IRS FBAR Penalty Guidelines Suggest Lower Risk of Multiple “Per Account” and “Per Year” Penalties

Penalties for willful violations of FBAR filing requirements can be as high as 50% of the balance of the subject accounts EACH YEAR. Penalties for nonwillful violations can be as high as $10,000 PER UNREPORTED ACCOUNT per year.

In a recently issued guidance memorandum, the IRS seeks to provide guidance to its personnel to ensure consistency and effectiveness in the administration of FBAR penalties. It is intended that this guidance be incorporated into IRM 4.26.16, Report of Foreign Bank and Financial Accounts (FBAR), and IRM 4.26.17, Report of Foreign Bank and Financial Accounts (FBAR) Procedures, no later than one year following its issuance.

In regard to willful violations over several years, the memorandum appears to recommend a penalty equal to 50% of the highest account balances for all years with violations. Thus, in lieu a 50% penalty for each year, one 50% penalty is imposed for all years, and it is then allocated across the years based on the balances of each year. The memorandum uses this example:

Assume highest aggregate balances of $50,000, $100,000, and $200,000 for 2010, 2011, and 2012, respectively. The total penalty amount is $100,000 (50 percent of the $200,000 highest aggregate balance during the years under examination).  The total of the highest aggregate balances for all years combined is $350,000.  The penalty for 2010 is $14,286 ($50,000/$350,000 x $100,000). The penalty for 2011 is $28,571 ($100,000/$350,000 x $100,000). The penalty for 2012 is $57,143 ($200,000/$350,000 x $100,000).  The penalty amounts for each year are subject to the maximum penalty limitation in 31 U.S.C. § 5321(a)(5)(C).

Examiners are still free to impose a higher or lower penalty, in appropriate circumstances. In no case will the penalty exceed 100% of the highest balance of the subject accounts in the years of nonreporting.

In regard to nonwillful violations when there are multiple accounts, the memorandum indicates in most cases only one $10,000 penalty should be imposed in each year – not $10,000 per account. The memorandum also notes, however, that lesser penalties (e.g., only imposing the penalty in one year) or greater penalties (i.e., per account penalties) may be imposed when appropriate.

Also, the memorandum notes that when accounts have co-owners, each shall be attributed the appropriate percentage ownership of the account balances in computing penalties.

Overall, this memorandum is helpful to taxpayers, since it indicates that maximum penalties should be the exception not the norm. However, to the extent that examiners use these guidelines to impose the suggested penalties in circumstances where a lesser penalty is warranted, the memorandum could be injurious to those taxpayers.

Interim Guidance for Report of Foreign Bank and Financial Accounts (FBAR) Penalties, May 13, 2015, Control Number: SBSE-04-0515-0025

Can the IRS Abate Interest and Penalties That Have Already Been Paid?

A taxpayer filed a late tax return, and paid with it interest and penalties based on the tax due. The taxpayer then filed a time-barred refund claim, providing that the tax amount due was overstated on the original return.

It was too late for the taxpayers to receive a refund of the overpaid taxes. However, the statute of limitations for refund of the interest and penalties paid had not yet expired. Could the IRS abate the penalties and interest due to the lower amount of tax that should have applied?

Code Sec. 6404(a) provides: “IRS is authorized to abate the unpaid portion of the assessment of any tax or any liability in respect thereof, which—(1) is excessive in amount, or (2) is assessed after the expiration of the period of limitation properly applicable thereto, or (3) is erroneously or illegally assessed (emphasis added).” Thus, from this provision, it would appear that the IRS has no authority to abate paid interest and penalties.

Nonetheless, in a Chief Counsel Advice, the IRS indicated that Code Sec. 6404 abatement “is permissive and that the IRS is not prohibited from abating the paid portion of assessments.”

CCA 201520010

Applicable Federal Rates–June 2015

Supreme Court Mandates State Income Tax Credits, Pretty Much

Maryland imposes income taxes on its residents. There is a state level income tax, and a county level tax. If a Maryland resident incurs income in other states and pays state income tax to those other states, there is a mechanism for the resident to receive a credit against the Maryland state level taxes for the non-Maryland taxes paid. This avoids double taxation of that income. However, there is no such credit mechanism for non-Maryland taxes paid in regard to the county level tax, so double taxes can result for those taxes.

The U.S. Supreme Court has ruled that the failure to provide such a credit for the county income taxes violates the Commerce Clause of the U.S. Constitution. Normally, the Commerce Clause only restricts federal laws that impede interstate commerce. Here, however, the violation was of what is known as the “dormant Commerce Clause” which is read to prohibit discriminatory state taxation even if Congress has not legislated on the subject.

The Court determined that the lack of a credit penalizes interstate commerce, as compared to intrastate commerce. It concluded this by testing whether interstate commerce produces more taxes than intrastate commerce, using the fiction that all states adopt the Maryland tax scheme at issue. Since interstate commerce generates double tax – a tax in each of the state where the activity occurs and the tax of residence, and since intrastate commerce (commerce conducting in the state of residence of the taxpayer) would only be taxed in the state of residence, interstate commerce is thus burdened with more taxes.

