

– Such persons who come forward now will owe back taxes, interest, and a reduced “miscellaneous offshore penalty” equal to five percent of their undisclosed foreign financial assets. Previously, they would have faced a 27.5% penalty.

The Fine Print

• However, as with all programs overseen by the IRS, there is always the fine print, the most important of which is a certification by the taxpayer that his or her failure to report all income, pay all tax, and submit all required information returns was not willful.

• Those taxpayers who cannot certify that their conduct was “nonwillful” are left with one option, albeit an unpopular one, and that is applying to the Offshore Voluntary Disclosure Program.

Traps for the Unwary

• Despite the seemingly taxpayer-friendly incentives, the streamlined procedures – both domestic and foreign – have many shortcomings. Here are a few of its shortcomings:

Traps for the Unwary(1) They do not provide an ironclad guarantee of immunity from

prosecution.

(2) The question that I get asked most frequently is if there is any risk of audit under the streamlined procedures. Returns submitted under either the foreign or domestic offshore procedures are not automatically selected for audit. Instead, they are subject to “verification.” • Through verification, the examining agent can request account

statements and other relevant documents to verify the information reported.

• However, this does not mean that an examination is impossible. On the contrary, such returns may be selected for audit under the existing audit selection processes applicable to any U.S. tax return (see point (3)).

Traps for the Unwary(3) A recent IRM Procedural Update dated August 13, 2014 sheds

some light on what type of submissions might be ripe for examination under the streamlined procedures.

• If there are at least five foreign information returns in the taxpayer’s streamlined submission (i.e., Forms 3520, 3520-A, 5471, 5472, 8938, 926, or 8621), then the agent must refer the case to the Large Business and International division of the Service (LB&I).

• The purpose of such a referral is not so the taxpayer can be entered into a drawing for a three-day cruise aboard the Disney “Magic.” Instead, it is quite the opposite. It likely means that an examination is on the horizon, one that could lead to the assertion of multiple willful or nonwillful FBAR penalties.


Beyond the FBAR – Everything You Never Wanted to Know About All of the Other

International Reporting Forms (But Must)

Form 3520

(1) Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts

– Under IRC § 6048, taxpayers must report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust, and receipt of distributions from foreign trusts.

– This return also reports the receipt of gifts from foreign entities under IRC § 6039F.

– The penalty for returns reporting gifts is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.

Form 926

(2) Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation

– Under IRC § 6038B, taxpayers must report transfers of property to foreign corporations and other information.

– The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

Form 3520-A

(3) Form 3520-A, Information Return of Foreign Trust With a U.S. Owner

– Under IRC § 6048(b), taxpayers must report their interests in foreign trusts, by United States persons with various interests in and powers over those trusts.

– The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.

Form 5471

(4) Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations

– Under IRC §§ 6035, 6038 and 6046, certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) must report information.

– The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

Form 5472(5) Form 5472, Information Return of a 25% Foreign-

Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business

– Under IRC §§ 6038A and 6038C, taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party.

– The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.

Form 8865

(6) Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships

– Under IRC §§ 6038, 6038B, and 6046A, United States persons with certain interests in foreign partnerships must report interests in and transactions of these foreign partnerships, transfers of property to these foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests.

– Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.

– The penalty is capped at $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.


(4) Taxpayers who are eligible to use the streamlined procedures and who follow all of the instructions are not subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties, even if their returns are subsequently selected for audit. However, immunity from penalties comes with a few caveats:


(a) First, any previously assessed penalties relating to the years that are selected for audit will not be abated.

(b) Second, to the extent that the IRS determines an additional tax deficiency for a return submitted under these procedures, it can assert additional tax and penalties relating to that additional deficiency.

(c) Finally, the IRS will unleash the full arsenal of penalties if it determines that the original tax noncompliance was due to fraud and/or that the FBAR violation was willful.


(5) Tax returns will be processed no different than any other returns submitted to the IRS. Reading between the lines, what the IRS seems to suggest is not to expect confirmation for receipt of the returns.

Even more important, unlike OVDP, the streamlined filing process will not culminate in the signing of a closing agreement with the IRS.


