Monday, March 27, 2017

Summa Holdings – IRS Pushed Back on Substance Over Form Doctrine

Domestic International Sales Corporations (DISC) allow deferral of federal income tax on certain income from exports. A DISC is often nothing more than a corporate shell formed to take advantage of a federal tax loophole. I’ll save the technical aspects for another day. Suffice it to say the DISC loophole was created for the purpose of incentivizing companies to export goods and using a DISC can result in significant tax savings. A Roth IRA is a common form of retirement savings vehicle. A taxpayer does not deduct contributions to a Roth IRA, but can take out contributions, including all gains from investment, tax free in retirement. When the tax benefits of a DISC are combined with the tax benefits of a Roth IRA the result is huge tax savings. It is unlikely Congress considered this result when passing legislation in 1997 to create Roth IRAs. Nevertheless, the law as it is written is clear, at least according to the Court of Appeals for the Sixth Circuit.

In Summa Holdings, Inc. v. Commissioner, (“Summa”) the IRS takes issue with two taxpayers who used the combination of a DISC and Roth IRAs to avoid taxation of income. The taxpayers set up two Roth IRAs. One Roth IRA for each taxpayer. They immediately made a contribution, within prescribed limits, and used the funds contributed to purchase shares of a DISC. A holding company was then formed which purchased the DISC shares back from the Roth IRAs, but the holding company itself was also owned by the Roth IRAs, 50 percent each. By funneling income through this structure into the Roth IRAs, each of the two Roth IRAs accumulated more than three million dollars, achieving major tax savings. The Roth IRAs grew by a combined 1.4 million dollars in one year alone.

The IRS, as you can imagine, did not like this tax savings scheme.

The IRS sought to recast the funds funneled into the Roth IRAs through this structure as dividends to the individual shareholders of Summa Holdings. The result of the IRS’s proposed recast would have been a large amount of tax, an excise tax penalty, accuracy related penalty, and interest on the tax and penalties. The IRS presented its argument based on the doctrine of substance over form. In simple terms, under this doctrine, the form of a transaction is ignored for the true substance of the transaction. The economic reality of a transaction is analyzed to determine whether or not the transaction meets legal requirements imposed by the Tax Code. The idea is to achieve a clear reflection of income on a tax return, or set of tax returns, by setting aside transactions that have no economic purpose other than tax avoidance. The concept of substance over form is captured exceptionally well by Judge Sterrett in the Tax Court case John D. Gray, 56 T.C. 1032 in which he writes “Once the fog of [a transaction] is blown away by the fresh air of economic reality the substance of the transactions is clearly visible.” Although the case was decided in 1972, it is still relevant.

The IRS’s point in Summa was that the structure the taxpayers set-up had no economic substance, except to avoid tax. On that point the IRS is correct. The Tax Court initially went along with the IRS’s argument and application of substance over form. There is no doubt substance over form has its place in tax law. Congress believes it does as well since the judicially created doctrine has been adopted in the Internal Revenue Code, but in this case the Court of Appeals for the Sixth Circuit said not so fast:

How can citizens comply with what they cannot see? And how can anyone assess the tax collector’s exercise of power in that setting? The Internal Revenue Code improves matters in one sense, as it is accessible to everyone with the time and patience to pour over its provisions. In today’s case, however, the Commissioner of the Internal Revenue Service denied relief to a set of taxpayers who complied in full with the printed and accessible words of the tax laws.

The Court of Appeals flatly rejects the IRS’s argument and reversed the Tax Court. It holds that the law allows the taxpayers to do exactly what they did and scolds the IRS:

It’s one thing to permit the Commissioner to recharacterize the economic substance of a transaction- to honor the fiscal realities of what taxpayers have done over the form in which they have done it. But it’s quite another to permit the Commissioner to recharacterize the meaning of statutes- to ignore their form, their words, in favor of his perception of their substance.

