News, Events & Blog
There has been a series of cases that bode ill for taxpayers who failed to file foreign bank account reports (FBARs). To review, the law requires taxpayers who have foreign bank accounts with a total balance of $10,000 at any point in a calendar year to file an FBAR the following year. Until recently, that return was due by June 30 with no extensions. Recent changes now make the return due at the same time your income tax is due and it is automatically extended to October 15 if you file an extension for your income tax return.
A non-willful failure to file can result in a penalty of up to $10,000 per account per year. However, the IRS has adopted procedures to reduce the amount pursuant to mitigation guidelines depending upon the total amount held in the accounts in any one year. The agent also has the authority to recommend a single $10,000 penalty regardless of the number of accounts or years. Further, if reasonable cause is demonstrated by the taxpayer, no penalty can be assessed for that year. Typically, taxpayers demonstrate reasonable cause in this area by showing they relied upon their tax preparers or advisors who failed to advise them to file. To succeed in making this showing, taxpayers must show the advisor was presented with all pertinent facts, that the advisor was competent to give advice on the subject and that the taxpayer relied, in good faith upon that advice. A recent bankruptcy case has held that if the advisor was aware of the foreign accounts, but failed to advise that FBARs were required to be filed, that the taxpayer could rely upon the failure to advise as if there had been a specific discussion about the requirement. It stated that to hold otherwise would require an advisor to review every possible form and filing requirement with a taxpayer and tell him whether it had to be filed. This, the court ruled, was not required by the law.
Unfortunately, those taxpayers charged with willful failure to file an FBAR do not have the opportunity to show reasonable cause. Somewhat illogically, the statute prohibits it. Yet one might argue (as the author and others have) that if you meet the elements of reasonable cause, you cannot have willfully failed to file. The penalties for a willful failure to file can be draconian. They are $100,000 per account per year or 50% of the balance in the account per year. With a six-year statute of limitations to assess the penalty, theoretically, a taxpayer could be assessed 300% of the highest balance. The IRS, has, however, graciously agreed that they won’t take more than 100%. To further add to the potential misery, there are no mitigation provisions for a willful failure to file an FBAR.
Not surprisingly, this has led to litigation on the issue of willfulness. Although FinCen has delegated the authority to the IRS to investigate and assess FBAR violations, the IRS has no mechanism to collect any assessment it may make, except possibly offsetting a taxpayer’s income tax refund by deducting the penalty as a debt owed to another Federal agency. Instead, The Treasury Department, through the Department of Justice, must file an action in Federal district court to obtain a judgment. The taxpayer may be able to pursue refund procedures in either the district court or the Court of Claims. Most of the reported cases have gone against the taxpayer. The facts in many of the cases involve taxpayers who have been convicted of tax evasion or who have admitted they intentionally concealed the foreign accounts to also conceal unreported income. These facts alone would seem to be all that would be necessary to sustain the willful FBAR penalty.
However, the courts are going further, unnecessarily in the author’s opinion, and are creating what almost appears to be a strict liability rule. Essentially, they state that when a taxpayer signs a return, he states he has read it and it is correct. Then they point to Schedule B, Part III, which contains the questions about foreign trusts and bank accounts. The courts continue that it contains a warning that other returns may need to be filed. Thus, say the courts, the taxpayer either had actual knowledge of the duty to file an FBAR or is guilty of “willful blindness” in not pursuing the matter further to determine what his obligations are under the law. An argument could be made that this is “dicta’ (comments by the court unnecessary to the ruling), but it is far from clear. Under this standard, a taxpayer who signs an income tax return and fails to file an FBAR may be, per se, deemed to be willful. Interestingly, the IRS has an internal rule that says simply failing to mark the box on the Schedule B, or marking it “no” is not enough. Perhaps that is why the courts that have made created this rule have spent a significant amount of time in their opinions setting forth the “bad acts” of the taxpayers in those cases. Unfortunately, they don’t state that to be the case. Very recently, one district court held in favor of a taxpayer where, it held, the facts did not rise to the level that it believed was intended by Congress when they passed the law. The author was advised by an Appeals officer in Tampa, Florida, that the Government was going to appeal the decision.
All the above, together with the implementation of FATCA in countries around the world, the continuing expansion of the Foreign Institutions and Facilitators list ( a list of banks and people that assisted taxpayers in setting up off-shore accounts or trusts, etc. that the IRS has determined should result in a 50% instead of a 27 ½ % off-shore penalty under an OVDP submission) point to the need for individuals who have foreign bank accounts, trusts or other off-shore assets or foreign unreported income to seek advice and seriously consider participation in the Off-shore Voluntary Disclosure Program (OVDP) where many of these penalties can be avoided or substantially reduced.