The Court notes that not all double tax consequences violate the dormant Commerce Clause. For example, if the nature of the double taxation arises from each state asserting different taxing systems (e.g., one taxes by source and one by residence), that might not violate the above test.

Thus, the Court appears to be requiring that a state taxing its residents on income must provide a credit for taxes imposed on the same income in other states. The majority opinion does say that there may be other constitutional means to avoiding double taxation other than a credit for taxes, but declines to name them or discuss them. So while it does not mandate a credit for taxes, that is the only route as of now that the Court acknowledges avoids constitutional infirmities.

The opinion should apply to similar arrangements in other states that do not offer the credit – not good news for those states.

Comptroller of the Treasury of Maryland v. Wynne, U.S. Supreme Court, Case No. 13-485 (2015)

Seniors Need to Use Care in Deferring Income Into 2016

Tax Planning 101 says to defer income into the next year if you can, since it is better to pay a tax later than sooner. You get to keep the money in your account and can earn interest (good luck with that with today’s nonexistent interest rates – thank you Federal Reserve) or invest it for other gains and appreciation. An exception to that rule is if tax rates are going up – in that case, you might be better paying the tax in an earlier year at a lower rate.

Medicare surcharges are going up in 2018. Those surcharges are based on income earned in 2016. The higher rates will impact single seniors with incomes between $133,500 to $214,000, and married couples between $267,000 to $428,000. The rate increases will likely be as high as $1,000 for singles or $2,000 for joint filers.

Thus, senior taxpayers who are in or around those brackets should use care at the end of 2015 in trying to defer tax into 2016 – e.g., deciding whether to sell shares for a gain.To decide what works best, they will need to put pencil to paper to see what year yields the best overall result.

Triple Drop and Check

Sounds like an ice hockey term, but this is a tax blog so don’t get your hopes up.

Parent corporation owns all the stock of subsidiary 1, which owns all the stock of subsidiary 2, which owns all the stock of subsidiary 3. Parent corporation also owns 100% of an LLC that had elected to be taxed as a corporation.

Parent corporation will transfer all of its interests in the LLC to subsidiary 1, which will transfer it to subsidiary 2, which will transfer it to subsidiary 3 (with stock issued to the transferor by the transferee at each step). After it is in subsidiary 3 a check-the-box election will be filed to treat the LLC as a disregarded entity. Hence the name – triple drop and check [the box].

How should this be taxed – as 3 successive Section 351 transfers, followed by a Section 332 deemed liquidation of the corporate LLC in subsidiary 3 upon the check-the-box election? No, says the IRS, in Rev.Rul. 2015-10. Instead, this is two Section 351 transfers. Then, the transfer from subsidiary 2 to subsidiary 3 is not a third Section 351 transfer, but is a ‘D’ reorganization. Does it matter? In many circumstances, the same tax results may apply. But Section 351 and the reorganization provisions can yield different results as to income and basis, so proper characterization may be important.

The IRS relied on Rev. Rul. 67-274. In that ruling, the IRS ruled that an acquisition by a corporation of stock of another corporation with its own stock followed by a liquidation of the acquired corporation should be treated as a ‘C’ reorganization. Because the stock of the new subsidiary was not acquired from a third party, a ‘D’ reorganization instead of a ‘C’ reorganization fits the bill in Rev.Rul. 2015-10, but the same general reorganization characterization from Rev. Rul. 67-274 applies here by analogy.

It is not material that there were three drops here. If there had only been one transfer of the LLC to subsidiary 1 followed by a check-the-box of the LLC to become a disregarded entity, the same ‘D’ reorganization treatment should again apply (this time at the subsidiary 1 level).

Rev.Rul. 2015-10

FIRPTA Changes Coming?

It is a pleasure to see something coming out of Congress these days that seeks to attract foreign investment, instead of repelling it. A recent bill by Representatives Brady and Crowley seeks to modernize FIRPTA by expanding exemptions for foreign pension funds and interest-holders in REITs.

In the 1980’s, FIRPTA exposed foreign investors in U.S. real estate to U.S. income taxes on their gains (and also imposed a withholding regime). Under the proposed bill, the exemption from FIRPTA for up to 5% owners in publicly-traded REITs would be increased to 10%. Foreign pension funds would also be exempted from FIRPTA.

These are not substantial changes to FIRPTA, but at least they are a step in the right direction. The Senate Finance Committee approved a similar bill in February 2015, so there is a reasonable likelihood that this bill may get through Congress.

