Fraudulent Conveyances in Employment Taxes

TFR and Fraudulent conveyancesEmployers who willfully fail to remit an employee’s withholding to the IRS are liable to the IRS for the “trust fund recovery penalty” (TFRP). Generally, the IRS will assess the Penalty against any responsible person who fails to collect and pay these taxes to the IRS. A responsible person can include a business owner, a corporate officer, director or office manager and a trustee or executor as well other individuals and entities.

Those who are subject to the TFRP may attempt to impede IRS collection efforts by conveying their personal or corporate assets to relatives or to nominee entities, without fully considering the civil and criminal tax consequences associated with making such transfers.  A fraudulent conveyance can be as simple as transferring an asset to a spouse or child, or may involve multiple entities and other devices. While there may be legitimate reasons for transferring an asset to a third party, making a fraudulent conveyance is not one of them.

IRS Lawsuit on a Fraudulent Transfer Scheme

An excellent illustration of an elaborate fraudulent transfer scheme is United States v. William Planes,et al (8:18-cv-02726) where  William  Planes (“William”) and his wife, Regina Planes (“Regina”), failed to pay employment taxes exceeding $9 million on behalf of  at least ten entities over a 12 year period. The following is a partial summary of what happened. I would, however, recommend reading the case in its entirety.

The IRS filed a lawsuit in the U.S. District Court, for the Middle District of Florida against William. In its complaint, the Government alleged that while employment taxes continued to accrue, but prior to the lawsuit being filed, the defendant, William Planes (William),  fraudulently transferred almost $600,000 to his wife Regina (Regina) Planes.

In furtherance of the scheme, Regina lied to the IRS by maintaining that she was not a financially responsible person of South Capital Construction, Inc. The Court subsequently entered a judgment against Regina finding that William made the transfer to Regina in order to prevent the IRS from collecting the penalty from him.

On November 5th 2018, the Government filed a second lawsuit seeking to:

  1. Reduce a separate trust fund penalty of $529,000 assessed against William Planes in 2003 to a judgment.
  2. Disregard the corporate entities that the defendants were using to impede IRS collections.
  3. Apply the entities’ assets to the judgment.

A day after the IRS assessed $529,000 penalty against William, the defendant created the William Planes 2003 Irrevocable Trust and the Regina Planes 2003 Irrevocable Trust. These two trusts, in turn, owned six limited liability companies which William and Regina either owned or controlled.

The Government also requested and secured a temporary restraining order (TRO) on November 6th 2018, enjoining the defendants or anyone acting on their behalf or in concert with from transferring any entity asset.

On November 7, 2018 Regina was served with the TRO. Less than two hours later William transferred the sum of $160,000 from three of the entities bound by the TRO to Coast to Coast, an entity in which William is a director.  A contempt hearing followed. The Court subsequently found the defendants in contempt and converted the TRO to a preliminary injunction.

While this case has yet to be referred to the IRS Criminal Investigation Division, I suspect it will be given the dollar amount.

Trust Fund Recovery Penalty and Prosecution

The amount of the TFRP is for the most part irrelevant in the Government’s decision to prosecute an individual. Taxpayers have been prosecuted where the TFRP was far less. The following cases illustrate the dollar range in TFRP cases that have resulted in criminal prosecution:

  1. On August 27, 2019, a North Carolina woman was sentenced to 14 months in prison for employment tax fraud for withholding and failing to pay over $78,937 in employment taxes deducted from the employees of a Pediatrician where she worked as an office manager, as well as the failure to pay over $35,472 representing the employer’s share of taxes. Instead, the defendant used the money to pay her credit card bills, go on personal vacations and fund a business venture. She also helped herself to $1.4 million from the Pediatrician’s bank account.
  2. In June of 2019 a Long Island business man pleaded guilty to failure to pay over employment taxes to the IRS. According to the documents filed by the DOJ, the defendant owned and operated several steel erection businesses on Long Island. Over a four year period the defendant owed almost $500k in employment taxes. In May of 2011, the defendant changed the name of his business to BR Teck Enterprises Inc. and transferred ownership of the corporation to another individual. Despite transferring ownership of the business to a third party, the defendant continued to operate the business ad continued to pay over employment taxes. From January 2012 through June 2017, the defendant racked up an additional $950K in unpaid employment tax liability.

An Individual who owns or controls a business or is considered a responsible person who has a fiduciary obligation to accurately collect, account for and pay over to the Internal Revenue Service, all federal employment taxes withheld from its employees as well as the employer’s portion of any payroll taxes. Failure to remit such payments will invariably lead to assessment of the TFRP against an individual or entity that is considered responsible.

The above examples make clear that the transfer of corporate or individual assets to another person or an entity as a strategy to defeat or impede IRS collection efforts will seldom, if ever, work. This strategy is viewed by the Government as a deliberative process and has served as strong evidence in criminal prosecutions of intent to defraud the U.S. Government.

Alternatives other than the fraudulent transfer of assets are available when dealing with payroll tax issues. These issues can sometimes be mitigated, when an experienced tax attorney becomes involved at an early stage in the process. Conducting a Google search and handling the problem yourself is no strategy at all. Perhaps, it is time to stop digging.


Case Background

On August 27, 2019 the Department of Justice (DOJ) announced a superseding indictment of a Florida business man and former Texas CPA for allegedly filing a false document. This was because he made an offshore disclosure using streamlined filing procedures.

The supplemental indictment alleges that, Brain Nelson Booker, a Florida resident, who was in the cocoa trading business in Venezuela, Panama and Florida, filed false Foreign Bank Account Reports (FBARs) for the years 2011-2013. The new indictment also included charges from the original indictment which was brought because Booker filed false income tax returns (under 26 USC § 7206(1) ) for the tax years 2010-2012.

In addition to the false FBAR and tax return charges, the Government alleges that Booker filed a false document under 26 U.S.C. § 7206 (1) when he submitted a certification of non-willfulness in October 2015 as part of a submission using the Streamlined Domestic Offshore Procedures. According to the charging document, Booker “falsely certified that he met all the eligibility requirements for treatment under the streamlined procedures, and falsely claimed, among other things, that his failure to report all income, and pay all tax  and submit all required information returns including FBARs was due to non-willful conduct.”

Booker was unavailable for comment, since he fled the United States to a non-extradition jurisdiction.

Government Argument

According to the Government, Booker only reported two foreign financial accounts he maintained in Venezuela on his FBARs and tax returns for 2008-2010, while omitting other accounts in Switzerland, Panama and Singapore.

In 2009 Booker was contacted by the Swiss Bank where he maintained one of his foreign financial accounts. The Bank, who participated in the DOJ’s Swiss Bank Program, notified Booker to either report his account to the IRS or leave the Bank.  Subsequently, Booker moved his account to another Swiss Bank.

In July 2015 Booker filed delinquent FBARs for 2008 through 2015, this time reporting all his foreign financial accounts, including the two Venezuelan accounts as well as his Swiss, Panamanian and Singapore accounts. In October 2015 Booker made an offshore disclosure using the streamline procedures. As part of the streamlined procedures, Booker submitted a certification of non-willfulness claiming that his failure to file FBARs identifying all of his accounts was due to the fact he first learned about FBARs in 2008 and was under the mistaken belief that he was only required to report personal foreign financial account and not the accounts held by his business.


How does Booker’s indictment affect tax payers in a similar situation?

This indictment represents the first prosecution for filing a false document in connection with a submission under the streamlined procedures and clearly signals that the IRS is making good on their earlier pledge that they intend to closely scrutinize taxpayer certifications submitted in connection with the streamlined procedures, and further, that they will pursue persons who make false statements in their certifications.

Taxpayers with undeclared foreign financial accounts are afforded an opportunity to come into compliance. The Offshore Voluntary Disclosure Program  (OVDP) and the Streamlined Offshore Procedures represent  two alternatives for coming into compliance, depending upon whether the failure to file was willful or simply due to negligence. Closely tied to the issue of willfulness is the criminal risk associated with using the streamline procedures to make an offshore disclosure.

Prior to the closure of the OVDP in September of 2018, taxpayers who willfully failed to disclose their offshore assets and/or were at risk of criminal prosecution, could make application to participate in the OVDP.

Once the taxpayer was cleared to make the offshore disclosure, he or she would file eight years of amended income tax returns, as well as eight years of FBARs. The individual would also submit a Miscellaneous Offshore Penalty Worksheet. The Taxpayer would also be required pay the outstanding amount of tax due, together with interest and a 20% accuracy related penalty. Depending upon the circumstances and when the disclosure was made, the taxpayer would pay a miscellaneous offshore penalty equal to 20-50% of in the disclosure year with the highest aggregate balance.

In exchange for the taxpayer coming into compliance, payment of all amounts due, and assuming there were no material misstatements in the taxpayer’s submissions, the IRS would generate a Closing Agreement (Form 906). The Closing Agreement would generally include a representation that the IRS would not refer the case for criminal prosecution. Furthermore, the Closing Agreement would foreclose the possibility of any further income tax or FBAR penalty assessment by the IRS for any year in the disclosure period. The Agreement would also preclude the taxpayer from making any claim for a refund at a later date.

