Background

You have foreign assets that are not in IRS compliance because you did not report them properly to the IRS and/or you failed to pay tax on foreign income. You are investigating how to come into compliance before the IRS learns about these assets, audits you and imposes severe penalties (or even worse, prosecutes you criminally). Perhaps you have received a letter from your foreign bank stating that it intends to disclose your account to the IRS.

You know that you must voluntarily disclose your foreign assets to the IRS before it obtains that information from your bank or other sources. You have learned that there is an IRS Offshore Voluntary Disclosure Program (OVDP), which has an eight-year tax look back period and a 27.5% or 50% penalty (depending on which bank you used). You’ve also learned that there is a Streamlined voluntary disclosure procedure which has a three-year tax look back period and a penalty of 5% (0% for US taxpayers who live abroad). Which route do you chose to make your foreign assets tax compliant?

Obviously, the Streamlined procedure is less onerous and less expensive and would be the preferred choice for coming into tax compliance. However, there are eligibility standards for being accepted into the Streamlined program. The most important standard is that the US taxpayer did not “willfully” fail to disclose the foreign assets. Willful non-compliance is the intentional violation of a known legal duty. In simple terms, it means “I know I have to report my foreign account, but I am not going to.”

On the other hand, the IRS defines non-willful conduct as: “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.” Apart from providing these definitions, which are rather amorphous, the IRS has provided little published guidance on what constitutes willfulness.

In determining willfulness or non-willfulness, the IRS will look at the taxpayer’s actions. As part of the taxpayer’s application for the Streamlined program, the taxpayer must submit a sworn self-certification detailing the facts supporting his or her non-willfulness. If the IRS concludes that the statement is false, the taxpayer could be subject to prosecution for filing a false statement or perjury. The taxpayer’s statement of non-willfulness is thus a critical document and will be the basis of the IRS agreeing or disagreeing that the taxpayer’s failure to disclose is non-willful. If the IRS rejects the non-willful certification, the taxpayer’s statements could form the basis of an IRS audit with potentially severe consequences including large penalties. If the application to the Streamlined program is rejected, it is too late to apply to the OVDP.

Based on our representation of hundreds of US taxpayers with foreign assets, below we analyze various factual situations that often arise in offshore cases, in order to determine how the IRS might determine willfulness or non-willfulness.

It should be noted that client fact patterns are all different, and usually contain both “good facts” and “bad facts”. It is the responsibility of a good tax attorney to evaluate all facts and guide the client to a conclusion. The factual examples set forth below may appear to be very “willful”, in order to illustrate a point. Your own facts could be much more benign.

In addition, while many of the examples below that showcase willfulness would point towards a conclusion that the Streamlined procedures are not appropriate, the OVDP would still be available in order to come into IRS compliance, put a cap on penalties and avoid criminal prosecution.

In order to assess willfulness, we begin with the reasons for opening a foreign account, the taxpayer’s background, and the source of the foreign funds.

What was the reason for opening the foreign account?

There are perfectly valid and legal reasons to open and maintain a foreign bank account. Perhaps you support family abroad via such an account. You may own foreign real estate and need an account to pay the mortgage, pay utility bills and other expenses associated with your foreign property. Perhaps you visit a foreign country often and require access to banking services when you visit.

If you lived and worked abroad, you would certainly need an account for banking purposes, as well as to deposit salary, pay bills, etc.

Perhaps your child is spending a semester studying abroad and you deposit funds into a local account.

We’ve had clients who opened foreign accounts in order to receive Holocaust reparation payments.

We’ve had clients who inherited money from foreign relatives and simply kept the funds overseas; or who inherited real property overseas and needed to open a foreign account to receive the proceeds from the sale of the inherited property.

These are all valid reasons for having a foreign account. If you were truly not aware that these accounts are reportable to the US government, you may likely have a basis for claiming non-willful conduct.

On the other hand, if your foreign real estate was rental producing, you had a net profit from the rental income, and you did not declare that net profit to the IRS, you would be closer to the “willful” side of the spectrum.

What is the taxpayer’s background?

Growing up in the foreign jurisdiction where the account is located, having family ties to the country, or business ties, would be relevant in making a case for non-willfulness. Often, a US taxpayer created the account while living in the foreign country, then later moved to the US, but did not know the account was then reportable to the IRS and did not access the account after moving to the US. Such facts would be relevant to non-willfulness.

