Grinches, Liechtenstein Royal Princes, Bankers, Toymakers (and Offshore Evasion): A Holiday Summons Tale

In today’s post returning guest blogger Dave Breen, the acting Director of Villanova’s Low Income Taxpayer Clinic, discusses the case of Greenfield v US. The issue in the case relates to the IRS’s cat and mouse game of finding assets and the unreported income from those assets that citizens have parked in offshore accounts. The issue in these cases does not generally involve much tax law.  The battle is won and lost on the issue of information.  If the IRS gets the information, the taxpayer generally loses.  Summons work is key and the Greenfield case is a major development.  For many years, Dave worked with IRS attorney John McDougal, whose retirement I wrote about last week.  In the spirit of the season, Dave recounts the story of the case and its implications.  Keith

A recent IRS setback in a summons enforcement case out of the Second Circuit piqued my interest, because I spent the final twelve years of my career in IRS Counsel working on IRS’s offshore initiatives addressing tax evasion through the use of offshore accounts in tax secrecy jurisdictions.  My take on this recent case is that taxpayers and some practitioners may believe that the era of IRS investigating offshore tax evasion has run its course.  I think this case does just the opposite.  The Court’s decision demonstrates that much of IRS’s data on offshore tax evasion is dated – possibly even too old to be of any value – but I also suspect that IRS has come to the same conclusion.  Rather than moving on to other areas of non-compliance though, I suspect IRS at this moment is developing more tools to secure the next wave of current information on offshore tax evasion.  This does not bode well for taxpayers who so far have avoided IRS’s inquiry into their offshore holdings.

read more...

A bit of history

In 2000 IRS used permission to use John Doe summonses to secure information on U.S. taxpayers who accessed funds in their secret offshore accounts through American Express and Mastercard credit cards.  IRS’s first major success occurred in 2002 when the U.S. District Court entered an order requiring American Express to comply with IRS’s John Doe summons.  The information IRS received pursuant to this summons provided the data for what became known as the Offshore Credit Card Project.  Rather than go into the specifics, I refer readers to Keith Fogg’s 2012 Villanova Law review article Go West: How the IRS Should Foster Innovation in Its Agents. Subsequent offshore initiatives relied on data secured through John Doe summonses to UBS and other foreign banks, information received from whistleblowers, and information provided by taxpayers applying to one of IRS’s voluntary disclosure programs.

Despite the success in securing records identifying offshore tax evaders, the quality of the information IRS received was sometimes problematic, because it was out of date or incomplete.  For example, when a federal judge in Miami ordered compliance with the aforementioned John Doe summons in 2002, it only covered records for tax years 1998 and 1999 – “old years” in IRS parlance. Further, information received often did not dove-tail with IRS’s information.  IRS is driven by social security number, name, and to a lesser extent, last known address.  Credit card data is driven by credit card number and billing address.  This created a mismatch.  Once IRS received the summoned information it took many months to link a specific taxpayer to a particular offshore account through a credit card, assemble the case, and assign it to an agent specially trained in examining offshore transactions.  The IRM discourages IRS from beginning examinations of “old” tax years – generally those returns beyond the most recent two tax years – unless there are compelling reasons.  IRS prefers to examine more current tax years where plenty of time remains on the 3 year statute of limitations under IRC §  6501(a).   Although the 1998 and 1999 credit card data was sufficient to prove a taxpayer had a foreign bank account in 1998 or 1999, the information was not particularly helpful in proving how much income was unreported in those years or whether there was unreported income in later, more current years.

As a result, examiners assigned to these early cases often had to issue administrative summonses under IRC § 7602 to taxpayers for their most recent foreign bank account records to secure foreign account information for years after 1999.  The Department of Justice, which handles summons enforcement matters before the U.S. District Courts for IRS, has been extremely successful in securing orders enforcing these summonses, but the process takes time.  During this long process the data gets older and has diminishing value to IRS.  Proof that the data has a limited shelf life was recently demonstrated in a summons enforcement case.

Greenfield decision

In August 2016 the Second Circuit placed a speed bump along IRS’s road to identifying offshore tax evasion with dated information.  In United States v Greenfield, 118 AFTR 2d 2016-5275 (2016) the court vacated the District Court’s order enforcing an IRS summons and remanded the case for further proceedings consistent with its opinion.  The case is noteworthy for several reasons, but most importantly I see this as a wake-up call for IRS as well as a reminder to offshore tax evaders that IRS continues to pursue offshore tax evasion rigorously.

In the spirit of the holiday season, I offer the following tale.

Once upon a time there was a toy maker named Harvey Greenfield, his son, Steven, and their toy shop, Commonwealth Toy, Inc.  We also have a Grinch, Heinrich Kieber, whose job was to copy, file, and safeguard records at Liechtenstein Global Trust (LGT) a financial institution owned by the Liechtenstein royal family.  One day, while tending to his copying duties at the bank, Mr. Kieber decided to press “2” instead of “1” and make an extra copy of records that identified individuals who banked (translate: “hid their untaxed income”) at LGT.  Kieber, playing “Secret Santa”, offered the documents to several nations.  Many told him to “go Fish,” while other countries, including the U.S. did not.  The U.S. found the information to be very helpful in finding out who was naughty and who was nice. Needless to say, Mr. Kieber’s decision did not make him any new friends among the 38,000 residents of Liechtenstein.  He was charged with theft of information under Liechtenstein law and promptly went into hiding, leaving a trail of Angry Birds in his wake.  Like the Cabbage Patch doll you stood 3 hours in line to buy for your daughter in 1983, his whereabouts today are unknown.

Back to the Greenfields.  Several of Kieber’s cache of confiscated documents tied Steven and Harvey to certain offshore entities that had been used, or were being used, to evade taxation.  It just so happens that at this time the U.S. Senate’s Permanent Subcommittee on Investigations had begun hearings in response to the LGT disclosure and a similar leak from the Swiss bank, UBS.  Harvey died in 2009, leaving Steven as primary beneficiary of the LGT holdings.  PSI twice invited Steven to come in and talk about LGT, Liechtenstein, and foreign accounts in general.  The first time Steven failed to appear.  PSI was not too pleased with being stood up for its Mystery Date with Steven, so they invited him again.  The second time he appeared but asserted his Fifth Amendment right to remain silent.

Enter the IRS, who decided to audit Steven’s 1040’s for 2005 – 2011.  But there was a snag.  Kieber did not copy everything about the Greenfields – just enough to identify them as beneficial owners controlling the funds in the offshore accounts.  These documents included some memos, a 2001 year-end statement for their Maverick Foundation (a stiftung, under Liechtenstein law), LGT account information forms for Maverick and two entities it owned, and a 2001 LGT profile for Maverick and another company.  Of particular interest to IRS was a March 23, 2001 memorandum prepared by LGT personnel, detailing a meeting in Liechtenstein between the Greenfields, LGT employees, and Prince Philip of Liechtenstein.  The memo stated in part:

“The clients are very careful and eager to dissolve the Trust with the Bank of Bermuda leaving behind as few traces as possible. The clients received indications from other institutions as well that U.S. citizens are not those clients that one wishes for in offshore business.”

Great stuff, but not enough for IRS to determine how much tax was owed.  IRS didn’t have a Clue as to Steven’s gross income.  To fill in the considerable gaps in information, IRS issued an administrative summons to Steven for records and testimony.  After discussions with Steven’s counsel regarding the breadth of the summons, IRS reduced its scope to the production of documents related to foreign entities to the 2001 through 2006 tax years.

Greenfield refused to comply with the “kinder, gentler” version of the IRS summons.  Convinced that this was no Trivial Pursuit, IRS refused to Lego of the issue and brought suit to enforce yet another less expansive version of the original summons in district court.  Steven wasn’t having any of that one either and defended by invoking his Fifth Amendment right to remain silent.

General Summons Law and Greenfield

Generally, a Fifth Amendment right to remain silent is not effective for documents because contents of documents are not testimonial.  Fisher v. United States, 425 U.S. 391 (1976).  However, while Fisher held that documents were not testimony, the Court held that the act of producing the documents could be testimonial, because it may communicate incriminatory statements of fact.  For example, if the only person with access to offshore bank statements is the person who controls the funds in them, the person coming to court with the bank statements is essentially saying (testifying or admitting), “The documents you want exist, I control them, they are authentic, and here they are.”  This is the “act of production” defense Steven raised.  But the Ping-Pong game did not end there.