In November of 2018, the IRS the announced the updated Voluntary Disclosure Practice Rules which now include both domestic and offshore disclosures. The penalties under the new regimen are quite onerous when compared to the penalties under prior iterations of the OVDP.

Recognizing that one size doesn’t fit all, the IRS permits taxpayers, whose offshore disclosures present little risk to no risk of criminal prosecution or the assessment of the civil willful FBAR Penalty, to use the streamline offshore procedures. There are two scenarios. One for persons residing outside of the U.S and the other for persons residing in the US

In both cases, the taxpayer will file three years of amended returns and six years of FBARs. In addition, the taxpayer must submit a certification of non-willfulness, wherein he or she must set forth in detail the reasons why the failure to file FBARs was non-willful.

Those residing outside of the U.S. who meets the physical presence requirements are not subject to any FBAR penalty, while those residing in the U.S. pay a 5% penalty in the disclosure year with the highest aggregate balance.  In addition, the taxpayer must pay any additional income tax due related to the unreported income associated with his or he offshore accounts.

The key difference between the OVDP and the streamlined procedures is that the OVDP provides a taxpayer with closure, whereas a submission using streamlined procedures does not. As such, those using the streamlined procedures are at risk that the IRS may determine that the taxpayer’s representations, as contained in the certification of non-willfulness were false or unsubstantiated. If such a determination is made, the taxpayer could be subject to the assessment of civil willful FBAR penalties, as well as the possibility of a referral to IRS Criminal Investigation.

The indictment of Booker serves as a cautionary tale for those taxpayers who elect to use the streamlined procedures rather than the new voluntary disclosure practice rules in order to avoid paying higher legal fees and FBAR penalties associated with the later protocol.  In this regard, some taxpayers may be tempted to stretch the truth in an effort save on the FBAR penalties and legal fees, only to later find themselves in serious trouble.

The instant indictment should also serve as a wake up call that undertaking an offshore disclosure requires a careful review of the facts with an experienced tax attorney to assess whether a person’s failure to file an FBAR and his “no” response to the Schedule B FBAR disclosure was the result of negligence or a willful attempt to prevent the Government from discovering the taxpayer’s foreign assets and the income derived therefrom.

Ultimately, whenever a criminal risk is present, streamline procedures should be avoided. Likewise, streamline procedures should be avoided where there is a possibility that the facts otherwise support the assessment of the civil willful FBAR penalty, rather than a finding of mere negligence. Taxpayers who struggle with the truth and particularly those with prior dealings with the IRS that have resulted in the taxpayer’s integrity coming into question, should think long and hard before making a false statement in a certification when making a streamlined disclosure. Such actions are shorted sighted and almost always meet with financial disaster.





Fraudulent IRS tax refunds

Fraudulent tax refundsEach year thousands of individuals flock to tax return preparation centers in anticipation of receiving a large income tax refund from Uncle Sam. For most, the money is already earmarked for a down payment on a new car, home improvement or a vacation with most of the refund spent within 90 days of its receipt. The problem arises when the taxpayer receives a tax bill years later from the IRS and is required to repay the refund plus additional tax, interest and, in certain cases, penalties. In many cases, the bill the taxpayer receives from the IRS will cover multiple years since it takes a long time for the IRS to catch up with and prosecute crooked return preparers. While there are taxpayers who are complicit and aware that they are not entitled to those large refunds, most taxpayers are totally taken by surprise, when the IRS contacts them.

The statute of limitation for the assessment of income tax is generally 3 years from the date the return is filed. However, in the case of a false or fraudulent return, the tax may be assessed at any time under IRC Section 6501(c) (1) Id. The question of whether a return preparer’s fraudulent conduct (related to a taxpayer’s return) extends the statute of limitation for the taxpayer, has been the subject of debate among the courts. In addition, a taxpayer’s negligence in failing to review his or her tax return, can serve as a basis for imposition of the 20 % accuracy related penalty.  In 2007 the Tax Court held that a third party preparer’s fraud extended a taxpayer’s statute of limitations (Allen v. Commissioner, (128 T.C. 37 (T.C. 2007)).  However, in 2015 the Court of Appeals, in BASR Partnership v. United States, (113 Fed Cl 181 (2013) aff’d, 795 F.3rd 1338 (Fed, Cir. 2015)), rejected the Tax Court’ holding in Allen. The issue was presented once again in a 2016 Tax Court Decision styled as Finnegan v. Commissioner  (T.C. Memo. 2016-118) where the Court held that in the case of a false or fraudulent return, the income tax may be assessed at any time. This case involved the tax years 1994-2001.

The Court in Finnegan also held that the taxpayers were liable for the 20% accuracy related penalty. The Court held that the taxpayers did not meet their burden of production under I.R.C. Section 7491(c). Quoting from Treas (Reg. Sec. 1.662-3(b) (1) (ii)), the Court stated that the taxpayers failed to “make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return which would seem too a reasonable prudent person to be too good to be true under the circumstances” (Id. at Pg. 29).

In addition, the Tax Court, in  rejecting the Court of Appeals decision in BASR noted that there was a persuasive dissent filed in BASR and also that a concurring opinion was filed that relied upon I.R.C. Section 6229, an inapplicable provision. Furthermore, the Tax Court pointed out that there is no jurisdiction for the appeal of any decision of the Tax Court to the Court of Appeals. In view of these decisions, it is important to point out that the Tax Court is the only forum, other than IRS Appeals, where a taxpayer can challenge a tax assessment without first paying the deficiency. In BASR, the taxpayer paid the outstanding deficiency and thereafter made a claim for a refund.

Tax return preparers

Individuals who have their Federal and State Income tax returns completed by an outside third party have many alternatives including using a licensed attorney, certified public accountant or enrolled agent, who has the knowledge and experience to ethically prepare tax returns in accordance with the tax laws. All things being equal, the cost to have your tax returns prepared by a licensed professional are commensurate with the fees charged by tax preparation services and other individuals. Given the repeated warnings from the IRS to stay clear of sleazy return preparers and information that is available on the internet, one would assume that consumers who have their returns prepared by outsiders would be somewhat circumspect in the selection process. After all, we review doctors, mechanics and other professionals prior to hiring them, right?

Inexplicably, many individuals spend very little time, if any, scrutinizing those who are tasked with the preparation of their income tax returns despite repeated warnings from the IRS. Nor is much time spent discerning the differences between a licensed professional, who is subject to professional standards, such as Circular 230, State Bar Ethics Rules and State Professional Regulations related to Certified Public Accountants and the impostors who operate illegally in the shadows.

Taxpayers often select a return preparer based upon a recommendation from a friend, relative or co-worker who in many cases has received a sizable tax refund. Unable to contain their joy, they naturally tell their friends, relatives, co-workers and anyone that will listen to them that: “I got a great tax guy.”

In the case of those who are new to the United States many will select a tax preparer that is from their home country and speaks their language. In most cases, the criterion for selecting a tax preparer comes down to the size of the refund.

Fraudulent tax return preparer business model

The fraudulent return preparer business model can be divided into three categories and many variations thereof. The First category constitutes return preparers who prepare fraudulent returns generating refunds to which taxpayers are not entitled. These preparers use fraudulent refunds as a means to build their tax preparation practices. They are also generally new to the game and unaware of the IRS use of analytics as a tool to detect patterns of fraud in the tax preparation industry. These return preparers may or may not charge higher fees than their licensed counterparts and sometimes may take a percentage of the refund, which, by that way, is illegal. This first category of fraudulent return preparer is fabricating returns and large refunds as part of marketing strategy designed to build a robust tax practice.

The second category of fraudulent return preparers is less concerned with building a large practice or longevity and more focused on the immediate financial gain. In many cases, the business is set up naming individuals other than the true owner as the principals for the business. For many scammers this is not their first rodeo. They are savvy enough to recruit preparers who have their own IRS identification numbers so that fraudsters’ identities remain anonymous. This also enables them to blame other preparers when the IRS uncovers the scam.

The fraud is perpetrated in the following manner. The return preparer prepares two tax returns; one that the taxpayer is shown and one that is actually filed with the IRS. In virtually every case, the client’s copy of the return reflects a much smaller refund, if any, than the refund reflected on the actual return filed with the IRS, which the client never sees. In addition, the client usually authorizes the refund to be deposited into an account controlled by the return preparer. Once the return is filed and the refund deposited, the return preparer pockets the difference between the refunds reflected on the client’s copy of the return and the higher refund received.

The third category of unethical return preparer known as the “ghost tax return preparer” has emerged over the years and was the subject of a recent IRS warning. Ghost tax return preparers are return preparers who are paid to prepare income tax returns by the public. Even though the law provides that anyone who is paid to prepare or assist in the preparation of a tax return must have a valid Preparer Tax Identification Number (PTIN), ghost return preparers are able to avoid IRS detection by not signing the tax returns they prepare. Instead, they print the returns and instruct their clients to sign and mail in the return to the IRS. In the case of e-filed returns, they prepare but refuse to digitally sign it as a paid preparer.

