I’ve summarized the key points and requirements, and the principal advantages and disadvantages of using, the new procedure vs. the regular OVDI program route in a mind map.
The map is available online at this link (hint: click the icon in the upper right hand corner of the map with two arrows on it to view the map full screen).
This closer look at these issues was prepared by my partner Richard (Rick) Josepher.
While much about the Zwerner case (U.S. v. Zwerner, Case No. 13-22082-CIV, So. Dist. Fl.) has been discussed regarding the FBAR penalties, there has not been much attention paid to the 6% late payment penalty and interest applicable to FBAR penalties which are not paid timely. The late payment and interest would arise in cases where the FBAR penalty is assessed but not timely paid. They do not arise in OVDP settlements as the FBAR penalty is paid without interest and late penalties under the terms of the OVDPs. Since these additional penalties are not insignificant, it is important to consider them in analyzing FBAR penalty cases.
Background. Zwerner was widely publicized. It was noteworthy because the government asserted that Zwerner should pay the maximum 50% FBAR penalty for each of three years in which he failed to willfully file FBARs. Imposition of the penalty for each of three years results in an aggregate penalty of approximately 150% the high balance in the account over the three years. In contrast to the multi-year imposition of the FBAR penalty asserted in Zwerner, the offshore voluntary disclosures programs (OVDPs) have imposed an offshore penalty for a single year.
On June 9, 2014, approximately two weeks following the verdict finding that Zwerner’s failure to file the FBARs was wilful, he and the U.S. reached a settlement. They agreed that the FBAR penalty of 50% would apply to two of the three years but not to all three years, and they agreed that the late payment penalty and interest would apply to each of those two years.
The Zwerner Settlement.
A. Stipulated Settlement. The stipulated settlement reads in part as follows:
“Under the terms of the settlement, by September 2, 2014, Zwerner is to fully pay the United States the 50% FBAR penalties assessed against him for 2004 and 2005 in the amounts of $723,762 and $745,209 respectfully, interest thereon of $21,336.11 and $20,947.52 respectively, plus statutory penalties that have accrued under 31 U.S.C. § 3717(e)(2) on the FBAR penalty assessments for 2004 and 2005 of $128,016.64 and $125,685.11 respectively. Once that payment is made, the parties will stipulate to dismiss this action with prejudice.”
B. FBAR and Late Payment Penalty and Interest . Below are shown the FBAR, late payment and interest penalties. The penalties and interest amounted to almost $300,000, as follows:
| YEAR | FBAR PENALTY | LATE PAYMENT | INTEREST | DATE ASSESSED |
| 2004 | 723,762 | 128,017 | 21,336 | 6/21/11 |
| 2005 | 745,209 | 125,685 | 20,948 | 8/10/11 |
| TOTAL | 1,268,971 | 253,702 | 42,284 |
1. Late Payment Penalty. The late payment penalty is “not to exceed” six (6%) percent per year penalty computed from the date of the assessment of the FBAR penalty, computed pursuant to 31 U.S.C. 3717(e)(2), and 31 C.F.R. § 901.9(d). In Zwerner, the penalty appears to have been computed at 6%. Based upon my review, the late payment penalty appears to be computed at 6% (rather than at a lower rate as permitted by statute), in cases where it is not otherwise compromised.
2. Interest for Late Payment. The interest due in Zwerner was computed at one (1%) percent per annum from the date of the assessment pursuant 31 U.S.C. §3717(b) and 31 CFR §901.9. The interest rate is based upon the current value of Treasury funds at the time of the demand for payment, and is computed pursuant to U.S. Department of the Treasury’s (Treasury) Current Value of Funds Rate (CVFR), published annually by the Secretary of the Treasury in the Federal Register and http://fms.treas.gov/cvfr/index.html. The current rate is 1.0%.
3. The Date of the Delinquency. The date of the “delinquency” starts the running of the interest and penalties and begins on the date the FBAR penalty assessment is mailed unless payment of the penalty is made within 30 days thereafter. As more specifically explained in the Internal Revenue Manual, the late payment penalty and interest are computed as follows:
IRM 4.26.17.4.3 (05-05-2008)
“Closing the FBAR Case with Penalties
6.E. No interest accrues on FBAR penalties prior to assessment, therefore only the penalty amount would be owed if full payment is made in a pre-assessment case or if payment is made within 30 days after the date a notice of the penalty amount due is first mailed to the filer. Under 31 U.S.C. § 3717(b), interest begins to accrue on the date the FBAR notice of penalty assessment is mailed but no interest is owed on payments received within thirty days from the date a notice of the penalty amount due is first mailed to the filer. In addition to interest, a six percent delinquency penalty applies to amounts remaining unpaid ninety days from the date a notice of the penalty amount due is first mailed to the filer. The applicable interest rate is found at http://fms.treas.gov/cvfr/index.html . This rate is updated at least annually but may be updated quarterly if certain criteria, identified in § 3717(a) (2), are met.”