The government’s comeback to the “act of production” defense is the “foregone conclusion” rule.  If the testimonial aspects of production are a “foregone conclusion”, that is, if the government can establish the “existence, control, and authenticity” of the records independent of the witness’s production of them, the act of producing them loses its testimonial nature.  But the government must be ready to establish independently that the documents exist, the witness controls them, and they are authentic.

Based on the record, the Court found the Government met the first two tests: it accepted the existence of the documents in 2001 and Greenfield’s control of them in 2001.  It was not so willing, however, to accept their authenticity and turned to the Government to establish the third prong of the test.

The Government elves had their work cut out for them.  They went back to their workshop and crafted several arguments with respect to the authenticity of the 2001 records. It put on its Poker face and argued that the 2001 documents could be authenticated in three ways: (1) an LGT employee could come to the United States and authenticate them in court; (2) Kieber himself could come out of hiding and authenticate them; or (3) authentication was possible through Letters of Request issued under the Hague Evidence Convention.

The Second Circuit wasn’t buying any of the Government’s arguments.  First, the Court found it unlikely that LGT would send a witness to the United States to authenticate the records.  Secondly, it was highly unlikely Kieber, who was in hiding, would do it; and (3) the Government could not show a single instance where Letters of Request issued under the Hague Evidence Convention had been used to authenticate documents from LGT or any other Liechtenstein financial institution in the past.  Why would the Government think it would work in this case?

The Court didn’t stop there.  Assuming arguendo that the Government passed the 2001 hurdle, it would still have to show that the documents existed and that Steven controlled them in 2013, twelve years later.  Existence and control in 2001 does not create an inference of existence and control in 2013.  Factors such as the type of records, the likelihood of transfer to another person, and the time interval involved all bear on the matter.  In rejecting the Government’s arguments the Court found any number of reasons why Steven may not have had a Monopoly on control of the records from 2001 to 2013 or that the documents still existed in 2013.  Therefore, the Court did not enforce most of the summons and Steven did not have to produce the records.

Conclusion

But before you settle your brains for a long winter’s nap, think about this.  Even though Steven may have sunk IRS’s Battleship, today IRS is not in any immediate Trouble.  In fact, it is already working on a new Mousetrap.  On November 30, 2016 IRS received permission to issue a John Doe summons to Coinbase, Inc., a virtual currency exchanger headquartered in San Francisco, California, that Les discussed last month in his post IRS Seeks Information via John Doe Summons Request on Bitcoin Users.  

The moral of the story?  Uno’s?  I suspect many clients with assets hidden offshore will still take a big Risk by not coming in under IRS’s voluntary disclosure program, but you don’t have to be a Mastermind to see that many of them will ultimately be Sorry.  But, I guess that’s The Game of Life.  Happy Holidays!

 

 

 

Retirement of a Friend and Driver Behind the IRS Offshore Program

Today, the IRS is honoring John McDougal, a special trial attorney based in Richmond, Virginia, with a retirement ceremony in the grand foyer of its national office at 1111 Constitution Avenue in Washington, D.C.  I cannot remember another person honored in this way who was not an executive in the organization.  I also cannot imagine a more deserving person for the IRS to honor.

In January, 1980, I moved into the office adjacent to John’s in the Richmond District Counsel Office of IRS.  How fortunate I was.  For almost 30 years I had John as my next door neighbor or nearby neighbor at work.  To have the opportunity to work next to the greatest attorney in all of Chief Counsel’s office certainly made me a better attorney.

read more...

Before recounting some of the amazing things John accomplished in his 43 years with Chief Counsel’s Office, I want to go back to the beginning of his tenure and talk about his sleep habits.  John is a night owl.  He does not stay up late to party but he has a bio rhythm that keeps him up into the wee hours of the morning and causes him to want to sleep into the later morning hours.  Today, many employers accommodate personal preferences and rhythms of this type but in the 1970s the world was a much more rigid place.

The official hours of the Richmond office were 8:30 AM to 5:00 PM.  In an effort to accommodate John’s schedule, the head of the Richmond office allowed employees to arrive by 9:00 AM before being charged with annual leave.  Each morning when they arrived for work, the office secretaries would begin calling John’s home in an effort to wake him up so that he could arrive by 9:00 AM.  On many days their efforts failed.  John would arrive at 9:05 AM or later and get charged one hour of annual leave.  He would then stay at the office and work each evening until 9, 10 or 11:00 PM; however, the office had no system of credit hours or comp time to accommodate this deviation from the official schedule and so John worked for several years with no ability to take a vacation because he used all of his leave time arriving late.

John, however, did not complain.  Finally, in the 1980s the office evolved into a form of work flexibility that accommodated John’s bio rhythms and allowed him to take vacations.  I tell this story in part because it is amazing in 2016 to imagine such a work world that would treat its most valued and hard- working employee in such a poor manner but also to make John human since John’s performance as an attorney and a colleague set such a high standard.

At his core, John is a great trial lawyer.  He loves to put a case together and to present it.  He has had many Tax Court trials over his career and taught trial practice skills at Chief Counsel and NITA programs.  He does not, however, love cases involving huge corporations that might take years to develop, teams of lawyers to assemble and lots of national office coordination.  He prefers fact intensive cases and especially fraud cases.  To my knowledge, he is the only special trial attorney in the SBSE stovepipe of Chief Counsel’s office because that designation was reserved for attorneys in the LB&I stovepipe until one Chief Counsel, who had litigated against John before becoming the Chief Counsel, reached out and gave John that designation in recognition of his ability.

In the 1980s John was assigned to a pilot program with the Department of Justice (DOJ) to handle criminal tax cases as a Special Assistant United States Attorney.  About eight attorneys from Chief Counsel offices around the country joined this program.  I believe that John was the only one who actually tried criminal cases.  During the 1980s and 1990s, he tried over 30 criminal cases while continuing to handle a heavy docket of Tax Court cases and advisory work in the office.  This was made possible by his skill, his organization and his hard work.

He went on a special assignment to the Virgin Island tax authority for several months, he went on assignment to the Senate’s Permanent Sub-Committee on Investigations for over a year and he was assigned to assist the Tax Court in handling a disciplinary hearing.

He traveled to the federal prison in Allenwood to try the Tax Court fraud case of master spy Aldrich Ames.  At the request of Washington District Counsel he tried the fraud case of Grossman v. Commissioner I discussed in a post recently.  He picked up a large fraud case on transfer from me where he tried it and won it and then convinced DOJ to have a receiver appointed in Florida to manage the assets of the taxpayer who had hidden them in many far flung ways, including offshore, and he worked with the receiver for over a decade to collect income from and sell the properties.  While working on that same case, he was stabbed and robbed late one night in Tampa but made it to work the following Monday where he showed his scar ala LBJ.  He created the theory that fraud on the tax return by anyone should hold open the statute of limitations and fought hard with the national office to convince it of the correctness of his theory which we have discussed here.

There are many other highlights of his career but I want to focus on his crowning achievement.  All of these special assignments together with his work in Tax Court and district court trials prepared him for his greatest assignment – working on the offshore credit card project and all that followed.

In 2000 when the IRS reorganized, all of the new divisions wanted John because of his reputation as a great attorney but he chose SBSE due to his desire for the types of cases it handled.  At almost that same time Revenue Agent Joe West in New Jersey had figured out how to find taxpayers hiding their assets offshore by obtaining credit card records in the United States.  John got paired to work with Joe and the world of taxpayers parking money offshore was turned upside down.  Though John was by no means the sole force behind the IRS efforts to break through the world of secrecy and offshore parking of assets to avoid taxes, John was a major force in this effort.  With the depth of knowledge he acquired earlier in his career and the penchant for hard work he always had, he played an important role for the past 16 years in changing the offshore landscape.  Through his efforts the IRS has collected billions of dollars.  It is hard to imagine an IRS attorney with greater impact over this time period than John.

As the IRS says farewell to a great attorney, I write to say thanks to a friend and colleague who taught me so much and who helped me in so many ways.

Summary Opinions through 12/18/15

Sorry for the technical difficulties over the last few days.   We are glad to be back up and running, and hopefully won’t have any other hosting issues in the near future.

