Three cases were recently decided against taxpayers that shed light on the hurdles Americans must climb if they have unreported foreign accounts or assets.
As I have previously described here (https://www.swlaw.com/publications/legal-alerts/2586), the IRS has three programs available to help taxpayers come clean, and avoid the full force of civil and potentially criminal penalties for failure to disclose foreign accounts and assets. As a broad proposition, if the taxpayer believes they may have acted willfully in that failure, they would use the Offshore Voluntarily Disclosure Program (OVDP). If the taxpayer thought they were perhaps non-willful, but did not have reasonable cause for their failure, they might use the Streamlined Filing Compliance Procedures (Streamline Procedures). Finally, if the taxpayer believed they did not act willfully and they had reasonable cause for their failure, they might use the delinquent Foreign Bank Account Report (FBAR) submission procedures, or the delinquent international information return submission procedures (the Delinquent Filing Procedures).
In general, to navigate OVDP, a taxpayer must file six years of amended returns and FBARs, pay all delinquent taxes with interest, and pay penalties that could include a penalty equal to up to 75% of the highest tax liability and a willfulness penalty of up to the greater of $100,000 or 50% of the highest balance of the unreported accounts.
In the Streamline Procedures, the taxpayer must file six years of delinquent FBARs and three years of amended returns, paying all delinquent taxes and interest and a penalty of 0% or 5% of the highest year-end balance of the unreported accounts (depending on the residency of the taxpayer).
In the Delinquent Filing Procedures, the taxpayer must argue they had reasonable cause (a standard applied under the rules of various related Code provisions), and the penalty is $0.
In the U.S. v Ott case, the United States District Court for the Easter District of Michigan determined that a taxpayer who dropped out of a prior version of OVDP acted willfully in not disclosing various Canadian accounts holding up to $1,900,000 at their highest. The taxpayer set the accounts up using the Canadian mailing address of his sister and had regular contact with the institution holding the accounts, though none of the mailing to his sister’s address were sent to him. The taxpayer did not file FBARs to disclose the accounts and checked the “No” box on his federal tax returns with reference to whether he had foreign accounts of over $10,000. Along with other tax, interest, and penalty assessments, the IRS assessed a $988,245 willful FBAR penalty against the taxpayer.
The Ott Court explained that in the context of FBARs, “willful” can mean either reckless or willfully blind. Recklessness, the Court expounded, includes carelessness and that a taxpayer is reckless if the taxpayer (1) clearly ought to have known that (2) there was a grave risk that the filing requirement was not being met and if (3) the taxpayer was in a position to find out for certain very easily. Noting that there is no consistent legal standard for willful blindness, the Court stated that willful blindness may be proven by objective recklessness.
The Court concluded Ott was reckless, and willfully blind, under these standards by checking the “No” box on his tax returns, by not informing his accountant of the Canadian accounts until years after the accounts were created, by using his sister’s address as a means of concealing the accounts, and by frequently and continuously being in contact with his foreign account (both online and directly with the Canadian financial institution).
The case illustrates the challenging willfulness standard and the risk a taxpayer takes to analyze the standard and select the Streamline Procedures or the Delinquent Filing Procedures. Before jumping into the Streamline Procedures or the Delinquent Filing Procedures, a taxpayer must carefully evaluate their exposure under the willfulness standard. Since that standard does not require intentional action, it can be a tricky standard to analyze.
In Part 2, I will summarize two other cases dealing with the reasonable cause standard.