Fraudulent return preparers have a total disregard for their clients or the damage done to the public trust. In many cases, taxpayers are left to pick up the pieces. If a taxpayer received a tax refund to which he was not entitled; he will be required to pay the IRS back. The problem is exacerbated in situations where the IRS does not uncover the fraud and the taxpayer has received refunds for multiple tax years.

Taxpayers may first become aware that they received a tax refund to which they were not entitled to when they receive a notice from the IRS adjusting their tax liability. In many cases, the Taxpayer will receive notices for multiple tax years. In other cases, a Taxpayer may first learn of the fraud when they are contacted by either an examiner from the IRS or a special agent from Criminal Investigation, both of whom may be investigating patterns of fraud by a return preparer.

IRS crackdown on fraudulent income tax preparers

The parade of return preparers and tax preparation services that have come under investigation by the Internal Revenue Service and Department of Justice illustrates how pervasive tax preparer fraud is. In 2016, federal prosecutors shut down more than 70 Liberty Tax Franchises for improprieties related to filing fraudulent returns and over inflating refunds. Prior to this time, another 60 locations which were subject of multiple federal lawsuits shut down or were enjoined by a federal court from further operation. In December of 2018, the Department of Justice and Internal Revenue Service launched an investigation into the Franchise, Liberty Tax Company, who is responsible for the sale and operation of its franchise locations throughout the United States. The investigation is ongoing. In addition, civil lawsuits have been filed in an attempt to deal with unethical return preparer practices.

In April of 2017, a class action lawsuit was filed in the United District Court for the Central District of California against Jackson Hewett, Inc. and a number of its franchisees alleging that the Defendants obtained thousands of dollars from the IRS in the name of the Plaintiffs. In order to carry out the fraudulent scheme, the Defendants would provide its customers with a copy of a tax return that differed from the return that was actually filed. The returns that were filed with the IRS artificially reduced the clients’ federal tax liability, resulting in tax refunds being generated.  The clients were unaware of the scam, since the defendants instructed the IRS to deposit the tax refunds into accounts the defendants controlled, all without the clients consent.

Attempts by the IRS and Department of Justice to curb these abuses have resulted in both criminal prosecutions and civil actions designed to enjoin the fraudulent return preparer.

On March 20, 2019 a Charlotte, North Carolina return preparer was sentenced to 24 month in prison for assisting in filing false tax returns. According to the Court documents, the return preparer was able to increase the tax refunds her clients received by claiming false refunds and reported income and expenses for fictitious businesses in order to claim the Earned Income Tax Credit. The fraudulent returns filed by the defendant resulted in a tax loss to the IRS in excess of $500,000.  In a separate prosecution, a Raleigh man was indicted and charged with conspiracy to defraud the United States and 14 counts of aiding and assisting in the preparation of fraudulent returns. Among the illegitimate items claimed as deductions, the defendant claimed false education credits.

In another case, Pennsylvania man was sentenced to 12 months in prison for filing false returns and conspiring to defraud the U.S. Government. The defendant, together with a co-conspirator was convicted of preparing fraudulent tax returns during the 2007 and 2010 tax years by falsely claiming employee business expenses and other nondeductible expenses. The false deductions resulted in claims for inflated refunds. The court noted that the refunds were specifically inflated as a means to grow the defendant’s tax practice.

In March of 2019 a Texas Federal Court permanently enjoined Jhane Broadway, a Dallas Texas return preparer individually and doing business as Jeprofessionalz (aka MaxTaxPros) from preparing federal income tax returns for others. In this particular case, the Government was able to establish that the tax return preparer prepared false returns that understated the tax liabilities of her clients by claiming false, improper or inflated deductions, including fabricated itemized deductions and Schedule C business losses. On the same day, a Federal Court in Beaumont, Texas entered a permanent injunction against another female return preparer, barring her from preparing federal tax returns for others. In entering the order, the Court found that the return preparer made fraudulent claims for the Earned Income Tax Credit, the fuel tax credit and the American Opportunity Credit. In addition, the Court found that the return preparer reported fictitious business and inflated federal income tax withholdings on her client’s tax returns.

Based upon the tax court rulings in Allen and Finnegan, a taxpayer who used a fraudulent return preparer could be in for trouble, particularly if the taxpayer used the same preparer for a number of years, since the statute of limitation for assessments is likely to remain open. Moreover, if you used a fraudulent preparer, there is a good chance you will be subject to the accuracy related penalty. For those sophisticated taxpayers who participated in the fraud you may be subject to the civil fraud penalty and possible criminal prosecution.

The takeaway here is that as a consumer, you need to conduct some due diligence prior to selecting a return preparer. You should never engage an unlicensed individual, since there is little recourse available in the event of a problem. Finally, if you have been caught up in an IRS investigation related to your returns, it is time to contact an experienced and knowledgeable tax lawyer. If ever there was an appropriate term then it is “Caveat Emptor,” which means “Let the Buyer Beware.”




Reporting personal expenses as businesses expenses on a tax return

business tax deductions 2The justification for purchasing that $75,000 Mercedes, Rolex watch or other luxury item, paying for an expensive vacation, making monthly mortgage payments on one’s personal residence, and paying for home improvements then deducting these expenditures as ordinary and necessary business expenses is sometimes based upon  a sense of entitlement.  In other instances, a business owner who claims deductions for personal expenses may feel justified in financially ingratiating himself based upon a mistaken belief that the sole predicate for tax evasion is the under-reporting of gross income. Nevertheless,  a misunderstanding of the tax rules pertaining to reporting of income and expenses in connection with the operation of a trade or a business or the IRS definition of “Income Tax Evasion”  does not justify cheating the U.S. Government.

The IRS is well aware that business owners and those who are self-employed are in a unique position. Unlike a salaried employee who receives a W-2 or a retiree who is issued a Form 1099R in connection with a pension distribution, business owners have the ability to determine their income tax liability. The absence of third party reporting to the IRS makes this possible.  Although the U.S. Tax System is a voluntary system, the IRS is aware that business owners routinely pay personal expenses from their business accounts and thereafter deduct those expenses as if they were associated with the operation of a trade or a business.

While a  criminal tax prosecution of a business owner can include the failure to file returns or the under-reporting of income and the overstatement of business deductions, many business owners assume that tax evasion is only associated with  income side of the ledger. Nothing could be further from the truth. I.R.C. Section 7201 defines income tax evasion, in pertinent part, as the willful attempt “in any manner to evade or defeat any tax imposed by this title or the payment thereof. . . .” Id.

In addition to tax evasion, business owners, who are caught cheating on their business and/or personal tax returns are oftentimes charged with other crimes  such as Conspiracy to Defraud the United States, money laundering, filing a fraudulent tax return, or theft of government funds.

In an effort the promote compliance, the IRS provides qualifying business owners who have routinely deducted their personal expenses or otherwise cheated their returns with an opportunity to come clean. While there is no guarantee of non-prosecution, a business owner who makes a complete and honest disclosure is more likely to avoid jail time than if he waits for the IRS to discover his nefarious conduct. The IRS Voluntary Disclosure Practice is not suited for everyone. Each case must be carefully evaluated based upon the facts, the taxpayer’s history with the IRS and whether other non-tax laws have been violated.  A taxpayer who has otherwise had a clean tax history may be looked upon more favorably than someone, who had prior problems with the IRS or was under criminal investigation for a non-tax crime (i.e. securities fraud).

Detection of fraudulent business deductions by IRS

The IRS detection of fraudulent business deductions can occur in a number of ways:

  • The first and most obvious way is when a business or an individual is selected for examination by the IRS. Detection can also occur in cases where there are unpaid payroll taxes by a business and the IRS is conducting an investigation to determine whether to assess the Trust Fund Penalty against an individual considered to be a “responsible person.”
  • Where a business is owned by multiple parties, the examination of one principal can potentially lead to the examination of other principals in the business. In other cases, a disgruntled employee, who was passed over for a promotion or a bitter ex may serve as the catalyst for an IRS examination of a business owner’s questionable business practices.
  • On occasion, the IRS has been able to detect illegal deductions of personal expenses by a business through an outside tax preparer. In this case, an outside tax preparer involved in the preparation of the business owners’ business and personal income tax returns is identified by the IRS to be engaged in systematic and pervasive pattern of preparing false returns for business and individual taxpayers.
  • Another way in which the IRS may discover illegal business deductions is through court filings, such as a bankruptcy, divorce, business litigation or post judgment liquidity determination.
  • Nondeductible personal expenses are sometimes discovered as a result of a companion investigation related to mortgage or bank fraud. It is not uncommon to find that a business owner has submitted fabricated and unfiled personal and business income tax returns inflating the bottom line for his business as a basis for securing a business or personal loan, while at the same time, either failing to file or filing false returns with the IRS reflecting tax losses.
  • Finally, social media, statements contained on a business website, the use of analytics by the IRS and cyber security breaches have provided the IRS with a treasure trove of evidence that business owners routinely deduct personal expenditures as business expenses.