(6) Taxpayers who think that they can outsmart the fox by seeking shelter

in the OVDP bunker in the event that the IRS rejects their non-willful certification are sadly mistaken. Why? Once a taxpayer makes a submission under the

streamlined procedures, it is too late to apply to its sister program, the Offshore Voluntary Disclosure Program.


– In other words, it’s “either or.” Attempting to “sneak” into the streamlined compliance program through the “back door” when a taxpayer cannot legitimately certify non-willfulness is like cutting off one’s nose to spite his face.

–When the smoke clears, such a taxpayer may end up paying a far steeper price than the miscellaneous penalty that he sought to avoid in the first place by rejecting the Offshore Voluntary Disclosure Program as an option.


– The only remaining option for a taxpayer whose streamlined submission has been rejected to come into compliance with his U.S. tax obligations is to file amended 1040s and delinquent international returns in what is known as a “quiet disclosure.”


– Taxpayers who find themselves caught in the struggle of choosing between streamlined and OVDP might look to the eminent archaeologist, Indiana Jones for some practical and sound advice. 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.”


(7) Assuming a taxpayer’s streamlined submission is rejected, the only remaining option for coming into compliance with one’s U.S. tax obligations is to file amended 1040s and delinquent international returns in what is known as a “quiet disclosure.”


–This poses a number of risks, including an examination that has the potential to be just as painful as a root canal in the sense that the IRS could assert multiple FBAR penalties that catapult a

taxpayer’s penalties into the stratosphere to the possibility of a referral to the Criminal

Investigation (CI) division of the IRS. –CI, in turn, could refer the case to the Department of Justice – Tax, with a recommendation for prosecution.


(8) The nonwillful certification – including all statements made in the streamlined submission (even those relating to the non-residency requirement for streamlined foreign) – must be signed under penalties of perjury.

• Why is this significant?


–It means that the IRS could reject a taxpayer’s streamlined submission not only if it obtains evidence that directly contradicts a taxpayer’s certification that he was not willful, but also if it obtains evidence that directly contradicts the taxpayer’s representation that he satisfies the non- residency requirement of the streamlined foreign procedures for the years in question. –As if that was not bad enough, the IRS could refer the matter to the Department of Justice with a recommendation that the taxpayer be prosecuted for perjury.


(9) With respect to the Streamlined Domestic Offshore Procedures, the five-percent

miscellaneous penalty is imposed on a broader base of foreign assets – not just those relating to FBAR reporting.

Who Is Eligible for the Streamlined Procedures

• The streamlined filing compliance procedures are designed only for individual taxpayers, including estates of individual taxpayers.

• They are available to both U.S. individual taxpayers residing outside the United States and U.S. individual taxpayers residing in the United States.

Who Is Ineligible?

1. Those taxpayers who cannot certify that their failure to report all income, pay all tax, and submit all required information returns was due to nonwillful conduct.

2. Those taxpayers who are under criminal investigation by IRS Criminal Investigation.

3. Those taxpayers who are undergoing a civil examination, regardless of whether that examination relates to unreported foreign assets.

Getting to Know the Streamlined Procedures

Now we’ll do a “deep dive” into the specific requirements of each program.

Getting to Know Streamlined Foreign

• U.S. taxpayers (or estates of individual U.S. taxpayers) seeking to use the streamlined foreign offshore procedures must satisfy the following requirements:

1. The applicable non-residency requirement (for joint return filers,

both spouses must satisfy the non-residency requirement); and

2. Have failed to file an FBAR with respect to a foreign financial account; and

3. The failure to file an FBAR must have resulted from non-willful conduct.


• Who is a U.S. Taxpayer?

1. U.S. citizens;

2. Lawful permanent residents;

3. Those satisfying the substantial presence test of IRC section 7701(b)(3).


• Non-residency Requirement– While the concept of “residency” might appear to

be straightforward, the streamlined procedures have contorted the definition of this four-syllable word to such an extent that it requires scribes to decipher its true meaning.


– The source of this confusion lies in the fact that the definition of “residency” under the streamlined procedures is radically different than the general definition of “residency” in the Internal Revenue Code.


