Tuesday, September 6, 2011

Burden of Proof for Willfulness in FBAR Violations (9/6/11)

A key issue in considering the FBAR willfulness penalty is the standard standard of proof if the Government pursues the FBAR penalty. The Government is required to pursue the FBAR penalty by filing a suit and, if successful, obtaining judgment, rather than through the panoply of collection devices for tax assessments.

In United States v. Williams, 2010 U.S. Dist. LEXIS 90794 (E.D. Va. 2010), previously discussed here, the court said that it was applying a preponderance of the evidence standard but it is clear that it held the Government to a fairly strict standard of proof. For burden of proof afficionados, I should state that historically in Anglo-American jurisprudence, a party alleging fraud must prove the fraud at a higher level than preponderance of the evidence. See generally Grogan v. Garner, 498 U.S. 279 (1991) (applying, however, preponderance of evidence for fraud exception to bankruptcy discharge because of the nature and context of that exception). For example, if the IRS asserts the civil fraud penalty under § 6663, the Code only says that the burden of proof is on the IRS (§ 7454(a)) but the Code is silent as to whether the burden is preponderance of the evidence or clear and convincing. But the law is clear that the IRS must prove fraud by clear and convincing evidence. See T.C. Rule 142(b); John Gamino, Tax Controversy Overburdened: A Critique of Heightened Standards of Proof, 59 Tax Law. 497, ___ n. 38 (2006) (“Tax Court Rule 142(b) echoes the statutory language but specifies the clear and convincing standard by which the government must carry its burden. While not technically controlling in other courts, Rule 142(b) is representative of the broadly prevailing rule.”). The clear and convincing burden is conceptualized as heavier than preponderance (the normal civil burden) and lighter than beyond a reasonable doubt (the criminal burden).
The term “willfulness” in the FBAR statute has the same meaning as willfulness in the criminal tax statutes and the civil fraud penalty. For that reason, the IRS itself has recognized that it would expect courts to apply a “clear and convincing” standard. See ILM 200603026 (1/20/06) (“Because the FBAR penalty is not a tax or a tax penalty, the presumption of correctness with respect to tax assessments would not apply to an FBAR penalty assessment for a willful violation – another reason we believe that the Service will need to meet the higher standard of clear and convincing evidence.”)

It is not clear why the Court in Williams said it was applying the lesser preponderance standard; since it held for the taxpayer, the application of the lesser preponderance of evidence standard did not affect the outcome. When I say that it is not clear in Williams why the court did applied the preponderance of the evidence standard of proof, the court offered no explanation; I understand from counsel for Williams that the issue was not briefed, perhaps because the preponderance of the evidence was all that was needed for the defendant to win.

What this means in the current context of the offshore voluntary disclosure initiatives, as Williams presages, is that the Government may have considerable resistance from the Courts in pursuing those who either did not join the voluntary compliance programs or who opt out.  The systemic resources will be burdened by pursuing the willfulness penalty in many cases and the Government may choose to throttle back on this use of its limited resources rather than risk losing many cases which will damage its tax enforcement priorities.  Perhaps the Government will choose to pursue only the relative few, very good cases, to make its point with some victories in the cases which it should win all along.  This means that many might avoid even the assertion of the willfulness penalty.

23 comments:

  1. That is how the Sopranos operate. Make an example of a bad payer by breaking his legs. Then when the others see, they will be afraid and make their payments.

    But what is this over? It is not like there is a real underlying crime involved. It is a question of informing the US government what offshore accounts that you have. I would argue that such information is protected by the Constitution and that they actually don't have a right to it.

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  2. Jack,
    How would this relate to non-wilful penalty assertion. Would govt need to file suit and possibly face resistance from Courts for that? Or could they assert npon-wilful penalties more easily. The max non-wilful penalty applied on a per account per year basis itself can be huge.

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  3. My understanding is that, for any FBAR penalty, the Government's only enforcement mechanism is to file suit, obtain judgment and then use collection mechanisms for the judgment.

    Now, if the nonwillful penalty is the issue in the suit, the Government should still have the burden of proof by a preponderance of the evidence. The reasonable cause defense will have to be asserted by the defendant (the taxpayer in tax parlance) and the defendant will bear the burden of persuasion -- more likely than not that the reasonable cause defense is valid. So, the Government's assertion of nonwillful penalties will be lighter, but Williams tells us that the Government cannot rely upon busy and inattentive courts to salute garbage when it serves up garbage.

