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Streamline Disclosures- The Art of the Non-Willful Certification.

Offshore disclosure to IRS.

The key to making an offshore disclosure to the IRS using either the Domestic or Foreign Filing Compliance procedures requires a thorough and painstaking analysis of the facts involving an individual’s failure to;

  • OVDP Lawyerreport his or her foreign financial accounts.
  • report income from foreign sources.
  • make the necessary disclosures.
  • report foreign financial assets consistent with FATCA.

Details in a Non-Willful Certification can spell the difference between closure and a subsequent examination by the IRS which leads to assessment of multiple Civil FBAR Non-Willful Penalties over a number of years, or even worse, the assessment of the Willful Civil FBAR Penalty.

Components of offshore disclosure.

The starting point for any case is gathering all facts, including whether the tax return was self-prepared or prepared by a paid preparer, the length of time the foreign financial accounts have been open and the Taxpayer’s status in the United States.  It is also necessary to determine whether Schedule B was included with the Taxpayer’s original returns, and if so, whether the Taxpayers checked “no” in response to Question 7(a) and 7 (b) concerning the existence of Foreign Financial Accounts and the acknowledgement of an obligation to file an FBAR.

In addition, detailing the origin of the funds in the Foreign Financial Accounts and whether those funds represent after tax dollars as well as the initial purpose for opening the Foreign Financial Accounts. Closely tied to this inquiry is whether the Foreign Financial Accounts are legacy accounts, which were in existence prior to an Individual’s arrival in the United States.

Since Streamlined Filing Procedures are less costly to a Taxpayer than participating in the Offshore Voluntary Disclosure Program (both in terms of penalties and legal cost), there is a tendency by those considering an offshore disclosure to default to the Streamlined Filing Procedures, without first considering all of the facts.  This can have catastrophic consequences especially in light of the recent IRS announcement that OVDP will be closed on September 18, 2018. The IRS has also intimated that it may also scrap the Streamlined Filing Procedures. This means that those who have failed to come forward can expect turbulence in the future.

 

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The Willful FBAR Penalty: Is it Limited to $100,000? Not so Fast.

 Assessment of FBAR penalty

FBAR

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

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

Bank Secrecy Act (BSA)

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

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

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

Civil FBAR penalty Amendment and willful failure

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

By: Anthony N. Verni, Attorney at Law, CPA.
© 1/26/2019
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Self Employed Tax Schemes That Always Fail

58981183 s

58981183 – 3d illustration of “irs report fraud” title on legal documents. legal concept.

If you are self-employed and recently received an examination notice from the Internal Revenue Service or are have concerns about the manner in which you have been operating your business, you may find the following discussion helpful. For purposes of this discussion, the term “self-employed” will include sole proprietorships, single member LLC’s, Sub Chapter S. Corporations as well as C Corporations.

Individuals who elect to go into business for themselves will typically seek out the assistance of an attorney who may or may not be familiar with the U.S. Tax Laws.  Others may elect to use services such as “Legal Zoom” for purposes of setting up a corporation or Limited Liability Company.  In both instances, the focus is usually on the issue of limited liability for the organizer and very little discussion on the subject of tax compliance.

Consequently, some Individuals who are self-employed see the business as a personal war chest to be used to fund lavish vacations or to purchase luxury items, such as homes, jewelry, and let us not forget the exotic automobiles.  If the self-employed individual has an affinity for fine food and wines, he may also determine he is entitled to write off all of his meals. After all, his is the business and without him, none of this would be possible.

Some are even so brazen as to place family members who perform no services on behalf of the business on the payroll.  In one extreme case, a taxpayer built a 3,000 square foot garage to house his exotic vehicles and depreciated the cost of the garage valued at over $200,000. This individual also wrote off the exotic vehicles. The other schemes include using business revenues to fund lavish events such as a daughter’s wedding or a golf outing or deducting payments for personal services  such as house cleaners, nannies and the like.