– The non-residency requirement has two strands:

1. First, the taxpayer must have a non-U.S. abode.

2. Second, the taxpayer must have lived outside of the U.S. for 330 full days or more in at least one of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed.


– After being translated from “Parseltongue” into English, the latter requirement means that the taxpayer could not have spent more than 35 days in the U.S. in any one of the three years covered by the streamlined procedures.


– Not unlike other key terms in the Internal Revenue Code, “U.S. abode” and “330 day physical presence” are legal terms of art that have precise meanings.

– Therefore, it is important to take the time to define them and understand how they have been interpreted by the courts.


1. Non-U.S. Abode

– According to information published by the IRS, IRC Section 911 and its regulations are the benchmark for determining whether the taxpayer has a non-U.S. abode.

– For purposes of IRC section 911, “tax home” has the same definition as it

does under IRC section 162(a)(2) (relating to traveling expenses while away from home). Under Treas. Reg. § 1.911-2(b), an individual’s tax home is considered to be located either:

• At his regular or principal (if more than one regular) place of business, or

• If the individual has no regular or principal place of business due to the nature of the business, then at his regular place of abode in a real and substantial sense.


2. Taxpayer Must Have Physically Resided Outside of the U.S. For 330 Full Days Or More In At Least One Year of The Look-back Period

– Practically speaking, a taxpayer can spend more than 35 days in the U.S. in two of the three years of the look-back period and still satisfy the non-residency requirement of the streamlined foreign procedures so long as he spent 330 full days or more outside of the U.S. in just one of those years.

– Two extreme examples in order to drive home the picayune nuances of this petulant rule.


– Example # 1: A taxpayer who spends 365 days in the U.S. in year one, 365 days in the U.S. in year two, and 35 days in the U.S. in year three satisfies the non-residency requirement of foreign streamlined, albeit “by the hair of his chinny chin chin” thanks to year three.

– Point: A taxpayer can flunk the non-residency requirement – with flying colors – by spending as many as 365 days in the United States in two of the three years of the look-back period but still pass it so long as he spent at least 330 full days abroad in just one of the three years.


– A helpful formula that illustrates the extreme scenario:

Up to 365 days in the U.S. in year one (or any other year of the look-back period) (+) Up to 365 days in the U.S. in year two (or any other year of the look-back period) (+) At least 330 days (or more) outside of the U.S. in year three (or any year of the look-back period) Satisfaction of non-residency requirement.


–Which year the taxpayer satisfies (or surpasses) the threshold of 330 full

days outside of the U.S. is meaningless so long as it happens during one of these three years.


– Example # 2: A taxpayer who spends 36 days in the U.S. in year one, 36 days in the U.S. in year two, and 36 days in the U.S. in year three fails the non-residency requirement.

– Why? Because there are 365 days in a year and in no year could he have spent at least 330 days outside of the United States. Instead, the maximum number of days that he spent outside of the U.S. in each year was 329 days, one day shy of the 330-day threshold.

– As you can see, the rigid requirements of the non-residency requirement can play the role of “spoiler” – not unlike the “Mean One Mr. Grinch” – to well-intentioned taxpayers wanting to “get right” with the IRS.


– Interesting question to ponder: Is the taxpayer in example 2 who is deemed ineligible for streamlined foreign eligible for streamlined domestic?

– Only if he has filed his U.S. tax returns for each of the most recent three years for which the U.S. tax return due date – or extended due date – has passed (a key requirement for streamlined domestic)


– If the taxpayer in example 2 filed U.S. tax returns in two of the most recent three years for which the U.S. tax return due date has passed, but neglected to do so in just one year, not only would he be ineligible for streamlined foreign but he would also be ineligible for streamlined domestic!


– What this means is that to the extent that the taxpayer still wants to “come clean” through the IRS’s amnesty program, he has only one remaining option: apply to the OVDP, where he must pay a penalty of at least 27.5% on the highest maximum aggregate balance of his offshore accounts over an eight-year look-back period.