    Moving from the particular to the systemic, I hope that you can see the mess that mass enforcement of FBAR penalties will create -- and it is not just a burden of proof issue. It is that allocation of systemic resources to filing the suit, proving the case, obtaining judgment, collection on the judgment that will create a nightmare in the process if the Government really wants mass enforcement of FBAR penalties.

    Of course, those taxpayers who surrender on the first volley (think of the Government's first offer of OVDI as the first volley) without opting out, the Government has the audit substantially served up by the taxpayer and wraps everything into the system of tax, penalties and interest (including the in lieu of penalty) which the taxpayer admits and the Government can use all its tax collection mechanisms to pry out the agreed upon costs.

    Unfortunately, the fear generated by the IRS's program really seems targeted to the really little guy upon whom systemic resources should not be expended and, to wrap in a related theme, the taxpayers who really benefit from the program and not these small guys from whom money is extorted by fear but the really bad actors with large amounts oversears, trusts, entities such as foundations, etc. The Government really created a program for the big-time tax cheats and just ensnared the minnows who have suffered great angst and dollar loss that they should not incur. My opinion.

    Jack Townsend

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  4. Jack

    My recollection is that the Williams case (which you blogged on before) was particularly egregious, in that the government knew of his foreign accounts, and he knew that they knew, so willfulness would be hard to prove.

    For a non-willful penalty, its hard to say what what exactly 'reasonable cause' means. I would think that anyone who ticked the Schedule B question incorrectly would have a hard time asserting reasonable cause. (In Williams case, that was held to be not sufficient, but his was an unusual case). And unfortunately, the costs of defending oneself in court could also be a hassle and expense for small defendants. Especially for someone who has an immigration matter pending too.

    The other thought is about audits -- can the IRS audit just FBARs ? If so, are normal audit protections available given that FBARs are not tax forms ?

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  5. To Anonymous @ September 7, 2011 3:01 PM

    True, the Government knew, but I don't believe that willfulness (intent to violate a known legal duty) is vitiated simply because the Government may have known about the account.

    In order for the Government to use the Schedule B answer of no regarding foreign accounts to establish willfulness for the FBAR, I think the Government would have to prove that, in providing the answer, the taxpayer acted willfully. If he or she did not act willfully in answer the question no, I can't see how the answer could them be used to support a finding of willfulness with respect to the FBAR (either for the criminal FBAR penalty or the civil FBAR penalty).

    Now, for the lesser FBAR penalty, I agree that answering the question no -- at least if the Government proves the act was volitional even if not willful (I think there may be a smidgen difference between the two) -- the Government would have a rebuttal to claims of reasonable cause.

    Jack Townsend

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  6. "...the mess that mass enforcement of FBAR penalties will create -- and it is not just a burden of proof issue. It is that allocation of systemic resources to filing the suit, proving the case, obtaining judgment, collection on the judgment that will create a nightmare in the process if the Government really wants mass enforcement of FBAR penalties."

    Spot on. And here we see the motivation behind FATCA's new Form 8938. This form largely duplicates the FBAR, and it's hard at first to see its usefulness. But crucially, it is a tax form. That means the IRS can collect penalties on it using their normal methods (wage garnishment, liens, etc) as an end-run around their current difficulties with FBAR penalty enforcement and the burden of proof issues that come with it.

    Although a few years late, 1984 has now truly arrived in the US.

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  7. Jack,
    Your opinion comments dated September 7, 2011 2:29 PM are right on the money!!

    I hope that somewhere in the OVDI process, some small offender has the balls (and resources from an immigrant association for example) to take on the IRS in court, on principle, and that you can represent them and win!! This is such an egregious use of fear which so disproportionally impacts the small guy, when the target of the program was elsewhere. Why no media has been willing to pick up this story and write about it amazes me. I guess it is easier for the NYTs of this world, to write pieces about Swiss Bank enforcement, but they would really have to work to understand the small fry impact of the OVDI. It probably doesn't sell newspapers.

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  8. Jack,
    Many thanks for this blog and your response to my post of 11:42am.

    Your blog has been a great aid during this OVDI process and I want to express my sincere thanks and tons of well wishes to you for this.

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  9. I have a comment on the Schedule B question.

    Taxpayers that used the most common tax software and e-filed may never even have answered this question.