Criminal cases

The landscape is littered with those who have tried to game the system and paid dearly. The recent criminal charges  filed in Los Angeles against attorney, Michael Avenatti, illustrate the point. Avenatti’s meteoric rise in notoriety was due, in part, to his representation of porn star, Stormy Daniels, his 147 appearances on CNN and MSNBC as well as his announcement of a possible Presidential bid in 2020. Avenatti’s current legal problems originated, in part, from unpaid employment and personal taxes, submitting fabricated business and income tax returns in connection with bank financing and his lavish lifestyle. In fact, Avenatti failed to file personal and business income tax returns for multiple years. Specifically, Avenatti provided a false 2012 business return for his law firm, reflecting approximately $11.5m in gross revenues and net income of $5.8m (Id. at Page 184). In sharp contrast, the actual business return filed with the IRS for 2012 reflected approximately $6.2m in gross revenue and a $2.1m loss. The tax loss was generated, in part, by significant personal expenses that were deducted as ordinary and necessary business expenses on the law firm tax return.

During the past 25 years, I have been tasked by various clients who were a party to business, matrimonial and bankruptcy proceedings to review business and personal tax returns where fraud was suspected. I have also represented dozens of business owners who have been subject to IRS scrutiny with respect to the deduction of personal expenses as business expenses.

In this regard, my office has reviewed hundreds of business and personal income tax returns of litigants and clients who were self-employed. In many cases, I concluded that the business owner engaged in a rampant and systematic pattern of deducting expenditures for personal expenses as ordinary and necessary business expenses. I have also encountered this pervasive practice during the due diligence phase involving the valuation and sale of a business.

Personal expenses deducted as business expenses

Personal expenses that have been deducted as ordinary and necessary business expenses by business owners have included, but are not limited to:

  • A business owner who was engaged in an oil and gas drilling business constructed a garage at his home at a cost of $350,000. The garage which included a two bedroom upstairs apartment, auto lifts and service bays, was used for servicing and storing the business owner’s collection of vintage automobiles and motorcycles. The proceeds to build the garage came from the corporate business account. The cost of the building was recorded on the books of the business, as if the business owned the garage. The business capitalized the cost of the building over the useful life of the building, reflecting depreciation expense on the business income tax returns. In addition all the costs associated with maintenance of the garage as well as the salary of a full time service mechanic were deducted by the business. Finally, the individual’s automobile and motorcycle collection and related costs were all carried on the corporate books and written off, despite the fact that these assets were titled in the owner’s name, individually.
  • A beach front condominium was purchased for $1.2m by a prominent personal injury lawyer. He and his family used the condominium exclusively as a vacation home. The cost of the condominium was depreciated by the business. In addition, the business owner deducted all of the carrying cost including mortgage, taxes, insurance and HOA fees as ordinary and business expenses for his law practice.
  • A South Florida Certified Public Accountant, who was engaged in the business of providing financial expert testimony during court proceedings, used the funds from his practice to finance a long term extramarital affair. The expenditures included regular trips to Las Vegas, and the Bahamas, the purchase of a $65,000 BMW for the business owner’s girlfriend, multiple shopping trips and the purchase of luxury personal items, as well as the expenses associated with the rental of a penthouse apartment on Brickell Avenue in Miami. All of these personal expenditures were deducted by the business as ordinary and necessary business expenses. Subsequently, the business owner’s wife discovered the affair and filed for divorce. Her divorce attorney retained my office to review the husband’s finances. As part of the divorce proceedings, the business owner was required to provide his business and personal tax returns as attachments to his financial affidavit as well as copies of his business and personal bank statements. These documents were relevant in the context of equitable distribution, alimony and child support.
  • In the early nineties, a South Carolina Real Estate Developer and its principals were sued for bank fraud by a New Jersey lender in connection with a failed real estate project in Atlantic City. A judgment in excess of $18m was entered in favor of the bank. As part of its collection efforts, my office was retained to evaluate the potential for recovery against the developer and its principals. In this regard I reviewed the business and personal income tax returns as well as the business financial statements and bank records, which were submitted to the bank as part of the loan approval process. The returns submitted to the bank reflected robust earnings and substantial liquidity, including cash, trading accounts and work in process. Pursuant to a court order, my office secured the actual business returns submitted to the IRS. In sharp contrast to the information submitted to the lender, the business returns filed with the IRS reflected significant operating losses. The losses were created in part due to the inordinate number of personal expenses that were paid from and deducted by the business as ordinary and necessary business expenses. During my examination of the business returns, my office was able to determine that one of the principals had a son at Cornell Medical School and a daughter who was attending college in Lucerne, Switzerland. In addition, the son had full time use of a luxury company car. The tuition and all expenses were being funded by the corporate entity with the costs deducted on the corporate returns as continuing education, professional conferences and other professional fees. In addition, two of the other business principals, who happened to be brothers, paid all of their personal expenses out of the business and had full time use of luxury automobiles leased by the business. Perhaps the most outrageous expenditure involved cosmetic surgery for the brothers’ wives, which were deducted as “consultant’s fees” on the business return.
  • A Brownsville, Texas couple, who jointly owned a lucrative internal medicine practice, routinely deducted annual business losses associated with a cattle breeding business operated from their home. The losses were generated in part based upon personal expenses that were paid from the cattle breeding business, and thereafter, deducted as ordinary and necessary business expenses on Schedule F of the taxpayers’ personal income tax returns. The initial IRS examination resulted in the disallowance of the losses associated with the cattle breeding business and the imposition of the 75% civil fraud penalty for a period of three years. However, the taxpayers’ problems did not end there. At the conclusion of the IRS examination a referral to criminal investigation was made. While the taxpayers were successful in avoiding criminal prosecution, the time spent aware from their medical practice and the costs associated with their choices resulted in their filing personal bankruptcy as well as a bankruptcy for their medical practice. Ultimately, the couple separated and divorced.

The above examples illustrate that business owners, who engage in the illegal practice of deducting personal expenses as a means of under-reporting their federal tax liability, paid the price for their actions. Deducting personal expenditures as business expenses, at least circumstantially, is probative evidence that a business owner willfully intended to cheat the government and can result in substantial civil and criminal penalties as well as the possible loss of freedom. Even in cases where a business owner reports all of his gross receipts on his business or personal return, claiming personal expenses as ordinary and necessary business deductions can result in more than merely the IRS disallowing the deductions.

Today, we are subject to heightened scrutiny due to social media, the legal and illegal exchange of financial information and cyber security threats. In addition, rarely if ever, do business owners engage in this unlawful practice without knowledge by a third party, such as a partner, employee, spouse or girlfriend, who may be able to corroborate the fraud.

In the past, business owners were able to enjoy the benefits of deducting personal expenses as business expenses in order to defeat the assessment and collection of income taxes. That is no longer the case. If you are concerned about your potential exposure, now is the time to consider coming forward. In some, but not all cases, there is a potential to right the ship by making a complete and honest disclosure. Depending upon your circumstances and particular facts of the case, utilizing the IRS Voluntary Disclosure Practice may be an alternative to jail time. While some taxpayers cite the low number of Department of Justice criminal tax prosecutions as justification for rolling the dice, any business owner who has been prosecuted and convicted for tax and other related crimes will tell you that it was not worth it. IRS tax prosecutions can result in financial ruin, loss of earnings, divorce, family break-up, bankruptcy and, in extreme cases, suicide.

In the 25 plus years I have been representing taxpayers, I have yet to find one that has since departed this earth who was able to take it with him. Ultimately, it is about the choices we make in life.



©April 5, 2019


Promises Too Good To Be True

Fraudulent Tax Resolution Co.In 1931, the famous jurist, Benjamin Nathan Cardozo, in discussing fraud stated that: “Fraud is the pretense of knowledge when knowledge there is none.” Ultramares Corp. v. Touche, 255 N.Y. 170, 179, 174 N.E. 441, 444 (1931). This famous quote has withstood the test of time and is particularly relevant to the tax resolution industry and the rampant fraud perpetrated upon the public each day.

Tax resolution or tax settlement firms are firms that advertise that they have tax experts who are capable of negotiating a settlement with the IRS for pennies on the dollar.  In all but limited circumstances, the IRS will insist on full payment. The IRS offers Installment Agreements and Partial Payment Arrangements. In addition, a taxpayer who is in financial dire straits may qualify as being “noncollectable” thereby suspending IRS collection efforts. In rare circumstances, a taxpayer may be able to reduce the amount that he or she has to pay in order to settle up with the IRS.

False claims are repeated on late night TV, the radio, print ads and the internet. The constant barrage of advertising usually includes assertions that tax attorneys, certified public accountants and former IRS employees are on staff and are prepared to lead the charge on your behalf. In reality, most of these charlatans are merely sales people reading from a script designed to separate you and your hard earned money. Make no mistake, these enterprises are “boiler room” operations engaged in the unauthorized practice of law and operate in violation of federal and state consumer protection laws

Every year, I receive inquiries from taxpayers who have been scammed by one of the many tax resolution companies out there. In each case, the taxpayer paid a tax resolution company anywhere from $3,000 to $10,000 and received nothing in return. Consequently, the taxpayer’s tax problem was not resolved.

Offer in Compromise (OIC)

When a tax resolution company claims that they can settle IRS debt for pennies on the dollar, they are referring to what is known as an Offer in Compromise (OIC). Offers are rarely successful for a number of reasons. First, the documentation is substantial. Second, there is a high level of IRS scrutiny when reviewing an Offer. Finally, whether an Offer is accepted is based upon objective criteria including income and expenses, assets and liabilities and the time remaining under the statute of limitations for collections.  The notion that a representative from a tax resolution company is going to march into an IRS and negotiate face to face is nothing less than absurd and conjures up the vision of a personal injury attorney negotiating the settlement of a slip and fall case with an insurance carrier.