Where the business structure is either a C or S Corporation or a multi member limited liability company, there may be less transparency than in the case of a sole proprietorship or single member Limited Liability Company. Nevertheless, there is always exposure.

The individual’s tax problems usually begin to surface following a downturn in business, a divorce, a business breakup, a disgruntled former employee, a formal filing (Bankruptcy) or default on a loan when the taxpayer’s nefarious actions may be unmasked.  It is very rare that tax evasion schemes are carried out without the assistance or at least, the knowledge of others and are usually accompanied by some form of financial representation that is inconsistent with the income that is reported.

When a business begins to struggle, the self-employed individual usually engages in fiscal austerity measures which may include not paying employment taxes to the IRS, failing to make quarterly installment tax payments, failing to remit state sales tax or failing to pay vendors.

However, that is where the austerity usually begins and ends.  As financial pressures mount, the individual may decide to transfer personal and corporate assets to a newly created nominee entity, a trust or to family members or friends with the hope of keeping these assets beyond the reach of the IRS.  In the case of substantial unpaid payroll taxes, the individual may sometimes form a new entity for purposes of avoiding the outstanding payroll tax liability but continuing the business. This process if repeated is known as “Pyramiding.”

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Unfiled Income Tax Returns “Come Into The Light”.

income tax return due date.jpg thumpSerial Tax Return Non-filers.

Every year, thousands of individuals fail to file their Federal and State Income Tax returns despite being required to do so. I refer to these individuals as “serial non-filers,” since many of these individuals are repeat offenders. These serial non-filers offer one excuse or another as to why they have not filed their taxes.

The first sign of trouble is when the IRS sends a letter requesting that the Individual file his or her outstanding return. The usual response is to ignore this letter. The Taxpayer may next receive an assessment of tax for the years in question based upon income reported to the IRS from a third party such as an employer, or brokerage firm, bank or other sources from which the IRS has filed a substitute return. All assumptions in the substitute return are resolved against the taxpayer and legitimate deductions such as home mortgage interest, taxes, etc. are ignored. In addition, the sale of capital assets is treated as ordinary income and the IRS ignores the taxpayer’s basis in the capital asset. Consequently, the tax liability is almost always overstated.

The taxpayer is now concerned but continues to ignore the notice of tax due and simply throws the notice in the trash. The serial non-filer is then shocked, when he or she goes to the ATM on a late Friday afternoon, and attempts to withdraw money from the ATM, only to find that all of his or her funds have been frozen based upon a Notice of Levy placed by the IRS on the individual’s accounts.

Sound familiar?

The non-filer eventually receives a notice of tax lien, which has been filed against their property. He/ She receives Notice from the IRS but simply throws it in the trash without first reading it. The taxpayer eventually learns of the lien from his mortgage broker who is working on a refinance of the taxpayer’s mortgage.

The taxpayer also recently interviewed for a dream job as a chief financial officer of a large construction company and the company makes an offer of employment, subject to a background and credit check. The credit report comes back and shows the outstanding tax liens. Needless to say, the offer is rescinded.

Following the denial phase, the serial non-filer realizes he/ she has a serious problem, but decides he/ she is going to handle the matter himself/ herself.  He/ she goes on the IRS website and becomes totally confused. He/she does nothing for another three months.

What’s wrong with this picture?

The serial non-filer could have avoided these problems by filing his or her returns and paying his or her tax. The situation looks tough but there is hope.  The serial non-filer can file his/ her delinquent returns, which reflect the actual tax due, which in most cases is substantially less than the amount assessed by the IRS. Remember when the IRS files a substitute return, it is based solely upon gross revenues reported by third parties.  The serial non-filer’s return will certainly include deductions which the IRS does not consider.

The serial non-filer finally decides to contact my office. We prepare and file the delinquent returns; the outstanding balance is approximately $25,000.00, about $150,000 less than the amount assessed by the IRS. We also negotiate an installment agreement, where the serial non-filer agrees to make regular payments via automatic deductions from his bank account. The serial non-filer received a small settlement from a minor fender bender and initially pays $5,000 down.  He/ she then makes five installment payments. Thereafter, the serial non-filer engages my office to file necessary paper work with the IRS upon which the Federal Tax Lien is withdrawn. The serial non-filer pays off the balance to the IRS within 24 months and is able to refinance his mortgage. Unfortunately, the job opportunity is forever lost.