    1) They may have skipped over an interview page that included the question "do you have foreign interest (this is not common)" among a bunch of other “not common” questions. They may not have paid enough attention to this because of the wording. Note that this interview question is not the same as the more elaborate question on Schedule B, and could easily have led some people astray (me for one).

    2) They may have chosen to enter their income by choosing specific topics, in which case they wouldn’t even have seen this interview page (the foreign income question is bundled with OID and other “non-common” income).

    Only in 2009 did the most popular tax software update itself to prevent the user from proceeding before he/she answers the question on foreign accounts.

    Moreover, e-filing means that these forms are never printed - and user can be blissfully unaware of even the names of the Schedules being sent. I am not sure how many people print their e-filed returns and go over each line of 1040 and schedules to verify all the answers during the software interview.

    E-filing, which simplified life for taxpayers and the tax collectors and which is so encouraged by IRS now could easily have let taxpayers answer wrongly or not answer this question at all (used a default answer of “no”).

    Tax software and e-filing make tax filing deceptively simple. You can be lulled into thinking that you are a software user instead of a taxpayer. You can be lulled into thinking that using software eliminates errors (it is only true for math errors). There is no doubt that ultimately the filer is responsible – but to treat this is a threshold for a crime is unfair.

    To all those judging on this board – I would appeal to try to understand that each taxpayer has a distinct background and circumstances. Each filer that got this question inadvertently wrong may have their own less-than-evil reasons for doing so. It is not automatically a crime to check the wrong box.

    God bless.

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  10. "It is not automatically a crime to check the wrong box."
    It is Kafkaesque that anyone should go to prison or pay exorbitant fines (like 1/2 of their personal wealth) for failure to properly check a box on a tax form. First it assumes that everyone must know the law because "ignorance of the law is no excuse". Yet even the experts find the tax code impossibly complicated. Ignorance is damned good excuse when dealing with laws that are unjustly complex and impossible to comply with 100% accuracy partly because so much depends on the interpretation of courts. Second, it seems a minor infraction, not up there with actual real crimes, to fill out a form incorrectly. What next? Are there going to be fines for failure to cross t's or dot i's?

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  11. where are the politicians and bloggers and business experts to help us on this fbar penalties.

    ok to pay taxes, penalties, lawyers but not this enormous fbar which i did notknow it existed.

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  12. Re: Kafkaesque
    This is how economics incentives start. Given a choice between losing 1/2 of one's money or breaking an esoteric law, most would choose to break the law.

    The US Govt is setting up a monstrous incentive here for offshore funds, secrecy, etc. The alternative of not hiding one's money is losing half of it.

    Rather than "getting in line" and paying 1/2 of one's money, most would work overtime to find a solution.

    I would not be surprised if the best and brightest legal, accounting and economic minds have not started work on this. The incentive is huge: 1/2 of all offshore bank accounts.

    And if a legal solution can be found, or invented, or legislated, how valuable would that be?

    This is why I say the IRS/DOJ/Congress are not looking at this as a economics situation involving real life players.

    They might be setting up a situation where even more people are driven offshore (or abroad), rather than their intent of closing offshore accounts, and bringing tax money back.

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  13. M:
    absolutely correct. It has other effects; to name a few: (1) drive US created wealth offshore forever; (2) drive foreign wealth invested in the US away forever; (3) isolate the US from international trade partners; (4) keep talented foreigners from wanting set up shop in the US; (5) keep US companies from being able to have foreign branches and trade missions.

    No longer American since I renounced my citizenship, I was born in the US; but here are some things that I will never ever do again: (1) buy real estate in the US; (2) buy stock in US-based company; (3) vacation in the US except at the insistence of my family members who are still in the US; (4) attend professional conferences in the US unless asked to by a publisher; (5) bank in a bank which has assets in the US (as a result of FATCA.

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  14. As long as I can remember (certainly since 2004-2005) Turbo Tax has asked you the Schedule B question pretty prominently (I recollect it being on a page on its own). The wording, as I recollect, is similar to the actual Schedule B question. I don't even know if its possible to skip it in the interview (if you are required to fill Schedule B at all). Maybe you could miss it if you skipped around the interview to the actual forms pages (in which case you should have looked at the forms and are presumably an expert).

    If you have a PoA on a relative's account or a life insurance policy with a cash balance, you might not realize that is a financial account.