More broadly, the level of the taxpayer’s education, business acumen and financial sophistication are also relevant to the issue of willfulness. We’ve had hedge fund managers and other financial professionals suggest to us that they are non-willful, and yet they have MBAs, manage millions of dollars and invest internationally. The IRS will likely call into question this disparity and reject a claim of non-willfulness. We’ve had a client who was a foreign attorney, with an account in her country of origin, who argued her non-willfulness, yet she took no steps to learn about her IRS reporting requirements while living in the US for decades.

We’ve also seen family histories that included forced exile, religious or ethnic persecution, and a resulting desire to safeguard funds in a jurisdiction that offered safety and stability. Thus, the rationale for the opening of the foreign account was not US tax avoidance. In many cases, the accounts were created in a foreign country long before the taxpayers even had any tax nexus to the United States. Such facts all support non-willfulness. However, the taxpayer better be prepared for the IRS to question why the account remained non-compliant after the taxpayer established a US nexus.

What is the source of funds in the foreign account?

Funds that were inherited or gifted from a foreign relative, or salary accumulated in a foreign account while the taxpayer lived and worked abroad and needed a local account for banking, bill paying, etc., suggest that the foreign account was not set up to willfully avoid US taxation.

On the other hand, if the offshore funds are earned income or investment profits that were diverted into a foreign account in order to avoid US taxation, rather than declared, after-tax proceeds, the IRS will find willfulness. The OVDP is the correct course of action for willful non-compliance.

If the funds were deposited in the foreign account in order to hide assets from creditors, or from a spouse, then it will be very difficult to argue in favor of non-willfulness. The difficulty in such a case is that hiding assets from a spouse, or attempting to avoid attachment by creditors, is not the same as willfully avoiding US taxation, but the IRS will impute willfulness toward the IRS from conduct towards creditors or potential creditors. “Hiding” an account is a willful action, no matter from whom you are hiding.

Finally, if the offshore funds are criminally derived, the IRS will not accept a voluntary disclosure, neither Streamlined nor OVDP.

Does the taxpayer have ties to the country where the account was/is located?

We have represented many US taxpayers who immigrated from foreign countries where they had local accounts for many years, in some cases since childhood. They may have even been subject to local tax withholding in such accounts. If such a client is truly unaware that after immigrating to the US, the account “back in the old country” becomes reportable to the US government, then a case for non-willfulness may be made.

If a US taxpayer did business in a foreign country and needed a local account to transact the business, or owned property in that country and needed a local account to pay the mortgage and other expenses, again, such facts suggest non-willfulness. Paying taxes to the foreign government would also support a claim of non-willfulness (and may also give rise to a Foreign Tax Credit on the US tax return).

However, a US taxpayer with an account in a tax haven jurisdiction (Switzerland, Cayman Islands, etc.) with no other ties to that country, will probably not succeed in arguing non-willfulness. IRS agents have told us directly “if your client is American and opened an account in Switzerland but had no other ties to Switzerland, then don’t tell us your client is non-willful.”

Did the taxpayer pay foreign taxes on the foreign assets?

In many cases, people have the mistaken understanding that because the foreign funds were taxed abroad (e.g., the foreign bank took withholding or the taxpayer filed foreign tax returns and paid foreign taxes), the taxpayer need not declare the same assets and pay tax again to the IRS. This is a mistake because the US Internal Revenue Code taxes world-wide income, even if already declared and taxed abroad. In many cases, a tax treaty between the US and the other country will allow for a foreign tax credit on a US income tax return, so that the same funds are not taxed twice. But the US taxpayer must still declare the foreign assets to the IRS, even if taxed abroad. A good faith misunderstanding of this requirement could form the basis of a non-willful certification. If the US tax loss was minimal because of a credit for foreign taxes paid, the case for non-willfulness is even stronger.

However, if the US taxpayer failed to declare and pay tax to the foreign government as well as to the IRS, then the IRS will likely deem that to be willful tax avoidance in two countries. The same conclusion would pertain not only to income in a financial account, but to all forms of income, such as salary, commission, real estate rental income, etc. In other words, willfulness towards one’s foreign tax obligations would be imputed as willfulness toward the IRS as well.

How was the account opened?

