The Pitfalls of Streamlined Foreign Account Disclosures

Background of the Offshore Disclosure Programs

The Bank Secrecy Act of 1970 requires U.S. taxpayers to maintain foreign bank account records and report foreign accounts annually on Schedule B of Form 1040. In addition, taxpayers are required to report foreign financial accounts with an aggregate value exceeding $10,000 at any time during the calendar year on FinCen Form 114 (or FBAR, formerly TDF 90-22.1).

In her keynote address at the American Bar Association’s 27th Annual Philadelphia Tax Conference last November, then–Principal Deputy Assistant Attorney General Caroline D. Ciraolo noted that since 2008, the Department of Justice (DOJ), working with IRS Criminal Investigation, has charged more than 160 U.S. account holders with tax evasion and willful failure to report foreign accounts and more than 50 individuals who assisted in the criminal conduct (http://bit.ly/2qoSIZy). Under the OVDP, the first of which was announced in 2009, more than 55,000 taxpayers have come into compliance and paid close to $10 billion in tax, interest, and penalties. Ciraolo also noted that the filing of FBARs has increased from 332,000 reports for 2007 to more than 1 million reports for 2015.

Under the current OVDP, taxpayers are required to file eight years of amended tax returns and delinquent FBARs. In addition to tax, interest, and penalties on the tax due, there is a miscellaneous penalty of 27.5% of the highest aggregate balance in the unreported foreign accounts in that eight-year period. If any of the banks at issue in the voluntary disclosure are on the IRS’s frequently updated list of Foreign Financial Institutions or Facilitators (http://bit.ly/2qkXhpV), the miscellaneous penalty is increased to 50%. In exchange for taxpayers paying these penalties and providing truthful and complete information, the DOJ agrees not to criminally prosecute taxpayers for their years of tax noncompliance and evasion.

Streamlined Filing Compliance Procedures

In 2012, the IRS announced streamlined procedures for individuals residing outside of the United States; in 2014, the streamlined procedures were extended to taxpayers residing in the United States. Under the streamlined procedures, taxpayers are required to file three years of amended tax returns and six years of delinquent FBARs. No miscellaneous penalty is applied to eligible nonresident taxpayers, while resident taxpayers pay a 5% miscellaneous penalty. Unlike the OVDP, however, taxpayers who use the streamlined procedures do not receive protection from criminal prosecution, nor is there a pre-clearance procedure available through which the taxpayers can determine if their disclosure is timely. As of January 2016, taxpayers using these procedures must submit “a narrative of specific facts which led to the failure to timely report all income, pay all tax and submit all required information,” including FBARs. Taxpayers must certify, under penalties of perjury, that the failure to report the foreign accounts was non-willful.

Taxpayers submitting a streamlined filing, either through IRS Form 14653, Certification of U.S. Person Residing Outside of the United States, or IRS Form 14654, Certification of U.S. Person Residing in the United States, are required to certify that their “failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-willful conduct.” Taxpayers must certify that they understand that “non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.” Furthermore, taxpayers are instructed to provide a narrative that explains their failure to report the financial account, including specific reasons for the failure to report all income, the source of funds in all foreign accounts or assets, and the name of any professional advisor involved. The clear purpose of these instructions is to allow the IRS to scrutinize the taxpayer’s sworn explanation of non-willfulness in order to ensure that those taking advantage of the streamlined procedures are, in fact, proper candidates for the program.

Facts May Not Support a Streamlined Filing

DOJ attorneys have been warning taxpayers since the streamlined program was first announced that it is “a very dangerous approach” to make a streamlined filing “while ignoring facts that might suggest willfulness to the government” (Jaime Arora, “Don’t Hastily Join Streamlined Compliance Program, Keneally Says,” Tax Notes Today, June 25, 2014, http://bit.ly/2ra74j7). Indeed, in her November 2016 remarks discussed above, Ciraolo noted that “Tax Division prosecutors are reviewing certain streamlined filings, and will investigate and prosecute taxpayers who willfully submit false statements in an effort to obstruct and impede the IRS and evade the payment of tax due.”