Tax liens & Levies

These Companies utilize aggressive sales tactics and typically represent that they can have tax liens removed from public record and also remove levies. While it is possible to have a tax lien withdrawn in certain cases, the IRS will generally not subordinate its claims against a taxpayer. Nevertheless, tax resolution companies boast that they have the ability to magically have liens and levies released.

Many Taxpayers have told me that when they asked for a refund, the Company told them to go pound salt or engaged in dilatory tactics, thus avoiding having to refund the client fees.  The most extreme case I handled involved an offshore disclosure where the Taxpayer paid a Tax Resolution Company over $45,000. The Company did nothing, except obtain the Taxpayer’s transcripts from the IRS exposing the Taxpayer to significantly greater penalties than would have been assessed had the Company taken appropriate action.

Tax resolution companies’ business model

The tax resolution business model compensates most of its employees based upon commission, which is an invitation for misrepresentations to the public, since the goal is to sign as many individuals as possible, irrespective of the facts surrounding a particular tax case. The sales people are well trained to tell anyone who calls that their case can be settled for a fraction of the outstanding tax debt. These assurances are generally made without ever reviewing a document or interviewing the client. Consequently, false advertising and representations are the order of the day.

 Standards of practice

Since most of these scammers are unlicensed they operate outside the State Bar Ethics Rules, State Regulations governing Certified Public Accountants or Circular 230 all of which proscribe standards of practice, ethics and continuing professional education. The Department of the Treasury, Office of Professional Responsibility handles consumer complaints, as they relate to those subject to Circular 230, which includes attorneys, certified public accountants and those enrolled to practice before the IRS.

There has been ongoing debate in terms of who is subject to Circular 230 particularly in light of Loving v. Internal Revenue Service, a 2014 decision. In Loving the U.S. Court of Appeals held that a Department of Treasury rule governing a “tax return preparer,” (which is defined as a person who prepares tax returns for compensation) exceeded IRS rule making authority. The 2011 regulations required a tax return preparer to register with the IRS, pay a fee and pass a qualifying exam.

Karen Hawkins, former Director of the Office of Professional Responsibility, asserted that

“there is no doubt that OPR has jurisdiction over the tax debt resolution industry and those working in it.” OPR Targets Debt Resolution Industry in Campaign Against Sanctionable Practices. Since OPR only reports the names and professional designation of those who are disciplined by the OPR, it is difficult to assess the number of individuals who are engaged in the tax resolution business who have been sanctioned.  In addition, an integral part of tax resolution involves tax return preparation including original and amended tax returns. As such, the OPR’s assertion that they have jurisdiction over the tax resolution industry is suspect.

Legal actions against tax resolution companies

In addition to the OPR, some states have taken legal action against tax resolution companies. In September of 2017 the State Attorney General for the Commonwealth of Virginia filed a lawsuit against Wall & Associates, Inc. (“Wall”) alleging that the Company misrepresented its tax debt settlement services, while at the same time they collected large retainers and monthly payment from their victims. The lawsuit alleges that Wall violated Virginia’s Consumer Protection Act by deceiving consumers by claiming that Wall’s average client settled his or her IRS debt for 10% of the total amount. The complaint further alleges that the Company made false claims concerning the tax related experience, qualifications and abilities of its employees, including characterizing sales people as “tax consultants” or “tax experts” and claiming that Wall’s employees were authorized, qualified or certified to practice before the Internal Revenue Service or state tax authorities when they were not. Id.

In December of 2018, the Attorney General for the State of Minnesota sued Wall alleging that the Company  violated Minnesota’s consumer protection laws by failing to register with the state and collecting large advance payments, while remaining unresponsive to customers.

Other honorable mentions include the television “Tax Lady” Roni Deutch, who was sued in 2010 by the State of California for swindling thousands of consumers who were facing serious IRS problems. Other Companies such as JK Harris and Tax Masters were subject to multiple suits for deceptive practices and elected to file for Bankruptcy.  Needless to say, these firms are no longer in business. In fact it is estimated that some 109 tax resolution companies have gone out of business from 2001-2011.

If you are contemplating retaining a professional in order to resolve your tax debt, you should only hire a duly licensed tax attorney who has the requisite training and experience to assist you in achieving closure with the IRS.  If you do your homework, you can find a tax attorney whose fees are commensurate with the fees charged by the scammers.


By: Anthony N. Verni, Attorney at Law, Certified Public Accountant

© March 29, 2019.

Large Tax Refunds: Are they too good to be true?Ghost tax preparers

The IRS has long cautioned taxpayers against using disreputable tax return preparers. In a recent announcement, the IRS warned taxpayers against using “Ghost Preparers” to prepare their tax returns. A Ghost Preparer is a variation of a disreputable tax preparer. These preparers target mostly immigrants who have just arrived in the U.S. and low to moderate wage earners, who often rely upon a referral from a friend or relative who previously received a large tax refund. Unbeknownst to the taxpayers, they are unwittingly committing tax fraud. Taxpayers who are unfamiliar with the U.S. system of taxation may not understand that they are responsible for the content of their tax returns, which they sign under penalty of perjury. Consequently, any false statement contained in a tax return is the ultimate responsibility of the taxpayer and can lead to unintended results including the assessment of additional tax, interest and penalties, as well as a referral to Criminal Investigation of the Internal Revenue Service.

The following discussion reinforces the point that you should stay clear of those who promise unusually large tax refunds and only hire a licensed Attorney, CPA or Enrolled Agent.

Ways Ghost tax return preparers defraud the IRS

Return preparer fraud and inflated refund claims are two of the IRS “Dirty Dozen” tax scams and have been the focus of the Internal Revenue Service for the past several decades. While technological advancements and the use of analytics have enabled the IRS to identify patterns of fraud associated with the fraudulent preparation of federal income tax returns, fraudulent return preparers continue to prey upon innocent taxpayers.

A disreputable tax preparer is a tax return preparer that promises and typically generates large tax refunds on behalf of its clients by fraudulently preparing income tax returns. The scheme involves making up deductions such as employee business expenses, investment advisory expenses, and other miscellaneous Schedule-A deductions.

They also fabricate medical expenses, charitable contributions and other itemized deductions. In certain cases, an unscrupulous return preparer will claim fictitious dependents to take advantage of or increase the refundable portion of the Child Tax Credit. In other instances, these fraudsters will create a fake taxpayer business and include made up income and expenses on Schedule C in order to maximize the Earned Income Credit. In extreme cases, these return preparers will create fictitious W-2’s utilizing phony federal taxes withheld in order to increase the tax refund.

Often times, the fraudulent return preparer will have the client’s tax refund deposited into an account over which the return preparer has control over. The return preparer will then retain a percentage of the refund or a pre-agreed upon flat fee and thereafter remit the balance to the client. In other cases the fraudulent return preparer will give the client a refund based upon the correct tax liability and pocket the difference generated by refund from the fraudulent return.

The traditional fraudulent return business will generally operate in the form of a corporation or limited liability company with a nominee named as the principal in order to mask the identity of the true owner. More often than not the True Owner is on the IRS radar for past transgressions and may be the subject of an injunction or prior criminal prosecution.

In many respects, the business may appear to be legitimate and will include a store front, phone number and website. As part of the scheme, the business will also have a Federal Employer Identification Number, Preparer Tax Identification Number (PTIN) as well as an Electronic Return Originator Number.  Unfortunately, these identification numbers are in the name of someone other than the true principal and, in some cases, have been stolen.

In response to the recent criminal prosecutions of and civil injunctions issued against unethical return preparers, the Ghost Preparer has emerged as the business model of choice for fraudsters. The Ghost Preparer is similar in many respects to the traditional fraudulent return preparer. The Ghost Preparer makes up deductions, claim credits and create fictitious income in order to maximize the client’s tax refund.  However, the Ghost Preparer differs in several respects.

The Law

Under the law, anyone who receives compensation for preparing a tax return, must have a valid (PTIN) and must sign the return. Unlike his unscrupulous colleagues, a Ghost Preparer does not sign the tax return and   omits any information which could provide the IRS with an audit trail. He will generally instruct the client to sign and mail the return to the IRS. In cases where the return is submitted electronically, the Ghost Preparer will submit the return as “self-prepared.”

The Ghost Preparer insists on cash payment for his services. In other cases, he may have the client authorize the IRS directly deposit the client’s tax refund into an account the Ghost Preparer has control over. Once the refund is received, the Ghost Preparer deducts his fee and remits the balance to the client.

Initially, clients are delighted with the huge refund they are receiving and are quick to the relay their good fortune to their friends and relatives. In turn, friends and relatives flock to the Ghost Preparer in hopes of also receiving a large tax refund.  The process is generally repeated for a period of three or four years before the IRS identifies the irregularities and contacts the taxpayer.

What happens next?

