Under federal tax law, U.S. citizens with a financial interest in, or signature authority over, a foreign bank account with a combined highest on time annual balance of $10,000 or higher are required to file a Report of Foreign Bank and Financial Accounts (FBAR) on an annual basis. When a taxpayer files their federal return, they are well advised to take note of the Schedule B questions that ask if they have an interest in a foreign financial account, and what country it is in, as their response could determine whether their failure to file the FBAR will be deemed willful and thus potentially subject the taxpayer to draconian civil penalties, and in the worst case scenario, to criminal prosecution.
When it comes to the FBAR filing requirement, if a taxpayer's nondisclosure is found to be willful, they may be subject to draconian penalties of up to 50% of the amount of the highest annual combined balance in the accounts or $100,000 whichever is higher. The revised penalty amount of 50% of the balance of the foreign account, is significantly larger than the previous limitation of just $100,000. Courts have recently upheld such a hefty penalty, finding that the IRS is not limited to just the $100,000 penalty. The key question is how does a taxpayer, or their advisor, know if their conduct might be found to be willful by the IRS or a Federal Court?
Many taxpayers mistakenly believe that willfulness is synonymous with intentional behavior. However, legally, for the IRS, when it comes to imposition of FBAR penalties, this is not the case. A taxpayer’s failure to disclose foreign assets or accounts, can be considered willful even if the taxpayer did not do so intentionally. As of today’s date, Courts have held that there are three (3) types of conduct that can be considered willful in nature: (1) Knowing Violation, (2) Reckless Violation and (3) Willful Blindness.
Perhaps the most challenging method for the IRS to prove willfulness under the FBAR regulations is to show that the taxpayer violated a known legal duty. As the name implies, a knowing violation occurs when a taxpayer knows of the filing and record-keeping requirements under FBAR but makes a deliberate decision not to report foreign accounts completely and in a timely manner. A key distinction here for taxpayers is that a knowing violation is synonymous with an intentional violation of the FBAR filing requirements. If a taxpayer is aware of their filing requirements under FBAR and deliberately attempts to hide the existence of their foreign accounts and not report them, they are considered to have committed a knowing violation. Thus, in proving a knowing violation, evidence of the taxpayer’s intent matters.
To prove intent, in this context, courts look to see if the taxpayer acted intentionally, deliberately, and without justifiable excuse. Some courts have concluded that this requires bad motive or evil intent. However, the IRS does not even have to go that far. Under this standard, proving willfulness only requires that the IRS prove that the taxpayer acted deliberately to not comply with offshore information reporting laws, such as failure to meet FBAR filing requirements, even though the taxpayer knew that they were required to do so. In this context the legal duty for the taxpayer with a reportable interest in a foreign bank account is to report these accounts under the FBAR where required. Thus, a taxpayer with knowledge of filing requirements, that intentionally does not, knowingly violates their legal duty to comply with the FBAR filing requirements. For instance, if the IRS can show that the taxpayer through their actions deliberately concealed their offshore accounts or were aware of the filing requirement through their tax preparer and does not do so, they may be considered to have violated their legal duty and can be hit with the heft civil and criminal penalties for willful violations.
The courts will look to see if there was a written requirement to disclosure any known foreign bank accounts to the preparer in their engagement letter or within the standard questionnaire most prepares require their clients to complete on an annual basis. There is also nothing stopping the IRS from contacting the previous preparer and inquiring into their standard operating procedures regarding inquiring with their clients as to foreign accounts. This very probability creates a conflict of interest between you and your original preparer because the preparer is required to annually inquire regarding foreign accounts to meet their federal due diligence requirements and, when confronted, will likely lie to protect their own interests as to whether they raised the issue with you or not.
Some Courts have held that the willfulness standard can also impact the taxpayer’s exposure as to whether they merely face civil vs. have exposure for criminal prosecution for willfully failing to file an FBAR. The standard of willfulness for a criminal violation, is based on conscious violation of a known legal duty. Furthermore, courts have found willful conduct through evidence of attempts to hide offshore financial account information especially where sources of taxable offshore income were also hidden from their preparer. The IRS on the other hand has applied this same standard of willful conduct to civil FBAR penalties as well.