Was the account opened by a relative and the US taxpayer is on the account “for convenience” or inheritance purposes? Was the account opened in order to receive a foreign inheritance? These facts would go toward non-willfulness. Moreover, if there is no tax loss to the IRS because, really, this was someone else’s money and you were on the account under a power of attorney, that is further support for non-willfulness.

In contrast, did the taxpayer travel to a jurisdiction where he had no ties, in order to open the account? Did the taxpayer utilize a service provider (banker, attorney, trust company, etc.) that promised banking secrecy, tax secrecy or the like? The IRS scans the Internet and makes note of such service providers that offer banking “confidentiality” or tax “secrecy”. If the taxpayer utilized the services of such a provider, the IRS will likely reject a claim of non-willfulness. Such facts would suggest that the taxpayer consider the OVDP rather than the Streamlined program.

Did the taxpayer utilize a foreign passport when opening the account? Did the taxpayer provide a foreign address? These are all “bad” facts that would suggest willfulness (unless, of course, you were living in that country when you opened the account), because they suggest efforts to conceal one’s US tax status to the bank and an affirmative attempt to posture the account as non-US related. On the other hand, a taxpayer who candidly advised the bank that he was a US person, would have a better chance of arguing for non-willfulness.

What were the taxpayer’s instructions to the bank?

Did the US taxpayer instruct the bank to open a numbered account? A “bad” fact that points to willfulness.

Did the taxpayer instruct the bank to “hold mail”? Another “bad” fact that points to willfulness.

Did the taxpayer utilize a “code name” or “code word” in communicating with the bank? Almost definitely, willfulness.

Did the taxpayer direct investments, order trades, etc.? Another “bad” fact. It is difficult to plead ignorance of reporting requirements while having the financial sophistication to open a foreign bank account and make foreign investments.

Did the taxpayer access the accounts?

If the account was passive, and the US taxpayer had little or no involvement in the account (did not manage investments, make deposits, took few or small withdrawals), the taxpayer would have a good case for non-willfulness. On the other hand, the use of a debit card to access foreign funds is a “bad” fact that would likely suggest willfulness. Withdrawal of cash and then repeatedly bringing just under $10,000 in cash on one’s person when returning to the United States would likely suggest willfulness, in addition to triggering violations of Customs laws. Asking a foreign banker to deliver cash or, even worse, items like diamonds, would almost certainly constitute willfulness. There is case law that “checking the box” on IRS Form 1040 Schedule B that one does not have a foreign account, coupled with the use of the account, such as by making withdrawals, could indicate willfulness.

Were there transfers?

Suppose a taxpayer closed his Swiss account and transferred the funds to a different bank. The timing is important. If the taxpayer closed the account between 2008 and 2015 and moved the funds to a different offshore bank, the IRS could argue that the taxpayer was a “leaver”, i.e., the taxpayer left his/her bank because the IRS was cracking down on UBS, Wegelin, Credit Suisse, Julius Baer, etc. and the taxpayer transferred the funds to another foreign account in order to keep one step ahead of the IRS. Moreover, because the IRS Offshore Voluntary Disclosure Programs (OVDP or OVDI) have been in effect since 2009, the taxpayer had years of opportunity to come forward to the IRS, but instead of coming into compliance, the taxpayer chose a different bank to continue to hide the funds from the IRS. In such a circumstance, the Streamlined program will not work and the OVDP is a better option.

Was the account titled in the name of an entity like a trust, corporation or foundation?

The IRS considers the overlay of a foreign entity as owner of the funds to be an additional affirmative step of obfuscation of the true ownership of the funds. In fact, Department of Justice tax prosecutors are particularly keen on prosecuting US taxpayers who utilized foreign trusts, or Panama corporations, or Liechtenstein foundations to own their non-compliant foreign assets. In a similar vein, transferring assets to the name of a nominee, or foreign friend or relative, is likewise viewed as a negative, willful act.

What was the taxpayer’s conduct vis-a-vis the foreign assets and preparing his annual income tax return?

We’ve had clients with CPAs who were simply in the dark regarding how to treat foreign assets for US tax purposes. One CPA knew that his client owned a foreign annuity policy, yet the CPA utterly failed to declare it on multiple year FBARs (FinCEN Form 114, which is an annual report to the Treasury Department about foreign accounts).  Many CPAs know that their clients are originally from foreign countries and visit those countries often and even own homes back in those countries, and yet the CPAs never ask whether the clients have foreign financial accounts. Such facts may support the client’s case for non-willfulness (although the focus would then shift to include the client’s own knowledge of IRS reporting obligations).