December had a lot of really interesting tax procedure items, many of which we covered during the month, including the PATH bill.  Below is the first part of a two part Summary Opinions for December.  Included below are a recent case dealing with Section 6751(b)(1) written approval of penalties, a PLR dealing with increasing carryforward credits from closed years , an update on estate tax closing letters, reasonable cause with foundation taxes, an update on the required record doctrine, and various other interesting tax items.

read more...
  • In December, PLR 201548006 was issued regarding whether an understated business credit for a closed year could be carried forward with the correct increased amounts for an open year.  The taxpayer was a partner in a partnership and shareholder in an s-corp.  The conclusion was that the corrected credit could be carried forward based on Mennuto v. Comm’r, 56 TC 910, which had allowed the Service to recalculate credits for a closed year to ascertain the correct tax in the open year.
  • IRS has issued web guidance regarding closing letters for estate tax returns, which can be found here.  This follows the IRS indicating that closing letters will only be issued upon taxpayer request (and then every taxpayer requesting a closing letter).  My understanding from other practitioners is that the transcript request in this situation has not worked well.  And, some states will not accept this as proof the Service is done with its audit.  Many also feel it is not sufficient to direct an executor to make distributions.  Seems as those most are planning on just requesting the letters.
  • Models and moms behaving badly (allegedly).  Bar Refaeli and her mother have been arrested for tax fraud in Israel.  The Israeli taxing authority claims that Bar told her accountant that she resided outside of Israel, while she was living in homes within the country under the names of relatives.  Not model behavior.
  • The best JT (sorry Mr. Timberlake and Jason T.), Jack Townsend, has a post on his Federal Tax Procedure Blog on the recent Brinkley v. Comm’r case out of the Fifth Circuit, which discusses the shift of the burden of proof under Section 7491.
  • PMTA 2015-019 was released providing the government’s position on two identity theft situations relating to validity of returns, and then sharing the return information to the victims.  The issues were:

1. Whether the Service can treat a filed Business Masterfile return as a nullity when the return is filed using a stolen EIN without the knowledge of the EIN’s owner.

2. Whether the Service can treat a filed BMF return as a nullity when the EIN used on the return was obtained by identifying the party with a stolen name and SSN…

4. Whether the Service may disclose information about a potentially fraudulent business or filing to the business that purportedly made the filing or to the individual who signed the return or is identified as the “responsible party” when the Service suspects the “responsible party” or business has no knowledge of the filing.

And the conclusions were:

1. The Service may treat a filed BMF return as a nullity when a return is filed using a stolen EIN without the permission or knowledge of the EIN’s owner because the return is not a valid return.

2. The Service may treat a filed BMF return as a nullity when the EJN used on the return was obtained by using a stolen name for Social Security Number for the business’s responsible person. The return is not a valid return.

  • Back in 2014, SCOTUS decided Clark v. Rameker, which held that inherited IRAs were not retirement accounts under the bankruptcy code, and therefore not exempt from creditors.  In Clark, the petitioners made the claim for exemption under Section 522(b)(3)(C) of the Bankruptcy Code for the inherited retirement account, and not the state statute (WI, where petitioner resided, allowed the debtor to select either the federal exemptions or the state exemptions).  End of story for those using federal exemptions, but some states allow selection like WI between state or federal exemptions, while others have completely opted out of the federal exemptions, such as Montana.  A recent Montana case somewhat follows Clark, but based on the different Montana statute.  In In Re: Golz, the Bankruptcy Court determined that a chapter 7 debtor’s inherited IRA was not exempt from creditors.  The Montana law states:

individual retirement accounts, as defined in 26 U.S.C. 408(a), to the extent of deductible contributions made before the suit resulting in judgment was filed and the earnings on those contributions, and Roth individual retirement accounts, as defined in 26 U.S.C. 408A, to the extent of qualified contributions made before the suit resulting in judgment was filed and the earnings on those contributions.

The BR Court, relying on a November decision of the MT Supreme Court, held that an inherited IRA did not qualify based on the definition under the referenced Code section of retirement account.  I believe opt-out states cannot restrict exemption of retirement accounts beyond what is found under Section 522, but it might be possible to expand the exemption (speculation on my part).   Here, the MT statute did not broaden the definition to include inherited IRAs.

  • In August, we covered US v. Chabot, where the 3rd Circuit agreed with all other circuits in holding the required records doctrine compels bank records to be provided over Fifth Amendment challenges.  SCOTUS has declined to review the Circuit Court decision.
  • PLR 201547007 is uncool (technical legal term).   The PLR includes a TAM, which concludes reasonable cause holdings for abatement of penalties are not precedent (and perhaps not persuasive) for abating the taxable expenditure tax on private foundations under Section 4945(a)(1).  The foundation in question had assistance from lawyers and accountants in all filing and administrative requirements, and those professionals knew all relevant facts and circumstances.  The foundation apparently failed to enter into a required written agreement with a donee, and may not have “exercised expenditures responsibly” with respect to the donee.  This caused a 5% tax to be imposed, which was paid, and a request for abatement due to reasonable cause was filed.  Arguments pointing to abatement of penalties (such as Section 6651 and 6656) for reasonable cause were made.  The Service did not find this persuasive, and makes a statutory argument against allowing reasonable cause which I did not find compelling.  The TAM indicates that the penalty sections state the penalty is imposed “unless it is shown that such failure is due to reasonable cause and not due to willful neglect.”  That language is also found regarding Section 4945(a)(2), but not (1), the first tier tax on the foundation.  That same language is found, however, under Section 4962(a), which allows for abatement if the event was due to reasonable cause and not to willful neglect, and such event was corrected within a reasonable period.  Service felt that Congress did not intend abatement to apply to (a)(1), or intended a different standard to apply, because reasonable cause language was included only in (a)(2).  I would note, however, that Section 4962 applies broadly to all first tier taxes, but does specify certain taxes that it does not apply to.  Congress clearly selected certain taxes for the section not to apply, and very easily could have included (a)(1) had it intended to do so.

I’m probably devoting too much time to this PLR/TAM, but it piqued my interest. The Service also stated that the trust cannot rely on the lack of advice to perform certain acts as advice that such acts are not necessary.  I am not sure how the taxpayer would know he or she was not receiving advice if it asked the professionals to ensure all distributions were proper and all filings handled.  I can hear the responses (perhaps from Keith) that this is a difficult question, and perhaps the lawyer or accountant should be responsible.  I understand, but have a hard time getting behind the notion that a taxpayer must sue someone over missed paperwork when the system is so convoluted.  Whew, I was blowing so hard, I almost fell off my soapbox.

  • This is more B.S. than the tax shelters Jack T. is always writing about.  TaxGirl has created her list of 100 top tax twitter accounts you must follow, which can be found here. Lots of great accounts that we follow from writers we love, but PT was not listed (hence the B.S.).  It stings twice as much, as we all live within 20 miles of TaxGirl, and we sometimes contribute to Forbes, where she is now a full time writer/editor.  Thankfully, Prof. Andy Gerwal appears to be starting a twitter war against TaxGirl (or against CPAs because Kelly included so many CPAs and so few tax professors).  We have to throw our considerable backing and resources behind Andy, in what we assume will be a brutal, rude, explicit, scorched earth march to twitter supremacy.  We are excited about our first twitter feud, even if @TaxGirl doesn’t realize we are in one.
  • This doesn’t directly relate to tax procedure or policy, but it could be viewed as impacting it, and we reserved the right to write about whatever we want.  Here is a blog post on the NYT Upshot blog on how we perceive the economy, how we delude ourselves to reinforce our political allegiances (sort of like confirmation bias), and how money can change that all.

Summary Opinions for November

1973_GMC_MotorhomeHere is a summary of some of the other tax procedure items we didn’t otherwise cover in November.  This is heavy on tax procedure intersecting with doctors (including one using his RV to assist his practice).  Also, important updates on the AICPA case, US v. Rozbruch, and the DOJ focusing on employment withholding issues.

read more...

I’ve got a bunch of Jack Townsend love to start SumOp.  He covered a bunch of great tax procedure items last month.  No reason for me to do an inferior write up, when I can just link him.  First is his coverage of the Dr. Bradner conviction for wire fraud and tax evasion found on Jack’s Federal Tax Crime’s blog.  Why is this case interesting?  Because it seems like this Doc turned his divorce into some serious tax crimes, hiding millions offshore.  He then tried to bring the money back to the US, but someone in the offshore jurisdiction had flipped on him, and Homeland Security seized the funds ($4.6MM – I should have become a plastic surgeon!).  His ex is probably ecstatic that the Feds were able to track down some marital assets.   I am sure that will help keep her in the standard of living she has become accustom to.