Conclusion.
In cases where the FBAR penalty is paid “up front,” as with OVDP settlements, late payment penalties and interest won’t be relevant. However, if FBAR penalties are paid more than 30 days after assessment, or remain unpaid while the FBAR penalties are being contested, as in Zwerner, the late payment penalty and interest can be significant and should be considered.
If an estate files to extend the due date of its Form 706 estate tax return, it can elect to defer the portion of the estimated estate tax that will be deferred pursuant to its Code §6166 election. It does not make the election itself until it files the Form 706 (prior to the expiration of the extended due date period).
Essentially, the estate is divided into two parts – the deferred portion and the nondeferred portion. Like any estate that is required to pay estimated estate taxes by the original 9 month due date for the Form 706, the taxes attributable to the nondeferred portion are due with the Form 4768 extension and the deferred taxes are not yet due. What happens if the taxes payable with the extension that are estimated and paid for the nondeferred portion are in excess of the taxes actually attributable to the nondeferred portion, as determined later upon the preparation and filing of the Form 706? Can the estate get a refund of that overpayment when it files the Form 706, or will the excess be applied toward the taxes attributable to the deferred portion and thus not be refundable?
This was the issue before the District Court in the recent case of Estate of Donald McNeely. Interestingly, when the extension payment was made, the taxpayer attempted to specifically allocate the payment solely to the nonexempt portion via an accompanying letter. It sought a refund of the excess of the extension payment over the tax attributable to the nondeferred portion on the Form 706.
The District Court held that the excess taxes on the nondeferred portion of $1.979 million need not be refunded by the IRS to the estate, but could instead be applied to the taxes that were otherwise eligible for deferral under Code §6166 as the installment payments became due. The court based its decision on Code §6402 which reads:
In the case of any overpayment, the Secretary, within the applicable period of limitations, may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall, subject to subsections (c), (d), (e), and (f) refund any balance to such person.
The court also noted that even if Code §6402 did not apply on the theory that there was no “overpayment” (a disputed issue in the case), then Code §6403 would allow for a similar result. Code §6403 provides:
In the case of a tax payable in installments, if the taxpayer has paid as an installment of the tax more than the amount determined to be the correct amount of such installment, the overpayment shall be credited against the unpaid installments, if any. If the amount already paid, whether or not on the basis of installments, exceeds the amount determined to be the correct amount of the tax, the overpayment shall be credited or refunded as provided in section 6402.
The estate made three interesting arguments to support its claim for refund: (1) that its designation of the estimated payment as payment for the nondeferred portion of its estate tax liability, and the IRS's acceptance of that payment, bound the IRS to that designation and required the IRS to refund the excess amount, (2) that §6403 does not apply because the estate paid prior to making the § 6166 election, and (3) that § 6402 requires a refund of the overpayment, rather than a credit, in recognition of the Estate's special rights to defer payment under § 6166. None of those arguments was able to persuade the court to allow the refund.
Estate of Donald McNeely, (DC MN 06/12/2014) 113 AFTR 2d ¶ 2014-930
Employers who reimburse employees on a pre-tax basis for premiums the employees pay on their own individual health insurance policies (whether under an Obamacare Exchange or otherwise) are at risk for a $100 per day per employee excise tax. This is according to a recent IRS Q&A.
There are those that assert such arrangements can be structured through Code §125 to avoid the excise tax.
Employers should tread carefully in this area.
IRA Q&A; See also Notice 2013-54
In a major change to the Offshore Voluntary Disclosure Program, the streamlined filing compliance procedures with their 5% penalty, has been opened up to non-willful violators that reside in the U.S. This is to be contrasted with the 27.5% penalty applicable to the OVDI program participants.
Those participating under the streamlined procedures will not have all the benefits of OVDI participation, thus there will be advantages and disadvantages for going this route. Taxpayers and their advisors will still need to run through the various methods available to become compliant to determine which works best. Nonetheless, the new procedures promise to ease the burden on many noncompliant taxpayers.