Tax resolution is extremely technical and therefore requires the assistance of an experienced attorney, who understands tax administration, the U.S. Tax laws and taxpayer’s options. Every case can be resolved. However, each case depends upon the amount owed, whether the taxpayer has had previous problems with the IRS, and of course, the taxpayer’s ability to pay.

 

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Willful FBAR Penalty- Legal Decisions Diminish Taxpayer Prospects for Successful Defense.

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

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

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

Court’s response.

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

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

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

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

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

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

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

 

 

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Immigration and Lying on your Tax Return: The Quickest way to deportation.

Lying on tax return as an immigrant.

The IRS has identified a rise in the number of immigrants who routinely lie Tax Returnson their tax returns in order to secure large refunds to which they are not entitled. To address this trend, the IRS has vowed to heighten scrutiny with the commitment to go after these taxpayers with vigor. As such, you will see increased civil, and in certain cases, criminal penalties being assessed on the perpetrators.

As an immigrant, lying on your Federal Tax Return can also have other consequences such as; denial of citizenship during the naturalization process and deportation.  Immigration law considers tax fraud to be a crime of moral turpitude and an aggravated felony, which upon conviction can result in the commencement of removal proceedings and deportation. Immigrants include individuals who are here legally such as those with student visas as well as lawful permanent residents.

Some of the things that the Internal Revenue Service has been focusing on include; under-reporting income, fabricating expenses and claiming refundable tax credit.

False claims by taxpayers include:

  1. Claiming increased federal and state withholding which does not correspond to the taxpayer’s W-2;
  2. Claiming additional child tax credits to which a taxpayer is not entitled to;
  3. Claiming additional dependents to which the taxpayer is not entitled to claim;
  4. Claiming a false earned income credit;
  5. Making up itemized deductions such as medical expenses, charitable contribution and miscellaneous expenses;
  6. Claiming false employee business expenses on Schedule A including business mileage and unreimbursed employee business expenses;
  7. Filing Form 1040, Schedule C  and reporting made up  income and expenses on a nonexistent business in order to generate a loss;
  8. Failing to disclose foreign financial accounts and other foreign financial assets and income from these assets on FinCen Form 114 and Form 8938;
  9. Lying on Schedule B, Part III, questions 7(a) and 7 (b) by checking “no”  in response to questions concerning the existence of foreign bank accounts and the obligation to file FinCen Form 114 (FBAR); and
  10. Obtaining a false social security number and filing an income tax return, while at the same time, applying and receiving government benefits using the individuals actual social security number.

The above list is only a partial list of things that some immigrants routinely lie about on their tax returns.

It makes no difference whether you self-prepared your tax return or you went to a questionable tax preparation firm to have your return prepared. If you signed the return under “penalty of perjury” you are responsible for its contents. “Willful Blindness” is not a defense.

My office handles hundreds of offshore disclosure cases a year and I routinely come across the above irregularities when reviewing taxpayer returns.  If your return was prepared by a third party and the tax return was filed as “self-prepared,” you can be certain that the return is inaccurate and contains material misrepresentations and omissions.  If you received a large refund, do not assume it is the generosity of the U.S. Government. There is chance that the refund was generated through fraud.

Remember, you have invested a great deal of time and money in order to pursue your dream in America. Processing your status from visa, to permanent resident and ultimately, to naturalization is a great accomplishment. Lying on your taxes is the fastest way to denial of citizenship and in some cases, a one way ticket back to your home country. It’s not worth it!

