Tax billCitizen Based Taxation

The origins of citizen based taxation can be traced back to the Civil War and the government’s struggle to raise revenue for the war effort. The predicate for imposing such a system was based upon the notion that Americans living outside of the United States were shirking their duties to America during a crisis. As a consequence, in 1861 the Government imposed an income tax on expats. This tax that was higher than the rate charged to the Americans who resided in the United States.

The law was subsequently reformed and beginning in 1864, nonresident citizens paid the same rate as citizens residing in the United States. In exchange for equalizing the tax rates, nonresident citizens were now required to pay income tax on their worldwide income.

The rationale for imposing citizen based taxation was predicated upon a sense of duty and community membership, sentiments that carried over from the Civil War. In 1924 the Supreme Court decided that citizen based taxation was constitutional (Cook v. Tait, 265 U.S. 47 (1924).  However, instead of relying on sense of duty and community membership, the Court appeared to rely upon the inherent benefits associated with becoming a U.S. citizen, but failed to detail the benefits. Presumably, these benefits include: the right to return to the United States, the ability to participate in the American economic and social community, and the right to access U.S. Courts for redress and the right to vote.

Over the years, efforts to mitigate the impact of citizen based taxation on non-resident citizens have included the implementation of the foreign tax credit in 1918 and the foreign earned income exclusion in 1926.

Tax Fairness for Americans Abroad

U.S. expats have been lobbying for years seeking to change the current U.S. citizen based taxation system to a residency based system. In December of 2018, Republican Congressman Holding introduced a bill entitled: “Tax Fairness for Americans Abroad Act” (H.R. 7358). This bill proposes a transition from citizen based taxation system to a system that is based upon residency. The bill would amend I.R.C. Section 911 by adding a Section 911A designated as “ALTERNATIVE FOR NON-RESIDENT CITIZENS OF THE UNITED STATES LIVING ABROAD” (Id. at Pg. 2).

With the introduction of this legislation in Congress, many expats, practitioners and other observers are overjoyed at the prospect of ending the citizen based taxation, which taxes U.S. Citizens and its legal residents on their worldwide income. However, I do not believe the change will occur, at least, for the foreseeable future.

Reasons that will hinder the change in the current IRS Tax based system

The proposed amendment provides qualified non-resident citizens of the United States, who elect to be taxed as nonresident citizens, with exclusion for foreign earned income as well as foreign unearned income for U.S. tax purposes. Alternatively, an Individual can elect to continue to be taxed based upon the current citizen based system.

In addition, qualified non-resident citizens would be allowed to exclude unearned income (Gains) associated with the “sale of personal property to the extent such income is attributable to periods during which the individual was a qualified nonresident citizen. Id. at Pg. 3. Similarly, HR 7358 would amend I.R.C. Section 7701(b) by adding a new definition for the term “Nonresident Citizen.” To be considered a non-resident citizen in a given tax year an individual must: (i) be a citizen of the United States; (ii) have a tax home in a foreign country; and (iii) must otherwise be in compliance with the U.S. tax laws for the previous 3 years.

Similarly, the individual must establish that he or she has been a bona fide resident of a foreign country or countries for an uninterrupted period of one year or alternatively meet the physical presence test which requires that an individual be present in one or more foreign countries for a minimum of 330 days during the tax year. The amendment excludes Federal Employees from the definition of nonresident citizen.

It is also important to note that the prospects for passing such legislation are slim based upon the history of citizen based taxation, the Government’s investment in financial reporting, FATCA, Bank Secrecy Act, concurrent FBAR filing requirements and the political climate in DC.

One could also argue that, the proposed bill undermines the integrity of FATCA and other IRS global tax enforcement initiatives designed to ferret out overseas tax cheats.

Perhaps the most significant reason HR 7358 will fail is the upcoming presidential election in 2020. It is highly unlikely that bipartisan support for HR 7358 could be achieved in the foreseeable future, given the current legislative climate in DC. The logic is clear.  The passage of any bill introduced by a Republican would be considered a victory for the President Trump. Consequently, democrats will never get on board.

Furthermore, there are no signs that the congressional stalemate will subside following the presidential election. Quite the contrary. Political commentators predict more of the same, irrespective of who is in the White house and whether the Republicans regain control of the House of Representatives. If Trump is reelected, more investigations will certainly follow. Even if the Republicans somehow are able to regain the majority in the House, there is no certainty that anything will be accomplished. Remember! “Repeal and Replace Obamacare.”

While politicians and expats alike may consider HR 7348 promising, I am reluctant to pop the cork just yet. We will just have to wait and see. Expats who meet the filing threshold will still be required to file FinCEN Form 114 (FBAR) with respect their Foreign Financial Accounts.



Assessment of the “willful” FBAR penalty

GSA US Tax Court bldg 450x450Courts have sustained FBAR penalties by reference to case law which is inconsistent with standards and principals applied in penalty cases under Title 26, despite the punitive nature of the willful FBAR penalty.

In order for the Government to successfully assess an FBAR Penalty, they must prove the following:

  1. The Taxpayer was either a citizen or a resident or a person doing business in the United States during the relevant tax period(s);
  2. The Taxpayer had a financial interest in, or signatory authority over the foreign financial account;
  3. The foreign financial account had a balance that exceeded $10,000 during the relevant tax year(s);
  4. The Taxpayer failed to disclose the foreign financial account.
  5. The amount of penalties was proper.

Proving Willfulness in FBAR context

In the FBAR context, willfulness “may be proven through inference from conduct meant to conceal or mislead sources of income or other financial information,’ and it ‘can be inferred from a conscious effort to avoid learning about reporting requirements.” (Williams, 489 Fed. App’x at 658). In addition, in Norman v. United States, 138 Fed. Cl. 189, 194 (Fed. Cl. 2018), the Court of Claims held that a taxpayer is put on inquiry notice of the FBAR requirement when signing a return. As such, a Taxpayer who signs a return will not be able to claim innocence for not actually having read the return, since the taxpayer is charged with constructive knowledge of its contents (Jarnagin v United States, 134 Fed. Cl. at 378 (Fed. Cl 2017).

The departure from the willful standard in the Title 26 context as it relates to civil tax penalties is also found in the May 23, 2018 Office of Chief Counsel, Internal Revenue Service Memorandum. This Memorandum provides that the standard for willfulness under 31 U.S.C § 5321(a) (5) (C) is:

“the civil willfulness standard and includes not only knowing violations of the FBAR requirements, but willful blindness to the FBAR requirements as well as reckless violations of the FBAR requirements.”