Long after the tax refunds have been spent on a home theater system, vacation and down payment on a new automobile, the taxpayer receives a Notice of Adjustment from the IRS advising him that he now owes $48,745.68 in additional tax, penalties and interest for a three year period. After the taxpayer picks himself off the floor, he contacts the Ghost Preparer only to find that the Ghost Preparer has moved on to greener pastures. Further inquiry reveals that the Ghost Preparer used a fictitious name. Since the tax return was deemed “self-prepared” the taxpayer is left holding the bag.

The taxpayer’s problems are often exacerbated where multiple years are involved and the total additional tax, penalties and interest exceeds $50,000.  A permanent lawful resident of the United States who has recently filed for Naturalization may suddenly find their application denied or subject to an indefinite delay in processing. In addition, a taxpayer may find his or her passport has been revoked or the subject of a Notice of Federal Tax Lien. In extreme cases, a taxpayer may also become the subject of an IRS criminal investigation and subject to deportation.

The fraudulent tax return industry has been able to flourish, in part, due to lack of oversight. Practice before the Internal Revenue Service is limited to Attorneys, Certified Public Accountants and Enrolled Agents who are governed by Circular 230. Unfortunately, tax return preparation is not limited to those who are subject to Circular 230. Consequently, anyone can prepare income tax returns including those intended on defrauding the IRS without having to adhere to the professional guidelines.

Financial and emotional cost related to being scammed by a Ghost Preparer, can be devastating and life changing.  If you have been receiving unusually large refunds, it may be advisable to have a professional take a second look to determine if you are the victim of a fraudulent return preparer. There are steps that can be taken to mitigate the impact of filing such returns.

The takeaway here is that you should only hire an Attorney, CPA or enrolled agent to prepare your federal tax return. In most cases, the preparation fees are no more than the fees charged by those not subject to Circular 230.



 Termination of OVDP and way forward

Following the termination of the Offshore Voluntary Disclosure Program (OVDP) on September 28, 2018, willfully delinquent taxpayers with exposure to criminal prosecution were left without an option for coming into tax and financial reporting compliance. Termination of the Program was due, in part, to the fall off in the number of delinquent taxpayers coming forward. The closure of the Program has caused some non-compliant filers to erroneously conclude that they are in the clear. Quite the contrary, the IRS is resolute in its commitment to ferret out and prosecute those who are engaged in offshore tax evasion and who continue to secrete funds overseas in order to avoid detection by the IRS. The IRS response to 2014 OVDP FAQ Number 4 makes this clear:

“Stopping offshore tax noncompliance and evasion remain top priorities of the IRS. The IRS enforces offshore compliance with tax and FBAR requirements using information received under the Foreign Account Tax Compliance Act (FATCA), the network of intergovernmental agreements between the U.S. and partner jurisdictions, automatic third-party account reporting, and other data-rich sources such as the Department of Justice’s Swiss Bank Program and various John Doe Summonses. The IRS leverages information resources using enhanced data analytics to continue to make it more difficult to evade tax by hiding offshore.”

Recognizing that the termination of the OVDP created a vacuum for individuals who are otherwise ineligible for either the Offshore or Domestic Streamlined Procedures, the IRS issued an Interim Guidance Memo on November 20, 2019 announcing the initiation of new Voluntary Disclosure Practice (VDP). However, the VDP is not a new iteration of the 2014 OVDP, but rather a modification of the existing VDP. Although the penalties under the VDP are significantly more severe than under the OVDP, the Practice still provides the taxpayer with an alternative to criminal prosecution. Making a voluntary disclosure does not guarantee non-prosecution, but can certainly enhance a taxpayer’s chances in most cases. Furthermore, in limited circumstances it may be possible to reduce the penalties.

The discussion that follows will shade light in understanding the new Voluntary Disclosure Practice that enhances a taxpayer’s chance of in the event of criminal prosecution. This discussion outlines the history of Offshore Voluntary Disclosures, filing requirements and penalty structure under the 2014 OVDP in comparison to the outline and essential elements of the VDP (Voluntary Disclosure Practice).

The History of Offshore Voluntary Disclosure Program (OVDP)

 From 2003 to 2018, the IRS has initiated four offshore programs permitting taxpayers to come forward and disclose their offshore accounts and pay delinquent taxes, interest and penalties. The first of the four initiatives was offered in 2003 and was related to the offshore Credit Card Project (CCP) the IRS pursued starting in 2000. The IRS served “John Doe” summonses on major credit card companies seeking records on foreign bank accounts, but by the time the agency gathered enough data to place files in the hands of revenue agents, most cases had approached the end of the 3-year statute of limitations period for assessment. It was around the time of this project, in 2003, when the IRS announced its first “Offshore Voluntary Compliance Initiative” (OVCI) in order to get taxpayers to come forward and “clear up their tax liabilities.” The 2003 OVCI resulted in $75 million dollars in taxes paid by taxpayers who participated.

The next program took place in 2009 in conjunction with a crackdown on offshore tax evasion involving Swiss bank accounts, specifically those held at Union Bank of Switzerland (UBS). The U.S. government compelled UBS to name its U.S. clients and ended up charging the bank with “conspiring to defraud the United States by assisting account holders in evading the IRS.” Following this suit, the IRS announced its 2009 Voluntary Disclosure Program and collected $3.4 billion from 15,000 disclosures. The window of opportunity that taxpayers had to come forward was from March 23, 2009 to October 15, 2009.

After the close of the 2009 OVDP, taxpayers continued to seek compliance in regards to their offshore accounts and as a result, on February 8, 2011, the IRS announced its 2011 Offshore Voluntary Disclosure Initiative (OVDI). The agency reported that almost 12,000 disclosures were made under the 2011 OVDI.

In 2012, the IRS announced the fourth iteration of the disclosure program. Unlike the previous initiatives, the OVDP was to remain open indefinitely. Under the 2012 OVDP, individuals voluntarily disclosing offshore bank accounts were assessed a 27.5 percent miscellaneous offshore penalty on the highest aggregate account or asset balance for the prior 8 years, i.e. 2003-2010 (“disclosure period”). Taxpayers participating in the Program were also required to amend or file Federal Income Tax Returns for the prior eight years and pay any income tax due and owing, together with an accuracy penalty of 20% and interest. Participants in the OVDP would, however, not be subject to other tax penalties such as the civil fraud penalty, filing late penalty, late payment penalty and others.

The 2014 Offshore Voluntary Disclosure Program

On June 18, 2014 the IRS announced modifications to the 2012 Program including transitional treatment for taxpayers currently participating in OVDP who met the eligibility requirements for the expanded Streamlined Filing Compliance Procedures announced on June 18, 2014. The modification to the OVDP provided certain taxpayers with the opportunity to remain in the OVDP while taking advantage of the favorable penalty structure of the expanded Streamlined Procedures.

On March 13, 2018, the IRS announced that it would begin to wind down the OVDP and that the Program would close on September 28, 2018. In announcing the closure of the OVDP, the IRS lauded the success of the Program by stating that:

“Since the OVDP’s initial launch in 2009, more than 56,000 taxpayers have used one of the programs to comply voluntarily. All told, those taxpayers paid a total of $11.1 billion in back taxes, interest and penalties. The planned end of the current OVDP also reflects advances in third-party reporting and increased awareness of U.S. taxpayers of their offshore tax and reporting obligations.” March 13, 2018 IRS Announcement

In its announcement, the IRS also cautioned that they will continue with their domestic and global enforcement efforts:

“The IRS notes that it will continue to use tools besides voluntary disclosure to combat offshore tax avoidance, including taxpayer education, Whistle blower leads, civil examination and criminal prosecution.” Id.

History of the Voluntary Disclosure Practice (VDP)

 The concept of making a voluntary disclosure has been in existence in one form or another for quite some time. Generally, the Practice has been used in domestic tax cases. The VDP permitted taxpayers with criminal exposure an opportunity to come into compliance and possibly avoid criminal prosecution. I.R.M § Under the VDP,the IRS considers a voluntary disclosure “timely” if they received the disclosure prior to the initiation of an investigation or examination and prior to the receipt of information from either a third pay or another criminal enforcement agency concerning a taxpayer’s non-compliance. In addition to the requirement that the taxpayer’s disclosure be truthful and complete, the VDP is limited to legal source income.

With the termination of the OVDP and the November 20, 2018 announcement, the VDP is now applicable to both domestic and offshore disclosures. It should be noted that the VDP is effective for voluntary disclosures received after September 28, 2018. The Interim Memo provides that all voluntary disclosures received or postmarked by September 28, 2018 would be handled under the 2014 OVDP procedures. Finally, the Interim Memo provides that the IRS has discretion with respect to domestic voluntary disclosures received or postmarked on or before September 28, 2019 to apply the new VDP.

Under the new Practice, a taxpayer seeking to make a disclosure is required to make a pre-clearance request on Form 14457 and submit the request to Criminal Investigation (CI) of the IRS, who is tasked with screening all voluntary disclosure requests including offshore and domestic to determine if the taxpayer is eligible to make such a disclosure.