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Case Where Texas Ranchers Were Victorious in IRS Appeal

Dallas Appeals Officer Reverses IRS Decision
Allows Business Expenses and Ranching Losses for 2011 & 2012 and Abates the 20% Accuracy Related Penalty

If you have been contacted by the IRS concerning your business expenses and the losses reflected on your Federal income tax returns, you should contact a competent tax attorneyBack in 2014, I represented a Texas couple in connection with an Appeal from an IRS decision disallowing the Taxpayers’ business expenses and losses associated with the Taxpayers’ ranching operations for the tax years 2011 and 2012 as well as the assessment of the I.R.C. § 6662(a) 20% accuracy related penalty.

The client names have been changed due to confidentiality. The Appeal was successful and resulted in the allowance of 100% of the Taxpayers’ business expenses and losses associated with their ranching operations for the relevant tax years, as well as the abatement of the 20% accuracy related penalty. The Appeal resulted in a total tax savings of approximately $300,000.

The Facts of the Case

Kenneth Johnson* and Pamela Johnson* (the Taxpayers) are residents of the State of Texas with their principal place of domicile located in Brownwood. Mr. Johnson comes from a long line of ranchers and farmers. His grandfather came to Texas in a covered wagon and started raising cotton and cattle. The family tradition continued with his father and uncle and subsequently with Mr. Johnson.

In July 2001 the Taxpayers purchased, a 100 acre property located in Brownwood, Texas. The original property consisted of a 2,650 square foot home, barns, sheds, stock tanks, as well as corrals and a cattle chute. In November of 2002, the Taxpayers purchased the adjoining 120 acres. The Taxpayers subsequently leased an additional 403 Acres. The leased property has three stock tanks, is cross fenced and has corrals for working livestock. All of the foregoing was acquired with the intent of establishing a viable ranching operation, consistent with Mr. Johnson’s rich family history in ranching.

Beginning in 2010 and continuing through 2012, Central Texas experienced a severe drought. Farmers and Ranchers in this area saw their earthen tanks as well as rivers and creeks dry up. In order to survive many ranchers and farmers had to haul water to their livestock. In addition, due to the lack of rainfall, ranchers, including the Johnson’s, were forced to purchase more hay and feed to try and make it through the drought. Ultimately, many ranchers, including the Taxpayers, were forced to mitigate their losses by selling off their livestock. As a result of the drought, ranchers were faced with a shortage of breeding stock available for sale, which in turn, resulted in higher livestock prices. Consequently, ranchers required additional time in order to replenish their herds.

In addition to the Taxpayers’ ranching operations, Mr. Johnson* was employed full-time in the oil and gas industry. The Taxpayer and his wife also owned and operated several other enterprises including a sales and marketing and mud logging business and also owned several rental properties. For the Tax Years 2011 and 2012, the Taxpayers self-prepared and filed their joint Federal income tax returns. For the tax years 2011 and 2012, the Johnson’s Federal income tax returns reflected ranching losses in the amount of $342,326 and $483,705 respectively.

In June of 2013 the Taxpayers’ 2011 and 2012 Federal income tax returns were selected by the IRS for examination. The Johnson’s were not represented during the IRS examination which resulted in the IRS disallowing 100% of the Schedule F (Farming) business expenses and the ranching losses sustained during the years in question. In addition, the IRS assessed the I.R.C. § 6662(a) 20% accuracy related penalty. The predicate for the IRS assessment was based upon the principle that a taxpayer may not deduct expenses and losses associated therewith, where a legitimate business purpose and profit motive is absent. The IRS assessed $102,697 and $145,112 in additional income tax for the respective tax years 2011 and 2012. In addition, the IRS assessed the 20% accuracy related penalty in the amount of $23,963.00 and $29,022.00 for the two years in question.

The IRS auditor provided the Johnson’s with Form 4549 (Income Tax Examination Changes) outlining the proposed changes. Thereafter, the Taxpayers contacted and retained the services of Kathryn J. Earnhardt, a local certified public accountant, for purposes of filing a written request for reconsideration to the Income Tax Examination Changes with the IRS. Ms. Earnhardt’s filed the request for reconsideration, but the IRS determined that it would not alter Form 4549. The IRS response consisted of Letter 692 (Request for Consideration of Additional Findings) and Form 886-A (Explanation of Items).