We’ve also had clients insist that they are non-willful, but when we explore whether their CPA asked if they had foreign accounts, the clients tell us that they answered “no” to their CPAs. Denying that one has a foreign account when one’s CPA affirmatively asks, is definitely willful. In addition, the IRS places emphasis on “tax organizers”, which are questionnaires that CPAs send to their clients to get the clients to focus on tax issues such as income, deductions, exemptions, charitable contributions, etc. If the taxpayer received a tax organizer that asked about foreign assets, and either ignored the question or answered inaccurately, the IRS will likely impute willfulness.

In some cases, taxpayers prepare their own tax returns without utilizing a CPA. The taxpayer will have to address his conduct in answering the question about foreign accounts on IRS Form 1040 Schedule B, line 7.  Did the taxpayer read the question and answer that he did not have a foreign account? Did the taxpayer ignore the question? The answers are all relevant to the issue of willfulness. The IRS takes the position that a taxpayer who signs a tax return is presumed to have read the tax return he is signing, including the question on Schedule B about foreign accounts. Further, that question specifically directs the taxpayer to the FBAR form. The IRS has taken the position that, having read this question and the direct FBAR language, the failure to take the next step and inquire about the FBAR constitutes “willful blindness”.

According to the Internal Revenue Manual (IRM),

Under the concept of “willful blindness”, willfulness may be attributed to a person who has made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements. An example that might involve willful blindness would be a person who admits knowledge of and fails to answer a question concerning signature authority at foreign banks on Schedule B of his income tax return. This section of the return refers taxpayers to the instructions for Schedule B that provide further guidance on their responsibilities for reporting foreign bank accounts and discusses the duty to file Form 90-22.1 [the prior FBAR form, the predecessor to FinCEN 114]. These resources indicate that the person could have learned of the filing and recordkeeping requirements quite easily. It is reasonable to assume that a person who has foreign bank accounts should read the information specified by the government in tax forms. The failure to follow-up on this knowledge and learn of the further reporting requirement as suggested on Schedule B may provide some evidence of willful blindness on the part of the person. IRM, 4.26.16.4.5.3 (07-01-2008).

Similar questions arise if the taxpayer utilized software (such as TurboTax), and such software directed the taxpayer to the FBAR form. Did the taxpayer attempt to learn about the FBAR form, or did he ignore the software’s prompts and thus was willfully blind?

On the other hand, the Internal Revenue Manual states that “[t]he mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness.” Id. Moreover, as one court has stated, “[w]illfulness has been found where ‘the facts and circumstances of a particular case, taken as a whole, demonstrate that the taxpayer knew or should have known that there was a risk and failed to take corrective action, with the result being the violation of the law”, McBride, 908 F.Supp.2d 1186, 1209 (D. Utah 2012), citing Jenkins (internal quotations omitted) (emphasis added). In other words, the taxpayer’s response to the Schedule B question (or a software question) is relevant, but not exclusively determinative. The totality of the taxpayer’s facts and circumstances are considered, including the other factors discussed herein.

Conclusion

It is apparent that one’s background facts and actions with regard to the foreign assets are crucial in a determination of willfulness or non-willfulness. It is important that a qualified attorney well versed in foreign assets and US tax compliance examine the totality of a client’s facts and help the client assess willfulness. As noted, apart from some vague definitions of “willfulness” and “non-willfulness”, there is little published IRS guidance.

Taxpayers must also understand that if the IRS rejects a certification of non-willfulness in an application for the Streamlined disclosure procedures, it will be too late for the taxpayer to then apply for the OVDP. The Streamlined procedure is therefore an all-or-nothing avenue. In this context, there are no degrees of willfulness. If the conclusion points towards non-willfulness more than willfulness, the client should give serious consideration to the Streamlined program and its significantly reduced (5%) penalty. On the other hand, if the client does not want to bear the risk of the IRS rejecting a claim of non-willfulness, the OVDP becomes the better alternative.

In deciding which program is best for a taxpayer, he/she should take advantage of the guidance offered by an experienced tax attorney who has evaluated the facts presented by many clients, as well as the IRS treatment of those facts. As the saying goes, “there is no substitute for experience.”