37.Example 1: Taxpayer has 2 foreign accounts that are income tax noncompliant - FAC1 at FB1 and FAC2 at FB1. In 2009, the Taxpayer deposits $100,000 into FAC1 and, one day later pursuant to instructions at the bank upon the deposit, the bank transfers the $100,000 to FAC2 at the same bank, FB1. FAC1 earns $-0- interest on the temporary deposit of $100,000 (the banks rules require that a deposit stay for 7 days before interest is earned) and FAC2 earns $5,000 interest on the longer-term deposit of $100,000. (Note FAC1 is income tax noncompliant because of other deposits.) According to FAQ 37, in calculating the OVDI/P miscellaneous / in lieu of penalty base (inside penalty without opt out, which I hereafter call the miscellaneous penalty), the "duplication" is eliminated. The way I have done that in the past is to eliminate the duplication amount in FAC1, the temporary account, and include it in FAC2. Either way, of course, since both accounts are noncompliant, the elimination of the duplication has the same effect on the aggregate penalty base for the year. But it is logical to exclude it from FAC1 because there is no income tax noncompliance with respect to the $100,000.
Q. If a taxpayer transferred funds from one unreported foreign account to another during the voluntary disclosure period, will he have to pay a 27.5 percent offshore penalty on both accounts?
A. No. If the taxpayer can establish that funds were transferred from one account to another, any duplication will be removed before calculating the 27.5 percent penalty. However, the burden will be on the taxpayer to establish the extent of the duplication.
Example 2: Same Example except that FAC2 is at a different bank, FB2. The result is the same. Again, the bottom line effect on the penalty base for the year is the same whether the elimination of the duplication occurs in FAC1 or FAC2.
Example 3: Same Example except FAC2 (the destination account) is income tax compliant. In this case, there is no duplication. Is the temporary deposit in FAC1 included in the miscellaneous penalty base? Technically, this situation does not fit FAQ 37.
Example 4: Same as Examples 1 and 2 except that, rather than transferring the temporary deposit in FAC1 to another account, it is transferred out of FAC1 to purchase noncompliant real estate that produces the same amount of income for the year -- i.e., $5,000 rental income (just as in the earlier examples FAC2 had produced $5,000 of interest income). Reading Example 37 literally, it does not eliminate the duplication because the destination asset is real estate rather than an account. Note in this regard that, for the miscellaneous penalty calculation, the real estate is included since it is noncompliant (just as noncompliant accounts are included). The key difference between the two is that a transfer to another foreign account (an FBAR reportable asset) gets a penalty base reduction to eliminate the duplication whereas a transfer into real estate (a non-FBAR reportable asset) gets no penalty base reduction to eliminate the duplication. (It is reported in a Linked-In practitioner discussion that the IRS is taking the position that double counting is required because the foreign real estate is not an account.)
Example 5: Taxpayer has 1 foreign account - FAC1 at FB1. Taxpayer also has noncompliant real estate worth $100,000. On this fact alone and if nothing else happened during the year, both the real estate and the amount in the account would be included in the penalty base for the year; there is no duplication. During the year Taxpayer sells the foreign real estate for $100,000 and deposits the money in FAC1 for a day and transfers it to his parents as a gift for them to buy a home. Does the taxpayer then have to duplicate the same $100,000 "asset" -- the enhanced temporary $100,000 in FAC1 and the noncompliant real estate -- in the miscellaneous penalty base? [Note I earlier erroneously inserted FAC2 as the account into which the sales proceeds were deposited; thanks to Asher Rubinstein for pointing this out; see his comments below; note that since Example 6 incorporates these facts, this change affects it as well.]
Example 6: Same as Example 5 except that the real estate is compliant and thus not included in the miscellaneous penalty base? Keep in mind that not a cent of interest is earned on the one day deposit. But, since the real estate is compliant, including the temporary deposit in the miscellaneous penalty base will not be a duplication.
Example 7: Same as Example 6 (real estate is compliant), the real estate having a net value of $100,000 is worth $200,000 with a mortgage of $100,000. Upon sale of the real estate, the taxpayer takes his $100,000 equity and redeploys it into another compliant real estate investment and deposits the $100,000 for the mortgage payment into FAC1 account with instructions to the bank to pay the mortgage holder immediately, which the bank does the next day, so the taxpayer has a $100,000 spike in his account. Is the $100,000 included in the miscellaneous penalty base? (In fact, I can report that the IRS technical advisers have allowed the elimination of $100,000 in this case.)
Example 8: Same as Example 7 except the real estate is noncompliant. Will there be an elimination of the duplication? (I think the IRS under the concept applied by the technical advisers to eliminate the duplication in Example 7, it would be eliminated in Example 8 as well.)
1. Do these results seem right and logically consistent? Notice particularly the apparent result of treating noncompliant FBAR reportable accounts better than compliant FBAR reportable accounts and nonFBAR reportable noncompliant and even compliant foreign assets. This is just, to me, illogical.
2. Can Example 7 (and Example 8) be reconciled with the other results?
3. Would it make any difference if the in-and-out in FAC1 occurred the same day rather than being delayed a day by FB1?
4. What if the bank statements show only day-closing balance so that a same day in and out would not be reflected on the balance (either for the day or for the month)? If the taxpayer must report the high balance and knows that there was an in-and-out which is not reported on the day-close balance, can the taxpayer use the day-close balance to report the high balance for the month? Is the taxpayer whose foreign account statements only show day-close balances (or use such balances for high monthly balance) benefited whereas the taxpayer whose foreign account statements show real high balances during the month screwed? Why?
While I have no personal information about specific instances, it is reported to me that in anecdotal cases, the IRS has eliminated temporary deposits, whether the source or destination of those temporary deposits were compliant or noncompliant and then require inclusion in the miscellaneous base based upon the compliance of the source or destination accounts or assets. The IRS technical people deny that such eliminations are authorized (I don't think they can state that they did not occur, just that they were not authorized if they did). However, the IRS technical person with whom I discussed the problem did admit that they authorized the elimination in Examples 7 and/or 8.
I would appreciate hearing results from readers -- either anonymously or for attribution. Keep in mind that readers can post anonymous comments. Also readers can send me an email at email@example.com; I would appreciate readers sending emails to state whether I am authorized to disclose their identities and information or just the information without disclosing the identifies.