Many taxpayers may not realize that when they file their tax return, they must answer this question. In addition, the wrong answer to this question could result in significant tax penalties. Under federal tax law, U.S. citizens with a financial interest in or signature authority over a foreign bank account are required to file a Report of Foreign Bank and Financial Accounts. (FBAR) If they failed to do so, and their failure to file the FBAR is deemed willful, the taxpayer is subject to higher penalties, which is 50 % of the value of the account that was not reported at the time of the violation 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. In addition, Courts have recently upheld such a hefty penalty, finding that the IRS is not limited to just the $100,000 penalty. Therefore, it is vital for taxpayers to contact the tax lawyers and C.P.A.’s at the Law Office of David W. Klasing, to know their rights and obligations under this standard beforehand. To do otherwise could be a costly mistake.
Legally, willfulness is not synonymous with intentional. This means, a taxpayer’s failure to disclose foreign assets or accounts, can be considered willful even if the taxpayer did not do so intentionally. Currently, 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 easiest method for proving willfulness under the FBAR 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 timely and completely report a foreign account. If a taxpayer is aware of their filing requirements under FBAR and deliberately attempts to hide the existence of their foreign account and not report them, they are considered to have committed a knowing violation. Thus, for a knowing violation evidence of the taxpayer’s intent matters.
If you have a controlling interest in foreign bank accounts, you must report these accounts under the FBAR. If you are unsure, you should contact the Tax Law Offices of David W. Klasing. This is important, as the IRS can prove willfulness by showing only that the taxpayer acted deliberately to not comply with the tax law, such as failure to meet FBAR filing requirements, even though the taxpayer knew that they were required to do so. Thus, a taxpayer with knowledge of filing requirements, that intentionally does not, knowingly violates their legal duty to comply with the FBAR.
Don’t try to conceal or hide the existence of the account from the IRS. When considering whether a taxpayer acted willfully, 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. Furthermore, courts have found willful conduct through evidence of attempts to hide financial information or sources of income. For instance, if the IRS can show that the taxpayer through their actions deliberately concealed the account or was aware of the filing requirement through an Attorney and CPA, such as those found at the Tax Law Offices of David W. Klasing. If so, they may be considered to have violated their legal duty and can be hit with the hefty penalty for willful violations.Some Courts have held that the willfulness standard can also depend on whether the taxpayer is subject to civil vs. criminal violations. The standard of willfulness for a criminal violation, is based on conscious violation of a known legal duty. The IRS on the other hand has applied this same standard of willful conduct to civil FBAR penalties as well.
A taxpayer could be liable for the hefty penalties discussed above for actions that were unintentional, but which are still considered reckless. Reckless conduct is a lower standard of conduct than intentional conduct, or known violation of a legal duty, but still meets the legal requirement of willfulness. Recently, courts have upheld findings that a taxpayer’s failure to disclose the highest balance of his foreign accounts was indeed willful despite the lack of 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 financial 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. Thus, a taxpayer with assets or financial accounts with balances in excess of millions of dollars could be subject to a penalty of 50% of this balance by the IRS, if their conduct is deemed to be reckless.
Courts have held that a taxpayer’s reckless conduct can be determined from the facts and circumstances. In other words, context matters, and the courts will look to see in what context the taxpayer’s actions took place to determine recklessness. For instance, where a taxpayer has failed to file a tax return, evidence that the taxpayer previously filed one, is proof of the taxpayer’s knowledge of the requirement to file andis 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 under FBAR, can be enough to show that the taxpayer complied with the tax law in one instance but did not comply in another: Thus, the taxpayer’s nondisclosure after being alerted to the possibility of the FBAR filing requirement when they filed their tax return, be considered reckless, and consequently constitute willful conduct under the law. Also, 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 individual taxpayer subjectively acted willfully.
Taxpayer’s should use caution if they fall into one of these categories: (1) where the taxpayer is a sophisticated businessperson, (2) if the taxpayer has extensive international agreements and dealings, (3) if the IRS can prove that the taxpayer attempted to avoid payment of taxes, despite knowledge of their obligation to do so, or (4) if the 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 the software, the FBAR questions are included and thus, they can still be held to the willfulness standard.
In addition, compliance with other regulatory filing requirements outside of the tax context may also be used against a taxpayer to argue recklessness, such as filing and obtaining a 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 considered negligent under the circumstances and would 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 for the government.
Willful blindness can be demonstrated if the taxpayer consciously decides not to educate themselves on their compliance requirements under FBAR. Specifically, when completing the tax return, the taxpayer is asked about their control or interest in a foreign bank account. Here the IRS can prove that a taxpayer was conscious, meaning they made a deliberate decision not to learn about their FBAR filing requirement. This knowledge or opportunity on the part of the taxpayer can be considered as willful blindness and thus willfulness. Other examples of conduct that the IRS may use to prove willfulness include having a high gross income, the level of education and background of the taxpayer, as well as a pattern of nondisclosure in the past. All of these circumstances, although seemingly insignificant to the taxpayer, can be extremely important to the IRS in proving willfulness.
In addition, a taxpayer’s conduct with respect to their foreign accounts themselves may be used against them to show willful blindness. For example, evidence that the taxpayers failed to provide the 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 account from others in order to 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 a qualified Tax Attorney and CPA, such as those found at the Tax Law Offices of David W. Klasing, about a foreign bank account and the filing requirements under FBAR, can be willfully blindness.
Further, other conduct by the taxpayer, can be held against them by the Court, when they argue lack of notice or knowledge of the FBAR filing requirements. 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 or balance of a foreign bank account, Courts may believe that the Taxpayer is trying to conceal or hide the account information to avoid the FBAR reporting requirement. Any of these activities can result in a taxpayer being hit with a willful violation penalty.
Gross negligence is generally considered to be more severe than mere negligence and requires proof that one has blatant indifference to acting reasonably or following their legal duty under the circumstances. Gross negligence is likely one step below recklessness. Thus, if the IRS can only show that a taxpayer did not meet their FBAR requirements in multiple years, it may rise to the level of gross negligence, but without any more proof, such as notice of the FBAR requirements, it is unlikely that a court will find the taxpayer acted willfully. This provides a basis for the taxpayer to avoid the willfulness standard in meeting their FBAR filing requirements.
Update: The Inflation Reduction Act, recently signed into law, increases the IRS’ budget by $80 billion over 10 years. This funding includes an increase in funding for enforcement by the IRS. In addition, the recent and growing trend appears to be that it is easier for the IRS to prove willfulness in Court under 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 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 FBAR violations.