The IRS has announced two new and highly sophisticated approaches to criminal tax enforcement. The first, called the “data initiative”, sounds similar to the data analysis first used by FinCen to uncover money laundering operations. It will consist of data analysis from information provided by field offices throughout the country. This will allow the IRS to identify areas of non-compliance that have nationwide impact and use its resources to coordinate investigations and provide greater support to the field agents. It will also help to deal with decreasing personnel and resources due to budget constraints. The initial projects will focus on international tax enforcement, employment tax and SEC microcap fraud. It is also expected to identify new areas of non-compliance and start investigations in these new areas.
The second “new” program will be a specialized group of agents already experienced in international tax enforcement. Their expertise will provide specialized skills and knowledge in this area of enforcement. Their efforts, along with the Department of Justice, international tax partners and information gathered from the Bank Secrecy Act, FATCA, whistleblowers, the Offshore Voluntary Disclosure Programs, the Panama Papers, etc., will allow them to identify, through data analysis, new or continuing non-compliance in the international area. Initially, the group will consist of 10 to 12 special agents working out of the Washington D.C. field office. Others will be located at “strategic” locations around the country.
These new programs should give further incentive to those who have yet to avail themselves of the Offshore Voluntary Disclosure programs to give further serious consideration to doing so. Time continues to run out for those continuing to believe they will not be discovered.
Tax filing time is upon us again. But some taxpayers are in a tough spot. They may not have filed for prior years and are afraid that, if they do so now, their prior failure to file will come to light and lead to serious consequences, including criminal prosecution. This is known as the “snowball effect”, where one failure to file leads to another resembling a snowball rolling down a hill and getting bigger and bigger as each year goes by.
The consequences of not filing your tax return can be both criminal and civil. On the criminal side, if the failure is “willful”, meaning you knew you had a duty to file but chose not to, the government could charge a violation of 26 U.S.C. 7301, punishable by up to 1 year in prison and a $25,000 fine for each year. In more elaborate circumstances, the government has also charged a felony violation under 26 U.S.C. 7201, the evasion statute, citing the failure to file as the method of evasion. This crime is punishable by up to 5 years in prison and a $100,000 fine for each year involved.
In the past 4 years, the IRS initiated 977 criminal investigations of non-filers. Of these, the IRS recommended prosecution in 712 cases. Over 751 (not all cases are completed in the same year) were convicted and sentenced. Of these, approximately 83.2 percent received prison time with an average incarceration sentence of 39.7 months (there is usually more than 1 year involved).
So how does the IRS discover non-filers? The IRS has computer programs that match information returns (1099s; W-2s; etc.) to filed returns. If there is no match because the taxpayer didn’t file, an investigation is initiated. Another computer program, called the “Stopfiler” program, which identifies those who have filed a return in the past and then stopped filing, which also results in an investigation. Add to this informants, undercover operations of return preparers and tax protest leaders. The list of informants runs the gamut of whistleblowers, motivated by hopes of an award, to disgruntled ex-employees (especially book keepers), ex-spouses, scorned lovers, jealous neighbors and business partners. Often, an audit of someone or something else can lead to you as the other party may reflect payments to you and the IRS contacts you to confirm you received the payment. With the recent enactment of the Foreign Account Tax Compliance Act (FACTA), the IRS is now receiving information from foreign banks about their American customers, thus eliminating the former secrecy of those overseas accounts.
On the civil side, there can be other serious consequences. If you are convicted of a tax crime, there is a 75 per cent of the tax penalty. Accordingly, if you would have owed $100 in tax, now you owe $175. There are other civil penalties including a failure to file penalty that caps out at 25 percent of the tax owed. There is another failure to file penalty, called the fraudulent failure to file, which is a civil penalty but higher than the “normal” late filing penalty. It is 75 per cent of the tax due.
Another dangerous possibility is that the IRS can and does prepare what are known as 6020(B) returns or substitute for returns. They take the information received from third party payers, such as 1099s and W-2s and prepare a return for the taxpayer. Only the standard deduction and 1 exemption is used in computing the tax. This is then sent out to the last address of record of the taxpayer and, if he doesn’t respond, they assess that amount of tax against him. This is usually a much higher tax than that the taxpayer would have computed had he filed. While the IRS may reduce this assessment when returns are filed later, several courts have said it doesn’t have to do so.
