Appeals Court Weakens “Willfulness” Defense in Failure to File Foreign Account Reporting Forms

By Mark Nestmann • August 3, 2012

What standard of proof does the IRS have to demonstrate in order impose the most severe civil or criminal penalties possible for failing to acknowledge a foreign account? The answer: less than you might think.

In 2010, a U.S. District Court analyzed that question, apparently for the first time.  A federal judge held that the IRS hadn't proven that a taxpayer “willfully” failed to disclose offshore accounts and therefore rejected the agency's attempt to impose a $200,000 civil fine. That fine amounted to $100,000 for each unacknowledged account. Alternatively, the IRS could have sought a civil penalty of 50% of the value of the account.

(In this context, “willfully” indicates an act undertaken intentionally or in deliberate disregard for the law. Absent a finding of willfulness, the maximum amount the IRS can fine a taxpayer for failing to disclose an offshore account is $10,000. This assumes that there is no tax evasion involved—that the taxpayer merely failed to file the FBAR, and/or failed to check “yes” on Schedule B. A criminal conviction for failing to file the FBAR also requires that prosecutors prove willfulness.)

The IRS appealed, and two weeks ago, the U.S. Fourth Circuit Court of Appeals overruled the District Court's decision. Barring a successful appeal to the Supreme Court, the ruling will make it much easier for the IRS to demonstrate "willfulness" and impose the most severe civil sanctions possible for failure to disclose offshore accounts.

Criminal sanctions for failing to disclose offshore accounts also depend on a finding of willfulness. So, you can count on more indictments of taxpayers for this offense, which may be punished by up to five years imprisonment and a $500,000 fine.

The background of the case makes a finding of willfulness especially problematic. Defendant J. Bryan Williams, a former executive with Mobil Oil Corp., pleaded guilty to tax fraud in 2003 in relation to approximately $7 million of income he diverted to unacknowledged Swiss accounts between 1993 and 2000. He also pleaded guilty to conspiracy to defraud the United States and to criminal tax evasion. Williams was sentenced to 46 months in prison and agreed to pay back taxes and interest.

But, the IRS wasn’t through with Mr. Williams. In 2009, it assessed a civil penalty against him for failing to acknowledge a foreign account on Schedule B of his 2000 tax return, and for failing to file Treasury Form TD F 90-22.1, the foreign bank account reporting form, or FBAR, for that same year.

Williams appealed the penalty, and the District Court agreed with him. By the time that the 2000 FBAR form was due, the IRS had already frozen Williams’ accounts in Switzerland. Williams had nothing to gain by failing to acknowledge accounts the IRS already knew about and had frozen. How could he therefore have any intent to conceal it?  Williams also testified that he relied on accountants to complete his tax return, and that none of them mentioned the requirement to file the FBAR. On that basis, Judge Liam O’Grady ruled that Williams’ failure to disclose the already-frozen assets in a foreign account was not a willful violation of the law.

Now that O'Grady's decision has been overturned, taxpayers are in a much weaker position to contest civil and criminal sanctions for failure to acknowledge offshore accounts. Indeed, in reviewing the decision (read it here), it seems to me that any U.S. taxpayer with an unacknowledged offshore account could be found to have willfully failed to declare merely by signing a U.S. tax return.

The IRS has many tools at its disposal to discover unacknowledged offshore accounts. It can examine disclosures made under "qualified intermediary" agreements, make inquiries under a tax information exchange agreement or mutual legal assistance treaty, sue the foreign bank in U.S. courts to force it to disclose the account records of U.S. taxpayers, or even bribe foreign bank officials. U.S. courts have upheld all of these methods of discovery. And once the information exchange provisions of the "Foreign Account Tax Compliance Act" (FATCA) come into effect in 2013, it will have an even greater flow of financial data to analyze.

If you have unacknowledged offshore accounts, contact a qualified international tax attorney to learn about your options on how to "come clean" before it's too late. The best option may be to enroll in the IRS Offshore Voluntary Disclosure Program (OVDP). If you're accepted in the program, you'll need to pay all back taxes and interest charges plus 27.5% of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. You can read more about the latest version of the OVDP here.

Copyright (c) 2012 by Mark Nestmann

P.S. For a definitive summary of the current IRS reporting requirements for offshore accounts, IRS offshore enforcement efforts, and the OVDP, you won't want to miss my colleague Jim Sexton's presentation at The Nestmann Group’s upcoming “Escape from America” seminar Oct. 26-27, in Scottsdale, Arizona. Jim, one of the savviest international tax planners I know, has helped dozens of taxpayers through the OVDP. Click here for more information and special early-bird pricing.

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About The Author

Since 1990, Mark Nestmann has helped thousands of clients seeking wealth preservation and international tax planning solutions. He is the author of highly acclaimed Lifeboat Strategy and other books & reports dealing with these subjects.

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