Another Runaway FBAR Case

 

Let’s talk about the FBAR (Report of Foreign Bank and Financial Accounts). It currently goes by the name “FinCen Form 114.”

This thing has been with us since 1970. It came to life as an effort to identify foreign financial transactions that might indicate money laundering or tax evasion. 

Sounds benign.

The filing requirement applies to a United States person, defined as

·      A citizen or resident of the U.S.

·      A domestic partnership

·      A domestic corporation

·      A domestic trust or estate

 We’ll come back that first one in a moment.

Next, one needs a financial interest or signature authority in a foreign financial account to trigger this thing.

A foreign financial account includes a bank account, which is easy enough to understand. It would also include a broker account (think Charles Schwab, but overseas). Some are not so intuitive, though.

·      A foreign insurance policy with cash value is reportable.

·      A foreign hedge fund is not.

·      A foreign annuity policy is reportable.

·      A foreign private equity fund is not.

·      A foreign cryptocurrency account is not reportable.

Some require a google search to understand what is being said.

·      A Canadian registered retirement savings plan is reportable.

·      A Mexican fondo para retiro is reportable.

Next, the foreign financial account has to exceed a certain dollar balance ($10,000) at some point during the year.

That $10,000 balance has been there for as long as I can remember. You will have a hard time persuading me that $10,000 in 1986 is the same as $10,000 now, but that number is apparently eternal and unchanging.

The $10,000 is tested across all foreign financial accounts. If it takes your fourth foreign account to put you over $10 grand, then you are over. Testing is done. All your accounts are reportable on a FBAR.

Like so many things, the FBAR started with reasonable intentions but has morphed into something near unrecognizable.

Fail to file an FBAR and the standard penalty is $10 grand. Fail to file for two years and the penalty is $20 grand. Have two foreign accounts and fail to file for two years and the penalty is $40 grand.

And that is assuming the error is unintentional. Do it on purpose and I presume they will execute you.

I exaggerate, of course. They will just bankrupt you.

It puts a lot of pressure on defining “on purpose.”

Let’s look at Osamu Kurotaki (OK).

OK was born in Japan and lives in Japan. He obtained a U.S. green card, making him a U.S. permanent resident. One of the pleasures of being a permanent resident is filing an annual tax return with the United States, irrespective of whether you live in the U.S. or not. One can talk about a foreign income exclusion or foreign tax credit – which is fine – but that annual filing makes sense only if someone intends to eventually return to the U.S. It does not make as much sense if someone does not intend to return, someone like OK.

OK paid someone to prepare his annual U.S. tax return. He found a CPA who was bilingual.

In 2021 the U.S. Treasury assessed civil penalties against OK for more than $10 million. His footfall? He failed to file FBARs. Treasury also upped the ante by saying that his failure was “willful.”

Huh?

Treasury is requesting summary judgement that OK willfully failed to file FBARs, prefers waffle over sugar cones and rooted for the Diamondbacks in the World Series. 

The Court wanted to know how Treasury climbed the ladder to get to that “willful” step.

So do I.

Here is what the Court saw:

·      OK is a Japanese speaker and does not speak English “at all.”

·      OK relied on his bilingual CPA to make sense of U.S. tax filing obligations.

·      His CPA provided annual tax questionnaires in both English and Japanese. The English was for theater, I suppose, as OK could not read English.

·      The CPA’s translation now becomes critical. Here are instructions to the FBAR in English:

U.S. taxpayers are required to report their worldwide income; that is, income from both U.S. and foreign sources.”

·      Here is the Japanese translation:

U.S. resident taxpayers are required to report their worldwide income, that is, income from both US. and foreign sources."

OK told the Court that he did not think he had a filing obligation because he was not a “U.S. resident.”

I get it. He lives in Japan. He works in Japan. His kids go to school in Japan. He is as much a “U.S. resident” as I am a Nepalese Sherpa.

Except …

OK was green card – that is, a “permanent” resident of the U.S.

Technically …

The Court cut OK some slack. Technically - and in a law school vacuum - he was a “resident.” Meanwhile - in the real world – no one would think that. Furthermore, OK hired a CPA who made a mistake. Even a trained professional erred interpreting the Treasury’s word salad. 

The Court said “no” to summary judgement.

Treasury will have to argue its $10 million-plus proposed penalty.

And I believe the Court just outlined reasonable cause.

Perhaps OK should consider turning in that green card. 

Our case this time was Osamu Kurotaki v United States, U.S. District Court, District of Hawaii.