The Court goes on to state:

Each word of the of the “substance-over-form doctrine,’” at least as the Commissioner has used it here, should give pause. If the government can undo transactions that the terms of the Code expressly authorize, it’s fair to ask what the point of making these terms accessible to the taxpayer and binding on the tax collector is. “Form” is "substance” when it comes to law. The words of the law (its form) determine content (its substance). How odd, then, to permit the tax collector to reverse the sequence-to allow him to determine the substance of a law and to make it govern “over” the written form of the law – and to call it a “doctrine” no less.

These are strong words used by the Court. Because the taxpayers used a legislatively approved mechanism to legally reduce tax, there is no basis for the Commissioner to change the application of the law, by arguing in esoteric terms, that what is plainly allowed under the law is somehow forbidden. While not expressly stated, the Court of Appeal seems to be reminding the IRS of a basic tenet of the U.S. Constitution, separation of powers. The IRS cannot legislate through the courts by arguing substance over form because it doesn’t like the result of proper application of the law. I guess the IRS forgot about that.

There is no question the substance over form doctrine has its place in tax jurisprudence. I, for one, think the IRS’s use of the doctrine is at times an overreach. The irony… Unfortunately, the courts tend to go along. It’s refreshing to see the IRS pushed back in persuasive terms in the Summa case. I wonder if it will mark a scaling back of the IRS’s use substance over form doctrine as a sword. Or, will the IRS in its arrogance persist? Probably the latter.

Thursday, February 16, 2017

Owe An IRS Tax Debt? You May Soon Be Contacted By A Private Collection Agency!

The IRS will soon begin using private collection agencies (PCA) to collect delinquent tax debts. The IRS has not yet announced a specific date, but said it will begin using PCAs as early as the spring of this year.

This is not the first time the IRS will try using PCAs. An independent study on cost effectiveness of using PCAs was conducted in 2009 that led to the IRS discontinuing use of PCAs. IRS Commissioner at the time, Doug Shulman, concluded based on the study that the IRS is more effective than the PCAs. Nevertheless, FAST Act was passed in December of 2015 and mandates the IRS to begin contracting with PCAs for help collecting on certain tax debts.

The relevant section of the FAST Act is incorporated in the Internal Revenue Code (IRC) at section 6306. The FAST Act also included in the new law which mandates the IRS to certify certain tax delinquencies to the State Department for passport revocation. You can find my blog on that topic here.

IRC Section 6306 states in part “notwithstanding any other provision of law, the Secretary shall enter into one or more qualified tax collection contracts for the collection of all outstanding inactive tax receivables.” Basically, this means the tax debts that the IRS is no longer actively trying to collect will be referred to a PCA.

What criteria will the IRS use to determine cases that will be referred to a PCA?

Three specifically designated types of cases will meet the criteria for referral:

1. At any time after assessment, the Internal Revenue Service removes a case from active inventory because of lack of
resources or inability to locate the taxpayer;
2. More than one-third of the applicable statute of limitation has lapsed and the case has not been assigned to an IRS
employee; or
3. For a case assigned to an IRS employee for collection, more than 365 days have passed without interaction with the
taxpayer or a third party in furtherance of collecting delinquent tax.

There are also designated categories of cases that are not eligible for referral to a PCA:

1. A case with a pending or active offer in compromise or installment agreement;
2. A case classified as innocent spouse;
3. Deceased taxpayers;
4. Minor taxpayers;
5. Taxpayers serving in a combat zone; and
6. Victims of tax-related identity theft.

The IRS will provide the taxpayer and the taxpayer’s representative notice of assignment of the case to a PCA. The PCA will then send a second notice and begin trying to collect on the tax debt.

Who are the Private Collection Agencies?

So far, The IRS has entered in to contracts with four companies:

1. ConServe based in Fairport, New York;
2. Pioneer based in Horseheads, New York;
3. Performant Recovery based in Livermore California; and
4. CBE Group based in Cedar Falls, Iowa.

What can the private collection agencies do?