Mr. and Mrs. Johnson* thereafter contacted me and retained my services to represent the Taxpayers in connection with filing an Appeal with respect to the IRS assessments for 2011 and 2012. The issues presented for Appeal included the disallowance of the Schedule F business expenses, the disallowance of the losses from the Taxpayers’ ranching operations for the years 2011 and 2012 and the assessment of the I.R.C. § 6662(a) 20% accuracy related penalty.

In January 2014, my office prepared and filed a Protest Letter and Form 12203 (Request for Appeals Review) on behalf of the Johnson’s with the IRS Appeals office in Dallas, Texas. A conference was subsequently scheduled with the Appeals office in Dallas for March of 2014.I attended the conference together with the Johnson’s. We met with Mr. Robert Warfield, an attorney with IRS Appeals. During the conference, we discussed the issues presented and the Johnson’s provided credible testimony concerning profit motive in their ranching operations, as well as the circumstances related to the draught. At the conclusion of the conference Mr. Warfield informed the Taxpayers that they were entitled to 100% of the business expenses and ranching losses reflected on Schedule F for the tax years 2011 and 2012 and that those adjustments would be made to the Taxpayers’ account. In addition, Mr. Warfield also informed the Taxpayers that the 20% accuracy related penalty would be abated.

The experience gained from this case is as follows: If you started a business within the last five years and have continued to sustain losses, there is a risk that your returns will be selected for examination and subject to the IRS disallowing the both the business expenses as well as any losses. A self-employed Taxpayer needs to be able to establish that the business is viable as a going concern, and that a clear profit motive exists. Since no two cases are alike, it is important to have credible evidence regarding income patterns in your industry and that your expenses are in line based upon your income. If you have been contacted by the IRS concerning your business expenses and the losses reflected on your Federal income tax returns, you should contact a competent tax attorney to discuss the specific facts of your case, industry profit and loss statistics and the options available to you.

* The clients’ names have been changed for purposes of preserving the privacy of attorney client privilege. The facts of the tax law case are the same.

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New Jersey Couple Avoids FBAR Penalty and Instead Receives Warning Letter

The following is an actual FBAR case handled by the Law Office of Anthony N. Verni. My Princeton New Jersey office was successful in securing a waiver of the proposed FBAR penalties for these two taxpayers.

FBAR statute of limitations can incur FBAR penalties by the IRS, here is a prior experience with a New Jersey coupleMr.and Mrs. Beránek (a.k.a. the “taxpayers”) are Czechoslovakia nationals.* The taxpayer as well as his spouse are retired and in their early seventies. The Beránek’s came to the United States in 1997 as Permanent Legal Residents and became naturalized citizens in 2004. Since their immigration to the U.S., Mr. and Mrs. Beránek have lived in Freehold, New Jersey.

The taxpayers maintained an account with UBS in Switzerland (the “UBS Account”), which was established in 1962. The taxpayers would routinely deposit their earnings from their employment as electrical engineers into the UBS Account. In addition to the UBS Account,Mrs. Beránek opened and maintained a joint account with her non-resident alien sister, Catalina in Zvolen Slovakia at Credit Suisse (the “Credit Suisse Account”).

In 1996 the Beránek’s sold their personal residence in Prague and liquidated a number of investments totaling $1,350,000. The proceeds were used to open a Brokerage Account with Raymond James in Newark, New Jersey. The taxpayers also owned a commercial rental property located in Prague until October of 2005, when the property was sold for $700,000. The proceeds from the sale were deposited into the UBS Account and remain there to date.

The taxpayers’ federal income tax returns were prepared by a local CPA near Howell, New Jersey, by the name of Sam Patel.** Each year the taxpayers would meet with Mr. Patel’s assistance and would provide her with copies of the Composite Form 1099 they received from Raymond James.