– This quagmire tends to disproportionately affect a class of people commonly referred to as, “Canadian snow birds,” – those who migrate south of the border for what might seem like an insignificant period of time during the unbearably cold months of winter to lie on a sun-drenched beach in Florida.


– The issue was best framed by Paul Barba in his blog, Updated IRS Streamlined Filing Program: Snowbirds Beware:

– “Does physical presence exceeding 35 days every year justify the disqualification of non-compliant taxpayers who have spent relatively small amounts of time in the United States every year from streamlined … and the imposition of a 27.5% (or 50%) penalty under OVDP?”


Remaining Requirements

1. U.S. taxpayer must file delinquent or amended tax returns, together with all required information returns (e.g, Forms 3520, 5471, and 8938) for each of the most recent three years for which the U.S. tax return due date – or extended due date – has passed; and

2. File any delinquent FBARs for each of the most recent six years for which the FBAR due date has passed.

Getting to Know Streamlined Domestic – The Requirements

• U.S. taxpayers (or estates of individual U.S. taxpayers) seeking to use the Streamlined Domestic Offshore Procedures must satisfy the following requirements:

1. Fail to meet the non-residency requirement (for joint return filers, one or both spouses must fail to meet the non-residency requirement);

2. Have previously filed a U.S. tax return (if required) for each of the most recent three years for which the U.S. tax return due date – or extended due date – has passed;

3. Have failed to report gross income from a foreign financial asset and pay tax as required by law. Even if the taxpayer reported gross income from the foreign asset and paid all taxes relating to that asset, this element is satisfied if the taxpayer failed to file an FBAR (FinCEN Form 114) and/or one or more international information returns with respect to the foreign financial asset. By information returns, the IRS is referring to Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621); and

4. The failures listed in number three must have resulted from non-willful conduct.

Getting to Know Streamlined Domestic

– With respect to the second requirement, if you take a quick glance at it, you may overlook a subtle yet critical point, one that has a rippling effect on the eligibility requirements for streamlined domestic.

– Very simply, a taxpayer who has not filed a U.S. tax return in one or more of the last three years – and who has not filed a timely request for an extension to do so – is ineligible to make a streamlined domestic submission.

Getting to Know Streamlined Domestic

• What must I submit?

1. For each of the most recent three years for which the U.S. tax return due date – or extended due date – has passed (the “covered tax return period”), file amended tax returns, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621);

2. For each of the most recent six years for which the FBAR due date has passed (the “covered FBAR period”), file any delinquent FBARs; and

3. Pay a miscellaneous offshore penalty. The full amount of the tax, interest, and miscellaneous offshore penalty should be submitted with the amended tax returns.

Miscellaneous Offshore Penalty For Streamlined Domestic

1. How is the miscellaneous offshore penalty calculated? – It is equal to 5 percent of the highest aggregate balance of

the taxpayer’s foreign financial assets that are subject to the penalty during the years in the covered tax return period and the covered FBAR period.

2. How is the highest aggregate balance determined? – By tallying the year-end account balances and year-end

asset values of all the foreign financial assets subject to the penalty for each year in the covered tax return period and the covered FBAR period and selecting the highest aggregate balance from among those years.


3. When is a foreign financial asset subject to the 5-percent miscellaneous penalty?

– When the asset should have been, but was not, reported on a Form 8938 for that year; and/or

– The asset was properly reported for that year, but gross income from the asset was not reported in that year.


– Deconstructing these two conditions leads to the inescapable conclusion that compliance is required not just on the asset disclosure front but also on the failure to report income front – even when the asset is properly reported – in order to avoid the 5% penalty.

– Example: If a foreign bank account is properly disclosed on an FBAR and Form 8938, but the associated interest income from the account is not included on the Form 1040 for the year, then the value of that bank account for the applicable year must be included in the 5% penalty base.


4. What does the term, “foreign financial assets” include?

– Financial accounts held at foreign financial institutions;

– Financial accounts held at a foreign branch of a U.S. financial institution;

– Foreign stock or securities not held in a financial account;

– Foreign mutual funds; and

– Foreign hedge funds and foreign private equity funds.


5. Is the miscellaneous offshore penalty under streamlined domestic in

lieu of accuracy-related penalties, information return penalties, and FBAR penalties? Yes.