  • I know I’ve said this before, but you should really follow Jack Townsend’s blogs.  From his Federal Tax Procedure Blog, a write up of the Second Circuit affirming the district court in United States v. Rozbruch.  Frank Agostino previously wrote up the district court case for us with his associates Brian Burton and Lawrence Sannicandro.  That post, entitled, Procedural Challenges to Penalties: Section 6751(b)(1)’s Signed Supervisory Approval Requirement can be found here.  Those gents are pretty knowledgeable about this topic, as they are the lawyers for the taxpayer. As Jack explains, the Second Circuit introduces a new phrase, “functional satisfaction” (sort of like substantial compliance) as a way to find for the IRS in a case considering the application of Section 6751(b) to the trust fund recovery penalty.
  • The Tax Court in Trumbly v. Comm’r  has held that sanctions could not be imposed against the Service under Section 6673(a)(2) where the settlement officer incorrectly declared the administrative record consisted of 88 exhibits that were supposed to be attached to the declaration but were not actually attached.  The Chief Counsel lawyer failed to realize the issue, and forwarded other documents, claiming it was the record.  The Court held that the Chief Counsel lawyer failed to review the documents closely, and did not intentionally forward incorrect documents.  The Court did not believe the actions raised to the level of bad faith (majority position), recklessness or another lesser degree of culpability (minority position).  Not a bad result from failing to review your file!
  • This isn’t that procedure related, but I found the case interesting, and I’ve renamed the Tax Court case Cartwright v. Comm’r as “Breaking Bones”.  Dr. Cartwright, a surgeon, used a mobile home as his “mobile office” parked in the hospital parking lot.  He didn’t treat people in his mobile home (which is good, because that could seem somewhat creepy), but he did paperwork and research while in the RV.  Cartwright attempted to deduct expenses related to the RV, including depreciation.  The Court found that the deductions were allowable, but only up to the percentages calculated by the Service for business use verse personal use.  I’m definitely buying an Airstream and taking Procedurally Taxing on the road (after we find a way to monetize this).
  • The IRS thinks you should pick your tax return preparer carefully (because it and Congress have created a monstrosity of Code and Regs, and it is pretty easy for preparers to steal from you).
  • Les wrote about AICPA defending CPA turf in September.  In the post, he discussed the actions the AICPA has been taking, including the oral argument in its case challenging the voluntary education and testing regime.  As Les stated:

The issue on appeal revolves whether the AICPA has standing to challenge the plan in court rather than the merits of the suit. The panel and AICPA’s focus was on so-called competitive standing, which essentially gives a hook for litigants to challenge an action in court if the litigant can show an imminent or actual increase in competition as a result of the regulation.

On October 30th, the Court of Appeals for the District of Columbia reversed the lower court, and held that the AICPA had standing to challenge the IRS’s Annual Filing Season Program, where the IRS created a voluntary program to somewhat regulate unenrolled return preparers.  The Court found the AICPA had “competitive standing”, which Les highlighted in his post as the argument the Court seemed to latch on to.   For more info on this topic, those of you with Tax Notes subscriptions can look to the November 2nd article, “AICPA Has Standing to Challenge IRS Return Preparer Program”.  Les was quoted in the post, discussing the underlying reasons for the challenge.

  • Service issued CCA 201545017 which deals with a fairly technical timely (e)mailing is timely (e)filing issue with an amended return for a corporation that was rejected from electronic filing and the corporation subsequently paper filed.  The corporation was required to efile the amended return pursuant to Treas. Reg. 301.6011-5(d)(4). Notice 2010-13 outlines the procedure for what should occur if a return is rejected for efiling to ensure timely mailing/timely filing, and requires contacting the Service, obtaining assistance, and then eventually obtaining a waiver from efiling.  There is a ten day window for this to occur.  The corporation may have skipped some of the required steps and just paper filed.  The Service found this was timely filing, and skipping the steps in the notice was not fatal.  The Service did note, however, that efiling for the year in question was no longer available, so the intermediate steps were futile.  A paper return would have been required.  It isn’t clear if the Service would have come to the same conclusion if efiling was possible.
  • Sticking with CCAs, in November the IRS also released CCA 201545016 dealing with when the IRS could reassess abated assessment on a valid return where the taxpayer later pled guilty to filing false claims.   The CCA is long, and has a fairly in depth tax pattern discussed, covering whether various returns were valid (some were not because the jurat was crossed out), and whether income was excessive when potentially overstated, and therefore abatable.  For the valid returns, where income was overstated, the Service could abate under Section 6404, but the CCA warned that the Service could not reassess unless the limitations period was still open, so abatement should be carefully considered.

 

 

Summary Opinions for the week of 05/01/15

Happy Memorial Day weekend!  We won’t be posting on Monday, but will probably be back in full force on Tuesday.  I know we have a handful of guest posts coming up on really interesting topics and I’m certain Keith and Les have some insightful things to add following ABA.

In the week of May the 1st, we welcomed first time guest poster, Marilyn Ames, who wrote on NorCal Tea Party Patriots v. IRS and disclosure of return information.

Here are the other procedure items from that week:

read more...
  • A recent Tax Court decision brought back the analysis used by the Supreme Court almost 20 years ago on a similar but slightly distinct fact pattern.  The situation can be tough to follow at first because it plays out at the intersection of Sections 6511 and 6512.  It also involves reliance on the earlier Supreme Court decision which caused a change to Section 6512 after it was decided.  In Butts v. Comm’r, the Tax Court denied taxpayers’ request for refund as being untimely.  The taxpayers failed to file in ’07 and ’08.  In 2011 (and 2012), SNODs were issued for 2007 and 2008, and later that year the taxpayer filed for review in the Tax Court.  In 2013, taxpayers filed joint returns, claiming overpayment due to employer withholdings.  The Court stated SCOTUS reviewed an almost identical case in Lundy v. Comm’r.   The issue in both cases was if the refund amount was allowed under Section 6512(b)(3), which allows refunds of any amount paid:

(A) after the mailing of the notice of deficiency;

(B) within the period which would be applicable under section 6511(b)(2), (c), or (d), if on the date of the mailing of the notice of deficiency a claim had been filed (whether or not filed) stating the grounds upon which the Tax Court finds that there is an overpayment; or

(C) within the period which would be applicable under section 6511(b)(2), (c), or (d), in respect of any claim for refund filed within the applicable period specified in section 6511 and before the date of the mailing of the notice of deficiency.

Based on the facts in Butts and Lundy, (A) and (C) do not apply.  In Lundy, SCOTUS stated it considered:

the look-back period for obtaining a refund of overpaid taxes in the…Tax Court under 26 USC 6512(b)(3)(B), and decide[d] whether the Tax Court can awarded a refund of taxes paid more than two years prior to the date on which the [IRS] mailed the taxpayer a notice of deficiency, when, on the date the notice of deficiency was mailed, the taxpayer had not yet filed a return.  We hold that in these circumstances the 2-year look-back period in 6513(b)(3)(B) applies, and the Tax Court lacks jurisdiction to award a refund.

One difference in Butts and Lundy is that in Lundy the taxpayer made its request within three years of the filing date, whereas in Butts the request was made more than three years after the filing date.  Based on a prior version of the statute, Lundy was precluded from obtaining a refund because it was outside of two years and there was not a reference to the three year statute applicable. Section 6512(b)(3) was modified in 1997 by Congress, and now the minimum statute of limitations would be the three years from the filing date.

In Butts, under Section 6512(b)(3)(B), the Court stated it must look to the mailing date of the SNOD as a hypothetical claim date and determine if a timely claim could have been made then based on Section 6511.  This requires a review of the two year statute from the date of taxes paid, and three years from the due date of the return.  The withholdings for 2007 were treated as having been paid on April 15, 2008, while the initial SNOD was issued in June of 2011.  Since both statutes had passed, no claim for refund could be allowed.  There was a similar issue with the 2008 return.