Press Release, Reps. Brady and Crowley Move to Increase Foreign Investment in U.S.
Real Estate, April 30, 2015

One Dollar of Tax Would Have Avoided $94,671.53 of Penalty

A corporation filed a 2008 income tax return reflecting a tax liability of “$0.00.” In the following year, the Corporation made no estimated income tax payments, based on Internal Revenue Code Section 6655(d)(1)(B) which provides that required annual installments can be as low as “100% of the tax shown on the return of the Corporation for the preceding taxable year” (i.e., $0)

The Code does go on to provide that this provision “shall not apply if…the corporation did not file a return for such preceding taxable year showing a liability for tax.” Both the IRS, and the District Court reviewing the issue, have concluded that since the corporation did not reflect any tax amount due in the preceding year, these limitations based on “tax shown on the return” and having a “liability for tax” do not apply. Since these limitations do not apply, a penalty of $94,671.53, plus interest was imposed by the IRS for failure to pay estimated taxes.

My first thought when I was reading this was that if the corporation had a one dollar tax liability in the preceding year it would have only had to pay one dollar estimated taxes to avoid penalties. Thus, there must be something wrong with the IRS’ interpretation of the statute if a one dollar difference in tax liability results in over $94,000 in tax penalties. Apparently, the taxpayer made a similar argument to the court, but the court was unpersuaded. It provided in its opinion that “[t]he fact that application of tax statutes sometimes presents harsh results does not negate the fact that the law must be enforced as written by Congress.”

Different rules apply for individual estimated taxes under Code Section 6655, since different statutory language applies. Further, that Code Section has an additional provision that explicitly provides that if the individual taxpayer had no tax liability in the preceding tax year he or she has no estimated tax payment obligations in the current year (Code Section 6654(e)(2)). Indeed, the presence of this exculpatory language in Code Section 6654, and its absence in Code Section 6655, may be supportive of the IRS and District Court position when there was no tax due in the preceding tax year. Nonetheless, this is a ridiculous result.

CAL PURE PISTACHIOS, INC. v. U.S., 115 AFTR 2d 2015-XXXX, (DC CA), 04/10/2015

IRS Plans to Shift Risk of Withholding Agent Fraud to the Taxpayer for Foreign Withholding

Chapter 3 of the Internal Revenue Code requires payors (and recipients) of certain types of U.S. source income to withhold tax if the beneficial owner or recipient is a non-U.S. person for income tax purposes. Chapter 4 also imposes similar withholding under FATCA for payments to foreign financial institutions and other foreign entities. The taxpayer who is withheld again can credit the withheld tax against their final U.S. income tax liability – if too much tax was withhold they can file a tax return and seek a refund. These are withholding mechanisms to help the IRS collect taxes, since collection and enforcement from non-U.S. person can be difficult, if not impossible, for the IRS.

Sometimes, the withholding agent will withhold the tax but wrongfully not pay it over to the IRS. The IRS has now announced that it is the taxpayer who will bear the risk of loss of such stolen or misappropriated tax money, not the IRS. Under regulations to be issued, the taxpayer will not be able to take credit for, or seek a refund of, withheld taxes if the withholding agent did not pay them over to the IRS. Thus, in those circumstances, the taxpayer will either lose its refund, or still owe tax to the IRS even though the withholding agent withheld the tax. The injured taxpayer could always sue the withholding agent and seek to recover the lost taxes – yeah, good luck with that. Alternatively, perhaps the IRS may pursue the withholding agent and obtain payment – yeah, good luck with that, too.

So let’s say a well-advised taxpayer, aware of this new risk, makes sure that the taxes are paid to the IRS by involving a third party agent to withhold and pay over the taxes. That should obviate the risk, right? Not so fast. The new regulations will indicate that if a withholding agent had obligations to withhold for other taxpayers and did not meet those obligations, any given taxpayer against whom the agent withheld would receive credit for amounts actually paid to the IRS, BUT ONLY on a pro rata basis. That is, a taxpayer whose tax money made its way to the IRS would only receive partial credit for such payment if the withholding agent did not pay over to the IRS withholding taxes for other taxpayers, even if all of the taxpayer’s withholdings did make it to the IRS. The IRS says it considered allowing for some type of “tracking” to allow full credit for taxpayers whose money did make it to the IRS, but that is impractical.

So let’s sum this up:

a. The Internal Revenue Code requires taxpayers to have part of their income withheld, as credit against their taxes. Not much a taxpayer can do about that – the taxes never even reach the taxpayer.

b. The withholding agent becomes a statutory agent of the government, and is obligated to conduct such withholding or suffer personal liability for un-withheld taxes.

c. The government’s agent defrauds the government by withholding the taxes, but not delivering them to the IRS.

d. The government says – you, Mr. Innocent Taxpayer, we are going to hold you responsible for the fraud you had nothing to do with, for a tax obligation we imposed on you, for the fraud of OUR agent.

Something is VERY wrong with this.

Perhaps this liability of the taxpayer will ultimately be found not to be allowable under the terms of the Internal Revenue Code, but who the heck knows? This has been out only a few days, but a quick Internet search sees no other comments. Please comment below if you feel otherwise – perhaps I am misreading something, but if not, then this liability seems absolutely crazy and overreaching.

Notice 2015-10