A private collection agency does not have the power of the IRS. The IRS can issue liens and levies, and summon records in its effort to collect on a delinquent tax debt. A private debt collector has none of those powers. A private debt collector must also adhere to the Fair Debt Collection Practices Act. Fair tax collection practices set forth in Internal Revenue Code section 6304 are also applicable limitations on PCAs. They can do no more than try to track down a taxpayer, send letters and make calls. They are prohibited from contacting third parties. There is no authority to file liens or issue levies. They cannot file a lawsuit to reduce a tax debt to judgment or foreclose on a tax lien. Their effectiveness rests solely in their persistence to collect a buck.

PCAs can collect financial information from a taxpayer, but only for the purpose of transmitting that information to the IRS. They can also negotiate installment agreements for agreements of less than 60 months that will result in full payment of the tax debt. However, the IRS reserves the right to approve or deny any installment agreement. According to IRS announcement 2006-63, all installment agreements on debts over $25,000 or covering a period of more than 36 months must be approved by the IRS. The IRS will likely continue following that framework.

What to do if your case is assigned to a private debt collector?

Assignment to a PCA may interfere with efforts to resolve a tax debt. In that case, a request should be made to refer the case back to the IRS in order to work out a resolution. In other cases, it may be advantageous to work with the PCA directly. A tax professional can help evaluate all available options.

There are many on-going scams targeting taxpayers and practitioners. A concern with the IRS’s use of PCAs is that it will be more difficult to distinguish between legitimate contacts and scammers. It is important to be vigilant to avoid falling victim to a tax scam. Taxpayers suspecting a scam or dealing with misconduct by a PCA employee can make a report by calling the TIGTA hotline 1-800-366-4484 or visiting the TIGTA website.

Friday, February 3, 2017

Examination Collectibility Consideration: Another Example of IRS Inefficiency

I recently read a very interesting report issued by the Treasury Inspector General for Tax Administration (TIGTA) on the topic of the IRS Examination function failing to consider the collectibility of potential assessments. Collectiblity is simply the likelihood the IRS will ever actually collect any tax following an assessment. The report is titled “Examination Collectibility Procedures Need to be Clarified and Applied Consistently.” It is a stinging criticism of IRS inefficiency. The full report can be found here. It’s worth a read.

It is rare for the IRS during an audit to consider whether or not any additional tax assessed at the conclusion of an audit can actually be collected. It’s even more unusual for the IRS Examination function to actually discuss collectability with the taxpayer or their representative. This is contrary to established policy and procedure. The Internal Revenue Manual states “Examiners are expected to consider the collectability during the pre-contact phase as a factor in determining whether to survey the return or limit the scope and depth of examination. Collectibility may also become a factor for consideration during the course of the examination.”

The IRS is failing to follow its own policy to consider collectability determinations in Examination in a majority of cases. The result is an extremely poor use of resources. TIGTA provides the example that in a five year period, the IRS Collection function received over 700,000 tax delinquent account (TDA) cases per year, all of which originated with an exam assessment. A TDA case is a case where the taxpayer owes a seriously delinquent tax debt. The number 700,000 represents nearly 10% of all TDA cases.

The IRS has cried foul about budget cuts over the last few years. Commissioner Koskinen stated a while back the IRS will simply do less with less in light of the on-going budget reductions. This comment was well publicized. I thought that comment was a clear example of poor leadership. Instead of striving to do better with resources available, he just threw his hands up like it was okay to do a crappy job for the U.S. taxpayer.

Examples like the IRS Examination function not following policy to consider collectibilty only solidifies my opinion that the IRS does not really need more money to do its job. They need to use the resources they do have to the fullest. Clearly they are not doing that! In this example, the Examination function simply plows forward to complete assessments of tax that will never be collected. It is completely unproductive work. Once a tax assessment is complete, how many IRS employees does it then take to sort through 700,000 TDA cases per year that land in the lap of the Collection function? A lot! All those employees require a desk or cubicle, chair, computer, etc. Administering these cases requires letters to taxpayers; so there is paper, ink, printing, postage, customer service demands in the form of taking phone calls, processing financial statements from taxpayers, etc., etc. It all adds up to a mind boggling amount of wasted money.