  • Peter Hardy and Carolyn Kendall, attorneys from Post & Schell, and prior guest bloggers here at PT, have posted on Jack Townsend’s Federal Tax Crimes blog (two-timers!) on the Microsoft appeal in In re Warrant to Search a Certain E-mail Account.  The guest post can be found here, and Jack’s summary of related materials on the Stored Communications Act can be found here.  Although the post deals with a drug case, the impact could be far reaching regarding subpoena power over electronic communications in the cloud (including datacenters outside of the US).  Peter and Carolyn tie in the Service’s review of foreign accounts nicely.
  • It’s like speed dating, but it might cost more and you only get lucky if you don’t get picked.  The NY Times has an op-ed on the IRS speed audit, with agency cut backs causing reduced response time for taxpayers, which if not promptly responded to could result in important collection due process rights being forfeited.  The op-ed indicates that the IRS may be sending out follow up letters the same day as the initial letter, which the author argues is in violation of the updated taxpayer bill of rights issued last year.  When you are on the op-ed, check out the comments the NY Times has picked as important.  Carl Smith was highlighted for indicating a few other ways the tax system is failing taxpayers.  This practice may save time for the Examination Division of the IRS but pushes more cases into the collection stream which also impacts the IRS resources.
  • On April 20th, the Tax Court issued a decision in Yuska v. Comm’r, holding the automatic stay invalidated a Notice of Determination Concerning Collection Actions regarding a tax lien that was issued after the bankruptcy petition.  Importantly, the Court declined to follow the IRS’s suggestion that the Court distinguish this case from Smith v. Comm’r, which had similar facts but pertained to a levy.  The timing of events were very important in following Smith, and the Service also argued that the Court should instead follow Prevo v. Comm’r, which was a lien case where the collection action occurred before the BR petition.  In Smith, the Serviced began collection actions, and then the taxpayer filed a bankruptcy petition, followed by the Service issuing a notice of determination concerning the levy, and then the taxpayer petitioning the Tax Court for review of the levy action.  The Court held the continuance of the collection action violated the stay under 11 USC 362(a)(1).  In Prevo, the sustaining of the lien occurred before the BR petition.  As to differentiating between a lien and levy case, the Court found the administrative review of a lien was clearly part of the administrative collection process and subject to the ruling in Smith, even if future administrative review was possible. Although the Court declined to differentiate between the two in this case, Keith noted that if the stay stopped the CDP case there can be important differences.  In a lien case, the NFTL remains valid (if not enforceable) until after the stay is lifted.  In a levy case, the stay prevents the IRS from moving forward with the levy completely.  Keith didn’t read the case, and still came up with something much more insightful and helpful to add.
  • This is becoming a little like an advertisement for Jack Townsend’s Criminal Tax Crimes Blog.  Jack posted on the recent 7th Circuit case, US v. Michaud, which reviewed whether or not the IRS had authority to issue a summons in a criminal matter prior to a DOJ referral.  The statute in question is Section 7602(b) & (d), which was modified after US v. LaSalle Nat’l Bank to make it clear the IRS did have this authority.  The 7th Circuit had some additional thoughts on when the IRS couldn’t issue the summons.  Check out the post for a discussion of that point, and Jack’s always helpful thoughts on the matter.
  • Context is always important.  For instance, being suspended can be very good (we took our daughters rock climbing this weekend, and being suspended by the rope was really helpful), but it can also be pretty bad in the school, professional or corporate context.  Such was the case in Leodis C. Matthews, APC, a CA Corp. v. Comm’r, where the Tax Court held that it lacked jurisdiction  over a deficiency petition brought be a corporation (law firm) that California had suspended its corporate privileges for due to failure to pay state taxes.  Interesting point of law.  Can someone bring the petition on behalf of the corporation so it does not lose its ability to contest the tax?  Timing is also interesting.   Corp is suspended May 1, 2013, and 90 day letter is issued June 30, 2014.  Taxpayer petitions court Oct. 1, 2014 (presumably timely), and had its corporation reinstated November 26, 2014.  You would guess he was trying to deal with his state tax issue during the 90 day period.  I also wonder if there is a way to get limited rights reinstated, so that the corporation could have petitioned the Tax Court.
  • We all hear the scare tactics on the radio about how if you owe more than $10,000, the IRS is going to come and take your assets, steal your children, put you in jail, shoot your dog, etc.  We are lucky enough to know this is BS, and an effort to garner business.  Sometimes, however, the IRS can show up at your premises (probably armed), and take your stuff.  You have to owe a bit more than $10k, and the Service has to jump through a lot of hoops.  In re: The Tax Indebtedness of Voulgarelis is one such writ of entry case.  In Voulgarelis, the taxpayer apparently owed around $300k, possibly more, and ignored six notices of intent to levy.  The Service sought an order authorizing it to enter the premises and levy the tangible property, which was granted in accordance with GM Leasing Corp. v. United States, 429 US 338 (1977).
  • The Service has updated its list of private delivery services that count for the timely mailing is timely filing rules under Section 7502.  The update can be found in Notice 2015-38.  As we’ve discussed before, failure to file these rules can result in harsh results.  These results can be seemingly arbitrary when a taxpayer selects a quicker FedEx/UPS delivery method that isn’t approved, and cannot rely on the rule.
  • In information notice 2015-74, the IRS has reminded businesses of the temporary pilot penalty relief program for small businesses that have failed to properly comply with administrative and reporting requirements for retirement plans.  That program ends June 2nd.

 

Summary Opinions for the weeks of 3/06/15 through 3/20/15

Image from https://storesafewasnotsafe.wordpress.com/

This will be the last post for the week, as we will all be busy with family activities (and taxes).  We should be back on Monday with some new content, and it looks like next week will cover some really interesting areas, including the recent Godfrey case, and sealing Tax Court records.

We have been very lucky over the last month to have a lot of really great guest posts.  We cannot thank those guest posters enough for the quality content, especially as the three of us have been very busy with our various other jobs (or appearing before the Senate–perhaps more on that next week also).  For the weeks that SumOp is covering in this post, we had Mandi Matlock writing on TPA Most Serious Problem # 17 on how deficient refund disallowance notices are harming taxpayers.  Peter Lowy wrote on the really interesting Gyorgy case, which deals with the taxpayer’s requirement to notify the Service on a change of address, but also highlights a host of other procedure items.   Patrick Smith joined us again, writing on Perez v. Mortgage Bankers Associate, and illuminating us on APA notice and comment requirements for different types of rules and the possible eventual reversal of Auer.  We also welcomed Intuit’s CTO, David Williams who wrote a response to Les’ prior post on H&R Block’s CEO indicating it should be harder to self-prepare (which Les was potentially in favor of).  And, another first time guest blogger, Patrick Thomas, joined us writing on the calculation of SoLs on collections matters.

We were also very lucky again to have Carl Smith writing for us, this time updating us on the Volpicelli jurisdiction case and the Tax Court pleading rules on penalties looking at the El v. Comm’r case.  A thank you to all of our guests over those two weeks, and a special thanks to Carl for his continued support.

To the other procedure items (if you keep reading, the image will make more sense):

read more...
  • The Service released CCA 201510043, in which Chief Counsel stated a taxpayer is entitled to two sets of collection due process rights for the same period when there were two assessments; one for assessment arising out of a civil exam and the other from restitution-based assessment.  Section 6201(a) was recently (five years ago) amended to require assessment and collection of restitution in the same manner as tax.  The advice has a nice summary of cases outlining why this double assessment of the same tax is not double jeopardy.  Although the general rule is that a taxpayer is entitled to one CDP hearing with respect to tax and tax years covered by the CDP notice, there are situations where multiple hearings are appropriate.  The advice highlights Treas. Reg. 301.6320-1(d)(2) Q&A D1 and Treas. Reg. 301.6330-1(d)(2) Q&A D1 as examples of allowing two CDP hearings when there has been additional assessments of tax or new assessments for additional penalties.  The Advice determined that this situation was analogous and warrants two separate CDP hearings.
  • The Northern District of California in In Re Wilson held that penalties for failure to timely file were dischargeable when the original due date was outside of the three year look back under BR Code 523(a)(7)(b), but the taxpayer had extended the due date and the extended date was within the three years.  The Court indicated this was a case of first impression.  Another interesting BR Code Section 523 issue.
  • This clearly only pertains as a practitioner point, and not something any of our readers would personally need, but OPR has announced a standard information request letter to make a Section 6103 request for information maintained by OPR relating to possible violations of Circ. 230.  Info about the letter is found here, and you can get the actual letter here.
  • The Ninth Cir. affirmed the Tax Court in Deihl v. United States in finding a widow spouse did not qualify for innocent spouse relief.  In the case the Court did not find there was clear error by the Tax Court in reviewing the widow’s testimony and find it was not credible.  The surviving spouse provided testimony that conflicted with other evidence regarding the couples’ business, and she did not offer any third party testimony regarding the abuse.  The widow argued that since the Service did not offer contrary testimony regarding the abuse, the Tax Court had to accept her testimony, which the Ninth Circuit stated was incorrect.  Further, looking to Lerch v. Comm’r, a Seventh Circuit decision, stated that the Tax Court did not have to accept testimony that was questionable, even if uncontradicted (tough to overcome the presumption of guilt that comes along with a name like Lerch).
  • Gambling causes fits for the Service.  Tipped casino employees used to underreport frequently, but apparently casinos will provide estimates to the Service.  Gambling website accounts might be offshore accounts (even if sourced in US banks). Add to that list of problems how to treat bingo, keno and slot machine winnings.  This blurb will focus on slot machines.  New proposed regulations offered in a recent IRS Notice would provide a safe harbor to determine gains and losses from a slot machine.  The issue is that gains from “transactions” are included in income.  Losses are deductible to the extent of winning, but generally as itemized deductions.  For slot machines, a “transaction” is session based.  What is a session can be a point of disagreement between the Service and taxpayers.  This is apparently becoming more murky now that people don’t use actual coins.   So, what are those retirees on the bus trips to AC or Vegas to do?  The Service is soliciting suggestions, but the current proposed safe harbor states that a session of play:

A session of play begins when a patron places the first wager on a particular type of game and ends when the same patron completes his or her last wager on the same type of game before the end of the same calendar day. For purposes of this section, the time is determined by the time zone of the location where the patron places the wager. A session of play is always determined with reference to a calendar day (24-hour period from 12:00 a.m. through 11:59 p.m.) and ends no later than the end of that calendar day

The Notice then goes on to explain how to calculate gains and losses during the session.