On the other hand, reckless conduct is a lower standard of conduct than intentional conduct, or a known violation of a legal duty, but still meets the legal requirement of willfulness when it comes to FBAR penalties. Thus, a taxpayer could be held liable for the hefty penalties discussed above for actions that were unintentional but sufficient to be deemed reckless. Case law shows, on multiple occasions, taxpayers whose conduct was deemed to be reckless in failing to disclose foreign financial accounts with combined balances often amounting to millions of dollars facing draconian penalties of 50% of their combined offshore balance by the IRS. Courts have upheld IRS findings that a taxpayer’s failure to disclose the highest balance of his or her foreign accounts was indeed willful despite the lack of any evidence of intentional conduct. The bottom line is that the IRS is not required to prove that a taxpayer’s failure to comply with the FBAR’s filing requirements was intentional for the taxpayer to face significant liability. Moreover, since it is easier for the IRS to prove reckless conduct on the part of the taxpayer, there is a greater likelihood that the taxpayer will have a harder time avoiding paying these higher penalties especially where they bear the burden of proof at trial.
Not only is the recklessness standard a lower burden on the IRS than having to prove the taxpayer acted intentionally, but courts have also consistently held that a taxpayer’s reckless conduct can be determined from an analysis of the surrounding facts and circumstances. In other words, context matters, and the courts will look to see in what context the taxpayer’s actions or actions took place to determine recklessness. For instance, a good example of proof of willful conduct that is often used in criminal tax prosecutions, is where a taxpayer is charged with willful failure to file a tax return. Evidence that the taxpayer has filed a tax return in the past is proof of the taxpayer’s knowledge of the requirement to continue to file on an annual basis, and his or her failure to do so later is enough to show willfulness. Similarly, the fact that a taxpayer filed a tax return, but did not disclose the amounts of his foreign bank accounts or assets on an FBAR, can be enough to show that the taxpayer complied with tax law in one instance but did not comply in another. Furthermore, after being alerted to the possibility of the FBAR filing requirement when they filed their tax return, the taxpayer's nondisclosure could be considered reckless, and consequently constitute willful conduct under that standard of conduct. Recklessness is an objective standard, meaning that the court will look from the outside looking in to see if the taxpayer has acted recklessly. Thus, the IRS doesn’t have to prove that the taxpayer subjectively acted willfully, only that based on the facts and circumstances taken together the IRS is justified in deeming that the taxpayer’s conduct rose to the level of recklessness.
In addition, other instances where Courts have also held that taxpayer’s conduct was reckless include: (1) where the taxpayer was a sophisticated businessperson, (2) had extensive international agreements and dealings, (3) simultaneously attempted to avoid payment of related income taxes associated with their foreign account, despite knowledge of their obligation to do so, (4) taxpayer used a tax preparer to prepare their returns. To this last point, taxpayers should be warned that even if they use a commercial tax preparation service or even just professional tax preparation software, the FBAR questions are known to be asked by programs like TurboTax and thus, self-preparing taxpayers using TurboTax can be held to the willfulness standard.
In addition, compliance with other offshore information reporting filing requirements outside of the pure tax context may also be used against a taxpayer to argue recklessness, such as filing and obtaining an offshore patent for instance. Furthermore, conducting various transactions and managing contractors internationally will also be used against a taxpayer’s argument that they were completely unaware of their FBAR reporting requirements.
Recently, the IRS successfully argued that proof of the taxpayer filing a return and answering the question of whether the taxpayer has an interest in foreign bank account is proof of recklessness, and therefore willfulness. The good news for the taxpayer is that the opposite is also true. If the taxpayer can show that they had no notice of the FBAR requirement, or that they were not put on notice, then it will be difficult for the IRS to prove willfulness. Instead at most, the taxpayer would be legally considered negligent under the circumstances and could potentially avoid the higher penalties for willful failure to meet the FBAR filing requirements.
In addition, some courts have held that the IRS need only prove that the taxpayer’s actions were “more likely than not” willful, to impose the willful penalty, a much lower burden of proof yet for the federal government.
Willful blindness is essentially the federal government’s attempt at showing that a taxpayer consciously decided not to educate themselves on their FBAR compliance requirements. Specifically, when completing the tax return, the taxpayer is asked about their control or interest in a foreign bank account. Here the IRS can attempt to prove that a taxpayer made a deliberate decision not to learn about their FBAR filing requirement. This opportunity to learn about the FBAR filing requirements and willful decision not to learn about the FBAR filing requirement on the part of the taxpayer can be considered as willful blindness and thus willfulness. Other examples of facts and circumstances that the IRS has used to successfully prove willful blindness include taxpayers with high gross income, higher levels of education, background, and sophistication of the taxpayer, as well as a pattern of nondisclosure in the past. All these facts and circumstances, although seemingly insignificant to the taxpayer, can be extremely important to the IRS in attempting to prove willfulness in a court of law.
