Recently, the IRS announced Streamlined Filing Compliance Procedures in order to encourage U.S. taxpayers to come into compliance with reporting their offshore financial accounts and assets.

For eligible U.S. taxpayers residing outside the United States, all penalties are waived under the streamlined procedures. For eligible U.S. taxpayers residing within the United States, the only penalty under the streamlined procedures is a miscellaneous offshore penalty equal to 5 percent of the highest aggregate balance of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period.

For this purpose, the highest aggregate balance is determined by tallying the year-end account balances and year-end asset values of all the foreign assets subject to the offshore penalty for each of the years in the covered tax return period and the covered FBAR period and selecting the highest aggregate balance from among those years.

With all the hype on the positive things that the streamlined procedures have to offer, it’s often easy to overlook the negative things. For example, the streamlined procedures do not limit the civil penalties otherwise associated with reporting U.S.-source income.

In other words, your returns could be selected for examination at any time, which could potentially lead to any one of the following results: First, any previously assessed penalties relating to the years that are selected for audit will not be abated. Second, to the extent that the IRS determines an additional tax deficiency for a return submitted under these procedures, it can assert additional tax and penalties relating to that additional deficiency. Finally, the IRS will unleash the full arsenal of penalties if the examination results in a determination that the original tax noncompliance was due to fraud and/or that the FBAR violation was willful.

In addition to civil penalties, the streamlined procedures do not immunize taxpayers from a possible referral to the Department of Justice for criminal prosecution. At the same time, the IRS Voluntary Disclosure Practice set forth in IRS Internal Revenue Manual (IRM) 9.5.11.9 seems to reduce the likelihood of such a referral if the taxpayer follows the procedures set forth in IRM 9.5.11.9

These include the following: (1) the taxpayer makes a “truthful, timely, complete” disclosure; (2) the taxpayer shows “ a willingness to cooperate;” and (3) the “taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.”

Am I “non-willful”?

Let’s begin with the definition of non-willful conduct as it pertains to the streamlined procedures. It 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 requirements of the law.”

Predictably, the vast majority of taxpayers with undisclosed foreign accounts give this question short-shrift, automatically believing that they are nonwillful without even giving it a second thought. In fact, many are appalled that they have even been asked such a question in the first place. This is a dangerous mindset.

Certifying nonwillful conduct is the most important part of a streamlined application. If there was a single part of the application that required objectivity, this would be it. Why? To the extent that the IRS ever questions your non-willful certification, or receives information that directly contradicts it, that would set off a chain of events unlike any other you have ever seen.

Indeed, not only would that jeopardize your status as a participant in the program, but in one fell-swoop your case could be referred to the Department of Justice for prosecution. And if you thought that the only tax crimes that you’d face were those relating to your failure to file an FBAR, you’d be in for a rude awakening. In addition to the crimes of Failing to File a Tax Return and Willfully Failing to File a FBAR, you could also be charged with perjury and obstructing the administration of the tax code for falsely certifying non-willfulness under penalty of perjury.

With this in mind, taxpayers must be cautious when certifying non-willful status to the government. It is recommended that all relevant facts and circumstances be analyzed before certifying non-willfulness under the Streamlined Filing Compliance Procedures.

Will The IRS Actually Inquire Regarding the “Non-Willful” Certification?

The short answer is “yes. The IRS has indicated that it will review each certification of non-willful status. This is consistent with its goal of treating taxpayers consistently.

In reviewing the “non-willful” certification, the government can be expected to inquire about the following:

(1) The manner in which deposits and withdrawals were made to and from the foreign account(s);

(2) The mechanics of how deposits and withdrawals were made;

(3) The form in which deposits and withdrawals occurred (i.e. cash, check, wire, travelers’ check, etc.);

(4) The amounts of each deposit and withdrawal;

(5) Where such deposits and withdrawals occurred;

(6) Whether there were limitations on the amounts that could be deposited or withdrawn; and

(7) Documents received when a deposit or withdrawal occurred (i.e. receipt, credit memo, debit memo, etc.).

A Hypothetical Case That Is Not Ripe For The Streamlined Program

John is a U.S. citizen. He is a successful businessman with a history of filing individual income tax returns. John is also the owner of an undisclosed foreign bank account which he inherited from his father ten years ago. The account is with Grosser Schweizer Bank, a Swiss bank.