The civil fraud penalty under 26 U.S.C § 6663 provides that in order to sustain the standard of proof, the civil fraud penalty has to be “clear and convincing.” Closely tied to the civil fraud penalty is the criminal tax evasion penalty under 26 U.S.C § 7201 which requires a proof beyond a reasonable doubt. While the willful FBAR penalty has it criminal counterpart in 31 U.S.C. § 5322(a), the Courts have illogically used the lower preponderance of evidence standard in willful FBAR cases despite the punitive effects of the Penalty.

While reliance upon professional advice is a valid defense in tax crimes and the civil fraud penalty, a question remains as to whether relying on a professional is a valid defense to the imposition of a willful FBAR Penalty. The viability of such a defense would require the following:

  1. The taxpayer subject to the penalty has provided all the relevant facts to the professional;
  2. After providing the relevant facts, the Taxpayer must have relied upon the advice of the professional; and
  3. The reliance must be reasonable under the circumstances.

DOJ position on using a professional advice as a defense for “Willfulness” in FBAR penalty

Given the string of government victories in the assessment of the willful FBAR penalties and current litigation, the Department of Justice is now pushing the envelope suggesting that reliance on a professional as a defense to the assessment of a willful FBAR penalty is not a valid defense. DOJ’s position is inconsistent with judicial precedent as well as administrative pronouncements.

In light of DOJ’s position, it is hard to imagine circumstances where, an argument that a professional (accountant or tax preparer) didn’t give a client advice concerning disclosure of their foreign financial accounts would be successful, especially if the client withheld all the relevant facts, for example; a case where a taxpayer answers “no” in response to question 7(a) on Schedule B as to whether the taxpayer had an interest in or was a signatory to a foreign financial account and fails to tell his accountant or fails to seek advice on whether to report a foreign financial account, Courts have generally held that such conduct constitutes “reckless” behavior, thereby meeting the “willfulness” standard (Kimble v. United States, No. 1:17-cv-00421 (Fed. Cl. 2018).

Similarly, in United States v. Dadurian, No. 9:18-cv-81276, the U.S. District Court denied the Taxpayer’s motion for summary judgment and the case was scheduled for trial for August 19, 2019. The Taxpayer had a financial interest over signatory authority over a number of foreign accounts, some of which had maximum balances over $2 million in certain years. Prior to 2007, the Taxpayer had filed FBARs in connection with her Swiss and German Accounts. According to the Taxpayer, her Tax Attorney advised her that she did not have to disclose her accounts. For the years 2007- 2010, and based upon the Attorney’s advice, Dadurian  failed to tell her new tax return preparer about the foreign assets and further declared on Schedule B, Part III, in response to question 7(a) that she did not have an interest or signatory authority over the foreign financial accounts. In arriving at its decision, the Court raised the issue as to whether reliance on a professional may constitutes reasonable cause in light of 31 U.S.C § 5321 (a) (5) (C) (ii), which provides that, “reasonable cause” is not a defense to willful FBAR violations. In its proposed jury instructions, the DOJ asked that the jury be instructed that: “If the United States Proves that Daniela Dadurian acted willfully, Dadurian may not claim as a defense that she relied upon the advice she received from accountants, lawyers or other professionals.”

Other cases that suggest that the DOJ is ratcheting up the pressure include:

  1. In United States v. Francis Burga , the Government filed suit in the United States District Court for the Northern District of California in its attempt to reduce the government’s willful FBAR Assessments approximating $120m to Judgment. In its complaint against Francis Burga and the estate of her late husband, Margelus Burga, the Government alleges that the defendants had financial interests in at least 294 Foreign Financial Accounts between 2004 and 2009 in a number of jurisdictions (including  Lichtenstein, the British Virgin Island, Switzerland, Singapore, Panama, China and Vietnam) and that she willfully failed to file FBARs.
  2. In United States v. Isac Scwarzbaum, Case No. 18-CV-81147, a U.S. District Court for the Southern District of Florida, was faced with deciding a Motion for Summary Judgment brought by the Taxpayer. The case involved a suit by the Government to collect outstanding civil FBAR penalties against the Defendant, Isac Scwarzbaum for his alleged failure to timely report his interest in foreign bank accounts in violation of 31 U.S.C. § for the years 2006-2009. The Taxpayer was born in Germany and retained his German Citizenship. but he became a U.S. Citizen in 2000. The Taxpayer’s father, a German Citizen, was a successful businessman. As a result of his father’s financial prosperity, the Taxpayer received various gifts as well as an inheritance, which together with investments; he used to support himself and his children.

Between the years 1993/94 to 2009, the Taxpayer engaged three separate certified public accountants. The defendant’s CPA who prepared the Taxpayer’s 2006 return, also completed an FBAR reporting a foreign account in Costa Rica. For the Tax Years 2007 and 2009, the Taxpayer elected to file FBARs without the assistance of a CPA.  However, the Taxpayer failed to file an FBAR for 2008 until 2011.

After receiving a letter from 2009 from one of his banks in Switzerland indicating that the IRS had submitted a treaty request in order to obtain information about accounts of certain individuals maintained at UBS and that his account seem to fit the scope of the request. The taxpayer claimed that he sought the advice of a Swiss Tax Lawyer and was told the request did not pertain to him. This claim was disputed by the Government.

In 2011 the Taxpayer entered the Offshore Voluntary Disclosure Initiative (“OVDI”). The taxpayer paid the outstanding income tax, interest and accuracy related penalties due as a result of the taxpayer’s failure to report the interest on foreign financial accounts. The defendant then elected to opt out of the OVDI and was subject to full IRS examination. The examining agent initially recommended that the IRS should assert a non-willful FBAR penalty against the taxpayer, but that recommendation was rejected and the willful FBAR penalties were assessed in 2016 in excess of $15m. Following this, the government filed a suit in order to reduce the assessments to Judgment. In response, the taxpayer filed a Motion for Summary Judgment arguing, among other things, that the facts in the case demonstrate that he was not willful since he did not have actual knowledge of the extent of the FBAR requirements. In denying the defendant’s Motion, the Court discussed the standards for “willfulness” pointing out that the Bank Secrecy Act identifies the FBAR penalty as a civil money payment and as such includes both knowing and reckless violations of a standard.

What is the way forward?

With the announcements of the closure of the OVDP in September of 2018 and the implementation of the new Voluntary Disclosure Practice rules in November of 2018, taxpayers with unfiled FBARs are left with the making a disclosure using the streamline procedures or proceeding under the new Voluntary Disclosure Practice Rules, which are quite onerous.

If you have failed to report your Foreign Financial Accounts, or opted out of the OVDP or considering opting out, it still may be possible to make a disclosure and avoid the willful FBAR penalty. But time is not on your side. Based upon legal precedent, the lines between the assessment of a willful vs a non-willful FBAR penalty will invariably rest upon the facts of the case, including but not limited to the account balances, number of years the account has been in existence, whether tax returns were filed and if so, whether the returns were self-prepared or prepared by a third party professional, whether the taxpayer has been absent from the United States for an extended period of time, as well as other factors.