It is not uncommon for taxpayers with unreported foreign accounts to have preconceived notions of the options available to them and try to shoehorn their facts into a non-willful statement in order to receive the benefit of the lower penalty scheme. It is therefore vital that tax advisors—both lawyers and accountants—fully appreciate the risks attendant to using the streamlined procedures and satisfy themselves that the taxpayer’s conduct is in fact non-willful before submitting a streamlined filing. Indeed, a tax advisor who prepares a streamlined filing for a taxpayer also is required to sign Form 14653 or Form 14654.

The most typical set of facts involves a taxpayer who inherited a foreign bank account or whose family members in a foreign country set up a bank account on his behalf, often when the client was a child. The client’s tax return preparer may not have asked about a foreign account, and the client may have had no knowledge that the account needed to be reported. In such a scenario, it is likely that the client will be able to provide credible facts supporting his non-willfulness.

Things start to get more complicated when other facts exist that tend to demonstrate that the taxpayer took specific steps to maintain the secrecy of the foreign account. Some common facts that demonstrate willfulness include, but are not limited to, the following:

• The account was held in the name of an offshore entity, such as a Panamanian or British Virgin Islands corporation, trust, or foundation.
• The account was identified solely by a code name, nickname, or number.
• The taxpayer instructed the foreign bank to hold all mail related to the account so that it would not be sent to the taxpayer in the United States.
• The taxpayer moved the money from one foreign account to another, particularly if such movement occurred after July 1, 2008.
• The taxpayer withdrew all funds from the account in cash.
• After withdrawing the funds from the account in cash, the taxpayer took steps to have the money brought into the United States and falsely reported on a tax return the source of the cash.
• There were repeated cash deposits into or cash withdrawals out of the foreign account.
• The taxpayer met with a representative of the foreign bank in the United States.
• Bank records show that the taxpayer requested the bank not to disclose the account to the IRS.
• When completing the accountant’s annual questionnaire, the taxpayer answered “no” to the question “Do you have a financial interest in a foreign bank account?”

In addition, the IRS may be suspicious of a streamlined filing if the account held a significant sum of money, since a large account is hard to “forget” when giving details to one’s tax return preparer. In such a case, the IRS may initiate an audit of the tax years at issue in the streamlined filing and may conclude that the taxpayer’s failure to report the account was in fact willful. Should the IRS so conclude, the taxpayer at best would be subject to fraud penalties; at worst, the taxpayer may face criminal prosecution related not only to the failure to report, but also to the statements made in the streamlined filing.

The best way for a tax advisor to protect a taxpayer from making an ill-considered streamlined filing is to inform her of the breadth of information that has been and continues to be gathered by the IRS and the DOJ relating to noncompliant U.S. taxpayers with foreign accounts. In the author’s experience, bankers tend to be fastidious and regularly keep notes of phone calls and meetings with clients or their advisors. If the government conducts an investigation of an individual’s foreign account holdings, that evidence certainly will be discovered. In short, there is no such thing as a secret account.

In addition, the bank records, including account-opening documents and signature cards, will need to be requested from the foreign bank in order to complete the streamlined filing. Those records often speak volumes and may tell a story very different from the taxpayer’s version of the facts. If the records reflect conduct that suggests willfulness, the taxpayer will need to have a credible explanation for that conduct. Taxpayers likewise will need to explain credibly why they failed to disclose the foreign accounts, and why they did not make a voluntary disclosure under the OVDP.

Taxpayers must understand that a streamlined filing that omits important facts may be caught by the government, resulting in the taxpayer being subject to criminal prosecution—not only for failure to report the foreign account, but also for false statements in the streamlined filing. Tax advisors should take the taxpayer’s version of the facts with a grain of salt and caution that if the records tell a different story, the streamlined procedures may not be available. In such a situation, taxpayers would be well advised to enter the OVDP and pay the higher miscellaneous penalty. The silver lining in that more financially painful scenario is the certainty that—if the disclosure is timely, truthful, and complete—the government will agree not to criminally prosecute. The peace of mind that comes with that certainty is priceless.