Once CI grants a taxpayer pre-clearance, the taxpayer must promptly submit all required voluntary disclosure documents using Form 14457. The revised Form 14457 will require the taxpayer to provide information related to non-compliance including a narrative that contains the facts and circumstances surrounding the noncompliance, as well as the disclosure of the taxpayer’s assets and any entities and/or related parties involved. The Form also requires the taxpayer to provide the name of any professional adviser, including but not limited to, accountants, lawyers, bankers and investment advisors that facilitated the taxpayer’s non-compliance in any manner.

Upon receipt of the taxpayer’s voluntary disclosure, CI has the option of granting or denying the taxpayer’s request for preliminary acceptance. If CI grants the taxpayer’s request, CI will notify the taxpayer in writing of preliminary acceptance and contemporaneously forward the preliminary acceptance letter and attachments to the Large Business and International (LBI) Unit of the IRS in Austin, Texas. The LBI Unit will determine the most recent year in the disclosure period, and thereafter forward the case to the appropriate “Operating Division and Exam for civil examination.” Id.

The new Practice includes a six year disclosure period and requires examination of the most recent six years of a taxpayer’s Federal Income Tax Returns. The VDP also permits the examiner to extend the scope of the examination to include other years of non-compliance. In certain instances, a taxpayer who cooperates, with the consent of the IRS, may be allowed to include additional tax years.

The taxpayer must submit all required returns as well as all FBAR reports for each year included in the disclosure period. Once all of the required returns and reports for the disclosure period are filed, the examiner will determine any additional tax, interest and penalties to be assessed. Depending upon the circumstances, the IRS will impose either the 75% civil fraud penalty under 26 I.R.C. § 6663 or the civil fraud penalty for the fraudulent failure to file tax returns under 26 U.S.C. § 6651(f) in the year of the disclosure period with the highest tax liability. In certain instances, the examiner may assert one of the two civil fraud penalties to more than one year. Where the taxpayer fails to cooperate in the resolution of the examination by agreement, the examiner may also extend the civil fraud penalty beyond the six years and request that CI revoke preliminary acceptance. I.R.M. §

The willful FBAR penalty will be asserted consistent with 31 U.S.C. §5321(a)(5)(C) which provides for a maximum penalty of the greater of 50% of the balance in the account at the time of the violation or $100,000. The willful FBAR penalty may be assessed for multiple years. In addition, the examiner has the discretion to assess additional penalties for failure to file information returns.

Although the taxpayer can request that the lower accuracy penalty (20%) under 26 U.S.C. §6662 be applied in lieu of the civil fraud penalty or that the non-willful FBAR penalty be applied rather than the willful FBAR penalties, the granting of such requests is “expected to be exceptional.” The taxpayer must establish by clear and convincing evidence that the assessment of the civil fraud penalty or the willful FBAR penalty was not justified.

Under the VDP, the taxpayer retains the right to appeal with the IRS Office of Appeals. This Practice differs from the OVDP. Unless the taxpayer elected to opt out there was no right to appeal under the OVDP.


Disclosure Period 8 years 6 Years but can be expanded
Accuracy Related penalty (assessed for each year of

additional tax liability)








Subject to taxpayer request

and clear and convincing proof
75% Civil Fraud Penalty or Civil Fraud Penalty for Fraudulent Failure to File Income Tax Returns Not Applicable 75% applied in year of highest tax liability or 15% per month or fraction thereof not to exceed 75%
Civil FBAR Penalties 27.5% of the highest Aggregate balance in Any year during the disclosure procedure The greater of 50% of the highest aggregate in the year of violation or $100,000

(Can be applied to multiple years).


 While the penalties under the new Practice rules for making a voluntary disclosure are severe in comparison the penalty structure under the OVDP, the new Practice does provide non-filers with an avenue to avoid criminal prosecution. The severity in penalties reflects the philosophy that those who have failed to come forward previously should not be rewarded for their delay. The new penalties also demonstrate that the longer you wait the more serious the consequences. Depending upon the circumstances, it may be possible to convince an IRS examiner that the penalties under the VDP are harsh and that lower penalties should be applied. In addition, individuals who do not have criminal exposure, should take advantage of either the Offshore or Domestic Streamlined Procedures where, depending upon the circumstances, the penalty will either is 0 or 5%. Failing to come forward is no longer an option. As each iteration of the OVDP and the VDP has demonstrated, the longer you wait, the more severe the penalties.


 Assessment of FBAR penalty


Some practitioners have applauded the decision in United States v. Colliot, 2018 U.S. Dist. LEXIS 83159 (W.D. Tex. 2018) and have even suggested that the assessment of the willful FBAR penalty is limited to the “greater of the amount (Not to Exceed $100,000) equal to the balance in the account at the time of the violation or $25,000.”  The Court in Colliot, ruled in favor of the Taxpayer, relying upon 31 C.F.R. § 1010.820 (Previously cited as 31 C.F.R. § 103.57), a regulation promulgated under a prior version of the Bank Secrecy Act. The U.S. District Court held that the earlier regulation was still valid, notwithstanding the changes to the FBAR penalty structure under the American Jobs Creation Act of 2004 (AJCA), which increased the maximum FBAR penalty for willful violations to the greater of $100,000 or 50% of the Balance of the Account. The Court reached its conclusion citing the absence of any new regulation adopting the higher penalty amount provided for under § 5321(a)(5).

Reliance upon Colliot is inaccurate, misplaced and inconsistent with Congressional intent. The limitation articulated by the Court in Colliot with respect to the willful FBAR penalty is in direct conflict with § 5321(a) (5) (C) (i) of the AJCA. Furthermore, the decision in Norman v United States case (Ct. Fed. Cl. Dkt 15-872T, Order dated 7/31/18) and the legislative history related to § 5321(a) (5) (C)(i) of the AJCA make clear that taxpayers who argue for the lower penalty provided for under 31 C.F.R. § 1010.820 will in all likelihood be unsuccessful. The question of whether the willful FBAR penalty is limited to the greater of $100,000 or 25% of the account balance at the time of the violation, requires a detailed discussion of Colliot and Norman, The Bank Secrecy Act and the relevant statutes and regulations as well as an examination of the legislative history and case law addressing statutory and regulatory conflicts.

Bank Secrecy Act (BSA)

On October 26, 1970 Congress enacted the Bank Secrecy Act (BSA) also known as the “Currency and Foreign Transaction Reports” to the address the legal and economic impact of foreign banking in the United States. The BSA was enacted, in part, based upon the findings by the House Committee on Banking and Currency (the “Committee”). Following a one day investigative hearing held on December 9, 1968, the Committee concluded that Americans were using secret foreign bank accounts and foreign financial institutions for nefarious purposes including income tax evasion, money laundering and other crimes.

As part of the BSA, Congress tasked the Treasury Secretary with the responsibility of promulgating regulations designed to facilitate the implementation of the BSA. As part of the implementation of the BSA, 31 C.F.R.§103.27, a U.S. Citizen with an interest in or control over one or more foreign financial accounts with a value exceeding $10,000 at any time during that calendar year is required to file FinCen Form 114 (previously TDF 90-22.1) with the Commissioner of Internal Revenue on or before June 30 of the following year. Although the power to assess a civil monetary penalty for FBAR violations was initially vested with the Treasury Secretary, it was later delegated to the Financial Crimes Enforcement Network (FinCEN). Treasury Order 180-01, 67 Fed. Reg. 64697 (2002). Authority was once again delegated to the Internal Revenue Service. 31 C.F.R. § 103.57.

Prior to 2004, The BSA permitted the imposition of an FBAR penalty only for willful violations of §5314. The penalty for willful violations prior to 2004 was capped at the greater of $25,000 or $100,000 under § 5321(a) (5) (B). Enforcement of § 5321(a)(5)(B) is mirrored in the regulations under 31 CFR §103.57(g)(2). Although §5314 is silent on the assessment of a negligence penalty, the regulations permit the assessment of a negligence penalty not to exceed $500.00. 31 CFR §103.57(h).

Civil FBAR penalty Amendment and willful failure

The civil FBAR penalty structure was amended in 2004 as part of the AJCA to include a maximum penalty of $10,000 for any violation of the provisions of §5314. In addition, the penalty for willful FBAR violations previously provided for in § 5321(a) (5) (B) was increased under §5321(a)(5)(C)(i), a newly created provision, to the greater of $100,000 or 50% of the of the account balance. The legislative history related to the changes to the willful FBAR penalty and the addition of the non-willful civil FBAR penalty chronicles Congressional concern over the lack of compliance in financial reporting related to offshore accounts. Congress made clear that improved compliance was the impetus behind raising the maximum penalty for willful FBAR violations:

The Congress understood that the number of individuals using offshore bank accounts to engage in abusive tax scams has grown significantly in recent years. For one scheme alone, the IRS estimates that there may be hundreds of thousands of taxpayers with offshore bank accounts attempting to conceal income from the IRS. The Congress was concerned about this activity and believed that improving compliance with this reporting requirement is vitally important to sound tax administration, to combating terrorism, and to preventing the use of abusive tax schemes and scams. The Congress believed that increasing the prior-law penalty for willful noncompliance with this requirement and imposing a new civil penalty that applies without regard to willfulness in such noncompliance will improve the reporting of foreign financial accounts.Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 108th Congress, JCS-5-05 at 387 (2005).