  • Add this to the list of things that will not get you out of the failure to timely file penalties – taxpayer could not access tax records because his storage unite doors had frozen over.  The argument received an icy reception (oh, man that was bad) with both the Service and the Tax Court. See Palmer v. Comm’r., TC Memo 2015-30 (for some reason this isn’t up on the TC web page anymore – sorry).
  • If you are going to cheat on your taxes, you probably should do so using offshore accounts (I usually charge clients a .5 for that advice, and you all just got it for free!).  Check out Jack Townsend’s blog on US v. Jones, an “ordinary tax cheat”, as Mr. Townsend put it, who got dinged with 80% of the bottom of the guideline range for sentencing.  He was using “sophisticated means”, which seemed fairly run of the mill.  Jack compares this to the sentencing of another UBS client, who ended up getting 22% of the bottom of the guideline range.  Switzerland should use this in its promotional materials.
  • In MSSB v. Frank Haron Weiner, the Eastern District of Michigan found that Section 6332(a) did not establish priority for competing liens, and instead Sections 6321, 6322 and 6323 established the priority (in favor of the IRS in this case).  In MSSB, a debtor owed funds to the IRS and a lawyer named Frank.  The Service recorded four liens, each before December 3, 2012.  Around $1.6MM was owed.  On December 6, 2012, Frank sued the debtor to recover unpaid legal fees and won.  In 2013, Frank obtained a writ to garnish the debtors IRA (Michigan must not offer much in terms of creditor protection for IRAs).  The Service stepped in, arguing it had priority on the IRA.  Frank countered, arguing that Section 6332(a) would give him the money.  The Section states:

Except as otherwise provided in this section, any person in possession of (or obligated with respect to) property or rights to property subject to levy upon which a levy has been made shall, upon demand of the Secretary, surrender such property or rights (or discharge such obligation) to the Secretary, except such part of the property or rights as is, at the time of such demand, subject to an attachment or execution under any judicial process.

Frank’s position was that his claim was the type of claim referenced by the “subject to an attachment or execution under any judicial process.”  The Court, however, held that the language did not direct which claim (that of the IRS or Frank) had priority, and only stated that the financial institution did not have to turn the funds over to the IRS.  The Court then looked to the other lien provisions, and found the IRS had priority and directed payment.

  • I went to see roller derby one time, which was really entertaining.  A perfect mix of roller skating and WWF.  All of the young women have funny/clever names, and often have slogans.  The announcer said of one that she had “champagne for her real friends, and real pain for her sham friends.”  Unfortunately, this has really nothing to do with this next case, except the tax court was dropping some real pain on a sham partnership.  In Bedrosian v. Comm’r, the Tax Court held that whether legal fees paid by a sham partnership were deductible was an affected item subject to TEFRA, and the Court had jurisdiction to make such a determination.  This was not the Bedrosians’ first Tax Court rodeo, and they keep making new TEFRA law, which now comprises a substantial chunk of revised Saltzman and Book Chapter 8 dealing with general exam procedures and a growing subsection dealing just with the complex world of TEFRA.

Between the National Taxpayer Advocate and the Courts: Steering a Middle Course to Define “Willfulness” in Civil Offshore Account Enforcement Cases Part 2

In Part 2 of their post on offshore compliance issues, Peter Hardy and Carolyn H. Kendall of Post & Schell discuss the standard necessary to prove willfulness for failing to file an FBAR. Les

In our first post yesterday, we discussed United States v. Sturman, in which the Sixth Circuit in 1991 upheld a criminal conviction for a willful failure to file an FBAR, and made clear that the standard for willfulness is an intentional violation of a known legal duty. We also observed that the IRS, in a 2006 Chief Counsel Advisory Memorandum, embraced this same definition of willfulness for the purposes of imposing civil FBAR penalties. In this post, we examine how some court opinions have eroded that willfulness standard in the civil FBAR context, a trend that leads us to agree with the recommendation made by the January 14, 2015 Report of the National Taxpayer Advocate that the willfulness requirement for civil FBAR actions be amended legislatively to reflect that willfulness requires not mere recklessness, but a voluntary and intentional violation of a known legal duty.

read more...

Civil FBAR Case Law: Williams and McBride

In contrast to Sturman, two courts that have considered the scope of willfulness in the civil FBAR context have suggested that failing to answer accurately the question regarding a foreign account on Schedule B can, without more, support a finding of willfulness with respect to a failure to file an FBAR. Further, these courts have stated that willfulness in the civil FBAR context includes mere recklessness, which includes careless disregard. These decisions clearly reflect that the government has disavowed the 2006 IRS memorandum’s embrace of a higher standard for willfulness in the civil FBAR context. Regardless of the exact fact patterns at issue in these cases, they state rules of law that may haunt future, more sympathetic account holders.

Williams

In United States v. Williams, the government filed a complaint to recover civil FBAR penalties assessed against the defendant for the year 2000. The defendant had deposited more than $7 million in assets into two Swiss bank accounts from 1993 through 2000, earning more than $800,000 on the deposits, and had failed to disclose these accounts or the income derived therefrom. On his individual income tax returns, Williams checked the relevant box on Schedule B “no,” thereby indicating that he had no foreign accounts. Likewise, Williams indicated on a tax organizer provided to him by his accountant in January 2001, for the purposes of his then-upcoming 2000 tax return, that he did not have a foreign account. However, Williams had retained counsel in the fall of 2000 because Swiss and U.S. authorities had become aware of his Swiss accounts, which were frozen in November 2000 on the day after Williams and his counsel had met with the Swiss authorities to discuss the accounts. Over the course of 2002 and 2003, Williams disclosed these accounts to the IRS, and disclosed them on his 2001 tax return and amended tax returns for 1999 and 2000, as part of his bid to participate in the IRS’s voluntary disclosure program. Williams was not accepted into the program, and he pleaded guilty in June 2003 to tax fraud, on the basis of the funds held in his Swiss accounts from 1993 through 2000. In 2007, he filed FBARs for all years going back to 1993, including for the year 2000.

After a bench trial regarding the basis for the civil FBAR penalties assessed for the 2000 tax year, the district court found that “[d]espite hiring tax lawyers and accountants, Williams had never been advised of the existence of the [FBAR] form prior to June 30, 2001, nor had he ever filed the form in previous years with the Department of Treasury.” The district court also found that Williams had not acted willfully as to his 2000 year FBAR. Specifically, it found that when Williams checked the “no” box on his 2000 personal income tax return indicating that he had no foreign bank accounts, and when he failed to file an FBAR on June 30, 2001, he already knew that the tax authorities were aware of his noncompliance, and he already had begun to meet with Swiss authorities. The district court found that this lack of willfulness was corroborated by Williams’s later disclosures of the accounts to the IRS and his filing of accurate returns. Finally, the district court rejected the government’s claim that Williams’s plea to tax evasion estopped him from arguing that he did not willfully violate his 2000 year FBAR obligation.

The Fourth Circuit, purporting to apply the standard of clear error, reversed the district court’s factual finding that Williams had not acted willfully in a 2012 unpublished opinion. When doing so, the Fourth Circuit also stated that, in the civil context, willfulness includes not just knowing violations, but also reckless ones. Citing Sturman for the proposition that willfulness may be inferred under the willful blindness doctrine, the Fourth Circuit emphasized that Williams had signed his 2000 income tax return, which had put him on notice about the 2000 FBAR filing requirements because of the question on Schedule B regarding foreign bank accounts, which references the FBAR – i.e., Williams should have realized that he had an FBAR filing requirement, but avoided learning about it. The Fourth Circuit also found that Williams’s guilty plea allocution for his tax convictions confirmed that his FBAR violation was willful. However, the Williams opinion contained a dissent, which argued that the record contained sufficient evidence supporting the conclusion of the district court, which had not clearly erred when it found a lack of willfulness. Moreover, the dissent observed that the district court correctly rejected the government’s collateral estoppel argument because Williams never admitted during his guilty plea to failing to file an FBAR, much less failing to do so willfully.

