In 2009, the Service introduced its first Offshore Voluntary Disclosure Program (“OVDP”). As a result of this program, more than 50,000 taxpayers have come forward and disclosed offshore financial accounts. In a news release issued by the IRS on January 28, 2015 (IR-2015-09), it reported that the government has collected over $7 billion from this initiative. In addition, as we know from the Zwerner case (reported in my blog on June 16, 2014), the Service has conducted thousands of civil audits relating to offshore financial accounts, resulting in the collection of taxes and penalties in the “tens of millions of dollars.” Last, the IRS has not been shy about pursuing criminal charges against taxpayers who fail to disclose their offshore financial accounts. In fact, the IRS reports that it has collected “billions of dollars in criminal fines and restitutions” since the introduction of the OVDP.
One may wonder whether the government’s offshore compliance enforcement activity will slow down as a result of the recent slashing of the Service’s budget. Reading the statements made by the IRS in the January 28, 2015 news release, the answer appears to be no. In fact, the announcement proclaims:
The IRS remains committed to our priority efforts to stop offshore tax evasion wherever it occurs. Even though the IRS has faced several years of budget reductions, the IRS continues to pursue cases in all parts of the world, regardless of whether the person hiding money overseas chooses a bank with no offices on U.S. soil.
IRS Commissioner John Koskinen recently stated that: “Taxpayers are best served by coming in voluntarily and getting their taxes and filing requirements in order.” Consequently, the Service announced that the OVDP “will be open for an indefinite period until otherwise announced (emphasis added).” While the OVDP may be a good means for taxpayers to get their houses in order, tax practitioners need to fully inform their clients about the program and its impact on their situation before placing them into the program, including:
- The reporting rules and the cost of compliance. Even under the OVDP, taxpayers routinely feel they are being overcharged/penalized by the government for doing nothing wrong. Clients need to be fully informed of the rules relating to foreign financial accounts and the costs of noncompliance.
- OVDP flaws. The OVDP is not without flaws. Its rules are not perfect. In fact, in many instances, the rules are unclear and/or incomplete, and application is blemished with subjectivity, potentially leading to unexpected results. Caution is advised!
- Penalties. If a taxpayer’s disclosure is incomplete or inaccurate, the taxpayer may be faced with hefty civil and/or criminal penalties.
- Closure Time. The OVDP, especially given continued IRS budget cuts, can be a lengthy process. From the time a complete submission is filed with the IRS, it can take months to close the matter. This can be unnerving to taxpayers, especially in light of the huge civil and/or criminal penalties that can result from noncompliance.
There are at least four (4) takeaways from IR-2015-09:
- The IRS, despite huge budget cuts, intends to remain focused on offshore financial accounts.
- The OVDP appears to be here to stay (or at least until the Service announces otherwise).
- The OVDP does not generate prompt results. Patience is required.
- While the OVDP may be a good mechanism to resolve offshore financial account noncompliance, it is not without flaws. Tax practitioners need to adequately advise clients about the program and the applicable law so that they are fully informed before submitting an OVDP application.
Continuation of the OVDP is generally good news for taxpayers. As stated, however, it is not the most taxpayer friendly voluntary tax compliance program. Consequently, tax practitioners need to: have a good understanding of the OVDP and the applicable law; they need to fully advise clients of their compliance obligations, including the costs and risks of noncompliance; and they need to fully inform clients about the OVDP, including the timing, risks, and liability, before making a submission to the program.
The Internal Revenue Service (“IRS” or “Service”) has repeatedly stated that, while its crackdown on the failure of taxpayers to report foreign financial accounts has been strong, it is reasonable in the application of the law. At least one taxpayer, Mr. Carl R. Zwerner, would likely debate that pronouncement.
On June 9, 2014, Bloomberg BNA Daily Tax Report (No. 110) revealed that a long and hotly-contested battle between Mr. Zwerner and the United States government has come to an end. This highly-publicized case is frightening. It illustrates that the IRS may not always be reasonable in the application of the foreign financial account reporting (“FBAR”) laws.
Mr. Zwerner, an 87-year old retired specialty-glass importer, is a United States citizen who resides in Coral Gables, Florida. He had a financial account in Switzerland. The account balance never exceeded $1.7 million. It appears the account was opened by Mr. Zwerner during 2004 in the name of a foundation. In 2007, he closed the original account and transferred the account balance to another Swiss account. The new account was opened in the name of yet another foundation. Mr. Zwerner controlled these accounts; he was undisputedly the beneficial owner of the accounts.
On June 11, 2013, the battle commenced when Assistant Attorney General Kathryn Keneally instituted a lawsuit against Mr. Zwerner in the United States District Court for the Southern District of Florida, seeking to collect almost $3.5 million in penalties from him for violating the FBAR rules. The assessment which the government was pursuing against Mr. Zwerner amounted to more than double the highest account balance of his Swiss financial account.
In the past five to six years, the United States Justice Department has filed over 75 criminal cases against taxpayers for failure to report foreign financial accounts. In these cases, the penalties sought by the government have usually been 50 percent of an account’s maximum balance, or less. While the government has authority to pursue multiple penalties, pursuit of penalties aggregating more than 50 percent of the maximum account balance has been rare. Mr. Zwerner’s case raises the issue of whether collection of more than an account’s highest balance constitutes a violation of the Eighth Amendment to the United States Constitution.