It appears that those who have already paid penalties under the OVDI program and have a closing agreement may not be eligible to participate in the streamlined program and get penalty money back – however, we will have to see how this pans out. There will surely be many displeased past participants in the program that paid significant sums to the IRS that will feel the sting if they are unable to benefit from the substantially reduced penalties.
The new announcement is not all good news. It imposes stricter rules on those entering the OVDI, and a higher 50% penalty in circumstances where the applicable financial institution where the account was held is under government investigation.
More to come once we have had a chance to review the revised programs and parameters. However, for those that are close to finalizing OVDI programs, immediate action to defer finalization pending review of the new procedures may be recommended.
Our post from yesterday here discussed how the U.S. Supreme Court ruled in Clark v. Rameker that inherited IRAs are not exempt from creditor claims in bankruptcy. Here are some more observations on that case:
We have written on the question whether inherited IRAs are exempt from creditors in a federal bankruptcy action here, here, and here. The various courts that have addressed the issue have gone in both directions.
The U.S. Supreme Court has now weighed in, and has ruled that inherited IRAs are not exempt from bankruptcy creditor claims.
The Court analyzed the issue as to whether inherited IRAs are enough like regular retirement assets (i.e., sums set aside until one stops working) to be entitled to the standard IRA exemption. It did so in an attempt to balance the interests of creditors and debtors, by giving only protection to those accounts that have enough “retirement fund” characteristics.
The Court found that certain key aspects of inherited IRAs are not like a retirement asset. In particular, the Court noted (a) inherited IRA holders cannot add new assets, (b) required distributions did not turn on whether the holder has reached retirement age, and (c) holders can withdraw from the IRA without penalty at any time. Thus, it is improper to allow an exemption.
The Court held:
For if an individual is allowed to exempt an inherited IRA from her bankruptcy estate, nothing about the inherited IRA's legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete. Allowing that kind of exemption would convert the Bankruptcy Code's purposes of preserving debtors' ability to meet their basic needs and ensuring that they have a “fresh start,” Rousey, 544 U. S., at 325, into a “free pass,”
This does not mean inherited IRA benefits cannot be protected against creditors of the recipient. Through the use of trusts and applicable spendthrift and other trust protections that exist under applicable state law, inherited IRA proceeds can be protected by leaving them to trusts instead of outright to the recipients. Of course, planning for such trusts will need to coordinate with the IRA rules for allowance of deferral of required distributions, to the extent such deferral is desirable or otherwise available.
CLARK v. RAMEKER, 113 AFTR 2d 2014-XXXX, (S Ct), 06/12/2014
Most tax practitioners tack on a Circular 230 disclaimer to their emails and other communications to avoid problems with reliance opinion and covered opinion provisions of Section 10.35 of that Circular. These disclaimers are either never read, or create questions among the few that do read them as to the meaning, effect, and purpose of such disclaimers. With the issuance of revised final Circular 230 regulations, those reliance and covered opinion rules no longer exist, and with them, the need for the disclaimers. As the IRS provided when it issued Proposed Regulations on the subject:
"many practitioners currently use a Circular 230 disclaimer at the conclusion of every email or other writing as a measure to remove the advice from the covered opinion rules in § 10.35. In many instances, these disclaimers are frequently inserted without regard to whether the disclaimer is necessary or appropriate. These types of disclaimers are routinely inserted in any written transmission, including writings that do not contain any tax advice. The proposed removal of current § 10.35 eliminates the detailed provisions concerning covered opinions and disclosures in written opinions. Because proposed § 10.37 does not include the disclosure provisions in the current covered opinion rules, Treasury and the IRS expect that these amendments, if adopted, will eliminate the use of a Circular 230 disclaimer in email and other writings."
Good riddance!
I thought we had reached the end of our FBAR streak, but not yet. In a Federal District Court case opinion released last week, the Northern District of California ruled that a U.S. online gambler was obligated to report his internet accounts with offshore poker sites PokerStars.com and PartyPoker.com on an FBAR form. Since the taxpayer could make deposits to, and withdraw from, his poker accounts, the court found that the accounts came within the definition of “a bank, securities, or other financial account.”
I don’t know how many U.S. persons have accounts with online gambling sites that are situated outside the U.S., but I am sure that the taxpayer here has plenty of company. If the aggregate balance in all of a taxpayer’s non-U.S. accounts exceeds $10,000 at any time during the year, an FBAR is due. As we all know by now, the penalties for not filing an FBAR can be severe.