Although Williams involves unusual facts, it implies – because it reversed for clear error the contrary conclusion of the fact finder – that willfully filing a false tax return that does not disclose a foreign account can be inherently synonymous with willfully failing to file the separate FBAR form for the same tax year, at least in a civil penalty case. Although the court also pointed to the inaccurate information Williams provided on his tax organizer as an example of additional conduct meant to conceal, that conduct seems secondary and intrinsic to its immediate consequence – the failure to disclose the account on the tax return. Whether the outcome in Williams was the product of the court’s embrace of the recklessness standard, or was the inevitable product of the court’s interpretation of the willful blindness doctrine, cannot be gleaned from the opinion. Certainly, the court made clear that it viewed the willfulness standard in a civil penalty case as different from the willfulness standard in a criminal case.

McBride

The District of Utah cited Williams when holding in 2012 that the willful filing of signed false income tax return supports a finding of willfulness with respect to failing to file an FBAR. In United States v. McBride, the defendant sought to reduce his tax liabilities arising from his increasingly successful company, and so contacted a financial management firm devoted to tax minimization, Merrill Scott and Associates (MSA). MSA presented McBride with a plan to shift his company’s income to offshore accounts owned by MSA’s foreign entities, over which McBride would have indirect control. MSA also gave McBride a pamphlet setting forth duty as a U.S. taxpayer to report his interest in any foreign account to the government. Pursuant to MSA’s plan, McBride created a transfer pricing scheme whereby the company purchased inventory from a manufacturer at an inflated price and the manufacturer then deposited the overpayment into the offshore accounts that McBride indirectly controlled. During 2000 and 2001, McBride routed roughly $2.7 million through these offshore accounts. McBride failed to inform his preparers of the MSA plan or his interest in the offshore accounts. On his individual income tax returns for both years, he checked “no” on Schedule B and signed the returns. In 2004, the IRS began to investigate McBride; he denied using MSA’s plan or having an interest in the foreign accounts and refused to complete FBARs for 2000 and 2001. Ultimately, the IRS asserted civil penalties against McBride for tax years 2000 and 2001.

After a bench trial, the district court found that McBride’s failure to file FBARs for 2000 and 2001 was willful. As in Williams, the court stated that “willfulness” for civil FBAR enforcement proceedings has the same definition as in other civil contexts: recklessness and willful blindness both constitute civil willfulness, which can be inferred from circumstances, including actions taken to conceal or mislead. However, invoking a recklessness standard hardly seemed necessary to establish liability: according to the court, ample evidence demonstrated that McBride had actual knowledge of his obligation to file an FBAR. The court found that McBride had read the pamphlet from MSA discussing the filing requirement and, more tellingly, he testified that he did not check “yes” on Schedule B “because . . . if you disclose the accounts on the form, then you pay tax on them, so it went against what I set up [MSA] for in the first place.” Despite this seemingly ample evidence of actual knowledge, the court also engaged in an imputed knowledge analysis; it held that because “a taxpayer’s signature on a return is sufficient proof of a taxpayer’s knowledge of the instructions contained in the tax return form,” and because McBride signed the return, which contained instructions concerning the FBAR filing requirement, McBride had imputed knowledge of the FBAR requirement. The court further noted, relying on Sturman, that circumstantial evidence of McBride’s willfulness included his misstatements to, and concealments from, the IRS during their 2004 investigation, which also contradicted his claim that he did not know he had a legal duty to file FBARs.

Finally, the court rejected McBride’s contention that he was not willful because he subjectively believed that he lacked a reportable interest in the foreign accounts based on professional advice. The court held that any belief by McBride that he was not legally required to file an FBAR was “irrelevant” in light of his signing of his tax returns. According to the court, under Lefcourt v. United States, once it is established that a filing was required by law, the only relevant inquiry is whether the failure to file was voluntary rather than accidental. This statement, considered in the abstract, is simply contrary to a definition of willfulness requiring an intentional violation of a legal duty that is subjectively understood by the individual.

Legislative Proposal

The Williams and McBride opinions both reflect that the government has disavowed the more measured position articulated by the IRS in its 2006 Chief Counsel Advisory Memorandum. They also provide ammunition for the government’s anticipated efforts to advance in future civil FBAR cases a lax definition of willfulness which allows for mere recklessness. Further, the McBride court’s reasoning under Lefcourt and the Williams court’s reversal for clear error suggest that simply failing to “check the box” on Schedule B of a tax return regarding a foreign account might cause any failure to file an FBAR to be deemed – at least by the IRS, if not a court – a per se willful failure in a civil case. Given this erosion of the willfulness standard, the suggestion by the National Taxpayer Advocate that the willfulness requirement for civil FBAR actions be amended legislatively to make clear that willfulness requires not just recklessness, but a voluntary and intentional violation of a known legal duty, therefore makes particular sense. As the Report suggests, restoring the integrity of the willfulness standard in civil cases will honor the intent of Congress that the draconian 50% penalty address the problem of bad actors concealing their income. Likewise, clarity regarding the standard for willfulness, and excluding the merely reckless from its net, would accomplish several goals:

  • Imposition of the severe 50% penalty for willfulness would be limited, at least in principle, to those who actually deserve it and to whom it was intended to apply: those individuals who intentionally disregarded a known legal duty, rather than those who merely “should have known better.”
  • Public criticisms of the IRS offshore disclosure programs and related enforcement should be muted. Although case-specific disagreements likely will remain regarding the application of the willfulness standard, it simply will be easier as a matter of principle for the IRS to justify imposing high penalties on intentional law breakers.
  • Excluding recklessness from the definition of willfulness enhances the clarity and fairness of the process of certifying non-willfulness, as required by the current “streamlined” program for offshore accounts. Programs such as the streamlined program, which offer the government the benefits of administrative convenience and maximizing the amount of taxpayers who enter into compliance with the tax system, succeed best when individuals and their advisors feel relatively secure about how the rules are both defined and applied. If willfulness includes recklessness, it is simply harder to predict what conduct eventually may be deemed to be willful. Further, if not checking the box on one’s tax returns to indicate the presence of a foreign account is regarded by the government as synonymous with civil willfulness for the purposes of the FBAR, then the streamlined program becomes almost incoherent, because its benefits and purpose will not be realized except in the most unusual cases.

However, we respectfully disagree with the Report that any legislative or policy change should reflect that the government cannot meet its burden through “circumstantial evidence.” Given the entrenched role of circumstantial evidence in gleaning mental state in both civil and criminal contexts, such line drawing seems unworkable in practice and would contradict basic principles regarding proof of mental state, for which “direct evidence” – to the extent that it is even possible in practice to distinguish direct and indirect evidence – rarely is available. Likewise, we disagree that the government should not have access to the doctrine of willful blindness when attempting to prove mental state. Again, willful blindness – like it or not – is an accepted method of proving mental state. Although the doctrine of willful blindness invites the unfortunate risk that fact finders will inappropriately conflate negligence with actual knowledge or intent, the doctrine itself, properly articulated, demands more than mere recklessness. Indeed, as the Supreme Court made clear in 2011 in Global-Tech Appliances, Inc. v. SEB S.A., willfulness blindness is not a substitute for actual subjective belief, and the doctrine requires that the defendant take deliberate, affirmative actions to avoid learning the critical facts. Deliberate indifference and the existence of known risks, standing alone, will not suffice. Ultimately, a clear definition of willfulness as an intentional violation of a known legal duty will harmonize the civil and criminal law for FBARs; how mental state may be proved should be left to traditional principles of civil and criminal law.

Between the National Taxpayer Advocate and the Courts: Steering a Middle Course to Define “Willfulness” in Civil Offshore Account Enforcement Cases Part 1

Today we welcome first time guest bloggers Peter D. Hardy and Carolyn H. Kendall who practice in the Internal Investigations & White Collar Defense Practice Group of the law firm of Post & Schell P.C., in Philadelphia, PA.  Peter, a principal in the firm, is the author of a legal treatise entitled Criminal Tax, Money Laundering, and Bank Secrecy Act Litigation (Bloomberg BNA 2010).  He also serves as an adjunct law professor for the Villanova University School of Law Graduate Tax Program, where he co-teaches a class on civil and criminal tax penalties. Carolyn, an associate at the firm, co-authored the 2014 Supplement to Criminal Tax, Money Laundering, and Bank Secrecy Act Litigation. Both conduct internal investigations and defend corporations, officers and other individuals facing criminal and civil investigations.  