 

IRS Wants Near $9 Million Penalty From A Holocaust Survivor

 

I’ll tell you what caught my eye:

This is a tax case in which the Government alleges that Defendant Walter Schik, a Holocaust survivor, failed to file a foreign bank account reporting form with the Internal Revenue Service …, which now seeks by this action to collect an almost nine-million-dollar civil penalty assessed against him for that failure.”

There are so many things wrong with that sentence.

Let’s talk about Form TD F 90-22.1, also known as the FBAR (“Eff- Bar”). The form existed before I took my first course in accounting years ago, but it has gathered steam and interest when Treasury started to chase overseas bank accounts during the aughts. If one has a foreign account, or has authority over a foreign account, which exceeds $10,000 during the taxable year, one is required to disclose on one’s individual income tax return (on Schedule B) and file Form TD F 9-22.1 with the Treasury.

Up to this point, it is just another form to file. We are drowning in forms, so what is the big deal?

The deal is the penalties for not filing the form. Let’s separate not filing the form because you did not know you had to file from knowing you had to file but deciding not to. That second one is considered “willful” (which makes sense) and can cost you a penalty from $100,000 to 50% of the account balance at the time of violation.

This is VERY expensive money.

The IRS assessed a penalty of almost $9 million against Schik for failure to file an FBAR.

Some background:

·      Mr Schik is a Holocaust survivor.

·      His education was cut short by, how shall we say this …, being in a concentration camp.

·      After the war, he immigrated to the U.S. and became a citizen.

·      After becoming a citizen, he opened a Swiss bank account where he deposited monies recovered from relatives who were slaughtered during the Holocaust.

·      He left the monies in Switzerland as he was fearful that another Holocaust-like event could occur.

·      Schik did not touch or manage the money. That was done by his son and a Swiss money manager.

·      Schik did talk with the money manager occasionally, though.

·      By 2017 one of those Swiss accounts had over $15 million.

·      His accountant never asked Schik if he had overseas bank accounts or explained the recently heightened IRS interest in the area.

I am sympathetic with the accountant. What are the odds of having a client who is a Holocaust survivor and having over $15 million in a Swiss bank account? One could go a career. I have.

The year at issue is 2007. There is a question on the individual tax return whether one has an interest or signature authority over a foreign bank account. Schik’s accountant answered it “No.” Schik did not correct his accountant. More fairly, Schik did not even notice the question.

Wouldn’t you know that Schik’s Swiss money manager got pulled into the UBS investigation?

UBS entered into a deferred prosecution arrangement with the United States. It however had to provide identities of U.S. citizens and residents who were customers of the bank.

At which point Schik submitted a voluntary disclosure to the IRS.

Which the IRS denied.

Without an alternative, Schik submitted a late FBAR.

The IRS then slapped the 50% penalty we are talking about.

Which brings us up to speed.

The penalty requires one’s behavior to be “willful.” Not surprisingly, the word has specific meaning under the law, and the Court evaluated whether Schik’s behavior was willful.

Treasury argued that “willful” means “objectively reckless.”

Got it. Ignoring an issue to an extreme degree is the same as knowing and not caring.

Schik argued that willful means “intentional disregard.”

The difference?

Schik argued that the underlying law was opaque, long-ignored and now quickly – if somewhat capriciously – conscripted into action. He no more intentionally disregarded his tax reporting obligations than he intentionally disregarded the newest developments in cosmological galaxy formation. There was no conspiracy by hundred-year-old Holocaust survivors: he just didn’t know.

And such is tax law. Nine million dollars hangs on the meaning of a word.

The Court noted that other courts – relying on records similar to those available to it - have found willfulness.

Not good for Schik. 

However, the Court was concerned about the many countervailing factors:

·      Schik was nearly 100 years old.

·      Schik had minimal formal education.

·      Schik did not manage the money.

·      Schik did not prepare his own tax returns.

·      Schik had no idea about a disclosure requirement.

·      Schik’s accountant did not explain the disclosure requirement.

·      The question answered “No” was pre-filled by the accountant’s software and did not represent any assertion made by Schik.

The Court denied the IRS summary judgement, noting there was a substantial question of fact.

I agree.

Who will review and clarify the facts?

“The Court believes that the Parties in this case would benefit from mediation. By separate order the Court will refer the Parties to the Southern District of New York’s Mediation Program. … the assigned District Judge … may determine that a case is appropriate for mediation and may order that case to mediation, with or without the consent of the parties.”