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


New rules in Tax Cuts and Jobs Act 

Tax cut and Jobs ActWith the enactment of the Tax Cuts and Jobs Act (“TCJA”), divorce attorneys and those that are divorced, in the process of divorce or who have a pre or post nuptial agreement should familiarize themselves with the new rules. Failure to do so can have serious tax consequences to the client, and further, may subject a legal representative to malpractice claim or a bar grievance being filed.

Changes affecting Alimony 

The most significant change is the deductibility of alimony. Under the TCJA, alimony is no longer deductible by the payor nor is it includable as income for the recipient. The changes apply to any divorce or separation instrument executed after December 31, 2018. The new rules also apply to any divorce or separation instrument executed on or before December 31, 2018, and modified after that date provided the modification expressly provides that the TCJA amendments apply. Accordingly, divorce attorneys as well as their clients need to pay particular attention to these new rules and the effective date. In addition, attorneys who are representing the paying spouse should consult with outside tax counsel for purposes of tax effecting and monetizing the loss of the deduction to the payor and the tax savings to the recipient.

The term “divorce or separation instrument” is defined as “(A) decree of divorce or separate maintenance or a written instrument incident to such a decree; (B) a written separation agreement; or (3) a decree not described in subparagraph A requiring a spouse to make payments for the support or maintenance of the other spouse.”  26 U.S.C. § 71(b)(2).

The rule changes under the TCJA also affect the use of alimony trusts.  Prior to December 31, 2018 alimony trusts were permissible and used to minimize the interaction between former spouses as well as secure the interest of the recipient spouse. These trusts were also used where a family business was involved in order to shield assets of the business from third party creditors. With the repeal of 26 U.S.C. § 682, alimony trusts may no longer be used in divorce after 2018. More importantly, an alimony trust created after 2018 will result in the spouse creating the trust to be taxed on any income generated by the trust. 26 U.S.C. § 672(e).

Personal exemptions

In addition to the change in the alimony rules and the prohibition on the use of alimony trusts, the TCJA provides for the suspension of personal exemptions in favor of a new larger standard deduction. The suspension of personal exemptions is not permanent and scheduled to burn off after December 31, 2025. Most matrimonial agreements, including divorce settlement agreements and pre and post nuptial agreements identify which spouse is to take the children as personal exemptions for federal income tax purposes and for which year. Who gets the exemption is the result of negotiation and considered in evaluating the value and fairness of the overall settlement. Loss of personal exemption is of particular importance to a party who divorced prior to the effective date and gave up something of value in exchange for the personal exemptions. Under the new rules, the loss of personal exemptions represents a real loss.

In certain circumstances, the financial impact occasioned by the changes to the divorce rules under the TCJA, may warrant one spouse making an application to the court for the modification of an existing divorce settlement agreement or a pre or post-nuptial agreement. However, attempting to either set aside or reform any such agreement will be an uphill battle for the following reasons: First, a divorce settlement agreement or a pre or post nuptial agreement will typically contain what is commonly referred to as an: “Integration Clause,” which effectively prevents either party from changing the terms of the agreement without a written modification signed by both parties. The likelihood that the spouse losing a tax benefit would ever sign such a modification is slim. Second, seeking to have an agreement set aside by a court is rarely, if ever, successful absent a showing of fraud, duress or unconscionability. Likewise, advancing a quasi-contract theory as a basis for reformation of an agreement will likely fail.

The takeaway here is that both attorneys and their clients should consult a tax attorney prior to entering into a divorce settlement agreement or a pre-nuptial agreement, to determine the tax implications associated with the changes to divorce rules. Furthermore, in cases involving significant marital assets, which have been the subject of estate planning, a review of the parties testamentary and trust documents is essential to avoid any unintended consequences. Consideration of the changes under the TCJA should be included when conducting financial analysis in a divorce case.



Electronic Filing For Businesses

E File form8300In an effort to promote compliance, on February 19, 2019 the IRS urged businesses that are required to file reports of large cash transactions to take advantage of the electronic filing option that was announced on September 19, 2012 by The Financial Crimes Enforcement Network (FinCEN). Under federal law a person who is engaged in a trade or business must file Form 8300 (Report of Cash Payments Over $10,000 Received in a Trade or Business) within 15 days after a transaction (IRC 6050I; 26 CFR 1.6050I-1(e); 31 USC 5331;  31  CFR 1010.330). Although businesses still have the option of filing Form 8300 on paper, electronic filing has several benefits. One of the benefits is that electronic filing is convenient and cost effective. It is also a secure way of transmitting sensitive financial information. Similarly, by filing Form 8300 electronically, businesses are able to receive immediate acknowledgement of receipt when filing is completed.

The filing requirement for Form 8300 authorized under Internal Revenue Code Section 6050I pre-dates the enactment of Section 5331 under the Bank Secrecy Act (BSA). Section 5331 enacted in 2001 requires non-financial trades or businesses to file Form 8300. In 2001 Treasury Regulations were issued permitting a single Form 8300 to satisfy both the Title 26 and Title 31 filing requirements.

Who is required to file?

Although the term “person” is defined differently under Titles 26 ad 31, the regulations under both titles expressly incorporate the definition of “person” under Section 7701 of the Internal Revenue Code to include an individual, trust, estate, partnership, association, company or corporation.  The term “trade or business” generally includes any activity carried on for the production of income from selling goods or performing services. It is not limited to integrated aggregates of assets, activities, and goodwill that comprise businesses for purposes of certain other provisions of the Internal Revenue Code. Activities of producing or distributing goods or performing services from which gross income is derived do not lose their identity as trades or businesses merely because they are carried on within a larger framework of other activities that may, or may not, be related to the organization’s exempt purposes.

What payments need to be reported?

While the Internal Revenue Code requires reporting cash receipts, Section 5331 of the BSA requires the reporting of receipts of coins or currency. The definition of “cash” under Treasury Regulation 26 CFR 1.6050l-1 (c) (1) is similar to the definition of “currency” under Title 31.

Under the Treasury Regulations the term “cash” includes:

  • Coin and currency of the United States or any other country which circulates and is accepted as money in the country in which it is issued
  • A cashier’s check, bank draft, traveler’s check or money order having a face amount of not more than $10,000 that is (1) received in a designated reporting transaction, or (2) received in any transaction in the which the recipient knows that the instrument is being used in an attempt to avoid the reporting of the transaction

Under Title 31 the term “currency” is defined to include foreign currency and to the extent provided in the regulations proscribed by the Secretary, any monetary instrument with a face amount of not more than $10,000, except a check drawn on the account of the writer in most financial institutions. 31 CFR 1010.330(c)(1).