Frequently Asked Questions Pertaining to the Miscellaneous Penalty

1. Is the 5-percent penalty intended to reach foreign financial assets in which the taxpayer has no personal financial interest or only a partial interest?

– A: No. The penalty is not intended to reach assets in

which the taxpayer had no financial interest, such as an employer’s account over which the taxpayer had only signature authority, or portions of assets in which the taxpayer had no personal financial interest.


2. I am a U.S. resident making a streamlined domestic submission. In addition to foreign financial accounts and assets, I own an income producing rental property in a foreign country that is not reportable on my FBAR or Form 8938. Must I include the real estate in the streamlined domestic offshore penalty base?


– NOTE: This question assumes that the rental property is not held through a foreign entity, such as a corporation. Thus, this question applies only to those situations in which the taxpayer holds the rental property directly.

– A: No. Any asset that is not the kind of asset reportable on either an FBAR or Form 8938 need not be included in the penalty base for the streamlined domestic offshore procedures.


3. The taxpayer is the sole owner of an incorporated business that owns various assets, including foreign financial accounts. Does the 5-percent penalty base include the

stock in the corporation or just the underlying financial accounts?


– The penalty base includes the stock in the corporation – and not the underlying financial accounts – unless the corporation is a disregarded entity.

– What is a disregarded entity? A disregarded entity is a business entity that is separate from its owner but which elects to be disregarded as separate from the business owner for federal tax purposes (example: a single-member LLC).


4. The streamlined domestic offshore procedures provide that foreign financial assets subject to the 5-percent penalty include assets that should have been, but were not, reported on Form 8938. The instructions for Form 8938 provide that any assets reported on timely filed Forms 3520 or 5471 need not be reported on Form 8938 for the same tax year. Are assets I report on delinquent Forms 3520 or 5471 excluded from the 5-percent penalty base?


– A: No. All assets that meet the definition of “foreign financial asset” in the instructions for Form 8938 and not reported on that form should be included in the 5-percent penalty base, unless the taxpayer reported them on timely filed Forms 3520 or 5471.


5. How should I value stock in a foreign corporation that is included in the 5-percent

penalty base for Streamlined Domestic Offshore filers?


– A: Any reasonable method for valuing the stock, such as using the balance sheet on Form 5471, for purposes of calculating the 5-percent penalty. No valuation discounts may be taken on foreign financial assets subject to the 5-percent penalty.


6. Can the taxpayer account for “double-counting” when determining the aggregate maximum balances during the disclosure period?– In other words, must assets in an account that was

closed and transferred to another account be double-counted – once in the old account and then again in the new account?


– A: Yes. However, the taxpayer carries the burden of establishing double counting.

– NOTE well: To the extent that the highest balance in the receiving account was not reached until some point after the closing balance was transferred from the old account, then the money transferred from the old account must actually have contributed to the highest balance in the receiving account before any duplication can be removed!


– What evidence can the taxpayer rely upon to meet his burden? Account statements

Pivotal Question

• Can the streamlined procedures be used to correct defective returns that go back beyond the most recent three years?– Scenario: John filed compliant tax returns and

FBARs for the most recent three years for which tax returns were due: 2012, 2013, and 2014. However, he failed to properly report a foreign financial asset in tax years 2009, 2010, and 2011 and did not make a voluntary disclosure. May he make a streamlined submission?

Pivotal Question

– A: Yes. • Assuming John makes a streamlined domestic

submission, how is his 5 percent penalty calculated?– A: Because the most recent three years are fully

compliant, there will be no assets in the penalty base for those years.

– For the three years prior to that, he must calculate the aggregate year-end account balances and year-end asset values. The penalty is 5% of the highest aggregate amount.

Pivotal Question

• When making his submission, what procedures should John follow?– He should attach the certification to a Form 1040X

for only the most recent tax year for which he filed an income tax return showing a zero change in tax.

– He should write in red ink, “Streamlined Domestic Offshore” at the top of the Form 1040X.