If one accepts the reasoning and finding of this case, then tax preparers should be adding to their questionnaires whether the taxpayer has any internet account based on an offshore site that funds gambling activities (or any other activity for that manner) for which the taxpayer can make deposits and withdrawals.
U.S. v. HOM, 113 AFTR 2d 2014-XXXX, (DC CA), 06/04/2014
I have been posting a lot of FBAR-related posts lately. Here’s one more.
There has been a question whether owners of “bitcoins” and other virtual currencies that have non-U.S. aspects, are subject to annual reporting on the FBAR form. They don’t appear to be financial accounts, but will the Treasury Department agree?
At least unofficially, it appears ownership of virtual currencies do not need to be reported on the June 2013 forms due June 30. So says Rod Lundquist, a Senior Program Analyst in the IRS's Small Business/Self Employed (SB/SE) division, during a recent IRS webinar titled “Reporting of Foreign Financial Accounts on the Electronic FBAR.” Things may change for future years.
Since this is not an official position, taxpayers may still want to consider reporting these items if they want to be conservative.
The Zwerner case has been discussed here and here. Many hoped that this case may give rise to judicial review of whether the 50% per year FBAR penalty for willful violations passes muster on U.S. Constitution limits on excessive fines. That no longer appears likely as the government and the defendant have now settled the pending litigation regarding that penalty.
I recently wrote about this recent jury verdict in an FBAR nonfiling case here. The following is a more detailed analysis by my partner, Richard (Rick) Josepher:
WHAT DOES ZWERNER CASE MEAN TO PRACTITIONERS AND TO TAXPAYERS CONSIDERING MAKING VOLUNTARY DISCLOSURES OF OFFSHORE ACCOUNTS WHERE PENALTIES ARE NOT DETERMINED UNDER FORMAL OFFSHORE DISCLOSURE PROGRAMS?
The recent jury verdict in the Zwerner case in Miami, Florida (U.S. v. Carl Zwerner, Civil Docket Case #1:13-cv-22082-CMA) has caused a concern among tax practitioners that if they don’t advise clients with offshore accounts to file within the Offshore Voluntary Disclosure Program, their clients run the risk of being subjected to penalties significantly in excess of those who enter the IRS’ Voluntary Offshore Disclosure Program (“OVDP,” or “Program” here refers, depending upon the context, to any of the IRS’ offshore voluntary disclosures programs since 2009, including the former programs in 2009 and 2011 and the currently applicable 2012 program).
The Zwerner case (“Zwerner”) was filed by the United States approximately one year ago (June 11, 2013). It was a civil suit in which the only dispute was the amount of the FBAR penalties. The U.S. alleged and a jury this week agreed, that Zwerner’s FBAR violations were “willful.” The U.S. has asserted that Zwerner must now pay the maximum FBAR penalties under the law.
Therefore, subject to a final court decision (and appeals as may occur), Zwerner is facing the maximum FBAR penalties under the law. The FBAR penalties, at 50% of the account balance for each of three years, exceed the balance in Zwerner’s offshore account (as further discussed below).
Zwerner is significant because it send this message to taxpayers and practitioners: A taxpayer who desires to comply and correct past returns voluntarily by filing a “quiet disclosure,” or by entering the OVDP and then “opting out,” although likely avoiding criminal prosecution as compared to never coming forward and being detected later, mighty be subjected to “Zwerner type treatment,” i.e., significantly harsher penalties than the already harsh penalties of the OVDP. Something doesn’t feel right here, as explained herein.
Background
In 2009, during the flurry of news and enforcement activity surrounding UBS, then IRS Commissioner Douglas Shulman announced a new IRS offshore voluntary disclosure program. In the announcement, the Commissioner made it clear that the new Program was intended to encourage taxpayers who had offshore accounts to disclose those accounts through participation in the Program. He said the IRS wanted to draw a clear distinction between those taxpayers who voluntarily came forward and those who did not insofar as civil and criminal penalties.
What has come to pass, is that while the OVDP provides assurances of no criminal prosecution to truthful and cooperative taxpayers who join the Program, the penalties imposed are often viewed by taxpayers as harsh and unfair. The feeling of taxpayers has been best stated by the National Taxpayer Advocate, which, in its 2013 report stated that taxpayers feel as if the IRS is “extorting and bullying” them with “unjustified penalties,” being applied through the OVDPs. (The Taxpayer Advocate is appointed under the provisions of the Internal Revenue Code, and has the statutory duty of filing an annual report to Congress which identifies problems taxpayers are having with the IRS and which identifies changes suggested).