While there are stiff civil and, in some cases, criminal penalties associated with failing to file Form 8300, a report issued by the Treasury Inspector General for Tax Administration (“TIGTA”) on September 24, 2018 concluded that the BSA Program has had a minimal impact on compliance. Nevertheless, if you are required to file Form 8300 you should be concerned and take action.

The takeaway here is that the IRS has streamlined the filing process for Form 8300 by permitting electronic filing. By doing so, businesses should take advantage of this process in lieu of paper filing, which remains an option. Those who fail to file Form 8300 may find it difficult to explain the reason for non-compliance in light of the electronic filing option. Failing to file Form 8300 may also create risk particularly where a financial institution has filed a Suspicious Activity Report (“SAR”) in connection with a transaction which should have been reported on Form 8300.  In the event an SAR is filed there is a possibility that you will be identified by the IRS and be subject to their scrutiny. The impetus behind requiring the filing of a cash transaction report is to promote compliance and establish money trails and expose hidden criminal trends and patterns that include money laundering and terrorist financing.




Deliquent Expat Filers and Facilitators 1

Expatriates (Expats) who continue to ignore their obligations to file U.S. Federal Income Tax returns and who fail to report their foreign financial accounts as well as those who fail to file information returns with respect to their interests in foreign entities may soon find themselves the subject of an IRS investigation or other procedural inquiries. Likewise, Expats with outstanding tax liabilities and outstanding FBAR penalties will soon feel the wrath of the Government. I am amazed when I travel overseas and speak with Expats. Many are unaware of the concept that U.S. Tax Persons are required to file U.S. Income Tax Returns and also required to report their income on a worldwide basis. I am equally amazed to find that Expats are neither aware of the tax return disclosures they are required to make, nor are they aware of financial reports that they may be obligated to file. This occurrence seems to be more prevalent in Asian countries and the Middle East, where English is not the primary language.

IRS ways of obtaining financial information from non-compliant Expats

Grand Jury Subpoenas, FATCA and CRS

The Department of Justice is increasingly making use of its grand jury subpoena power as a means of obtaining financial information from non-compliant Expats. Efforts are being coordinated with the IRS Criminal Investigation in response to the treasure trove of financial information regularly being received from countries that are signatories to the Foreign Account Tax Compliance Act (FATCA).

Furthermore, on October 5th 2018, in accordance with the Common Reporting Standards (CRS), Switzerland began automatically sharing client data with tax authorities in dozens of countries. The initial exchange was with the European Union countries and other countries including Australia, Canada, Guernsey, Iceland, Isle of Man, Japan, Norway and South Korea. The information exchanged includes the account owner’s name, address, country of residence and tax identification number as well as the reporting institution, account balance and capital income. It is estimated that about 7,000 banks, trusts, insurers and other financial institutions that are registered with the FTA collect data on millions of accounts.  The CRS was developed in July of 2014 by the Organisation Economic Cooperation and Development (OECD) and calls for the automatic exchange of financial information on an annual basis. Although the U.S. is not a signatory to the CRS, the information may nevertheless find its way into the hands of the IRS.

Cyber Security Threats

The Panama Papers have also been instrumental in assisting the U.S. Government in identifying those individuals, including bankers, attorneys, accountants and investment advisors who facilitated the fraud against the U.S. Government. The information obtained by the U.S. Government from the  Panama Papers has produced countless indictments and convictions including the recent indictment in November of 2018 of an investment manager, attorney and a U.S. accountant as well as a former U.S. resident and taxpayer.  The risk of being unmasked when there is a cyber breach is real and cannot be overstated.  Any information that becomes public is free for the taking and can be used in a subsequent tax prosecution or IRS civil audit.

Pressure on Foreign Financial Institutions

The enactment of FATCA and the stiff penalties financial institutions face for non-compliance has created an atmosphere of suspicion and has resulted in the heightened scrutiny of U.S. Taxpayers, who reside overseas.  Some banks, such as HSBC in Hong Kong have gone overboard and now require documents from Expats over and above the information collected under FATCA and the CRS. This provides additional information which the IRS can use to identify Expats, who are non-compliant. Banks have capitulated, particularly where they have a presence in the United States and are subject to jurisdiction in the United States. Likewise, smaller banks, who do not have a U.S. presence, are feeling the pressure, since they are required to use a correspondent bank in order to transact business in U.S. dollars.

Other Information and Leads

The IRS continues to develop new leads from financial information obtained from taxpayers who have come forward and made offshore disclosures as well as from those individuals and firms who have been prosecuted. They have also able to identify those individuals who made quiet disclosures in order to avoid detection from the IRS. In addition, whistle blowers have provided the Government with valuable information that is being used to aid in criminal tax and FBAR prosecutions. The IRS is employing sophisticated analytics and date mining tools as means of identifying Expats who are non-compliant and continues to work with its global tax partners in identifying tax cheats and those seeking to hide their assets overseas. Finally, the IRS uses social media as a means of identifying tax cheats.

Collection Efforts

Expats who have come clean, but have yet to pay what they owe should also be worried. The IRS is leveraging its collection efforts by utilizing judicial, civil forfeiture and procedural tactics, as well as social media, all of which are designed to enhance the collection of unpaid income taxes and FBAR penalties from Expats.

The Bureau of Fiscal Service (BFS) is responsible for collecting all non-tax debts including FBAR penalties. The IRS may also refer non-tax debts to a private collection contract of to the Department of Justice.  Once the debt is referred to BFS, they are required to take action to either collect or compromise the non-tax debt. They may also suspend or terminate the collection action under 31 CFR § 5.9 and 285.12(b); 31 USC 3711(g) (9).

If the Government elects to file a civil action to recover an FBAR penalty they must initiate the action within two years of the later of the date the penalty was assessed or the date any judgment becomes final in a criminal action that involves the same transaction that resulted in the penalty ( IRM §; IRM § The purpose of filing suit is to reduce the FBAR penalty to a judgment. The bar is quite low in terms of the level of proof the Government is required to show in order to sustain a willful FBAR penalty. In U.S. v Garrity, a suit initiated by the Government to collect a willful FBAR penalty, the Court held that the Government may prove the issue of willfulness by a preponderance of evidence rather than the higher clear and convincing standard. (U.S. v Garrity No. 3:15-cv-00243-MPS (D. Conn. Apr. 3, 2018)). The Garrity decision is consistent with a long line of cases where Courts have held that the preponderance of evidence standard is the standard applied in collection actions filed by the IRS to recover the civil FBAR Penalty. See Bedrosian v. U.S., (DC PA 9/20/2017) 120 AFTR 2d 2017 5832; U.S. v Bohanec, (DC CA 2016) 118 AFTR 2d 2016-6757; U.S. v McBride, (DC UT 2012) 110 AFTR 2 2012-6600; and U.S. v Williams (CA 4 2012) 110 AFTR 2d 2012-5298.