Certifying Non-willfulness

Background

• Of the recent changes made to the streamlined procedures, none have received as much attention – or stirred up as much debate – as the new rule requiring certification of non-willfulness as a condition for gaining entry.

• This section focuses on the requirement of the streamlined procedures that the failure to report income from a foreign financial asset not be willful.

• This requirement cuts to the heart of penalty mitigation offered by the new procedures.

Background

• In order to qualify for the streamlined compliance procedures, U.S. taxpayers must certify that “the failure to file tax returns, report all income, pay all tax, and submit all required information returns, including FBARs, resulted from non-willful conduct.”

Pivotal Question

• Under what circumstances can a taxpayer certify that his failure to report foreign financial assets and pay all taxes due with respect to those assets was not willful?

Muddying The Waters

• As a preliminary matter, a taxpayer will only be able to determine whether his conduct is non-willful if he knows how the IRS interprets the term, “willful.”

Muddying The Waters• The problem lies in the fact that instead of starting out with

a baseline definition of the term “willfulness” and proceeding to “non-willfulness,” as is the logical progression, the IRS defines it in the negative, completely disregarding the predicate term.

• Taxpayers are left to discern the meaning of such adjectives as “negligence,” “inadvertence,” “fraud,” and “mistake” – which the IRS uses generously to define non-willfulness – without anything more than a Webster pocket dictionary.

• The danger this poses is that these are legal terms of art that cannot be interpreted according to their common, ordinary, and everyday meanings.

Muddying The Waters

• Willfulness is an elusive term.• While it may be easy to define, it is not easy to

apply when it comes to the myriad of circumstances that exist in the offshore arena.

• Courts have compared willfulness to a “chameleon” that changes in tone and color according to the Code section involved and the circumstances.


Certifying non-willfulness for Purposes of the Streamlined Procedures

• The best way I’ve seen the concept of willfulness explained is by Jack Townsend, author of “Tax Crimes.”


• Professor Townsend views the path between willfulness and non-willfulness as lying on a continuum, with “non-willfulness” at one end and “willfulness” at the other.

• Visualize an electromagnet spectrum, with short-wavelength radiation (gamma) at one extreme pole and long-wavelength radiation (radio waves) at the opposite pole.


• Focusing on these extreme poles, substitute “Not willful” for the “short-wavelength” pole and “Definite willfulness” for the “long-wavelength” pole.


• As Professor Townsend so eloquently explains, the facts of some cases will present themselves so far in the direction of one of the extreme poles that determining whether the conduct is willful or non-willful will be as easy as finding a free drink in Las Vegas.


• These are what might be considered “slam dunk” cases for a specific type of disclosure.

• Example: A taxpayer who falls on the “Definite willfulness” end of the spectrum should not think twice about applying to the Offshore Voluntary Disclosure Program. On the other hand, a taxpayer who falls on the “Not willful” end of the spectrum might be able to avail himself of a number of different options, from making a “quiet disclosure” to making a streamlined submission.


• Determining willfulness is not always so black and white

• According to Professor Townsend, this is analogous to when the facts of a particular case lie at points other than at the extreme poles of the spectrum, such as when they lie in the middle.

• These cases present a real challenge.


• Indeed, when the needle of the spectrum vacillates in the middle, questions abound. For example, how close must the facts be to either end before one can confidently make a decision?

• In these cases, assessing willfulness becomes exceedingly difficult, requiring a careful balancing of the facts both for and against it. Needless to say, it should be left to the professionals.


• In dealing with these gray areas, one should never forget that there will always be risk – it is inherent in a willfulness assessment. Indeed, “a taxpayer not at material risk for prosecution is not the same as a taxpayer at ‘no risk’ of prosecution.”

• This implies that a person must be willing to assume at least some risk.

• Those who are risk-averse should seek shelter in the OVDP bunker, and put themselves out of their misery, rather than subjecting themselves to any further agony.

Overcoming the Pitfalls of Certifying Non-willfulness

The following is some practical advice on how to prepare your explanation of

non-willful conduct.


1. First, you must tell your “story,” which must consist of more than just blanket denials.

– For example, you can shout from the rooftop that you were “non-willful” from now until eternity, and even shed a tear along the way. But unless you explain why your conduct did not run afoul of willful blindness, the IRS is likely to view this as nothing more than self-serving.