If the IRS corrected just this one example of its failure to follow policy and thereby work more efficiently and effectively, it could save many millions of dollars a year. TIGTA says “If examiners do not follow the IRM procedures to consider and evaluate collectability while working their cases, there is a higher risk of uncollectible assessments and inefficient use of both Examination and Collection functions’ limited resources.”

In other words, a lot of IRS employees are paid for work that does nothing productive. According to the report, “all of the cases that [TIGTA] reviewed were sent to the Collection function. Both Examination and Collection function resources were spent developing the assessment and pursuing collection, but ultimately all of the cases were closed without the taxpayer making any subsequent payments to the IRS.” TIGTA estimates that IRS Revenue Officers spent more than 22,000 hours (yes, twenty-two-thousand hours, that translates to over 10 years of 40 hour work weeks) working on cases where Examination failed to consider collectability. Every one of those cases was closed by Collection without any payment from taxpayers. Ouch!

If the IRS only followed its own policy and procedure, not only would it save a lot of tax dollars, it would almost certainly produce more revenue by turning its attention to focus on more productive work – work that might actually produce payment of some taxes. There are many very good people that work at the IRS who have little to no control over issues like this. Addressing systemic problems takes sound and strong leadership at the highest level, and that is truly lacking at the IRS.

Wednesday, January 25, 2017

Not Required to File a Tax Return? Maybe You Should File Anyway!

The IRS offers five reasons why you should file a tax return even when it is not required.

According to the IRS:

Most people file a tax return because they have to. Even if a taxpayer doesn’t have to file, there are times they should. They may be eligible for a tax refund and not know it.

Here are five tips on whether to file a tax return:

1. General Filing Rules. In most cases, income, filing status and age determine if a taxpayer must file a tax return. Other rules may apply if the taxpayer is self-employed or a dependent of another person. For example, if a taxpayer is single and under age 65, they must file if their income was at least $10,350. There are other instances when a taxpayer must file [even when the income is much lower. For Example, the threshold for self employed individuals is much lower]. Go to for more information.

2. Tax Withheld or Paid. Did the taxpayer’s employer withhold federal income tax from their pay? Did the taxpayer make estimated tax payments? Did they overpay last year and have it applied to this year’s tax? If the answer is “yes” to any of these questions, they could be due a refund. They have to file a tax return to get it.

3. Earned Income Tax Credit. A taxpayer who worked and earned less than $53,505 last year could receive the EITC as a tax refund. They must qualify and may do so with or without a qualifying child. They may be eligible for up to $6,269. Use the 2016 EITC Assistant tool on to find out. Taxpayers need to file a tax return to claim the EITC.

4. Additional Child Tax Credit. Did the taxpayer have at least one child that qualifies for the Child Tax Credit? If they do not qualify for the full credit amount, they may be eligible for the Additional Child Tax Credit. Beginning in January 2017, by law, the IRS must hold refunds for any tax return claiming either the EITC or the Additional Child Tax Credit until Feb. 15. This means the entire refund, not just the part related to either credit.

5. American Opportunity Tax Credit. To claim the AOTC, the taxpayer, their spouse or their dependent must have been a student enrolled at least half time for one academic period to qualify. The credit is available for four years of post-secondary education. It can be worth up to $2,500 per eligible student. Even if the taxpayer doesn’t owe any taxes, they may still qualify. Complete Form 8863, Education Credits, and file it with the tax return. Learn more by visiting the Education Credits web page.

All taxpayers should keep a copy of their tax return. Beginning in 2017, taxpayers using a software product for the first time may need their Adjusted Gross Income (AGI) amount from their prior-year tax return to verify their identity. Taxpayers can learn more about how to verify their identity and electronically sign tax returns at Validating Your Electronically Filed Tax Return.

I add the following reason why you might want to file a tax return even when not required to do so:

As noted above, taxpayers have to file in order get any refund they may be owed. No one should just leave that money on the table. This is even more important if back taxes are owed. A refund can help pay down, or even pay off an old tax debt.