The Government can and often time uses administrative offsets as a means of collecting an outstanding FBAR penalty as well as unpaid income taxes. However, the offset may only be used after there has been an attempt to collect the debt directly from the debtor under 31 USC § 3711(a). In addition, the Government must provide the debtor with “written notice of the type and amount of the claim . . . . 31 USC § 3716 (b) (1). It is noteworthy, that administrative offset is not subject to the statute of limitations under 31 USC § 3716 (e) (1).

Administrative offsets often include payments received from Federal Benefits Programs like Social Security, and can also include tax refunds. There are, however, limitations. If a statute exists exempting a program from administrative offset, then the Government may not use those payments as an offset. The administrative offset of income tax refunds requires that the creditor agency certify, among other things, that the debt is at least $25, past due, legally enforceable and that reasonable efforts have been made to obtain payments. The IRS must also provide the debtor with a 60 day notice that the debt is past due and unless repaid, will be referred to BFS (31 USC § 3720A (b); 31 CFR § 285.2(d)).

Another collection tool is wage garnishment for collection of unpaid income taxes and FBAR penalties. The Government may garnish the wages of non-governmental employees under 31 USC § 3720D (a) but must provide the debtor with a 30 day Notice and the opportunity for a hearing. The debtor is entitled to a hearing if he or she requests one. A cautionary note with respect to a hearing; while the Government has the burden of proving the existence and the amount of debt by a preponderance of evidence, the debtor must prove that the debt does not exist, the amount is incorrect, and the repayment schedule is unlawful or that the garnishment would cause a financial hardship. Once again, a low bar for the IRS.

Once the Government has reduced the FBAR penalty to a judgment, it may then seek to seize and sell the debtors property by judicial sale, even in cases where the property is co-owned with a spouse, against whom the FBAR penalty has not been assessed. The Government can also conduct discovery as to the debtor’s financial condition. In pursuing the collection of a judgment against a debtor, the IRS does, however, have to comply with the Federal Debt Collection Procedures Act. In addition, a Court may order that the debtor make installment payments under 28 USC § 3204.

Increasingly, the Government is contracting with third party agencies as a means of collecting outstanding FBAR penalties (31 USC § 3718(a)) and overdue income taxes. This is a trend, which in all likelihood will continue given the IRS budgetary constraints. Collection agencies usually work on a percentage of money that is collected. This has the effect of reducing the fixed costs associated with the IRS paying salaries and benefits to staff.

Under 31 USC § 3711 (e) Delinquent debts for unpaid FBAR penalties and unpaid income taxes can be and are almost always reported to the credit bureaus, subject to a notice requirements. The debtor must be given a 60 day notice prior to the Government reporting a delinquent debt to the credit bureaus (31 CFR § 5.14, 5.4.).

The IRS is also permitted to enter into installment agreements and may also compromise the debt as a means of settling outstanding FBAR penalties. The latter process, however, requires DOJ approval where the FBAR penalty exceeds $100,000 (31 USC § 3711 (a), (2); 31 CFR § 902.1(a) & (b); IRM §

Consequences facing Taxpayers with significant income tax liabilities

Taxpayers with significant income tax liabilities in excess of $51,000 may suddenly find that their passport has been revoked or that they are unable to renew the passport. This new provision of the law can be particularly stressful to those living overseas. Imagine, you are living in England and have planned a family vacation to Singapore. The IRS sends the Notice to you, but you do not receive it. You pack and head to the airport only to find that your passport has been revoked.

26 USC § 7345 styled as: “Revocation or Denial of Passport in Case of Certain Tax Delinquencies,” provides in pertinent part:

“If the Secretary receives Certification by the Commissioner of Internal Revenue that an individual has a seriously delinquent tax debt, the Secretary shall transmit such certification to the Secretary of State for action with respect to denial, revocation, or limitation of a passport pursuant to section 32101 of the FAST Act” (26 USC § 7345 (a)).

The term “seriously delinquent tax debt” is defined under 26 USC § 7345 (b) (1) as an “unpaid, legally enforceable Federal Tax Liability of an Individual” which (i) has been assessed; (ii) is greater than $50,000 and (iii) is the subject of a federal tax lien or a levy.

Section 7345 only applies to unpaid legally enforceable tax debt and does not apply to unpaid FBAR Penalties or Child Support obligations.

In the event the Expat receives a Notice (Notices CP 508C) from the Commissioner of the IRS, he or she has the option of entering into an installment agreement or attempting an offer in compromise in order to have the Certification vacated. If the Expat believes the Certification is erroneous he or she is also entitled to judicial review and may commence an action either in the United States District Court or the United States Tax Court (26 USC § 7345 (e)(1)). This can pose a particular hardship for Expats, who may be forced to travel to the United States to fight the Notice.

Expats with unpaid tax and FBAR liabilities may be subject to enforcement actions in the foreign country where they reside. The United States has tax treaties with five countries including Canada, Denmark, Sweden, France and Netherlands that contain “assistance in collections” provisions. Other treaties provide for limited assistance in collections. In addition, assistance language may be contained in some multilateral conventions. Traditionally, there has been fierce resistance by foreign Governments when asked to assist in the enforcement of U.S. judgments. However, the landscape is changing, in part, due to the unequal bargaining power the U.S. Government enjoys when dealing with foreign governments.

Finally, those who have counseled, advised or assisted taxpayers in developing schemes to avoid paying U.S. income taxes and/or side stepping the U.S. financial reporting requirements, may now find themselves in the cross hairs of the U.S. Government. In July of 2018 the United States together with Great Britain, Australia, Canada and the Netherlands set up the Joint Chiefs of Global Tax Enforcement (J5), an alliance designed to ferret out individuals and firms that facilitate tax evasion. The J5 was created in response to a call by the Organisation for Economic Cooperation and Development (OECD) for better cross-border coordination in the fight against tax evasion and money laundering. The J5 representative agencies include the Australian Criminal Intelligence Commission and the Australia Taxation Office, the Canada Revenue Agency, the Fiscale Inlichtingen-en Opsporingdienst, HM Revenue and Customs, and the Internal Revenue Service Criminal Investigation. Through active collaboration, the J5 hope to  enhance existing investigations and intelligence programs, identify significant targets for new investigations, improve the tactical intelligence threat picture, and raise international awareness that the J5 is working together to reduce transnational tax crime, cyber crime and money laundering.