Methinks the IRS should just have allowed the voluntary disclosure.  

Was the IRS encouraging compliance, promoting education and providing a ramp to enter/reenter the tax system? Or is this something else, something with the purpose of terrifying the next person?

Our case this time was United States of America v Walter Schik, 20-cv-02211 (MKV)

Owing A Million Dollar Penalty

What caught my attention was the size of the penalty.

The story involves Letantia Russell, a dermatologist from California who has been in the professional literature way too much over too many years. The story started with her attorneys reorganizing her medical practice into a three-tiered structure and concealing ownership through use of nominees. Then there was the offshore bank account.

Let’s talk about that offshore account.

Back when I came out of school, one had to report foreign accounts above a certain dollar balance. The form was called the “TD 90-22.1.” I remember accountants who had never heard of it. It just wasn’t a thing.

The requirement hasn’t changed, but the times have.

If you have an overseas bank account, you are supposed to disclose it. The IRS has a question on Schedule B (where you report interest and dividends) whether you have a foreign bank account. If you answer yes, you are required to file that TD 90-22.1. The form does not go to the IRS; it instead goes to the Treasury Department. Mind you, the IRS is part of Treasury, but there are arcane rules about information sharing between government agencies and whatnot. Send to Treasury: good. Send to IRS: bad.

The rules were fairly straightforward: bank account, balance over $10 grand, own or able to sign on the account, required to file. There was no rocket science here.

Don’t play games with account types, either. A checking account is the same as a savings account which is the same as a money market and so on. Leave that hair-splitting stuff to the lawyers.

About a decade or so ago, the government decided to pursue people who were hiding money overseas. Think the traditional Swiss bank account, where the banker would risk jail rather than provide information on the ownership of an account. That Swiss quirk developed before the Second World War and was in response to the unstable Third Republic of France and Weimar government of Germany. Monies were moving fast and furious to Switzerland, and Swiss bankers made it a criminal offense to break a strict confidentiality requirement.

Thurston Howell III joked about it on Gilligan’s Island.

Travel forward to the aughts and the UBS scandal and the U.S. government was not laughing.

Swiss banks eventually agreed to disclose.

The IRS thundered that those who had … ahem, “underreported” … their foreign income in the past might want to clean-up their affairs.

The government dusted-off that old 90-22.1 and gave it a new name: FinCen 114 Report of Foreign Bank and Financial Accounts.

The IRS was still miffed about that government-agency-sharing thing, so it came up with its own form: Form 8938 Statement of Foreign Financial Assets.

So you had to report that bank account to Treasury on the FinCen and to the IRS on Form 8938.  Trust me, even the accountants were trying to understand that curveball.

Resistance is futile, roared the IRS.

Many practitioners, me included, believed then and now that the IRS went fishing with dynamite. The IRS seemed unwilling to distinguish someone who inherited his/her mom’s bank account in India from a gazillionaire hedge-fund manager who knew exactly what he/she was doing when hiding the money overseas.

And you always have … those people.

Letantia Russell is one of those people.

The penalties can hurt. Fail to fail by mistake and the penalty begins at $10,000. Willfully fail to file and the penalty can be the greater of

·      $100,000 or

·      ½ the balance in the account

Letantia dew a $1.2 million penalty on her 2006 tax return. I normally sympathize with the taxpayer, but I do not here. One has to be a taxpayer before we can have that conversation.

It went to District Court. It then went to Appeals, where her attorneys lobbed every possible objection, including the unfortunate trade of Jimmy Garappolo from the New England Patriots to the San Francisco 49ers.

It was to no avail. She gets to pay a penalty that would make a nice retirement account for many of us.

Talking Expatriation (And A Little Latin)

A friend contacted me recently. He was calling to discuss the tax issues of expatriating. As background, there are two types of expatriation. The first is renouncing citizenship, which he is not considering. The second is simply living outside the United States. One remains an American, but one lives elsewhere.

It is not as easy as it used to be. 

I have, for example, been quite critical of Treasury and IRS behavior when it comes to Americans with foreign bank accounts. If you or I moved overseas, one of the first things we would do is open a bank account. As soon as we did, we would immediately be subject to the same regime as the U.S. government applies to the uber-wealthy suspected of stashing money overseas.  

Some aspects of the regime include:

(1) Having to answer questions on your tax return about the existence of foreign accounts. By the way, lying is a criminal offense, although filing taxes is generally a civic matter.