They also assist clients in offshore account disclosure and compliance via IRS disclosure programs (OVDP and Streamlined Procedures) which is the subject of today’s blog post. Picking up on a recommendation in the National Taxpayer Advocate’s 2014 Annual Report, they explain in a two part post the change they feel necessary to the willfulness standard applied to the reporting (or failure to report) offshore bank accounts. Today’s post describes the problem and early case law. Tomorrow’s post will explain where the standard veered off course and how to get it back on track with the appropriate legislative change. Keith

The government has pursued for several years a successful enforcement campaign against undisclosed offshore accounts; the definitive opening salvo in this campaign was the deferred prosecution agreement in February 2009 involving Swiss banking giant UBS. In addition to numerous prosecutions of account holders, professionals, and banks, the IRS has reported that over 38,000 U.S. taxpayers to date have self-disclosed their offshore accounts. The reporting form that has driven this enforcement campaign is the Foreign Bank Account Report, or FBAR, an annual report required under the Bank Secrecy Act (BSA) for U.S. taxpayers holding offshore accounts with a value above $10,000 at any point in the year. Underlying the success of the campaign and the number of voluntary disclosures has been the potentially draconian civil penalties associated with failing to file an FBAR: a “willful” failure to file an FBAR, or the “willful” filing of a false FBAR, can produce a civil penalty equal to fifty percent of the entire account balance, for every year of violation. Given a six year statute of limitations, stacked civil penalties could equate to three times the account balance. Thus, although a “willful” FBAR violation can result in criminal penalties, the tail of potentially very severe civil penalties often has wagged the dog of most taxpayers’ very unlikely real world criminal exposure, and has allowed the IRS to dictate some tough terms when outlining its offshore disclosure programs, which permit taxpayers to avoid criminal prosecution and avoid the harsh 50% penalty.

On January 14, 2015, the National Taxpayer Advocate issued a detailed report (“Report”) regarding suggested reforms of the civil FBAR penalty regime. Although the Report contains many good proposals, we focus here on just one, which seems to strike at the heart of the many critiques raised over the years regarding the perceived inequities in the structure and application of the IRS’s various offshore voluntary disclosure (OVD) programs. The OVD programs have netted many people who may have inadvertently failed to file FBARs, and who are not wealthy people with substantial accounts. As the Report explains, uncertainty has compelled some individuals who never committed fraud to resign themselves to significant civil penalties because“[b]enign actors cannot be sure that IRS will not view their FBAR violations as ‘willful,’ and attempt to impose severe penalties. This is because the government has eroded the distinction between willful and non-willful violations.”

read more...

We agree. Court victories by the government in civil FBAR enforcement actions have diluted the willfulness threshold, from the more appropriate standard of an intentional and voluntary violation of a known legal duty, to a standard of mere recklessness. A “recklessness” standard lacks precision and invites severe penalties simply because an individual is presumed – or is concerned about being presumed – to have “known better,” even if he in fact did not know.

The Report therefore wisely proposes that the willfulness requirement for civil FBAR actions be amended legislatively to make clear that willfulness requires not just recklessness, but a voluntary and intentional violation of a known legal duty. In the first part of this two-part post, we describe how, prior to the current offshore enforcement campaign, willfulness in the civil FBAR context was understood to be equivalent to willfulness in the criminal context. In the second part, we describe how recent case law in the civil FBAR context has eroded this definition, and why the Report’s legislative proposal would benefit both taxpayers and the IRS by correcting this apparent trend. As practitioners who assist taxpayers with disclosing their offshore accounts and becoming fully tax compliant, we join with the Report and the public and private comments of many of our colleagues in observing that this erosion of the willfulness standard fails to distinguish adequately between most account holders and true bad actors, and therefore can discourage those who otherwise wish to become fully compliant.

Admittedly, the Report’s legislative proposal is unlikely to attract much Congressional support, given current budget deficits and the presumed desire of legislators to avoid being depicted as protecting offshore account holders. Nonetheless, the legal point remains: if an individual did not act with the intent to violate a known legal duty, then it is difficult to argue why he should be subject to a very draconian, albeit civil, penalty from the perspective of either fairness or the smart use of limited enforcement resources. As the Report states, the enhanced civil penalties for willful conduct were enacted to target bad actors, not to ensnare the inadvertent or negligent. Moreover, and aside from the benefits of attaining consistency between the civil and criminal penalty regimes for willful conduct, the practical reality is that the current IRS “streamlined” program for disclosing offshore accounts, which requires that the taxpayer submit a certificate attesting to his non-willfulness, is complicated by the possibility that the taxpayer is really being asked to assert that he did not act “recklessly,” which is a potentially much murkier claim than asserting that he did not act with fraudulent intent. Indeed, and as we explain, even the IRS used to state that willfulness for the substantial civil FBAR penalties demanded the same heightened showing required for criminal willfulness.

However, and as we note in our second post, we respectfully disagree with the Report that any legislative or policy change should prevent the government from meeting its burden through use of circumstantial evidence or the doctrine of willful blindness. Such proposals would contradict well-settled methods of showing mental state, and would be unworkable in practice.

United States v. Sturman and the IRS’s 2006 Chief Counsel Advisory Memo

If performed “willfully,” failing to file an FBAR, or filing a false FBAR, is a felony violation of the BSA under 31 U.S.C. §§5314 and 5322(a). A “willful” act, for the purposes of Section 5322 – and also for the vast majority of criminal tax offenses – means a voluntary and intentional violation of a known legal duty.

Prior to the government’s relatively recent offshore account enforcement campaign, the federal courts offered scant guidance as to what qualified as a “willful” failure to file an FBAR. In 1991, the Sixth Circuit upheld a criminal conviction for a willful failure to file an FBAR in United States v. Sturman. Defendant Sturman challenged on appeal his convictions for tax fraud and failing to file FBARs pertaining to business proceeds deposited into Swiss bank accounts. He argued in part that the government had failed to establish he was aware of the legal requirement to file FBARs. The Sturman court rejected this claim and upheld the convictions. In so doing, it cited Cheek v. United States, the seminal case regarding willfulness in the criminal tax context, for the propositions that the test for willfulness is a “voluntary, intentional violation of a known legal duty” and that willfulness “may be proven through inference from conduct meant to conceal or mislead sources of income or other financial information.” In upholding the convictions, the Sixth Circuit noted that the defendant had taken multiple steps to conceal his overseas assets from the government apart from his failure to file the FBAR, including concealing his signatory authority, interest in various transactions, and interest in the corporations that were transferring money to the foreign accounts. The Sturman court also noted that the defendant had admitted his “knowledge of and failure to answer” the question on Schedule B of his federal income tax return, which referred taxpayers to a booklet outlining the FBAR reporting requirements. The court found that the evidence of Sturman’s “acts to conceal income and financial information, combined with the defendant’s failure to pursue knowledge of further reporting requirements as suggested on Schedule B[,]”established willfulness.

The analysis in Sturman therefore reflects that an individual’s mere knowledge of and failure to answer correctly the question on Schedule B concerning foreign bank accounts, absent some other affirmative acts of concealment, is insufficient evidence to establish that the individual knew of the FBAR reporting requirement and willfully violated it – at least in a criminal case.

Once, the IRS itself took its cues from Sturman and embraced a more robust definition of willfulness in the civil FBAR context. In an IRS Chief Counsel Advisory Memorandum released on January 20, 2006, the IRS outlined its position on the willfulness requirement for imposing elevated civil penalties under 31 U.S.C. §5321(a)(5)(C) for an FBAR violation. The IRS stated in this 2006 memorandum that there were no cases “in which the issue presented is construing ‘willful’ in the civil penalty context[,]” a statement that was true at the time. The IRS then expressed its view that the willfulness requirement for imposing a Section 5321 civil penalty is identical to the willfulness requirement for criminal penalties under Section 5322 – i.e., a voluntary and intentional violation of a known legal duty – because both sections use the same word: “willful.” The IRS further noted in the 2006 memorandum that willfulness can be inferred where an “entire course of conduct establishes the necessary intent,” and as an example in the context of a criminal FBAR violation cited to Sturman. This reference to Sturman was potentially instructive because, as noted, the defendant’s criminal conviction for failing to file an FBAR in that case rested on additional affirmative acts of concealment beyond merely failing to check the correct box on Schedule B of his income tax return.

In our second and final post, we will discuss how some recent court rulings have relaxed this standard of willfulness in the civil FBAR context, so as to allow for mere recklessness, and how a legislative fix regarding the definition of willfulness would help to inject needed clarity into the “streamlined” program for offshore accounts, and restore overall fairness.