In conclusion, U.S. tax and financial reporting and its enforcement continue to evolve and remain a top priority for the IRS. Particularly vulnerable are those taxpayers living overseas who are not in compliance in regards to their U.S. tax and financial filing obligations. Expats who have outstanding tax and FBAR penalties should not be fooled into thinking that they are beyond the reach of the U.S. Government.  Finally, those who have facilitated and aided their clients in setting up foreign bank accounts and sham corporations as a means to perpetrate a fraud on the U.S. Government need to be worried. The IRS is definitely coming for you. The landscape is littered with convicted taxpayers, attorneys, accountants, bankers and other advisers who thought they could game the system. If you are such a person you need to contact a tax attorney who can assist you in coming forward and making a disclosure. In many cases it may be possible to utilize one of the streamlined procedures and avoid paying any FBAR penalty. Of course, you will be required to pay any outstanding income tax, without incurring any penalty.  Resolution for those who have outstanding tax debt and unpaid FBAR penalties is also possible. Alternatives do exist.

If you are at risk, you need to be proactive and seek out the advice of a capable tax attorney. Please feel free to call and schedule a free consultation.

The Trust Fund Recovery Penalty: Are You At Risk?


Trust fund recovery penalty

The assessment of the § 6672 penalty can be devastating, and in some cases, life changing. Individuals who are subject to the penalty usually state that they were unaware that failure to collect and pay employment taxes to the IRS could result in personal liability for unpaid payroll taxes. The § 6672 penalty, commonly known as the “Trust Fund Recovery Penalty” (“TFRP”) imposes personal liability on individuals who are required to collect, account for, and pay over employment taxes and who willfully fail to collect such tax, or truthfully account for and pay over such tax.The requirements for imposition of the penalty are:

  1.  The penalized person is deemed to be a “responsible person” or someone responsible for having collected and paid the tax in the first place; and
  2. The penalized person must have willfully failed to collect and pay that tax (Godfrey v. United States, 748 F.2d 1568, 1574 (Fed. Cir. 1984)).

The TFRP provides the IRS with an alternate means of collecting unpaid employment taxes, when the employer is unable to do so, by permitting the IRS to pierce the corporate veil and hold those responsible for the employer’s failure to pay the outstanding taxes (White v. United States, 372 F.2d 513, 516, 178 Ct.Cl. 765 (1967)).

The TFRP usually comes into play when a business is experiencing a financial crisis. The disruption to an employer’s cash flow requires making tough decisions by those in charge of deciding which creditors get paid. The list of creditors usually involves the IRS. Employers are required to withhold income and FICA taxes from employee salaries and must also contribute the employer’s share of FICA taxes. The withheld funds are to be placed in trust with the government designated as the beneficiary. Often times employers will utilize trust funds, which are a ready source of cash, in order to satisfy operating expenses with the justification that the business is merely receiving a loan from the government. In more egregious cases, trust funds have been used to continue to pay for the personal expenses and lavish lifestyle of those who are in charge of paying the bills. These individuals are usually, but not always, the corporate officers, directors or managers of a business, but also include others. Suffice it to say, the IRS views the dissipation of trust funds by those in charge as stealing.

The IRS commitment to pursue those who have failed to account and deposit payroll taxes on behalf of their employees is underscored by the remarks made by the Assistant Attorney General at a Federal Bar Association Conference:

“Since January 2015, the Tax Division has sharpened its focus on civil and criminal employment tax enforcement. As most of you know, these cases involve employers who fail to collect, account for, and deposit tax withheld from employee wages. These withholdings represent 70 percent of all revenue collected by the IRS, and as of September 2015, more than$59 billion of tax reported on Forms 941 remained unpaid. These employers are literally stealing money, knowing that their employees will receive full credit for those amounts when they file their returns. The employers gain an unfair advantage over their competitors and the U.S. Treasury is left holding the bag.”

Acting Assistant Attorney General Remarks at Federal Bar Association Tax Law Conference (March 4, 2016). The 26 U.S.C § 6672 (a) provides in part that:

“Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

The following discussion identifies persons who may be at risk, the common mistakes made during an IRS examination and the assessment process as well as procedural options that may be utilized to contest the assessment of the TRFP.

Who Is Responsible For The Collection, Accounting And Payment Of Payroll Taxes?

The assessment of the TRFP requires that the IRS establish that the person against whom enforcement is sought had a duty to collect, account and pay over employment taxes. The term “person” is defined in 26 U.S.C. § 6671(b) and includes:

“an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.”

The courts use the term “person” and “responsible person” interchangeably. While the term “person” is statutorily defined, the latter is not. Rather, the term “responsible person” is a creation of the courts (Slodov v United States, 436 U.S. 238 – Supreme Court 1978). In order to be considered a responsible person, the taxpayer must be “under a duty” to collect, truthfully account for, and pay over” any taxes.
The inquiry will always focus on whether the person has “significant control over the enterprise’s
finances” ((Fiataruolo v. United States, 8 F.3d 930, 939 (2d Cir. 1993), (quoting Hochstein v. United States, 900 F.2d 543, 547 (2d Cir. 1990)).

While many of the cases involve officers, directors and shareholders, the courts have expanded who qualifies as a responsible person to include creditors, employees, accountants and attorneys. If the responsible person could have impeded the cash flow of the business to prevent the trust funds from being squandered, then he or she will be held liable (Thomas v. United States, 41 F.3d 1109, 1113 (7th Cir. 1994)). Furthermore, the TFRP can be assessed against more than one person (Thibodeau v. United States 828 F.2d 1499, 1503 (11th Cir. 1987)). Consequently, each person found liable can be held responsible for the full amount of unpaid trust fund taxes.

The IRS considers the following factors when making a determination of whether a person is a responsible person:

  1. Does the person(s) have a duty to perform?
  2. Does the person(s) have the power to direct the act of collecting trust fund taxes?
  3. Does the person(s) have the accountability for and authority to pay trust fund taxes?
  4. Does the person(s) have the authority to determine which creditors will or will not be paid?
  5. Does the person(s) have the status, duty and authority to ensure that the trust fund taxes are paid?
  6. Is the person(s) an officer, director, or shareholder of the corporation?
  7. If the person(s) is an officer, what do the corporate by-laws state regarding the person(s) responsibilities as it relates to financial matters?
  8. Does the person(s) have the ability to sign checks?
  9. Does the person have the authority to hire and fire employees?
  10. Does the person have the authority to sign and file the excise tax or employment tax returns, such as Form 941, Employer’s Quarterly Federal Tax Return?
  11. Does the person control payroll/disbursements?
  12. Does the person control the corporation’s voting stock? and
  13. Does the person(s) make federal tax deposits?