So, what to do? The obvious answer is to file the returns. But there are a lot of considerations in doing so. Is the taxpayer already under investigation? Is any of his income from unlawful activities? Is any of it from off-shore entities or bank accounts? How much does he owe? What is his compliance history? Is he or a related entity under audit? The taxpayer needs to consult and retain an attorney who has experience in this area. While some accountants try to resolve these issues on their own, they do so at their and the taxpayer’s peril. This is because there is no accountant privilege in the Federal tax system in criminal cases. Accordingly, should a criminal investigation exist or arise while the accountant is working on the matter, everything a taxpayer tells that accountant must be disclosed by the accountant if he is interviewed pursuant to an IRS subpoena or a Grand Jury subpoena. Further, if such an investigation arises, the returns themselves may be exhibit “A” in the case. However, if an attorney, who has been retained by a taxpayer, in turn retains an accountant, the attorney/client work product privilege then extends to the accountant, thus preventing disclosure by the accountant without the taxpayer’s consent. This is pursuant to a case called KOVEL. Hence, the appellation, “Kovel accountant”. Further, there are considerations as to whether the filing of delinquent returns should be done by “quiet” disclosure or formal disclosure pursuant to the IRS voluntary disclosure policies for domestic and foreign disclosure.
The goal is to get the taxpayer into compliance while limiting the potential that he may be prosecuted. Understanding how the IRS deals with these types of cases is critical to accomplishing the desired result.
As you know, the Internal Revenue Service closely scrutinizes transfers between family members of stock, units, and partnership interests (“Stock”) in any corporation, limited liability company, or partnership that is family-owned (a “Family Business”). The Service has announced proposed regulations that eliminates the use of valuation discounts that would otherwise decrease the estate and gift tax value of such Stock when transferred by sale or gift to family members. If you are considering a gift or sale of Stock in a Family Business, you may want to consider taking action right away to implement your planning.
When Stock in a Family Business is transferred between family members, valuation discounts are commonly applied for, among other things, lack of marketability and lack of control. The lack of marketability discount is based on the fact that a Family Business cannot easily be sold on the open market and is not publicly traded; so, the true value of the Stock is actually worth less than a pro rata portion of the total value of the underlying assets. The lack of control discount is based on the fact that a non-voting interest or a minority interest that does entitle the owner to a vote (but not unilateral control of the entity) is worth less to an arm’s length purchaser than if they could control the entity. These discounts are designed to reflect the true economics of a Family Business from the view point of a third party purchaser.
Valuation discounts have been an effective tool to reduce or eliminate federal estate and gift taxes on transfers of Stock in Family Businesses for many years. The Service, however, has long sought to limit the benefit of this tool. This has been especially true when the Service determines that the Family Business in question has no legitimate “business purposes.” The proposed regulations address the Service’s concerns by eliminating all discounts. We expect attorneys, accountants, appraisal experts, and other planners to comment in the next ninety (90) days about the validity and public policy implications of the proposed regulations. However, the very real possibility is that the proposed regulations will be effective when the final version is published, which might occur in as little as one hundred and twenty (120) days.
The new regulations do basically two (2) things. First, when valuing Stock in a Family Business certain restrictions on liquidation rights are disregarded when such rights lapse after a transfer (for instance if the General Partner of a partnership dies) or if after a transfer the restrictions may later be removed by the transferor or the transferor’s family. Second, any lapse of voting or liquidation rights is deemed to be a transfer to the other family member/owners in the Family Business. Both rules only apply if one (1) or more members of the family has control of the Family Business both before and after the transfer or lapse. Control may occur when certain voting or equity thresholds are met; furthermore, ownership by a particular family member will be attributed to related family members, making it hard not to pass the threshold of control. In plain English, this means that valuation discounts will no longer be available for transfers of Stock in a Family Business to family members.
Existing Family Businesses would not be “grandfathered” under the proposed regulations. Only gifts or sales completed prior to thirty (30) days after the effective date of the final regulations would be exempt from the new rules. It is also very likely that regardless of how broad or narrow the final regulations may be, the ultimate validity of the regulations will be determined through taxpayers litigating this issue in the Tax and Federal Courts. Therefore, once the new regulations are made final, we may not have any certainty in this area for the next several years while legal battles are fought with the Service.
