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)

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)