Evidence that the taxpayers failed to provide the offshore financial institution where the foreign bank account is held, with their address and contact information and did not inform others outside of immediate family about the existence of the foreign account, may be sufficient for the IRS to argue willfulness. Here, the IRS would argue that the taxpayers were trying to deliberately conceal the offshore financial accounts from others so they can later argue that they had no knowledge of the FBAR reporting requirements. Moreover, particularly due to the level of education or sophistication of the taxpayer, failure to mention or ask their preparer about a foreign bank account and the filing requirements under FBAR, can be considered willful blindness.
Moreover, other conduct by the taxpayer, can be held against them by the Court, For instance, if a taxpayer has filed tax returns or an application for one of the taxpayer relief programs with the IRS that includes misrepresentations or false information, the Court will not believe the taxpayer is being truthful about their contention that they did not know of the FBAR filing requirements. Also, if a taxpayer reports only a portion of the income on their tax returns but fails to report the income deposited to an undisclosed foreign account, Courts will likely believe that the Taxpayer was trying to conceal or hide the account information to avoid the FBAR reporting requirement as it would be a red flag as to unreported offshore taxable income. Any of these activities can result in a taxpayer being hit with a willful FBAR reporting penalty.
Gross negligence is slightly harder for the government to prove than ordinary negligence but would not be enough to show that the taxpayer acted willfully regarding an FBAR penalty or criminal FBAR reporting prosecution. Negligence is the failure to use reasonable care under the circumstances. Gross negligence is generally considered to be more severe than mere negligence and requires proof that one has acted or failed to act with blatant indifference to acting reasonably or following their legal duty under the circumstances. Thus, if the IRS can only show that a taxpayer did not meet their FBAR requirements in multiple years, this may rise to the level of gross negligence, but without any more proof, such as the taxpayer had notice of the FBAR requirements, it is unlikely that a court will find the taxpayer acted willfully. This provides a potential defense for the taxpayer to avoid being deemed to have met the willfulness standard in failing to meet their FBAR filing requirements.
The recent and growing trend in federal case law is that it is getting easier and easier for the IRS to prove willfulness in Court where civilly and criminally penalizing a taxpayer’s failure to file an FBAR. Accordingly, taxpayers with foreign financial accounts are in greater danger of being hit with hefty penalties, unless they can show that their conduct does not rise to the level of willfulness. As a result, taxpayers should protect themselves by seeking out and retaining a dually licensed International Tax Attorney and CPA like those found at the Tax Law Offices of David W. Klasing, who is experienced in all facets of the FBAR filing requirements and has decades of success in helping clients avoid willful civil and criminal FBAR violations.
Note: As long as a taxpayer that has willfully committed tax crimes (potentially including non-filed foreign information returns coupled with affirmative evasion of U.S. income tax on offshore income) self-reports the tax fraud (including a pattern of non-filed returns) through a domestic or offshore voluntary disclosurebefore the IRS has started an audit or criminal tax investigation / prosecution, the taxpayer can ordinarily be successfully brought back into tax compliance and receive a nearly guaranteed pass on criminal tax prosecution and simultaneously often receive a break on the civil penalties that would otherwise apply.
It is imperative that you hire an experienced and reputable criminal tax defense attorney to take you through the voluntary disclosure process. Only an Attorney has the Attorney Client Privilege and Work Product Privileges that will prevent the very professional that you hire from being potentially being forced to become a witness against you, especially where they prepared the returns that need to be amended, in a subsequent criminal tax audit, investigation or prosecution.
Moreover, only an Attorney can enter you into a voluntary disclosure without engaging in the unauthorized practice of law (a crime in itself). Only an Attorney trained in Criminal Tax Defense fully understands the risks and rewards involved in voluntary disclosures and how to protect you if you do not qualify for a voluntary disclosure.
As uniquely qualified and extensively experienced Criminal Tax Defense Tax Attorneys, KovelCPAs and EAs, our firm provides a one stop shop to efficiently achieve the optimal and predictable results that simultaneously protect your liberty and your net worth. See our Testimonials to see what our clients have to say about us!
If you have failed to file FBARS or tax return that should have reported taxable offshore income for one or more years or have taken a position on a tax return reporting foreign taxable income that could not be supported upon an IRS or state tax authority audit, eggshell audit, reverse eggshell audit, or criminal tax investigation, it is in your best interest to contact an experienced dual licensed international tax defense attorney & CPA to determine your best route back into federal or state tax compliance without facing criminal prosecution.
See our 2011 OVDI Q and A Library
See our FBAR Compliance and Disclosure Q and A Library
See our Foreign Audit Q and A Library