Our experience is consistent with the findings of the Taxpayer Advocate, i.e, many of our clients have the feeling that they are being extorted, bullied and unfairly being subjected to disproportionate and justified penalties. As practitioners, we in turn feel as if there is little room for discretion and that the “down-side” of a disclosure other than within the framework of the OVDPs is too risky since penalties can be extreme, as Zwerner proves and as we are aware. Further, the courts and the IRS are applying a definition of “willful” which in short, is hard not to meet, because the concept of “willful blindness” can be applied to make almost any omission of a large offshore account seem “willfully blind” regardless of other facts and circumstances and regardless of the years and years during which the IRS never (or almost never) enforced penalties against offshore account holders whereas now it has done an “about face” and is enforcing with a vengeance and seemingly without any passion or consideration of the long term consequences to the credibility of our system of tax administration, which, after all is founded on trust and confidence that the laws will be fairly enforced.
Prior to the 2009 OVDP, taxpayers with an offshore account would make “quiet disclosures” to avoid criminal prosecution. In most cases or all cases a quiet disclosure succeeded in assuring that there would be no criminal case filed after the disclosure, although the IRS never “guaranteed” it would not prosecute following a quiet disclosure. The process of making “quiet disclosures” was based upon a long-standing administrative process set out in the Internal Revenue Manual (the “IRM”). The quiet disclosures would usually be made by the filing of amended returns which fully and truthfully disclosed a legal source income, showed the taxes due, and included payment or a willingness to pay once billed. Quiet disclosures could only be made prior to the time the IRS contacted the taxpayer or otherwise was investigating the taxpayer. Zwerner made a quiet disclosure (after his counsel made an attempt at “noisy disclosure,” which, in general if done correctly, involves contacting the IRS criminal division and advising them that your client will be filing).
In short, Zwerner filed amended tax returns and disclosed his offshore accounts and reported income and otherwise complied. However, he did not enter the 2009 OVDP at any time (the OVDP permitted those who made quiet disclosures prior to the announcement of the 2009 OVDP to later file within the OVDP, which Zwerner did not do).
While, unlike the OVDP, a “quiet disclosure” does not “guarantee” a taxpayer of no criminal prosecution, the practical result and the experience of practitioners who have assisted clients who have made quiet disclosures is that there is a very small likelihood of a criminal prosecution for two principal reasons: (1) Voluntary compliance results and is generally encouraged in our tax system, and (2) there is little to no incentive to prosecute a taxpayer who comes forward voluntarily, with busy U.S. Attorneys and a public which would likely be unsympathetic, or worse, were the IRS to punish taxpayers who voluntarily correct their mistakes.
Since the 2009 OVDP, the IRS has often made it clear in talks to practitioners and now in Zwerner that it would like all taxpayers to voluntarily disclose within the OVDPs. In press releases and speakers, the IRS has stated that it intends to harshly treat taxpayers who disclose quietly using the procedures in IRM 9.5.11.
Is Entering the OVDP and Then “Opting Out” Viable?
The OVDP has an “opt out” procedure, which entitles a taxpayer who has entered the OVDP to request consideration of the penalties under the rules applicable outside of the Program. A taxpayer would generally consider opting out in a case where the OVDP FBAR penalty is viewed as being excessive, primarily in cases where the taxpayer claims that the FBAR non-filing was non-willful. Practitioners consider the opt out as the best of both worlds in theory, as follows: (1) by entering the Program taxpayers receive a promise that they won’t be criminally prosecuted if they abide by the rules of the rules of the Program (whereas, the IRM expressly avoids promising that there will be no criminal prosecution in the case of voluntary disclosures under IRM 9.5.11), and (2) by opting out the taxpayer is able to assert non-willful conduct, such that, if the IRS agrees, FBAR penalties would be a maximum of $10,000 per account and could be zero.
However, the problem with the opt out procedure under the OVDP rules insofar as reducing the FBAR penalty is that the IRS intended the opt-out procedure to apply only to “a discrete minority” of cases. Based upon the examples in the FAQ, discussed below, taxpayers who have omitted reporting large accounts or significant income will be treated harshly. Thus, although there is quite a “buzz” resulting from the treatment of Zwerner, based upon the facts as viewed by the IRS in his case, the penalties imposed are consistent with the harsh treatment set out in the FAQs, at #51.2, as reprinted below. Perhaps practitioners didn’t want to believe the examples in the FAQ. (Not discussed further here is that the taxpayer who opts out is subjected to a full examination whereas a taxpayer in the OVDP is not; rather, usually the amended returns are accepted as filed).