The account was funded with pre-taxed foreign assets that John’s father liquidated over a number of years. Presently, the account contains a balance of $ 1 million and earns interest at the average rate of two percent per year.

John has never deposited or withdrawn any significant amounts of money from the account. He does not receive statements, as per his father’s arrangement with the Swiss bank, but he visits the bank when he is on vacation in Switzerland. During his last visit, he reviewed account statements and withdrew small amounts of spending money for dinner, wine, and a three-night stay at a five-star hotel.

While John has timely filed his individual income tax returns for the last ten years, he has withheld all information pertaining to his Swiss bank account from the IRS. Specifically, he never disclosed the bank or the interest earned on the account on Schedule B. In fact, he consistently checked the “no” box on Schedule B, which asks the taxpayer if he has a foreign bank account. Nor has John ever filed an FBAR. Finally, John never disclosed his foreign account to his tax return preparer or sought independent legal advice about how to properly handle the foreign account.

John wants to apply to the Streamlined Domestic Offshore Program. The issue is whether he is eligible. In other words, can he legitimately certify non-willfulness? Or, should he seek shelter in the OVDP bunker?

As a preliminary matter, this case involves inherited funds in a foreign financial account. Generally, having inherited funds in a foreign financial account, without more, is not deserving of non-willful status by the IRS. But, as should be obvious, this case involves a lot more than just inherited funds.

Very simply, John will not be able to certify non-willfulness. In fact, that is the least of his worries. Why? Because these are just the type of facts that are likely to result in a referral to the Department of Justice – Tax for prosecution. The potential charges would include the following:

a. Filing a False Tax Return (IRC § 7206(1));

b. Willful Failure to File an FBAR (31 USC §§ 5314 and 5322(a) and 31 CFR § 1010.350).

The government’s case would be built on the two essential elements of these crimes:

♦ Substantial Tax Deficiency: The government is very likely to satisfy this element. The account statements prove two percent unreported interest income every year on a $ 1 million deposit. That is $ 20,000 per year. Over ten years, that is a total of $ 200,000 of unreported income. At a tax rate of 35%, John’s tax deficiency is $ 70,000. That is more than enough to satisfy the element of a substantial tax deficiency. Unfortunately for John, that number could grow even larger. Why? In states having a state income tax, if the prosecutor wanted to go for the jugular, he could increase this tax deficiency with the state tax loss. As if that was not bad enough, the sentencing guidelines provide for a two-point enhancement whenever foreign bank accounts are used to perpetuate tax fraud. These two points have the effect of driving the criminal offense level, not to mention the actual sentence itself, into the sentencing stratosphere. What this means is that it is all but certain that John will become a guest of Club Fed. Indeed, these two points increase the criminal offense level to a level corresponding to more than twice the tax deficiency that exists in this case (i.e., over $ 140,000).

♦ Badges of Fraud: Turning to the second and last factor, the government appears to easily satisfy this element too. The government can argue the following:

• John lied when he signed his return under penalty of perjury that it was true and correct.

• John lied when he checked the box “no” on Schedule B, failing to disclose that he had a foreign bank account.

• John lied when he failed to disclose on Schedule B, the country where his foreign bank account was located.

• John lied when he failed to report on Schedule B that he had interest income from a foreign bank account.

• John knew he was required to file an FBAR by virtue of the fact that he had been alerted to the FBAR requirement by the information on Schedule B.

• John intentionally failed to file the FBAR.

• John concealed $ 1 million in income producing assets and over $ 70,000 in unreported income from the IRS by hiding the assets and the income in an undisclosed offshore bank account.

• John never told his tax return preparer about his “secret” Swiss bank account.

• John never sought any independent legal advice about how to handle his “secrete” foreign bank account.

To understand how the above badges of fraud could be introduced at trial and how damaging they can be, imagine John taking the stand and being subjected to a relentless hour-long cross-examination by a skilled prosecutor. To say that it would be the equivalent of placing an infant in the middle of a highway at rush hour would be an understatement.

As bad as this case might be for John, it could get a lot worse with the addition of just a few more bad facts. The following badges of fraud are just as likely to get the attention of the revenue agent examining John’s offshore bank account as a red flag is likely to get the attention of a bull at a rodeo:

♦ John maintained his Swiss account in the name of a foreign shell corporation or foreign trust, or some other entity typically used to conceal ownership.

♦ John made several wire transfers from his Swiss account to a U.S.-based investment account.