2. Second, your certification should include “objective supporting evidence.”

– In a Forbes article entitled, “Am I Non-willful Under The Streamlined Procedures,” Charles Rettig, an expert in the field of foreign asset reporting wrote, “What objective evidence might exist to appropriately demonstrate a lack of personal knowledge by the taxpayer about their foreign reporting requirements?”


3. Third, you must directly confront the presumption, as unfair

as it might seem, that the IRS will impute a sinister motive to your failure to report your foreign bank account(s): namely, that you were willfully blind.


• If there is any doubt in your mind, look no further than the comments of Caroline Ciraolo (acting Assistant Attorney General pending approval of the nomination of Cono Namororato to be AAG) at the Federal Bar Association Annual Conference:


“We are taking particular interest if we find evidence of an account holder claiming non-willful conduct in a streamlined compliance filing or delinquent submission only to find that evidence produced by the Category 2 banks suggests otherwise. We are using information gleaned from the program to open new investigations, pursue new targets around the globe, and we will continue to do so as the information is developed.”


• Refresher on willful blindness:

– Willfulness may be attributed to a person who has made a conscious effort to avoid learning about the FBAR reporting and record keeping requirements.

– Example: The failure to learn of the filing requirements coupled with other factors – such as efforts taken to conceal the existence of the accounts and the amounts involved – may lead to a conclusion that the violation was due to willful blindness.


• According to Mr. Rettig, the most critical questions that must be answered in order to rebut the presumption that a taxpayer made “a conscious effort to avoid learning about the FBAR reporting and record keeping requirements” are the following:

1. “Should the taxpayer have inquired of their return preparer about the need to report an interest in a foreign financial account?”

2. “Should the preparer have gone beyond providing a tax organizer that recites the Schedule B reference relating to an interest in a foreign financial account and perhaps explained what types of foreign interests are reportable?”


• Fourth, explain why you didn’t “intentionally violate a known legal duty,” citing supporting facts.

• Remember: Blanket denials will not suffice!

• Fifth, sift through all of the “bad” facts that the IRS may lump into the willful blindness category to see if you can either neutralize these pestilent facts or turn them into “good” facts.

• By anticipating what facts are likely to raise red flags, you will be able to draft s thoughtful explanation to rebut allegations of a sinister or deceitful motive. This is the best antidote for avoiding ambush.


Consequences of Making A ‘Bad’ Choice

• You must thoroughly invest in due diligence to avoid the IRS’s punishments, which have been known to drive many a sane taxpayer to the brink of insanity.

• Do not take the streamlined procedures lightly! To the

extent that your non-willful certification turns out to be a bad judgment call on your part, all that you will have succeeded in doing is making a bad – but otherwise, manageable – situation that much worse.

Parade of Horribles• How so? If your non-willful certification is rejected, not only

will you become ineligible for the streamlined procedures, but you could be subject to any one of the following “parade of horribles”:

– You will be ineligible for OVDP (once you make a streamlined submission, it is too late to apply to OVDP). Your only remedy for coming into compliance with your U.S. tax obligations would be to file amended 1040s and delinquent foreign information returns in what is otherwise known as a “quiet disclosure.”

Parade of Horribles

– You are but a heartbeat away from an examination that has the potential to be more intrusive than a rectal examination. Keep in mind that the IRS could assert multiple willful or non-willful FBAR penalties and that these penalties can be aggregated – one on top of the other – until they reach the stratosphere.

Parade of Horribles

– Your case could be referred to the Criminal Investigation (CI) division of the IRS for investigation. CI, in turn, could refer your case to the Department of Justice – Tax, with a recommendation for prosecution.


– To the extent that the IRS obtains evidence that directly contradicts your certification of non-willfulness, it could refer your case to the Department of Justice with a recommendation that you be prosecuted for perjury.

• Remember that the non-willful certification – including all statements made in the streamlined submission (i.e., particularly those relating to the non-residency requirement for streamlined foreign) – must be signed under penalties of perjury.