The CPA was unfamiliar with the FBAR filing requirements, and further, did not understand the concept that U.S. Taxpayers are taxed on their worldwide income. Consequently, Mr. Patel failed to prepare and file FBAR reports, failed to report the interest income earned on those accounts and failed to report the income and expenses from the rental property on the taxpayers’ income tax returns. In addition, Mr. Patel also failed to report the sale of the property in 2005 on the taxpayers 2005 tax returns.

In 2010 the taxpayers were notified that their 2005-2007 federal income tax returns were selected by the IRS for examination. The taxpayers retained an Upper Montclair, New Jersey CPA, who was competent in the area of IRS examinations, but he too was unfamiliar with the reporting requirements for foreign financial accounts.

As part of the examination process the IRS auditor asked the taxpayers about the existence of any foreign financial accounts and whether the taxpayers had any foreign source income.

In response to the IRS agent’s questions, the taxpayers disclosed that they had two foreign financial accounts and that interest income was earned on these two accounts. In addition, the taxpayers told the IRS that they received rental income from the commercial rental property in Prague, but sold the property in 2005. As a result of the taxpayers’ disclosures, the scope of the examination was expanded to include the tax years 2008 and 2009.

At the conclusion of the examination, the IRS advised the taxpayers that an additional income tax in the amount of $2,822 for the years 2005-2009 would be proposed. The agent also told the taxpayers that he was recommending a negligence FBAR penalty in the amount of $100,000, representing a $10,000 penalty for each account for each of the five years.

The taxpayers then retained my office in Princeton NJ for purposes of bringing them into compliance with the IRS and pursuing an abatement of the proposed negligence FBAR penalties.

During my initial meeting with the Beránek’s, I was not able to discern that the taxpayers were unaware of the FBAR reporting requirements nor were they aware of their obligation to report their worldwide income for Federal income tax purposes.

The taxpayers also informed me that neither Mr. Patel nor his assistance ever asked the Beránek’s whether they had any interest in any foreign financial account or whether the taxpayers received any income from foreign sources. Based upon the foregoing, I determined that reasonable cause existed and that an abatement of the proposed FBAR penalties should be pursued.

I contacted Mr. Patel and secured the taxpayers’ complete file. I was also able to secure an affidavit from the Mr. Patel wherein he acknowledged being unfamiliar with the FBAR filing requirements and also admitted that he was not aware that U.S. Taxpayers must report their worldwide income for federal income tax purposes.

I contacted the IRS agent’s supervisor and explained the situation. We agreed that the taxpayers would submit amended income tax returns for 2005-2009 and also prepare and file delinquent FBARS for the same years. We further agreed that we would revisit the FBAR penalties proposed by the agent once the taxpayers brought their filings current.

We amended the taxpayers’2005-2009 Federal Income Tax Returns. We also prepared and filed FBAR reports for 2005-2009.

The amended returns, together with the taxpayers’ remittance in the amount of $2,822 were delivered the IRA agent. We also provided the agent with, copies of the filed FBARS, a letter brief, outlining the relevant facts supporting our abatement request and Mr. Patel’s affidavit.

Following his review of the documents submitted and supervisor review, the examining agent advised me that he would be withdrawing his recommendation for the imposition of the FBAR penalties and would instead recommend that a warning letter be issued to the taxpayers. Several weeks later the taxpayers received a warning letter (Letter 3800) from the IRS and the case was closed.

Anthony N. Verni is an attorney and certified public accountant with over 20 years of experience.His practice is focused on representing expatriates and other U.S. Taxpayers, who have failed to report their worldwide income and/or failed to meet the FBAR reporting and other U.S. financial reporting requirements. Mr. Verni services clients in the Tri-tate area, South Florida, as well as client residing outside of the United States. In addition, Mr. Verni represents clients in domestic tax matters including examinations, appeals as well as taxpayers with un-filed income tax returns.

*The clients’ names have been changed for purposes of preserving the attorney client privilege. The facts of the case, however, are the facts from the actual case.

**The CPA name and location is fictitious, based upon a confidentiality agreement.

©2017 Anthony N. Verni, Attorney at Law, CPA

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