Friday, January 20, 2017

NRP Audits - The Honest Taxpayer's Worst Nightmare

An audit by the IRS of tax returns can be very intimidating. When the IRS audits a taxpayer they usually don’t look at every single line item on a tax returns, and they don’t’ look at every single receipt. This is particularly true when a taxpayer demonstrates maintenance of accurate and complete books and records. BUT, a regular audit is nothing compared to the dreaded National Research Project (NRP) audit. Its predecessor, the TCMP audit, or Taxpayer Compliance Measurement Program audit, was highly controversial.

TCMP audits produced many complaints. The TCMP program was postponed in 1994 due to political pressure; then, the program was completely eliminated in 1995 due to budget cuts implemented by Congress. However, the IRS was back at it a few years later under what it calls the National Research Project. It’s the same overwhelming and burdensome audit as the TCMP audit, just under a new name. These audits of randomly selected taxpayers are highly intrusive audits that look at, and require proof of, every detail reported by a taxpayer on their tax return. They often last longer than a normal audit because of the extreme level of detailed review.

According to the IRS, the purpose of the NRP is:

NRP provides the IRS with current, reliable data on filing, payment, and reporting compliance that will support strategic decisions about the placement and type of resources necessary to effectively address the needs of taxpayers. This is done in the most cost-effective and least burdensome manner possible.

To paraphrase, the IRS uses NRP audits to statistics that are analyzed to determine how to better catch those cheating on their taxes and to better allocate resources for that purpose. The problem is that individuals randomly selected for the audit are subjected to a grueling line-by-line, receipt-by receipt audit. Every aspect of the return is reviewed and verification of every single deduction is reviewed. You often hear these audits referred to as the “audit from hell.”

Thinking of NRP audits reminds me of the short story “The Lottery” by Shirley Jackson. According to Wikipedia “one of the major ideas of ‘The Lottery’ is that of a scapegoat, or someone who is blamed for society's evils and is banished in a sort of renewal ritual. The act of stoning someone [randomly selected] to death yearly purges the town of the bad and allows for the good.” This seems oddly fitting to the rational of randomly selecting sacrificial taxpayers for NRP audits in order to figure out how to better catch tax dodgers. It must be okay since it is done in the name of the greater good, right?

In order to develop reliable data from these audits, the IRS must review every detail of the tax return. These audits are not fun. The bad actors caught up in an NRP audit can be assured of owing a lot more in taxes. The average Joe does a pretty good job of reporting to the IRS and paying taxes. But, they are not perfect in saving every receipt, logging every business use of a vehicle, or expense of entertaining a client. The result is that not only do they have to reconstruct proof of expenditures in excruciating detail, they often end-up losing deductions because their proof does not perfectly comply with the Internal Revenue Code. In an ordinary audit, many Revenue Agents will allow an expense deduction when it is verified by proof consistent with the spirit of the Internal Revenue Code, even if that proof is not strictly compliant. Not the case with an NRP audit. The deduction is denied absent proof that strictly complies with the Internal Revenue Code.

While the purpose of the NRP audit is noble, it is a nightmare for those unlucky taxpayers who are selected. It’s interesting that the Internal Revenue manual section lists one of the program benefits as follows:

When a compliant taxpayer is unnecessarily or ineffectively contacted by the IRS, the public's perception of the effectiveness and fairness of the federal tax system is hurt. Additionally, compliant taxpayers want to know that the IRS is capable of ensuring that everyone pays their fair share of taxes. The IRS uses a variety of techniques such as document matching, correspondence and audits to verify that taxpayers accurately report their tax liability on their returns. The IRS should audit those returns most likely to have errors. Various methods are used to identify errors with the most common method using Discriminant Function (DIF) (sic) formulas to select returns for examination.

The Discriminant Index Function (DIF) referenced in the above quote is a scoring formula applied to tax returns to determine those that will be selected for audit.