Practical & Sound Advice


• Do not overlook the environment that we now live in: The U.S. government’s aggressive pursuit of taxpayers with unreported offshore accounts.

• Be honest with yourself. To the extent that your conduct might be deemed let us say, “less than non-willful” (to put it mildly), you must swallow your pride and make the obvious choice – apply to OVDP. To quote a cliché, “an ounce of prevention is worth a pound of cure.”


• Thinking that you can somehow “sneak” into the streamlined program without being detected is as foolish as a man who robs a convenience store in a ski mask at midnight but forgets to remove his work uniform with his named stitched across the front.


• Regardless of which program you choose – streamlined or OVDP – keep in mind that your disclosure must be made before the IRS or DOJ is in hot pursuit.

• This is the very essence of voluntary disclosure.


• The metaphor that I like to use here is the hunting of a fox by a thirsty bloodhound. If the bloodhound has already detected the scent of the fox and is hot on his trail, then the fox is “squat.” Indeed, no amount of pleading with the bloodhound is going to save the fox from the sharp and carnivorous teeth of the salivating bloodhound.

Practical & Sound Advice• Don’t go it alone! Talk to a tax attorney.

– A tax attorney will be able to provide practical and sound advice on what may be the most important decision that you ever make – whether your certification fully substantiates your claim of non-willfulness and whether it can be submitted in good faith.

– He or she can check the consistency of your explanation and ensure that it is supported by ironclad evidence, such as tax and information returns. Having the “right” documents to prove your story will assuage the IRS agent and ease the tension.

Quiet Disclosure

Under what circumstances is making a quiet disclosure in today’s environment a smart choice for a taxpayer with an undisclosed foreign bank

account?

Quiet Disclosure

• “One size does not fit all.” Indeed, certain cases are ripe for quiet disclosure, while others aren’t.

• Before throwing out the idea of making a “quiet disclosure” with the bathwater, consider this: A quiet disclosure furthers the IRS’s mission of encouraging voluntary compliance and self-policing by allowing taxpayers to self-correct.

• Thus, by overlooking the delinquent FBAR submission procedures, you might be making a huge mistake.

Quiet Disclosure

• The IRS recently published a bulletin entitled, “Options Available to Help Taxpayers With Offshore Interests” back on January 13, 2015.

• The bulletin consists of a chart whereby a situation is posited in the left-hand column and the corresponding recommended compliance option is listed adjacent to the situation in the right-hand column.

Quiet DisclosureSituation Compliance Option

Taxpayers who have properly reported all taxable income but recently learned that he/she should have been filing FBARs in prior years to report a personal foreign bank account or to report signature authority over bank accounts owned by an employer.

Taxpayers who reported, and paid tax on, all their taxable income for prior years but did not file FBARs, should file the delinquent FBAR reports according to the instructions (send to Department of Treasury, Post Office Box 32621, Detroit, MI 48232-0621) and attach a statement explaining why the reports are filed late.

No penalty will be imposed for the failure to file the delinquent FBARs if there are no underreported tax liabilities and you have not previously been contacted regarding an income tax examination or a request for delinquent returns.


Taxpayers who only have certain delinquent information returns, but no tax due.

A taxpayer who has failed to file tax information returns, such as Form 5471 for controlled foreign corporations (CFCs) or Form 3520 for foreign trusts but who has reported, and paid tax on, all their taxable income with respect to all transactions related to the CFCs or foreign trusts, should file delinquent information returns with the appropriate service center according to the instructions for the form and attach a statement explaining why the information returns are filed late.

No penalty for the failure to file the delinquent Forms 5471 and 3250 if there are no underreported tax liabilities and you have not previously been contacted regarding an income tax examination or a request for delinquent returns.


Non-resident U.S. taxpayers with delinquent returns with low risk factors (including tax owed less than $1,500/year).

Filing Compliance Procedures for Non-Resident U.S. Taxpayers

Non-resident U.S. taxpayers should file delinquent tax returns, including delinquent information returns, for the past three years; delinquent FBARs for the past six years; and additional required information regarding compliance risk. Payment of any federal tax and interest due must accompany the submission.

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