    But a plain term deposit or bank account ? Unlikely, but maybe one could miss the question for 1-2 years. But missing the question on tax software for many years in a row ? Not very likely. In fact, very unlikely (again assuming that a Schedule B was filled out at all). The 'Geithner' defense is pretty weak. In fact, IMHO anyone using tax software has less of an excuse for not ticking the question correctly. (although I can buy not reading the forms if they were e-filed).

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  15. Anon @ September 10, 2011 10:15 AM

    “As long as I can remember (certainly since 2004-2005) Turbo Tax has asked you the Schedule B question pretty prominently (I recollect it being on a page on its own). The wording, as I recollect, is similar to the actual Schedule B question. I don't even know if its possible to skip it in the interview (if you are required to fill Schedule B at all).”

    Wrong. Don't remember or recollect. If you have the software - go thru the interview again. I did this for all 8 previous tax years. The wording is not even close to the Schedule B question. I quote these below.

    Actual Schedule B question:
    7 a. At any time during 2003, did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account? See instructions for exceptions and filing requirements for Form TD F 90-22-1

    Actual Software Interview question (3rd of 3 questions on other investment page):
    Did you have an interest in a foreign account or receive a distribution from a foreign trust? (This is not common)

    No is selected by default in software. Like I said before, you can completely skip over the "OID" section or “Other Investment Income” section and not encounter even this "foreign" question. To amend returns, I actually had to search for the foreign question, because it is clubbed with some other "uncommon income". Only in 2009, did it have a page of its own (in addition to the question) and did not let you proceed without checking one of the boxes (no points for guessing why it changed in 2009).

    You do this interview 8 times in 8 years. If you believed that you had got it right the previous year, why would you anything different the next year and the next year and the next? Transfer information from previous year, download W2/1099, E-File. There is over-simplification in the filing and over-zealous interpretation of it. Software interview has not been so perfect that people with wrong answers can be automatically put in jail.

    >> The 'Geithner' defense is pretty weak. In fact, IMHO anyone using tax software

    Having an opinion is oh-so-easy. People neither have the time nor the means to vet material presented to them. This is why governments, PR firms, big business can sway public opinion at will. To really understand a behavior you have to be in that person's shoes – have their background, their education, their language, their experiences and circumstances. This is why “don't judge”/”you don't know me” have become righteous cliches in popular culture.

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  16. I glanced at the interview for TT 2010,2009 and 2008 and the explanatory note (to be fair, I had to click on the explanation separately) seems to match the Schedule B question closely. Sorry, I don't have older versions installed or any inclination or reasons to search for them although I have no doubt that searching for older TurboTax CDs has become a cottage industry.

    'You do this interview 8 times in 8 years. If you believed that you had got it right the previous year, why would you anything different the next year and the next year and the next'

    The interview is something you do only once a year, maybe twice at most if you amend. Most people are not likely to remember the interview from last year, so its starting afresh each year. Besides my recollection is that the interview format does indeed change somewhat from year to year, so its not a matter of mechanically repeating something done several times a month. Turbo Tax also asks about foreign tax credits in general.


    A reasonably sophisticated taxpayer could indeed miss all foreign income on any foreign accounts for 8 years, and miss the question every time 8 years in a row if using tax software. But that seems a little thin to me for non immigrant taxpayers with a reasonable level of income and education. I didn't buy Geithner's explanation either ...

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  17. Anonymous @September 10, 2011 8:03 PM

    I am not sure that you are contradicting anything I say, but I agree that once you know to click the right buttons, things will fall in place.

    There are US citizens abroad that didn't know they had to file tax returns every year. There are residents in US who didn't know that they have to include WW income on their returns. The overwhelming majority follow the rules they know exist. Just read this blog to get a non-scientific poll of how many people thought they were compliant till the ground below caved.

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  18. 'There are US citizens abroad that didn't know they had to file tax returns every year'

    I fully sympathize with those people, since the US is very anomalous in this case, taxing income even when abroad.

    'There are residents in US who didn't know that they have to include WW income on their returns'

    I agree, and I sympathize with many (including recent immigrants) who fall into that category.

    However, I was just saying that for a financially sophisticated taxpayer, to miss the Schedule B question and reporting of WW income on tax software not once, no twice, but for 8 years -- well, I'd be skeptical of that. [ Assuming that person had to fill Schedule B]

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  19. "However, I was just saying that for a financially sophisticated taxpayer, to miss the Schedule B question".