(2) Having to complete a schedule to your tax return listing your foreign financial and other assets. Move here from a society that has communal family ownership of assets and you have a nightmare on your hands. What constitutes wealthy for purposes of this schedule? Let’s start at $50,000, the price of a (very) nice pickup truck.

(3) Having to file a separate report with the Department of Treasury should you have a foreign bank account with funds in excess of $10,000. The reporting also applies if it is not your account but you nonetheless have authority to sign: think about a foreign employer bank account. It should be fun when you explain to your foreign employer that you are required to provide information on their account to the IRS.

(4) Requiring foreign banks to both obtain and forward to the IRS information about your accounts. Technically the foreign banks have a choice, but fail to make the “correct” decision and the IRS will simply keep 30% of monies otherwise going to them.

To add further insult, all this reporting has some of the harshest penalties in the tax Code. Fail to file a given tax form, for example, and take a $10,000 automatic penalty. Fail to file that report with the Treasury Department and forfeit half of your account to the government.

Now, some of this might be palatable if the government limited its application solely to the bigwigs. You know the kind: owners of companies and hedge fund managers and inherited wealth. But they don’t. There cannot be ten thousand people in the country who have enough money overseas to justify this behavior, so one is left wondering why the need for overreach. It would be less intrusive (at least, to the rest of us 320 million Americans) to just audit these ten thousand people every year. There is precedence: the IRS already does this with the largest of the corporations.

Did you know that – if you fail to provide the above information – the IRS will deem your tax return to be “frivolous?” You will be lumped in there with tax protestors who believe that income tax is voluntary and, if not, it only applies to residents of the District of Columbia.

There is yet another penalty for filing a frivolous return: $5,000. That would be on top of all the other penalties, of course. It’s like a party.

Many practitioners, including me, believe this is one of the reasons why record numbers of Americans overseas are turning-in their citizenship. There are millions of American expats. Perhaps they were in the military or foreign service. Perhaps they travelled, studied, married a foreign national and remained overseas. Perhaps they are “accidental” Americans – born to an American parent but have never themselves been to the United States. Can you imagine them having a bank close their account, or perhaps having a bank refuse to open an account, because it would be too burdensome to provide endless reams of information to a never-sated IRS? Why wouldn’t the banks just ban Americans from opening an account? Unfortunately, that is what is happening.

So I am glad to see the IRS lose a case in this area.

The taxpayer timely filed his 2011 tax return. All parties agreed that he correctly reported his interest and dividend income. What he did not do was list every interest and dividend account in detail and answer the questions on Schedule B (that is, Interest and Dividends) Part III. He invoked his Fifth Amendment privilege against self-incrimination, and he wrote that answering those questions might lead to incriminating evidence against him.

Not good enough. The IRS assessed the penalty. The taxpayer in response requested a Collections Due Process Hearing.

Taxpayer said he had an issue: a valid Fifth Amendment claim. The IRS Appeals officer did not care and upheld the penalty.

Off to Tax Court they went.

And the Court reviewed what constitutes “frivolous” for purpose of the Section 6702 penalty:

(1) The document must purport to be a tax return.

(2) The return must either (i) omit enough information to prevent the IRS from judging it as substantially correct or (ii) it must clearly appear to be substantially incorrect.

(3) Taxpayer’s position must demonstrate a desire to impede IRS administration of the tax Code.

The first test is easy: taxpayer filed a return and intended it to be construed as a tax return.

On to the second.

Taxpayer failed to provide the name of only one payer. All parties agreed that the total was correct, however. The IRS argued that it needed this information so that it may defend the homeland, repair roads and bridges and present an entertaining Super Bowl halftime show. The Court asked one question: why? The IRS was unable to give a cogent reply, so the Court considered the return as filed to be substantially correct.

The IRS was feeling froggy on the third test. You see, the IRS had previously issued a Notice declaring that even mentioning the Fifth Amendment on a tax return was de facto evidence of frivolousness. Faciemus quod volumus [*], thundered the IRS. The return was frivolous.

The Court however went back and read that IRS notice. It brought to the IRS’ attention that it had not said that omitting some information for fear of self-incrimination was frivolous. Rather it had said that omitting “all” financial information was frivolous. You cannot file a return with zeros on every line, for example, and be taken seriously. That however is not what happened here.

