© 2013 by Galyan Law, a P.C.

Currently, the IRS has several programs available for U.S. taxpayers living in the United States who wish to voluntarily come forward and cure prior failures related to foreign assets and unreported foreign income.  In servicing clients, tax advisors need to be cognizant of not only future filing obligations related to offshore assets of the client, but also how to advise on a proper cure for prior misconduct.

 

U.S. taxpayers living in the U.S. who have undisclosed foreign accounts, unfiled information returns, or undisclosed foreign entities may file an offshore voluntary disclosure under either the Offshore Voluntary Disclosure Program (OVDP) or the Streamlined Domestic Offshore Procedures[1] (Streamlined Procedures). The risk of a Streamlined Procedures filing is greater than filing an OVDP, as taxpayers are required to certify under penalty of perjury that their failure to file FBARs and report foreign source income was due to non-willful conduct.  Taxpayers whose conduct arises to willful are not eligible for the Streamlined Procedures, but may file under the OVDP.  Further, there is no Closing Agreement provided as part of a Streamline Procedures filing.

 

The determining factor between choosing the OVDP and the Streamlined Procedures is whether the failure to disclose foreign financial assets and income was as a result of willful or non-willful conduct. 

 

Non-willful conduct is defined as conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirement of the law.

 

The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty.  Willful acts must be voluntary rather than accidental or unconscious.  United States v. McBride, 908 F.Supp 2d 1186, 1205 (2012). Evidence of willful intent may be proved by circumstantial evidence and reasonable inferences drawn from the facts.  Id.   

 

Willfulness may also “be proven through inference from conduct meant to conceal or mislead sources of income or other financial information.” United States v. Sturman, 951 F.2d 1466, 1476-77 (6th Cir. 1991).

 

Factors to Consider for Willful:  When advising clients about differences between the OVDP and the Streamlined Procedures, practitioners need to take adequate steps to gather the important facts of each case and consider all facts together to properly determine whether the client was a non-willful actor for Streamlined Procedures purposes. 

 

The following are factors to consider in determining willful vs. non-willful state of mind.

 

  1. Source of Funds:  Funds which originated in the U.S., either reported or not for tax purposes, and transferred to a foreign jurisdiction may be indicative of willfulness.  In addition, funds earned overseas, deposited into the foreign account, and which were unreported for U.S. income tax purposes may show willfulness.  On the other hand, funds earned in a foreign jurisdiction prior to immigrating to the United States, or gifts and inheritance from a foreign person which remained offshore may be less indicative of willful acts by the client. 

 

  1. Contact with the Foreign Asset:  Willfulness may be shown in cases where the client personally set up the foreign financial account and/or foreign entity holding the account, personally managed the account, had full control of the funds, had access to the funds via debit cards, or transferred the funds to avoid detection (a “Leaver”).  The Service considers a “Leaver” to be willful in their actions.  “Leavers” are those persons who moved funds from one offshore financial institution to another at the time they were advised of their U.S. reporting requirements. Another important factor to consider is whether the client had a “Hold Mail” on the account instructing the financial institutions to hold the mail for the client at the institution. 

 

  1. Use of nominee entities:  A factor of willfulness is the use of a nominee entity, particularly in a tax haven jurisdiction, to hold foreign financial accounts.  Practitioners should consider requesting documents to determine whether the client is listed as the ultimate beneficial owner of the underlying assets. 

 

  1. Use of facilitators: Consider whether a business person (advisor), accountant, attorney, or other financially sophisticated persons was involved in setting up the foreign financial account and/or foreign entity or in advising in its continued use. 

 

  1. Failure to disclose to tax preparer:  Inquiry as to reasons why a client failed to disclose foreign sourced income and foreign assets to tax preparer may assist in determining whether client acted willful.  Willfulness may be established where the client affirmatively marking “No” on the tax organizer with regards to foreign financial accounts and/or foreign sourced income, and reported “No” on Part III of Schedule B.

 

  1. Sophisticated Taxpayer:  The education level, occupation, and sophisticated means of the client should be considered to determine whether the client acted with a willful state of mind. 

 

  1. Dual National Status:  Taxpayers, especially non-U.S. born persons, may be operating under mistake of law. A non-willful state of mind may be shown in those cases where the funds originated overseas prior to the taxpayer immigrating to the U.S. if the client was  under the mistaken believe that asset are not subject to U.S. income tax or reporting requirements. 

 

  1. Foreign Taxing and Disclosure Requirements:  Non-willful state of mind may be shown if the taxpayer filed foreign tax returns, paid tax in the foreign jurisdiction, and operated under the mistake of law that the income was not subject to U.S. reporting requirements because of double taxation.

 

  1. Outside Factors:  Clients may have held assets overseas in anticipation of litigation, bankruptcy, or divorce proceedings.  Outside factors are circumstantial evidence to show the client was acting in a manner to avoid detection of the funds held overseas. 

 

  1. Continued Failure to Comply:  Some Taxpayers may continue non-compliant behavior even after being advised of their reporting duties for foreign income and assets.  The client’s behavior may shift from non-willful to willful after the client has been advised of their duty to report foreign financial assets.  Practitioners who have advised clients of reporting obligations, and where the client fails to comply, must consider the on-going relationship with the client.

 

No one factor is determinative and all factors, including those not listed here, must be considered in making a determining whether the client was non-willful in their failure to disclose foreign assets and foreign sourced income. Practitioners with clients who have foreign source income and foreign financial accounts which have not been disclosed for U.S. income tax and Bank Secrecy Act purposes must review the facts of each case prior to making a recommendation of an offshore voluntary disclosure under either of the two above programs.  The main focus of the analysis is to determine whether the actions of the client rise to the level of being considered “willful”.  Using the Streamline Procedure in the wrong case could result in prosecution, 50% FBAR penalties and 75% income tax fraud penalties.    You do not want to be the representative of the client who “chose poorly”.

 

One final note, if you are the practitioner who advised the taxpayer initially, you and your records may be subject to subpoena by taxing authorities.  You should immediately disengage and refer that client to counsel.

 

[1] The IRS also offers a Streamlined Foreign Offshore Procedures for those U.S. persons who reside outside the United States and meet the residency requirement as set forth in the settlement program.

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