    Who exactly is financially sophisticated? Who says that US citizens abroad and recent immigrants are not financially sophisticated, but longer term residents are? There are numerous posts here and other blogs that their CPAs and tax preparers didn't know how to handle foreign income. This is also my recent experience in talking to a few “tax experts”. Why then, is the automatic expectation on someone who came in say 8 years ago.

    Knowledge is the key. If you knew about global income, even the poorly phrased interview question would trigger the right response. If you knew about global income, you would search out the section when you would enter it and do. If you didn’t know about it - well then you are screwed.

    From my perspective (as I previously tried to explain), you can miss this several times if you can miss it once. I quoted the difference between actual SB question and interview question. I pointed out that if you have the knowledge that you would click the right buttons (and conversely that if you don’t have the knowledge that you wouldn’t click the right buttons).

    If you really want to understand this, please work the software (all years) using previously mentioned methods (import prior year, selectively enter/download income and efile, perhaps suspending your current knowledge). If you don't have the time/inclination as you have suggested earlier, it is hard to take your conclusion seriously. You are suggesting that small fry knowingly and intentionally risked jail time and their full net worth to evade miniscule tax.

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  20. 'If you really want to understand this, please work the software (all years) using previously mentioned methods (import prior year, perhaps suspending your current knowledge). If you don't have the time/inclination as you have selectively enter/download income and efile, suggested earlier, it is hard to take your conclusion seriously. You are suggesting that small fry knowingly and intentionally risked jail time and their full net worth to evade miniscule tax.'

    I don't have the time, motivation or software to do all that (and it would be impossible to suspend current knowledge), although I have no doubt that a number of people have been trying that for the past few months.

    I will grant that few people realized how draconian FBAR penalties could be (relative to tax penalties), otherwise I'm sure there would have been far more compliance. In any case, I wasn't really alleging willfulness so much as a dismissal of 'reasonable cause' for the Geithner defense.

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  21. This is what I said earlier in my posts. People don't have the time or means required to understand, but must form opinions anyway.

    You try to brand this "the Geithner defense" although his case is unrelated to SB-Part III question. Likening a small fry’s case to Geithner’s is a hard sell at best.

    According the current implementation reasonable cause is not even related to the SB-Part III (or how many times you got it wrong). Reasonable cause is allowed if and only if global income is reported. It’s ironic because SB-Part III is not related to income or tax. It is related only to existence of assets (interest in or signature authority over). If you didn’t know about global income, you can be screwed over (literally) a few dollars.

    What is just plain English “reasonable cause”. People who have followed all the rules they knew are in trouble now. How much warning did the system give these people before delivering extreme punishment? Were immigrants alerted to this requirement on arrival? Did IRS force foreign banks to issue 1099-INT to US residents? Did a clearing house send a note to people who legally transfer funds abroad? You can fall off a veritable cliff-with-no-sign here.

    I move in circles where there still is wide spread ignorance of FBARs and foreign income. It would be a tragedy if IRS cannot distinguish between them and say someone who uses entities to evade tax.

    Finally, I am not arguing for a reasonable cause because of software. Even in non-foreign-income cases, tax payer is liable for all mistakes regardless of source. My point and I quote my previous post: “Each filer that got this question inadvertently wrong may have their own less-than-evil reasons for doing so. It is not automatically a crime to check the wrong box.”

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  22. I am stuck between a rock and a hard place. I have invested all my US earnings in my home country
    since i am not sure if i would get the Green Card.
    I bought a house with close to 50% down payment and i plan to pay off it soon. If i do a disclosure now i am pretty much screwed and if i do not i cannot sleep well.
    My FBAR penalties would be steep and i cannot pay. My tax dues would be very negligible.

    The only option seems to be for me to strip my equity in the home and leave in the next year or so.

    A friend of mine says and i totally agree
    "In America you should always have debt and no equity in anything if you are an immigrant. Keep all your money out so that when such laws comes to effect pack your bag and leave.
    BTW my friend can sleep well and unfortunately
    i cannot after coming to know of this crap

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  23. How can you strip equity from home ? If you take home equityu loans or something, then that loan is still due. It would not be a good idea to take out money from your house with no intention of repaying it, that may be considered mortgage fraud.

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