FAQ #51 “Opt Outs” and Examples
IRS’ FAQ #51 below sends mixed messages. First, while FAQ states the Service will look to ensure that its “bests interests” and the “integrity of the voluntary disclosure program [remains] intact,” exactly what this means is not known and not published in any official form or any unofficial form. Further, the FAQ states that a criminal investigation may result “if issues are found.” Is this gratuitous advice to practitioners and taxpayers that if there is a fraudulent return, it’s a good idea not to opt out and be subjected to a “full blown” income tax exam, is it intended to discourage opt outs because the mention of criminal investigation tends to intimidate, or both? FAQ #51, partially reprinted below, reads as follows:
If the offshore penalty is unacceptable to a taxpayer, that taxpayer must indicate in writing the decision to withdraw from or opt out of the program. Once made, this election is irrevocable. An opt out is an election made by a taxpayer to have his or her case handled under the standard audit process. It should be recognized that in a given case, the opt out option may reflect a preferred approach. That is, there may be instances in which the results under the applicable voluntary disclosure program appear too severe given the facts of the case. There will be other instances where this is less clear. In the latter cases, the Service will look to ensure that the best interests of the Service and the integrity of the voluntary disclosure program remain intact. In these cases, it is expected that full scope examinations will occur if opt out is initiated. It is expected that opt out will be appropriate for a discrete minority of cases. Moreover, to the extent that issues are found upon a full scope examination that were not disclosed by the taxpayer, those issues may be the subject of review by Criminal Investigation. In either case, opting out is at the sole discretion of the taxpayer and the taxpayer should not be treated in a negative fashion merely because he or she chooses to opt out. The specific procedures for opting out are set forth in a separate guide titled Opt Out and Removal Guide for the 2009 OVDP, 2011 OVDI, and now the OVDP. The guide is posted to the website.
IRS Position in Zwerner In Line With Examples in FAQ Examples
In Zwerner, the only issue for trial was the FBAR penalty (no underlying taxes or penalties under the Internal Revenue Code were in dispute). The underlying income taxes and penalties were resolved during the examination and no civil fraud penalty was imposed. However, in cases which are subjected to an independent exam as part of an opt out examination, an examining Agent might well assert a civil fraud penalty in cases with an omission of significant offshore income where the agent also intended to assert a willful FBAR penalty. The same would apply in the case of an exam resulting from tax returns filed by a taxpayer disclosing voluntarily, but outside of the OVDPs, as did Zwerner. In short, Zwerner appears to have benefitted by the resolution of the income tax issues prior to the resolution of the FBAR issue, and the example below in FAQ 51.2 illustrates this point. The example below presents a Zwerner-like multi-year FBAR penalty in a case where civil fraud is found, and applies what the IRS states is the proper result.
FAQ 51.2 Question: Under what circumstances might opting out of the civil settlement structure of the 2011 OVDI be a disadvantage for the taxpayer?
FAQ 51.2 Answer: Example 7 – Civil Fraud Penalty Warranted. In 2002, Taxpayer sold a building located in Country X for $400,000 short term capital gain, which he intentionally failed to report on his 2002 Form 1040. Assume the taxpayer’s basis in the building was zero. He deposited the sales proceeds in an offshore account with a bank located in Country Y. The account with the bank in Country Y is in the name of a trust the taxpayer established in Country Z in 2000. The account earned $12,000 in interest each year from 2003 through 2010. The taxpayer closed the account with the bank in Country Y in 2010 and brought the funds back into the United States, disguising the funds as a loan from an allegedly unrelated entity.
The highest balance in the foreign account was $496,000. The Offshore Penalty under OVDP is $136,400 (i.e., 27.5% of $496,000). The total of the tax deficiencies for the years 2002 through 2010 was $173,600. This consisted of a tax deficiency of $140,000 for the 2002 year (for the unreported gain of $400,000) and a total of $33,600 for the tax years 2003 through 2010 (for the unreported interest income). The 75% civil fraud penalty would otherwise apply with respect to the related tax deficiencies. There is no statute of limitations for assessments of tax attributable to fraud.