It could be argued that the IRS’s effort to avoid unnecessarily contacting taxpayers by conducting the NRP audits to update the DIF is, in and of itself, an unnecessary contact. They are so intrusive that the positive public perception the IRS seeks to uphold is terribly undermined. Thus, conducting NRP audits is contrary to the stated benefit.

A better focus for the IRS would be to update its antiquated technology to better engage in matching internal records like 1099s and W-2s to a tax return to verify accuracy. The IRS could also utilize examinations selected under standard protocol and elevate those to NRP audits, rather than random selection of any taxpayer. At least in this manner those subjected to the rigors of an NRP audit are taxpayers who were already selected for audit under normal protocol. There are enough “no change” audits selected under normal selection procedures for use in comparison with audits that do result in adjustment that it seems like a reasonable and viable approach to developing accurate statistical data to update the DIF.

Unfortunately, there is no reason to believe the IRS is going to stop doing this. Taxpayers with the misfortune of being selected for an NRP audit are best served by engaging an experienced CPA or tax attorney; specifically, a tax professional with experience handling NRP audits. It’s best to select one with experience handling these types of audits. Next, the taxpayer needs to immediately begin assembling all records for the year or years under audit. Those records should be organized in a manner which can be easily followed and then matched to your tax return entries by the IRS Revenue Agent conducting the audit. Workpapers and accounting records used in preparation of a tax return are often very helpful and sometimes required.

No taxpayer ever really knows if and when he’ll be audited, so it’s best to stay prepared. Keep very good organized records, be diligent in keeping all bookkeeping up to date and accurate, do not comingle personal nondeductible expenses with business expense deductions, and use a highly regarded CPA to prepare your tax returns. Consult with your CPA on best practices for keeping required records for common problem areas like meals and entertainment, vehicle, travel, business use of home, etc. Raising the level of diligence will go a long way to help get efficiently through not only an NRP audit efficiently, but a regular audit as well. Doing so will eliminate a lot of stress and some of the cost associated with the audit experience.

Wednesday, January 18, 2017

New FBAR Filing Due Date in Effect

Some U.S persons that have a financial interest in, or signature authority over, financial accounts outside the United States are required to file FinCEN Report 114, commonly referred to as the FBAR. This requirement is imposed by the Bank Secrecy Act. The law has been in place since 1970, but many people subject to the FBAR filing requirement have only recently learned of the law. This is due in large part to the IRS’s ramped up enforcement of FBAR filing in recent years.

The FBAR is required to be electronically filed when the aggregate balance of all financial accounts outside the United States is over $10,000. FBARs have always been due on June 30 for the preceding year with no available extension. For example, the FBAR for 2015 was due on June 30, 2016. That is changing for 2016 FBARs. The due date for filing of FBARs will now correspond with the due date for filing individual income tax returns. 2016 FBARs will be due on April 18, 2017.

Also new to FBAR filing this years is that taxpayers may now obtain a maximum six month extension to file. FBAR enforcement is handled by the IRS, but filing is administered by the Financial Crimes Enforcement Network, AKA FinCEN. FinCEN will be giving the six month extension automatically. According to their website “to implement the statute with minimal burden to the public and FinCEN, FinCEN will grant filers failing to meet the FBAR annual due date of April 15 an automatic extension to October 15 each year. Accordingly, specific requests for this extension are not required.” While no action is necessary to obtain an extension at this time, that could change in the future if a procedure is implemented similar to the procedure for requesting an extension of time to file an individual income tax return.

For taxpayers who have missed an FBAR filing deadline in the past, there are options to correct that filing omission. Options include the Offshore Voluntary Disclosure Program, Streamlined Filing Compliance Procedures, or Delinquent FBAR Submission Procedures. Choosing a viable option is highly fact specific and a tax professional should be consulted.

