Taking Tax Advice From Friends

 

I received a text message one night this past week.

I was researching living trusts on the internet. It sounds like it might work for my situation.

I had two immediate reactions:

First, excellent. I am a fan of doing your own research and understanding what an expert is recommending.

Second - and maybe more important – use the expert.

The problem with DIY tax research is that you may not know what you do not know. Granted, in many cases it might not matter as much (hey, can I deduct the mileage for my gig income?), but in other cases it might matter a lot.

Let’s talk about the Horowitz case from 2019.

Peter Horowitz was an anesthesiologist. Susan Horowitz was a PhD working as a public health analyst for the U.S. Department of Health of Human Services.

In 1984 they moved to Saudi Arabia. They lived mostly on Susan’s income while banking most of Peter’s salary.

They used U.S.-based accountants, so they knew to (and filed) federal taxes on their Saudi earnings.

One thing about a bank account in Saudi Arabia: it does not pay interest. After a couple of years, the Horowitzes got tired of that and opened a Swiss bank account. They were also concerned about untangling the Saudi account when the Saudi gig played out.

Makes sense.

The Horowitzes did not tell the U.S accountants about the Swiss account. This meant that they did not report the interest income nor did they report the existence of the foreign account to the Treasury or IRS.

Why?

Their friends in Saudi Arabia told them that they did not have to pay U.S. tax on interest earned on the Swiss account.

In 2001 they moved back to the U.S. That Swiss account had grown to $1.6 million. Peter called the bank every year or two to keep an eye on the account.

COMMENT:  I would too.

Fast forward to 2008, the year that UBS got in trouble with the (non)reporting on Swiss bank accounts. UBS notified the Horowitzes that they would be closing the account. Peter traveled to Switzerland and moved the funds to another bank. Susan travelled the next year to add her name to that account.

Peter opened a “numbered” account, which meant that a number rather than a name identified the account. He also requested the new bank to not send correspondence (termed “hold mail” - something the IRS did not like).

Why?

The bank explained:

… these services allowed U.S. citizens to eliminate the paper trail associated with undeclared assets and income they held … in Switzerland.”

This is going downhill.

In 2009 Peter started reading about IRS enforcement on foreign bank accounts. He and Susan decided to consult a tax attorney.

The Swiss account was now worth nearly $2 million.

They learned that they were supposed to – all along – have been reporting that account.

 In 2010 they closed the Swiss account, repatriated the funds and applied for a voluntary Treasury disclosure program.

Good idea.

They filed amended returns for the interest income, as well as filing FBARs disclosing the existence of the foreign account.

The interest income was not inconsequential: they sent the IRS more than $100 grand in back taxes.

Got it. It was going to hurt, so they might as well rip the band-aid.

In 2012 they opted out of the voluntary disclosure program (OVDP).

COMMENT:  The default ODVP penalty was 27.5%. I suspect - but do not know for certain - that they were hoping for a better penalty result during the audit process. Considering the Swiss account had neared $2 million, the penalty alone would have been around a half-million dollars.

In 2014 the IRS sent notices. The Horowitzes, their accountants and the IRS conferred but failed to reach an agreement.

The penalties now became an issue. The base FBAR penalty is $10 grand per instance. The IRS however saw the Horowitzes behavior as willful, meaning they wanted enhanced penalties. To muddy the waters further, the law had changed. What used to be a maximum $100 grand penalty was now the greater of $100 grand or 50% of the account.

COMMENT: You may also know the FBAR by its current name: FinCEN Form 114.

The Horowitzes protested. Their behavior was not willful, and - even if it was - the old penalty (maxed at $100 grand) should apply.

The Court was short on the willfulness issue.

The court acknowledged that the couple ‘insis[ed] that neither of them had actual knowledge on the FBAR requirement.’ But, relying on United States v. Williams …., it reasoned that willfulness in the civil context ‘covered not only knowing violations… but reckless ones as well’.”

In particular, the court pointed to the fact that the tax returns signed by the Horowitzes ‘included a question of whether they had foreign bank accounts, followed by a cross-reference’ to the FBAR filing requirement. It also found significant that, by their own account, the Horowitzes had ‘discussed their tax liabilities for their foreign accounts with their friends’ but failed to ‘have the same conversation with the accountants they entrusted with their taxes for years’.”

The Horowitzes appealed.

They argued that they messed up, but that mistake was not willful. The enhanced penalties should not apply.

The IRS countered: “willfulness” in this context includes recklessness, which standard was met by:    

The Horowitzes never asking their tax preparer whether they had to report the Swiss bank accounts,

The Horowitzes asking their friends about international tax matters demonstrated their awareness of potential issues,

The Horowitzes knew to report their Saudi earnings and U.S.-based interest income from domestic banks, and

The Horowitzes signed their tax returns without reviewing them with any care.

Here is the Court:

… their only explanation for not disclosing foreign interest income related to some unspecified conversations they had with friends in Saudi Arabia in the late 1980s. Yet, if the question of whether they had to pay taxes on foreign interest income was significant enough to discuss with their friends, they were reckless in failing to discuss the same question with their accountant at any point over the next 20 years.”

Taking all of these circumstances together, the record indisputably establishes not only that the Horowitzes ‘clearly ought to have known’ that they were failing to satisfy their obligation to disclose their Swiss accounts, but also that they were in a ‘position to find out for certain very easily’.”

How much are we talking about across the years?

Including interest and penalties, it was close to $1 million.

Our case this time was Horowitz v US, No. 19-1280 (4^th Cir. 2020)

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?