The IRS could not make a blanket declaration about mentioning the Fifth Amendment because there was judicial precedence it had to observe.  Previous Courts had determined that a return was non-frivolous if the taxpayer had disclosed enough information (while simultaneously not disclosing so much as to incriminate himself/herself) to allow a Court to conclude that there was a reasonable risk of self-incrimination.

The Court pointed out the following:

(1) The taxpayer provided enough information to constitute an accurate return; and

(2) The taxpayer provided enough information (while holding back enough information) that the Court was able to conclude that he was concerned about filing an FBAR. The questions on Schedule B Part III could easily be cross-checked to an FBAR. Given that willful failure to file a complete and accurate FBAR is a crime, the Court concluded that the taxpayer had a reasonable risk of self-incrimination.

The Court dismissed the penalty.

The case is Youssefzadeh v Commissioner, for the at-home players.

I am of course curious why the taxpayer felt that disclosure would be self-incrimination. Why not just file a complete and accurate FBAR and be done with it? Fair enough, but that is not the issue. One would expect that an agency named the Internal “Revenue” Service would task itself with collecting revenue. In this instance, all revenue was correctly reported and collected. With that backdrop, why did the IRS pursue the matter? That is the issue that concerns me. 

[*] Latin for “we do what we want”

Beany Baby Billionaire Caught With Secret Swiss Bank Account

I cannot understand people who go to great lengths to underreport income. I am not talking about tax planning – perhaps even aggressive tax planning – to reduce one’s tax under the law. Some actions are so routine one may not even see them as tax planning, such as moving from a higher-tax state (say Ohio) to a lower-tax state (say Florida or Nevada). 

What I am talking about is flat-out tax evasion. We have now crossed a line. The Supreme Court has acknowledged that no one is under compulsion to pay more tax than necessary, but likewise all are under compulsion to pay the appropriate tax.

Enter Ty Warner. He was responsible for the “beanie babies” from the 1990s and is the 100% owner of TY Inc and other business interests. There must be a LOT of money in beanie babies, as Forbes has ranked him as the 209th wealthiest American, with a net worth estimated at $2.6 billion.

He opens a secret bank account with UBS in 1996. In 2002 he transfers over $93 million from there to another Swiss Bank. He obfuscates the ownership of the account by tagging it with the name “Molani Foundation.” The UBS account threw off $3.2 million in income for 2002.  This income is not reported to the accountants and is not included on his tax return. Mind you, he had already reported $49.1 million on his income tax return.

QUESTION: Is it possible to have so much income that one forgets some of his/her income?

You can pretty much guess that there was no FBAR filed. How could there be? There apparently was no "foreign" account, at least to Warner.

Fast forward the conversation and UBS gets dragged into the IRS and Justice Department hunt for secret Swiss bank accounts.

Oh, oh, Warner realizes the jig is up. He tries to enter the IRS Offshore Voluntary Disclosure Program, but he was denied entry. A likely reason is that the IRS had already identified him as owner of one or more unreported accounts.

Now he has a serious problem. Could there be tax fraud? I cannot say. I can say that I recall sitting across a conference table from a client who could not tell you (or me) if his tax return – showing $33 million in gross income – included all his income for the year. Is it possible that $3.2 million got lost in Warner’s reported income of $49.1 million? It is possible, but the other actions – like fudging the name of the Swiss account or not telling the accountants – look bad.

What Warner did run into face-first is the FBAR reporting. This is the filing for foreign accounts over $10 thousand. It is mailed separately from the tax return, and it is due July 1. For decades no one paid much attention to these reports, but in the aughts the IRS decided that there was money to be found. They began the crackdown on foreign bank accounts, starting with UBS - eventually ensnaring Ty Warner. The penalties for an FBAR are confiscatorily insane, as the government somehow justifies that they can take up to half of whatever is in the account. For multiple years. Reflect for a moment that the government is saying that – should they press beyond two years - they can take from you more than you have – or ever had – in the account.

This has nothing to do with the earnings from the account. For example, for 2002 Warner’s secret account generated approximately $3.2 million in income. Did the government want taxes on the $3.2 million, which would be about $1 million? Nope. Did they want all of that $3.2 million? Nope.

What they wanted was one-half of the highest balance in the account. What was that amount for Warner? Try $53.6 million.

Warner doesn’t pay taxes on $3.2 million. Let’s be generous and say that it was $3.2 million for several years. It now costs him $53.6 million to cash-out?

Set aside whether this is confiscatory. I cannot understand why Warner –or anyone - would even go there. Let’s be honest: would he even have noticed the taxes had he correctly reported the $3.2 million to begin with?