Because of the uncertainty of the new proposed regulations, we recommend that our clients who may be inclined to transfer Stock in a Family Business, whether by gift, sale, or both, consider all of their planning options as soon as possible to determine if they should go ahead with some transfers prior to the issuance of the final regulations. We would be happy to sit down with you and discuss all of your planning options.
In April 2016, over 11.5 million documents, some dating as far back as the 1970’s, were hacked from the Panamanian law firm Mossack Fonseca and released to the worldwide media. The papers include detailed information for over 214,500 offshore entities. Much of the information would normally be considered attorney client communications. These “Panama Papers” have disclosed that some U.S. taxpayers may have tax liabilities and possible criminal exposure.
The U.S. Justice Department has initiated a criminal investigation into these offshore tax schemes and the use of “shell” foreign entities to conceal the offshore holdings by both individuals and corporate entities. This may result in foreign banks turning over any records relating to the Mossack Fonseca firm. Of course, as these documents are analyzed, they may lead to others who were not clients of Mossack, but simply dealt with or were involved with their clients. These events further emphasize that owners of offshore companies and bank accounts must act immediately to identify and mitigate risks of criminal and tax sanctions.
The IRS as of this date has not announced whether taxpayers disclosed in the “Panama Papers” will be eligible for Offshore Voluntary Disclosure Program (OVDP) protection. Taxpayers who have reason to think they or their entities may be disclosed in the” Panama Papers” should immediately seek counsel to explore possible legal and tax exposures.
Regardless of any involvement with the “Panama Papers”, anyone with an offshore entity, bank account or other offshore interests or holdings, should consider a review of their obligations to file various forms with the IRS, including Foreign Bank Account Reports (FBAR), Foreign Trusts Reports (3520 and 3520-A), Interest in a Foreign Corporation (5471), to mention just a few. The OVDP is an opportunity to resolve many of these issues. However, as it recites, it could be discontinued at any time. Further, the penalties to be paid under the program have been periodically increased as the IRS has determined that there is greater public awareness of these requirements. Waiting will not make these issues go away.
ShuffieldLowman’s four downtown offices are located in Orlando, Tavares, DeLand and Daytona Beach. The firm is a 37 attorney, full service, business law firm, practicing in the areas of corporate law, estate planning, real estate and litigation. Specific areas include, tax law, securities, mergers and acquisitions, intellectual property, estate planning and probate, planning for families with closely held businesses, guardianship and elder law, tax controversy – Federal and State, non-profit organization law, banking and finance, land use and government law, commercial and civil litigation, fiduciary litigation, construction law, association law, bankruptcy and creditors’ rights, labor and employment, environmental law and mediation.
Many homeowners associations and condominium associations struggle with the manner in which a bankruptcy filing by one of its owners should impact the ledger that is maintained by the association for the property owned by the owner that files the bankruptcy case. I often see associations fail to maintain a ledger, or other account information, which will allow the association to distinguish between: (a) the amounts that came due before the filing of the owner’s bankruptcy petition (often referred to as the “Pre-Petition Amounts Due”); and (b) the amounts that came due after the filing of the owner’s bankruptcy petition (often referred to as the “Post-Petition Amounts Due”). The best way to maintain records that distinguish between the Pre-Petition Amounts Due and the Post-Petition Amounts Due is to separate a ledger for an owner that files bankruptcy into two ledger parts. One part would reflect the Pre-Petition Amounts Due and the other part would reflect the Post-Petition Amounts Due.
The ledger for the Pre-Petition Amounts Due (the “Pre-Petition Ledger”) would reflect the amounts due, itemized by type of charge, as of the date of the filing of the owner’s bankruptcy petition. That ledger balance would increase, after the bankruptcy filing, by the addition of any interest charges or late fees associated with the unpaid assessments listed on the Pre-Petition Ledger and by the addition of any attorney’s fees or legal costs associated with collection efforts relating to the recovery of the Pre-Petition Amounts Due. The ledger for the Post-Petition Amounts Due (the “Post-Petition Ledger”) would include all future accruing assessments after the date of the bankruptcy filing, as well as interest charges or late fees associated with the unpaid assessments listed on the Post-Petition Ledger. That ledger would also include any attorney’s fees or legal costs associated with collection efforts relating to the recovery of the Post-Petition Amounts Due. Once the bankruptcy case ends, the owner’s split ledgers can typically be re-combined into a single ledger.