While no one factor is dispositive, check-signing authority is considered strong indicia of responsibility, even in cases where the check signer is instructed by a superior not to pay the taxes (Howard v. United States, 711 F.2d 729, 734 (5th Cir. 1983)). The facts in each case are evaluated by the IRS when making a determination as to responsibility. As the Court of Appeals pointed out in Godfrey:

“. . . the case law makes abundantly clear, a person’s “duty” under § 6672 must be viewed in light of his power to compel or prohibit the allocation of corporate funds. It is a test of substance, not form” (Godfrey 748 F.2d at 1576).

What Constitutes Willfulness Under 26 U.S.C. § 6672?

In addition to establishing that the individual is a “responsible person”, it is necessary that the Government prove that the person acted willfully. The Internal Revenue Manual defines “willfulness” in the context of the TRFP as: “intentional, deliberate, voluntary, and knowing, as distinguished from accidental. Willfulness is the attitude of a responsible person who with free will or choice either intentionally disregards the law or is plainly indifferent to its requirements” (I.R.M. §

Some of the factors the I.R.S will consider in making a determination of whether a responsible person was willful include:

  1.  Whether the responsible person had knowledge of a pattern of noncompliance at the time the delinquencies were accruing.
  2.  Whether the responsible person had received prior IRS notices indicating that employment tax returns have not been filed, or are inaccurate, or that employment taxes have not been paid.
  3.  The actions the responsible party has taken to ensure its Federal employment tax obligations have been met after becoming aware of the tax delinquencies.
  4.  Whether fraud or deception was used to conceal the nonpayment of tax from detection by the responsible person. Id.

The courts have construed “willfulness” under § 6672 to mean the “voluntary, conscious and intentional act” of paying creditors other than the IRS when the company is financially troubled (Phillips v. IRS, 73 F.3d 939, 942 (9th Cir. 1996) (quoting Davis v. United States, 961 F.2d 867, 871 (9th Cir. 1992)); Klotz v. United States, 602 F.2d 920, 923 (9th Cir. 1979)).

While evidence of willfulness requires proof of a voluntary, intentional, and conscious decision not to collect and remit taxes thought to be owed, it does not require proof of a special intent to defraud or deprive the Government of monies withheld on its account (Godfrey 748 F.2d at 1576, citing Scott v. United States, 354 F.2d at 295). The Court of Claims has consistently rejected the view that “a finding of willfulness entails a showing of evil motive, bad purpose, or calculated malevolence” (Id. at 1576). The focus of inquiry is rather “on the deliberate nature of the individual’s election not to pay over the money and the circumstances of that refusal” (Id. at 1576). Consequently, if a person deemed a responsible party discovers that there are unpaid taxes, the responsible person has an immediate duty to use all unencumbered funds to pay taxes (United States v. Kim, 111 F.3d 1351, 1357 (7th Cir. 1997)). Failure to pay the back taxes will result in personal liability on the part of the responsible person.

The Court of Appeals in Godfrey echoed the White definition of willfulness as meaning “a deliberate choice voluntarily, consciously, and intentionally made to pay other creditors instead of paying the Government.” Godfrey 748 F.2d at 1577, citing Scott 372 F.2d at 521. The Court of Appeals citing Feist v. United States, 607 F.2d at 961 also noted that willful conduct may also include a reckless disregard of an “obvious and known risk” that taxes might not be remitted. Finally, the Godfrey Court citing Bauer v.
United States, 543 F.2d at 150; stated: “Mere negligence in failing to ascertain facts regarding a tax delinquency,” however, “is insufficient to constitute willfulness under the code” (Godfrey 748 F.2d at 1577).

Assessment of The Trust Fund Penalty

When an employer falls behind on the payment of its payroll taxes, the IRS will send out a Federal Deposit Tax Alert Notice to the business. If unanswered a Revenue Officer (“RO”) is assigned to the business to investigate the reason the business in non-compliant. The RO will attempt to bring the business into compliance by directing the business to set up a special trust account for the deposit of employment taxes. If the business fails to come into compliance, the next step will be to conduct an investigation of potentially responsible individuals against whom the § 6672 penalty can be assessed. The RO will then attempt to secure the business’s bank records and other records of the business. The RO will also issue Letter 3586 to the potentially responsible individuals setting a meeting (“Interview”). Letter 3586 is accompanied by Notice 784 “Could You Be Personally Liable for Certain Unpaid Federal Taxes.”

At this point the potentially responsible should seek the advice of a tax attorney. Most individuals are ill equipped to handle an IRS Interview and may unwittingly say something that will be used to establish responsible party status. In some cases, an individual’s statements may serve as a basis for a referral to the Criminal Investigation. Remember, the IRS is not there to help you. The RO will use Form 4180
(“Report of Interview With Individuals Relative to Trust Fund Recovery Penalty”) when conducting TFRP Interview. “The Form is intended to be used as a record of a personal interview with a potentially responsible person.” I.R.M. § 1. At the conclusion of the Interview, the individual will be asked to read and sign the Form. If you are not represented, there is a very good chance the IRS will deem you to be a responsible person. More often than not, Form 4180 is used to ensnare a person as a responsible person.

Depending upon the circumstances, and particularly where criminal exposure exists, a good tax attorney may advise the individual not to sign Form 4180. The attorney might also request that the Form be completed outside of the presence of the RO to provide the taxpayers additional time in which measured responses to the questions can be framed. Finally, if the Individual plans on attending the Interview, it is extremely important that he or she be represented by tax counsel.

Following the Interview, the RO will determine whether to proceed with the proposed assessment. If the RO decides to move forward, he or she will generate and send the responsible person a 60 day Preliminary Notice styled as “Letter 1153” together with Form 2751 (“Proposed Assessment of Trust Fund Penalty”) Thereafter, the IRS must wait 60 days after the issuance of Letter 1153 and the Proposed Assessment before issuing a notice and demand for payment. The responsible party has 60 days to respond and 75 days if the letter is addressed out of the country. In response to the Notice the Taxpayer has the following options:

  1. Panic and take no action (Can be fatal to your chances).
  2. The individual can sign Form 2751 in which he agrees with the assessment.
  3. File a protest letter and then proceed to IRS Appeals.
  4. Request mediation.
  5. If the individual disagrees with the decision from Appeals, he or she has a right to judicial review.

There are also alternatives with respect to post assessment including Offers in Compromise, Installment Agreement, Partial Pay Installment Agreements and Currently Not Collectible that may serve as a basis for minimizing the financial impact associated with being subject the assessment of the TFRP.


