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Saturday, June 07, 2014


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:


    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.


    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 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 § (“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.

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