The total of the IRC § 6677 penalty for failing to file a Form 3520 to report the $400,000 transfer to the account (35% of $400,000) and the failure to file Forms 3520-A (5% of the $400,000 plus the interest income added each year) was $495,200. The statute of limitations for assessing FBAR penalties for willful violations in each year is open for the 2005 through 2010 calendar years. The total amount of willful FBAR penalties that may be assessed is $1,398,000 (50% of the balance in the account for each year, including the $12,000 in interest income added to the account each year).
What Zwerner Tells Us and What It Does Not
So, what in fact can we learn from Zwerner? Here are some of my thoughts:
1. The IRS shows it will take the “bullying approach.” The IRS will take the “bullying” approach referenced in the Taxpayer Advocate Report and shown in FAQ #51.2. In other words, there is no question that under the current law, the IRS has the statutory right to assert the maximum FBAR penalties in multiple years. The question has been whether it will show restraint and attempt to treat taxpayers outside the OVDP not worse than those in it. The answer: The IRS might act to impose the maximum penalties allowable on “opt-outers” or quietly disclosing taxpayers. The maximum 50% FBAR penalty was asserted against Zwerner, as shown below (the amounts were those shown in the Complaint):
2. The quiet disclosure in Zwerner accomplished its goal, i.e, he was did criminally investigated/ Zwerner is only about dollars, i.e., the amount of civil FBAR penalties which will apply. Zwerner appears to me to have made a “voluntary disclosure” outside of the OVDP. However, in its Motion for Summary Judgment the government in Zwerner maintained that he did not disclose the information required by IRM 9.5.11.1 regarding “voluntary disclosure communication and therefore did not make a “voluntary disclosure” under the IRM. The government maintained further that Zwerner did not provide the broader information required to be provided under the 2009 OVDP and therefore did not meet its requirements, and I agree. In fact, the agreement to provide information regarding matters not directly related to the taxpayers return or tax is one aspect of the OVDP disclosure that is not common to the voluntary disclosures under the IRM. Regardless of whether the voluntary disclosure perfectly met the parameters of the IRM, Zwerner was not criminally prosecuted, after he filed timely amended returns and disclosed and corrected the prior omissions. Nonetheless, since Zwerner did not make a voluntary disclosure within the confines of the 2009 OVDP or any later OVDP, the civil penalty guarantees in the OVDP did not apply to place a ceiling on the FBAR penalty. However, while entering the OVDP does provide specific assurances that there will be no criminal investigation, quiet disclosures remain viable and have not been repealed by the Programs.
3. Zwerner highlights the issue of IRS discretion in applying FBAR penalties to those taxpayers who come forward outside of the OVDP penalty structure.
A. Should taxpayers not within an OVDP, i.e., quietly disclosing or opting out- be afforded the same “benefits” afforded taxpayers who participate in the OVDP, i.e., should his FBAR penalty have been “capped” at one year and capped at the maximum rate under the OVDP (20%, 25% or 27.5%, under the 2009, 2011 and 2012 Programs, respectively)? Should the IRS impose the maximum FBAR penalty of 50% of the account balance per year because it can under the statutes, just because some taxpayers aren’t in the Program?
B. Is the OVDP’s use in avoiding criminal prosecution over blown, i.e., is the concern really more with how much the penalty will be rather than avoiding criminal prosecution since a quiet disclosure will likely (but not necessarily) avoid criminal prosecution? How much discretion should the IRS have and what kind of guidelines are appropriate to restrain unbridled discretion and unpredictable results?
C. Will the IRS seek to punish those who enter the Program and then opt out? While the IRS has the discretion to “mitigate” FBAR penalties as set out in its manual at IRM §4.26.16.4.6 (“Mitigation”), it is not obligated to do so. Therefore, the possibility of any kind of treatment is possible, including maximum FBAR penalties, without any guidance or guidelines to the IRS or to taxpayers or their representatives. Based upon our experience and that of other practitioners, and based upon a limited sample size of opt outs which have been concluded most often the opt out result has been fairly close to the result which would have applied had the opting out taxpayers remained in the Program, with the IRS taking a broad view of “willful blindness,” but then applying mitigation under the IRM to reduce the penalties to come close to those which would have resulted under the Program. However, there are no guarantees and no guidelines to rely upon for taxpayers or practitioners, and some practitioners have reported that their clients who opted out were treated harshly.