If you are involved in a business that is delinquent on its payroll taxes, there is a high likelihood that you will be investigated by the IRS. Those individuals responsible for management of the business are particularly vulnerable to the TFRP should the business ultimately fail to pay its employment taxes.
When looking into the issue of responsibility, the IRS will most always pick the low hanging fruit. Since the IRS considers failure to pay your employment taxes stealing, the necessity of legal representation cannot be understated. If the IRS is currently conducting an investigation into the employment taxes of your business, it is advisable to get ahead of the curve particularly if there is a risk of a referral to Criminal Investigation of the IRS. A potentially responsible person should never attend an Interview without the assistance and advice of counsel. Many individuals I have counseled simply waited too long. You cannot hide your head in the sand!

By Anthony N. Verni.


 Wilfull FBAR Penalty.

The following is intended as an update to my January 26, 2019 Blog on the subject of the limitation of the willful FBAR (Foreign bank Account Report) penalty under United States v. Colliot, 2018 U.S. Dist. LEXIS 83159 (W.D. Tex. 2018) which capped the maximum willful FBAR penalty at $100,000. The predicate for the District Court’s decision is 31C.F.R. § 1010.820. In addition to Norman v United States (Ct. Fed. Cl. Dkt 15-872T, Order dated 7/31/18- (please see my January 26, 2019 Blog)), United States v. Horowitz, 2019 U.S. Dist. LEXIS 9484 (D. Md. 2019) and other recent decisions have dealt the Colliot decision a fatal blow. Consequently, individuals who are subject to the willful FBAR penalty should avoid using the Colliot decision as a basis for limiting their liability.

The District Court in Colliot 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. § 5321(a) (5) (C)(i). The Court’s logic in reaching its conclusion was the absence of a new regulation adopting the higher penalty amount provided for under § 5321(a) (5)(C)(i).

The Horowitz and other recent decisions make clear that the Colliot decision is fatally flawed. While the Horowitz decision focused on the taxpayers’ “willful blindness” in sustaining the willful civil FBAR penalty, the Court also addressed the taxpayers’ reliance on the Colliot in asserting that the willful civil FBAR penalty was capped by 31 C.F.R. § 1010.820. The Horowitz decision came before the Court on a Motion for Summary Judgment filed by the Government seeking to sustain the FBAR penalties assessed against the Horwitz’s. The taxpayers filed a Cross Motion for Summary Judgement.

Is willful civil FBAR penalty limited?

The following discussion only addresses the issue of whether the willful civil FBAR penalty is limited under 31 C.F.R. § 1010.820(g) (2) in light of the 2004 Amendment which increased the maximum willful civil FBAR penalty to the greater of $100,000 or 50% of the account balance at the time of the violation.

United States v. Horowitz case analysis.

Peter Horowitz and his wife, Susan, lived in Saudi Arabia from 1984-2001 where Peter worked as an anesthesiologist. In 1988 the taxpayers opened a joint bank account at UBS. The account was funded with the money Peter earned as an anesthesiologist. The taxpayers returned to the United States in 2001 but did not close their UBS account, which as of 2008 had a balance of almost $2 million. Late in 2008, after learning of the legal problems UBS was experiencing, Peter travelled to Switzerland and closed the UBS account. After closing the UBS account, Peter transferred the account balance to an account that he opened at Finter Bank, another Swiss Bank, in which he designated the account as a “hold mail” account. The Finter bank account was opened solely in Peter’s name because Susan was not present at the time.

Peter was responsible for communicating with the taxpayers’ accountant who prepared their 2007 and 2008 federal income tax returns. Peter never disclosed the foreign financial accounts to the taxpayers’ accountant. In response to the questions that appear on Schedule B, Part III, concerning the existence of foreign financial accounts, the taxpayers always checked the “No” box. In addition, the Horwitz’s failed to file FBAR reports for 2007 and 2008. The taxpayers subsequently entered the Offshore Voluntary Disclosure Program sometime in January of 2010, but later elected to opt out.

The IRS assessed the willful FBAR penalty against each of the taxpayers for both the 2007 and 2008 tax years in the amount of $247,030. The Horwitz’s filed a timely protest letter and the matter was affirmed by IRS Appeals. The Government thereafter brought suit to reduce the assessment to a judgment.

In response to the Government’s Motion for Summary Judgment, the taxpayers filed a Cross Motion for Summary Judgment asserting their conduct did not rise to the level of willfulness. In their Cross Motion, the taxpayers, relying upon Colliot, also asserted that the willful FBAR penalty should be capped at $100,000. They cited 31 C.F.R. § 103.27, which is now 31 C.F.R. § 1010.820(g) (2) in support of their argument.

In granting the Government’s Motion for Summary Judgment, the District Court of Maryland for the Southern District laid to rest any hope of future reliance on Colliot. The Court, citing United States v. Larionoff, 431 U.S. 864, 873, 97 S.Ct. 2150, 53 L.Ed.2d 48 (1977 articulated a long standing principle that: “it is settled law that an agency’s regulations “must be consistent with the statute under which they are promulgated.” Furthermore, the Court, quoting from Norman v. United States 138 Fed.Cl. at 196 stated:

“Since the civil penalty amount for a “willful” violation in 31 U.S.C. § 5321(a)(5) (2003) was replaced with 31 U.S.C. § 5321(a)(5)(C)(i) (2004), the April 8, 1987 regulations are “no longer valid.”

The Norman decision is bolstered by Kimble v. United States No. 17-421, 2018 WL 6816546, at *15 (Fed. Cl. Dec. 27, 2018), a recent 2018 decision by the United Court of Claims, wherein the Court rejected the conclusion reached in Colliot that the IRS was bound by the maximum penalty provided for prior to the amendment in 2004. In Kimble, the Court, in sustaining the IRS assessment for willful violations of the FBAR statute, stated that the conclusion reached in Colliot:

“conflicts with the decision of the United State Court of Appeals in Barseback Kraft AB v. United States, 121 F.3d 1475 (Fed. Cir. 1997), where the Federal Circuit concluded that the fact that regulations ‘had not been formally withdrawn from the Code of Federal Regulations [did] not save them from invalidity’ based on a conflicting federal statute.” Id.

Finally, the Court in Horowitz’s case, in rejecting the taxpayers’ arguments, cited I.R.M. § which provides:

“[f]or violations occurring after October 22 2004, the statutory ceiling is the greater of$100,000 or 50% of the balance in the account at the time of the violation.” I.R.M. § (Nov. 6, 2015).

Considering the Horowitz, Kimble and Norman decisions as well as I.R.M. §, a successful challenge to the willful FBAR penalty based upon 31 C.F.R. § 1010.820(g) (2) is no longer viable. 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.).

United States v. Colliot case analysis.

 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.

United States v. Norman case analysis.

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

© 1/29/2019