 Congress also created a separate provision for a civil penalty for Non-Willful violations, making a clear distinction between willful and non-willful violations. H.R. Rep 108-755 at 615 (2004) (Conf. Rep.).

 In Colliot, the IRS filed a lawsuit against Dominque G. Colliot to reduce the assessed penalties to a money judgment. The action filed in the United States District Court for Western Texas related to penalties that were assessed for willful failure to file FBAR’s for 2007-2010. The IRS assessed a $544,773 penalty for the tax year 2007 and $196,082 for the tax year 2008. Smaller penalties were also assessed for the tax years 2009 and 2010. In assessing the penalties, the IRS relied upon the authority contained in § 5321(a)(5) and 31 C.F.R. § 1010.820(g)(2). In response, Colliot filed a motion for summary judgment asserting that IRS incorrectly applied the law in calculating the civil willful FBAR penalties.

In its analysis, the Court discussed the 2004 amendment to § 5321 which increased the maximum civil penalties that could be assessed for the willful failure to file an FBAR, and in doing so, acknowledged the increase in the willful FBAR penalty to a minimum of $100,000 and a maximum of 50% of the balance in the unreported account at the time of the violations. The Court also noted the absence of any change to 31 C.F.R. §1010.820(g)(2), which caps the maximum willful FBAR penalty at $100,000. In granting Colliot’s motion for summary judgement, the Court wholly ignored United States v. Larionoff, 431 U.S. 864, 873 (1977) and instead focused on the powers delegated by Congress to the Treasury Secretary under § 5321(a)(5) to determine the amount of penalty so long as it did not exceed the ceiling set by § 5321 (a)(5)(C).

In Larionoff, the Supreme Court, citing Bowles v.Seminole Rock Co, 325 U.S. 410,414 (1945) and quoting language from the Bowles decision stated:

“In construing administrative regulations, ‘the ultimate criterion is the administrative interpretation, which becomes of controlling weight, unless it is plainly erroneous or inconsistent with the regulation”. Id. at 873.

The Court, citing Manhattan General Equip Co. v Commissioner, 297 U.S. 129,134(1936) further stated:

“For regulations, in order to be valid, must be consistent with the statute under which they are promulgated.” Id at 873.

In Manhattan General Equip Co., the Supreme Court held that:

“A regulation which does not do this, but operates to create a rule out of harmony with a statute, is a mere nullity” Id at 134.

In the Norman decision, the IRS assessed a penalty against Mindy P. Norman in the amount of $803,530 for the willful failure to file an FBAR in connection with a Swiss bank account she maintained during the tax year 2007. The taxpayer appealed the assessment with the IRS Office of Appeals, who affirmed the IRS assessment, concluding that Ms. Norman willfully failed to file an FBAR. The Taxpayer then paid the penalty in full and instituted an action In the United States Court of Federal Claims. Following a one day trial and in response to a letter sent by the Norman citing the Colliot decision, the Court of Claims, Ordered the IRS to respond and comment on Colliot. The IRS filed a timely response. However, the Court did not permit the Taxpayer to file a reply. After considering the IRS response and the trial testimony and other documents, the Court ruled in favor of the IRS and concluded that Ms. Norman willfully failed to file an FBAR in 2007 and that the assessed penalty in the amount of 50 percent of the balance of the unreported account was proper.

In arriving at its decision, the Norman Court painstakingly dissected the Colliot decision and properly pointed out the defects in the District Court’s logic in ruling in favor of the Ms. Colliot. The Court of Claims traced the legislative history of the BSA, the relevant statutory and regulatory provisions and the impact of the changes to the FBAR penalty structure as a result of the AJCA. The Court concluded that the District Court in Colliot ignored the mandate created by the amendment in 2004 and instead elected to focus on the language in §5321(a)(5) that vests the Secretary of the Treasury with the discretion to determine the amount of the penalty.

The Court of Claims cited the following language used by Congress in amending the statute as a basis for invalidating C.F.R. § 1010.820:

Congress used the imperative ‘shall’ rather than the permissive, ‘may,’ thereby raising the ceiling for the penalty, and in doing so, removed the Treasury Secretary’s discretion to regulation any other maximum.” Norman at Pg. 8.

The Norman Court cited Larionoff for the proposition that Congress has the power to supersede regulations by amending a statute. The Court stated that “in order to be valid [,] [regulations] must be consistent with the statute under which they are promulgated.” The Norman Court concluded that § 5321 (a) (5) (C) (i) which sets the maximum penalty to the greater of $100,000 or 50% of the balance of the account, is inconsistent with 31C.F.R. § 1010.820 rendering 31 C.F.R. § 1010.820 invalid.

The foregoing has particular relevance for those who have failed to take advantage of the Offshore Voluntary Disclosure Program, which is now closed, or otherwise failed to utilize the streamlined procedures and those who have made quiet disclosure and now found themselves the subject of a grand jury subpoena.  The IRS has consistently maintained that offshore financial crimes are a top priority and continues to work with its global partners in unmasking those with unreported foreign financial accounts. FATCA is also producing a steady stream of taxpayer information from which the IRS develops leads. In addition, current prosecutions of facilitators and taxpayers as well as taxpayers who have elected to come forward have yielded a treasure trove of information which the IRS is using to identify other non-compliant taxpayers.

Those who have failed to come forward and report their foreign financial accounts are more likely than not, going to be subject to the willful civil FBAR penalty consistent with Norman decision. Mitigation of the willful FBAR penalty is only possible where the taxpayer comes forward and makes an honest disclosure.

By: Anthony N. Verni, Attorney at Law, CPA.
© 1/26/2019

The Foreign Bank Account Report (FBAR) can be submitted with the advice of a tax law attorney.Case Facts.

April 3, 2018, the U.S. District Court in United States v. Garrity held that, for purposes of the assessment of the Willful FBAR penalty, the Government’s burden of proof is a “preponderance of evidence,” rather than the higher “clear and convincing” standard. The Garrity decision involved the Government suit to reduce the Willful FBAR Penalty to a Judgement. The Court also found that “the Government may prove the element of willfulness in this case with evidence that Mr. Garrity Sr. acted recklessly.” The decision is in keeping with a recent line of Court decisions favoring the Government.

In Garrity, the Government assessed the 31, U.S.C. U.S 5321(a) (5) Willful FBAR Penalty against Paul G. Garrity, Sr., who died in 2008 for his willful failure to report his interest in a foreign account he held in 2005.

Court’s response.

In the Court’s Memorandum and Order, in response to legal brief submitted by the parties, the Court rejected the Taxpayers’ argument that the civil FBAR statute is analogous to the civil tax fraud statute, requiring proof by clear and convincing evidence. The Court also rejected the Taxpayers’ argument that an internal memo by the of Office of Chief Counsel of the IRS calls for a higher standard of proof similar to the burden of proof the Service has when asserting the civil fraud penalty under 26 U.S.C.  §6663. In dismissing the Defendants argument, the Court noted that the internal memo predated any Court decision on the subject and further, opined that the internal memo was not binding on the Court.

Instead, the Court relied upon the consistent application of the preponderance of the evidence standard in a civil FBAR action established in United States v. Williams No. 09-437, 2010 wl 3473311, at *1 (E.D. Va. Sept. 1, 2010), rev’d on other grounds, United States v. Williams,489 F. App’x 655 (4th Cir 2012) and consistently followed by other Courts. (See also United States of America v. McBride, 908 F. Supp. 2d 1201-1202 (D. Utah 2012)).  Some observers have commented that the decision in Bedrosian should provide hope for the Taxpayer. However, the case is of limited value.

In Bedrosian v. United States of America, 2017 U.S. Dist. LEXIs 56535 (ED PA 2017) the District Court for the Eastern District of Pennsylvania held that the Taxpayer was not willful in his failure to report a larger account on his FBAR. However, the Bedrosian decision should be distinguished on the facts and not viewed as a departure, from Williams or McBride on the application of the criminal standard to the Willful FBAR cases or the standard of proof required to sustain a Willful FBAR penalty assessment.

Despite its ruling in favor of the Taxpayer, the Pennsylvania District Court for the Eastern District did hold that the criminal standard on willfulness does not apply in the case of a Willful FBAR Case and that the government only need show a reckless violation of the statute to apply the higher FBAR penalty. The Court also stated that the preponderance of evidence standard should apply. These principles are in keeping with the prevailing view.

The Court also rejected the Defendants argument that the Government must show that Mr. Garrity, Sr. violated a “known legal duty” in order to establish the “willful element under 31 U.S.C. § 5314 and instead applied the “reckless” criteria.

The recent Court decisions make it difficult, if not impossible, for a Taxpayer to overcome the Assessment of the Willful FBAR penalty since these decisions have emboldened the IRS.

With the recent decision by the IRS to end the Offshore Voluntary Disclosure Program in September of 2018 and the suggestion that Domestic Filing Compliance Procedures may also come to an end, the stakes for Taxpayers could not be higher.  Without question, the IRS will pursue these cases with vigor. For those Taxpayers who have yet to make a voluntary disclosure, the failure to do so could have financially catastrophic consequences in the form of the assessment of the Willful FBAR Penalty.