It is important for an association be able to separate the Pre-Petition Amounts Due from the Post-Petition Amounts Due for a number of reasons. Several of those reasons are discussed below.
First, when a payment is received for an account in which the owner is in bankruptcy, the association will need to apply it to either the Pre-Petition Amounts Due or the Post-Petition Amounts Due. The “side of the ledger” to which the payment will need to be applied will depend upon a number of factors, including whether the payment was made by the owner or the bankruptcy trustee and, in the event of a Chapter 13 filing, the manner in which the association’s claim is to be treated in the owner’s bankruptcy plan. If there is a single ledger that is maintained, there would be no clear way to distinguish the payments made toward the Pre-Petition Amounts Due from the payments made toward the Post-Petition Amounts Due.
Second, in a Chapter 7 case that results in a bankruptcy discharge and in which the association did not have a recorded lien at the time of the filing of the bankruptcy petition, the association will typically need to write-off all Pre-Petition Amounts Due. That task is far easier if the association splits its ledgers or otherwise maintains records which will allow it to easily determine which amounts were included in the Pre-Petition Amounts Due.
An association can continue to seek recovery of post-petition assessments from an owner who files a Chapter 7 case and obtains a bankruptcy discharge. See 11 USC §523(a)(16). However, if an association does not split its ledgers, it may find it difficult to determine the amount of post-petition assessments and other charges that can be demanded as part of the Post-Petition Amounts Due.
Third, if the owner files a Chapter 13 case, he might present a bankruptcy plan that provides for payment of all Pre-Petition Amounts Due, with the payment of all Post-Petition Amounts Due being made outside of the plan. That owner might also present a plan that calls for any lien held by the association which secures the Pre-Petition Amounts Due, to be “stripped away”, with the owner remaining liable for paying all Post-Petition Amounts Due. In either instance, if there is a single ledger that is maintained, there may be no clear way to distinguish those amounts that are being claimed under the Pre-Petition Amounts Due from those amounts being claimed under the Post-Petition Amounts Due.
The penalty for not maintaining accurate information can be severe. An association that seeks to recover debt that has been discharged in bankruptcy or that seeks to recover pre-petition debt (subject to limited exceptions) directly from an owner who is a debtor in an active bankruptcy case, may be liable for monetary damages and/or attorney’s fees for violating the “discharge injunction” or the “automatic stay” provisions of the Bankruptcy Code. See 11 USC §105(a), § 362(a), and §524(a).
At least one bankruptcy court’s written opinion has recognized the need for an association to maintain separate accounting records to differentiate the Pre-Petition Amounts Due from the Post-Petition Amounts Due. In the case of In re Moreno, 479 B.R. 553, 567 (Bankr. E.D. Cal. 2012), the court granted sanctions against an association for its attempt to collect amounts which had been discharged in bankruptcy. In that case, the court noted: “once the Debtor filed for bankruptcy protection, the Association should have started a new and separate accounting to properly track the post-petition debt that would be covered by §523(a)(16).” The court further noted that the association’s attempt “to divide the discharged [pre-petition] portion of the Debtor’s account from the post-petition portion of her account by simply drawing a line across the Accounting [on the date of the bankruptcy filing]” did not result in a proper determination of the post-petition amounts due as that caused post-petition interest to be improperly calculated on both the unpaid pre-petition debt (which was discharged) and the unpaid post-petition debt. 479 B.R. at 567-68.
An association that fails to either split its ledgers into a Pre-Petition Ledger and a Post-Petition Ledger or to take other steps to maintain separate accounting records to distinguish the Pre-Petition Amounts Due from the Post-Petition Amounts Due is likely to encounter greater difficulties in determining the amounts that are due from owners who file bankruptcy. Also, the failure to take the needed steps to maintain separate accounting records can result in an association being subject to sanctions from a bankruptcy court in the event the association seeks to collect amounts which are no longer recoverable.
ShuffieldLowman’s four downtown offices are located in Orlando, Tavares, DeLand and Daytona Beach. The firm is a 34 attorney, full service, business law firm, practicing in the areas of corporate law, estate planning, real estate and litigation. Specific areas include, tax law, securities, mergers and acquisitions, intellectual property, estate planning and probate, planning for families with closely held businesses, guardianship and elder law, tax controversy – Federal and State, non-profit organization law, banking and finance, land use and government law, commercial and civil litigation, fiduciary litigation, construction law, association law, bankruptcy and creditors’ rights, labor and employment, environmental law and mediation.