Pursuant to the Eighth Amendment, the amount of a penalty must bear a relationship to the gravity of the offense; it cannot be excessive. Is a penalty of the magnitude imposed on Mr. Zwerner excessive?
The facts of this case appear to be as follows:
Mr. Zwerner was required to report the foreign financial account from 2004 through 2007 by filing an FBAR on or before June 30 of each following year. He only filed an FBAR, however, in October 2008 (delinquent for 2007). Further, he did not report any income from the account before 2008.
The IRS alleged in its complaint that Mr. Zwerner, on October 13, 2008, filed a delinquent FBAR, reporting the account for 2007. At that time, he also filed an amended 2007 income tax return, reporting the account’s income. On March 27, 2009, Mr. Zwerner filed delinquent FBARs, reporting the account for 2004, 2005, and 2006. At that time, he also filed amended income tax returns for those years, reporting the account’s income.
The government asserted Mr. Zwerner’s failure to report for 2004, 2005, 2006 and 2007 was willful. It pointed out the following facts in support of this position:
• The account was placed in the name of two separate foundations to disguise the identity of the true owner.
• On Mr. Zwerner’s original income tax returns for 2004, 2005, 2006 and 2007, he specifically reported on Schedule B that he held no interest in a foreign financial account.
• For the years at issue, Mr. Zwerner reported to his CPA on a tax organizer that he had no interest or signatory authority over a foreign financial account.
• Mr. Zwerner admitted he was aware of the FBAR rules.
Based upon the above facts, the IRS assessed penalties against Mr. Zwerner relating to each tax year for “willful” failure to comply with the FBAR rules. Pursuant to 31 USC 5321(a)(5), the penalties are equal to the greater of $100,000 or 50 percent of the account balance as of the date of violation. Consequently, for 2004, 2005, 2006 and 2007, these penalties, with interest, exceeded $3.45 million or over twice the account’s highest balance. Despite demand, Mr. Zwerner failed to pay the assessment. As a result, the lawsuit resulted.
The facts do not sound good. There are, however, some mitigating facts.
About four months after filing a late FBAR for 2007, and amending his 2007 income tax return, reporting the foreign financial account income, and paying the tax, in February 2009 Mr. Zwerner’s legal counsel approached the IRS Criminal Investigative Division. Without disclosing Mr. Zwerner’s identity, the lawyer inquired about his particular situation for tax years 2004, 2005 and 2006. The IRS issued a letter stating that no criminal action in the hypothetical case presented by the lawyer would be pursued. So, Mr. Zwerner, at counsel’s advice, filed the delinquent FBARs and amended his income tax returns, reporting the income. At that time, he also paid all income tax due and owing. It is important to note, Mr. Zwerner was not under exam when he took corrective action. In 2010, the Service began an examination of Mr. Zwerner’s income tax returns. Mr. Zwerner’s attempt at voluntary compliance pre-dated by a few months the formal FBAR voluntary disclosure programs.
Unfortunately for Mr. Zwerner, his case proceeded to trial in May 2014. The jury returned a verdict, finding Mr. Zwerner’s violations of the FBAR rules were “willful” for tax years 2004, 2005 and 2006. It found, however, any violation of the FBAR rules for 2007 was not willful. This verdict left Mr. Zwerner faced with penalties of about $2.2 million.
Mr. Zwerner’s counsel filed a motion with the court to dismiss or reduce the verdict on the ground that the penalty was excessive and violated the Eighth Amendment of the United States Constitution. The court was set to hear arguments on the motion this month. The parties, however, settled the matter. So, this important issue remains open.
Several takeaways exist:
• Until the courts look at this issue, it remains unclear whether FBAR penalties in excess of an account’s highest balance are excessive and constitute a violation of the Eighth Amendment.
• When a taxpayer goes to the Service, even on an anonymous basis, and obtains guidance, the Service may still bombard the taxpayer with noncompliance penalties.
• Despite rhetoric about its reasonable approach to FBAR enforcement, it appears the government will continue to use its strong arsenal of penalties to obtain compliance.
This area of law continues to be complex and full of traps for unwary taxpayers and their advisors. The Service continues to tell us that it intends to apply the FBAR rules in a reasonable manner. Time will tell. Tax advisors must be careful so that they do not walk their clients, without full disclosure of the risks, into the penalty assessment gauntlet.
Larry J. Brant
Larry J. Brant is a Shareholder in Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long-term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationNew York, NY, 10.24.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," Oregon Society of Certified Public Accountants (OSCPA) 2019 Northwest Federal Tax ConferencePortland, OR, 10.28.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationSan Francisco, CA, 11.14.19
- "The Oregon Corporate Activity Tax," Oregon Society of Certified Public Accountants (OSCPA) 2020 OSCPA State & Local Tax ConferencePortland, OR, 1.6.20
- "The Road Between Subchapter C and Subchapter S – It May Be A Well-Traveled Two-Way Thoroughfare, But It Isn’t Free of Potholes and Obstacles," The J. Nelson Young Tax InstituteChapel Hill, NC, 4.23.2020-4.24.2020