4. Opting out looks “scarier” and FAQ #51.2 example 7 must be considered more seriously. Since there is no formal guidance which is binding on the IRS and since there is no published information available upon which taxpayers or representatives may rely insofar as FBAR penalties which will be imposed outside of the OVDP, representatives and taxpayers have only one way to disclose offshore accounts and to be certain of the amount of penalties, i.e., within the OVDP and not opting out.
Remaining Issues In Zwerner Relating to the Court’s Ability to Review the Amount of the Penalties and The IRS’ Discretion in Applying Them
The District Court, having received the “wilful verdict” is expected to next address some of the following legal issues which remain for the court (and not a jury) to decide:
1. Whether the amount of FBAR penalties assessed against Zwerner violates the Eighth Amendment as an excessive fine?
2. Whether the District Court has authority to review the issue of whether Zwerner qualified for the 2009 or 2011 Offshore Voluntary Disclosure Program, or the 2005 Last Chance Compliance Initiative, and, if it does, can it award any relief if he did qualify?
3. Whether the United States violated the Equal Protection Clause the United States Constitution when it assessed multiple 50% penalties against Zwerner?
IRS May Soon Revisit OVDP Penalty Policy
In prepared remarks to the U.S. council for International Business-OECD on June 4, 2013, new IRS Commissioner John Koskinen addressed modifications to the OVDP are being considered. A portion of his remarks are as follows:
Now, while the 2012 OVDP and its predecessors have operated successfully, we are currently considering making further program modifications to accomplish even more. We are considering whether our voluntary programs have been too focused on those willfully evading their tax obligations and are not accommodating enough to others who don’t necessarily need protection from criminal prosecution because their compliance failures have been of the non-willful variety. For example, we are well aware that there are many U.S. citizens who have resided abroad for many years, perhaps even the vast majority of their lives. We have been considering whether these individuals should have an opportunity to come into compliance that doesn’t involve the type of penalties that are appropriate for U.S.-resident taxpayers who were willfully hiding their investments overseas. We are also aware that there may be U.S.-resident taxpayers with unreported offshore accounts whose prior non-compliance clearly did not constitute willful tax evasion but who, to date, have not had a clear way of coming into compliance that doesn’t involve the threat of substantial penalties.
We are close to completing our deliberations on these respects and expect that we will soon put forward modifications to the programs currently in place. Our goal is to ensure we have struck the right balance between emphasis on aggressive enforcement and focus on the law-abiding instincts of most U.S. citizens who, given the proper chance, will voluntarily come into compliance and willingly remedy past mistakes. We believe that re-striking this balance between enforcement and voluntary compliance is particularly important at this point in time, given that we are nearing July 1, the effective date of FATCA. We expect we will have much more to say on these program enhancements in the very near future. So stay tuned.
We hope that the IRS revises its OVDP penalties and takes the discretion to punish severely out of the current process so that taxpayers who comply feel as if they were treated fairly. At this time, the “voluntary” in “voluntary compliance” is missing, and moreover, the unpredictability and potential punitive nature of the OVDP, quiet disclosures and “opt outs” makes it difficult to imagine that the administration of our tax laws will be benefit over the long . The Taxpayer Advocate has made recommendations for changes in the OVDP which make sense, and include less punitive measures and more published guidance which can be relied upon rather than FAQs which can change day to day and can’t be relied upon by taxpayers. The IRS or Congress would do well to listen and act upon those recommendations.
Many states and local jurisdictions impose income taxes on all of the income of their residents. Some of this income may be from sources outside of the state or locality, and thus the source of income jurisdiction may also impose income taxes on that same income.
There is no denying the authority of the state or local jurisdiction of residence to tax the income. However, if no credit is granted for taxes on that income imposed by the source jurisdiction, is that an unconstitutional restraint on commerce that is not permitted under the Commerce Clause of the U.S. Constitution?
I don’t have an answer for you on that question…yet. But the U.S. Supreme Court has taken on a case that will likely decide this issue.
Note that the U.S. Commerce Clause explicitly only limits federal government restrictions on commerce between the states. However, an implied limitation on state and local action under the Commerce Clause has arisen under what is referred to as the “dormant Commerce Clause” that limits state and local power to unjustifiably to discriminate against or burden the interstate flow of articles of commerce. Whether the dormant Commerce Clause requires the above tax credits is the issue the U.S. Supreme Court will decide.
The case has the potential to limit the tax revenues of those states and localities that do not provide a tax credit for income taxes of the source jurisdiction.
Maryland State Comptroller of the Treasury v. Brian Wynne