U.S. v. Bohanec – Another Court Case on the Willful FBAR Penalty

U.S. v. Bohanec, a case decided in the U.S. District Court for the Central District of California, involved a married couple both of whom immigrated to the United States. They owned a camera shop that grew to a successful international business using Ebay as their sales platform. They started depositing income earned outside the United States in a bank account with UBS in Switzerland. The Bohanecs failed to report and pay tax on income earned outside the U.S. They also failed to report their foreign bank accounts.

The U.S. taxes its citizens on worldwide income. The U.S. also requires reporting of any foreign financial account via the FBAR when the aggregate balance of foreign financial accounts exceeds $10,000 for a given year. The penalties for failing to file an FBAR can be draconian. A non-willful penalty is $10,000 and can apply for each open year there is a violation. The willful FBAR penalty is significantly higher increasing to $100,000 or 50% of the account balance at the time of the violation, whichever is higher. Again, the willful FBAR penalty can apply to each open year there is a violation.

The Bohanecs had a sizable Swiss bank account that grew to exceed 1 million U.S. dollars. They did not report the account, the interest it earned, nor their income earned outside the U.S. They also had a few other reporting omissions.

The Bohanecs opened an account in Mexico with funds transferred from the UBS account. Mr. Bohanec had one additional account in Austria where Mr. Bohanec received disability payments. He had been receiving disability payments from an injury more than 40 years ago, prior to his arrival in the U.S. The entire time he was depositing the disability payments to the Austrian account, which grew to over $500,000.00.

They neglected to notify their CPA, stopped using a bookkeeper, and stopped maintaining books. They ignored Schedule B instructions, an attachment to the tax return inquiring about foreign accounts. Finally, realizing they had a serious reporting problem, they entered the IRS’s Offshore Voluntary Disclosure Program (OVDP). The OVDP is a special program that lets taxpayers who failed to report foreign accounts to come forward voluntarily to report all previously unreported foreign financial accounts and unreported income. In exchange for the taxpayer coming forward, the IRS offers lower penalties than those that might apply if the taxpayer had not come forward.

The Bohanecs made the right decision to participate in the OVDP, yet still failed to make a full and proper disclosure. Despite going forward voluntarily, they did not report all accounts and still omitted income. As a result, they were rejected from the OVDP. The IRS then asserted a tax deficiency with interest and a fraud penalty. On top of that, the IRS assessed a willful FBAR penalty against Mr. Bohanec and another will FBAR penalty against Mrs. Bohanec.

The Bohanecs did not pay the FBAR penalty so the United States sued them to reduce the FBAR penalty to a judgment. The only issue before the Court was whether or not the failure to file a timely FBAR was “willful” for the year 2007. The Court determined it was in fact a willful failure to file and entered judgment against the Bohanecs in the amount of $160,915.75 each.
The Bohanecs argued that they had no knowledge of the FBAR reporting requirement. The IRS argued that actual knowledge is not necessary for a willful finding, only that the conduct is reckless.

There are not a lot of Court decisions on the issue of the willful FBAR penalty, but there are few now. The Court cites both Unites States v. Williams, 489 Fed. Appx. 655 (4th Cir. 2012) and United States v. McBride, 908 F. Supp.2d 1186 (D. Utah 2012). The Court falls in line with both the Williams and McBride cases further solidifying the low standard to establish the willful FBAR penalty.

First, actual knowledge is not required. “Where willfulness is an element of civil liability, the Supreme Court generally understands the term as not covering only knowing violations, but reckless ones as well. “Recklessness” is an objective standard that looks to whether conduct entails an unjustifiably high risk of harm that is either known or so obvious that it should be known.”

Second, proof of willfulness only requires a showing by the government of a preponderance of the evidence, not the higher and more stringent standard of clear and convincing evidence. “The monetary sanctions at issue here do not rise to the level of particularly important individual interests or rights. Accordingly, the preponderance of the evidence standard applies.”

All of the decided cases decided on the willful FBAR penalty involve some fairly egregious behavior. It’s not hard to see how the courts have been able to find willfulness when it includes “recklessness” and only a preponderance of the evidence is required. What remains to be seen is the case where the facts do no support a finding of recklessness in this developing area of the law.