♦ Grosser Schweizer Bank was not the original bank to hold the assets. Instead, it was established at “Swiss Miss Bank.” John transferred the account from Swiss Miss to Grosser Schweizer Bank after reading a press release in The Wall Street Journal announcing that Swiss Miss had been issued a summons by the U.S. government requesting information about U.S. taxpayers who held financial accounts there.

♦ Before transferring the account to Grosser Schweizer Bank, John had a long discussion with the bank manager regarding bank secrecy. The manager seemed to put John at ease when he said that Grosser Schweizer would never release any information pertaining to his account to the IRS.

♦ John, with the assistance of personnel at Grosser Schweizer Bank, held the account in the name of a fictitious person or entity.

♦ John, with the assistance of personnel at Grosser Schweizer Bank, set up a standby letter of credit or some other loan arrangement with the U.S. branch of Grosser Schweizer Bank so that he could use the money in his foreign account as collateral for a loan without bringing it into the U.S.

♦ John gave Grosser Schweizer Bank instructions to hold his bank statements and not to send them to him in the United States.

♦ John skimmed taxable income from his business and deposited it into his Grosser Schweizer account without reporting it to the IRS.

♦ John survived an earlier civil examination by lying to the IRS about his Swiss bank account.

The list goes on. The point is that unreported foreign bank cases are not difficult for the government to prosecute.

Finally, in reviewing the non-willful certification under the streamlined procedures, resident taxpayers should anticipate the government asking whether their foreign accounts remain open. If not, the government will want to know where the funds were transferred when the account was closed.

Will the IRS Interview Me?

An interview by an IRS examiner (in person or by phone) should be expected. And while interviews are usually reserved for resident taxpayers, the fact that consistency and uniformity are at the heart of the IRS’s mission means that these interviews will be expanded to include offshore taxpayers.

Only those directly involved in creating and maintaining the foreign account and assets are capable of determining non-willful status. If such status is not supported by sufficient objective facts, other methods of coming into compliance should be considered, including the OVDP.

Civil vs. Criminal Resolution?

By far, the overwhelming majority of tax disputes result in a civil resolution. However, taxpayers frequently ask about the difference between a civil and a criminal tax case.

The primary difference can be found in the potential punishment resulting from a criminal conviction. Resolution of a civil case may be limited to a payment to the government of taxes, interest and possibly penalties. Resolution of a criminal case, on the other hand, may include a period of incarceration in addition to payment to the government of taxes, interest and possibly penalties. And despite the jokes about “Club Fed,” spending a couple of years in federal prison is no laughing matter.

But incarceration is just the tip of the iceberg. While easy to overlook, the collateral consequences of having a felony conviction can be as serious as incarceration itself. For example, one of the most serious collateral consequences is the loss of a professional license. For a parent with a young family to support, the loss of a professional license may mean the loss of their livelihood and thus, the ability to provide for their family.

Stigmatization is another serious collateral consequence. It can bring personal, social, and financial ruin. In the words of James Donovan, a politician who was indicted on charges of larceny and fraud in connection with a project to construct a new line for the New York City Subway only to later be acquitted, “Which office do I go to to get my reputation back?”

To the extent that the taxpayer makes material, possibly intentional, misstatements in the non-willful certification, he is but a heartbeat away from the government unleashing its vast criminal enforcement powers. To understand why, one need look no further than the certification form that must be signed by the taxpayer under the streamlined procedures. It says, “I recognize that if the Internal Revenue Service receives or discovers evidence of willfulness, fraud, or criminal conduct, it may open an examination or investigation that could lead to civil fraud penalties, FBAR penalties, information return penalties, or even referral to [IRS] Criminal Investigation.”

Will This Criminal Problem Go Away?

If my streamlined application triggers an audit and that audit results in a referral to CI for investigation, can I just pay up and move on – with the expectation that the criminal problem will go away? No. Payment of the tax won’t technically deflect a criminal investigation or prosecution. In appropriate cases, payment may permit you to argue that you really wanted to pay the taxes that you owed all along and, when first advised that you may have underpaid, you moved promptly to pay.

However, the government cannot generally accept that as a resolution of the criminal case because if it did, every target would simply pay the tax. Indeed, the criminal enforcement program would be rendered useless if every taxpayer who underreported his income could do so with the idea that, if caught, all that he would have to do is simply pay any taxes, penalties, and interest.

As an experienced criminal defense attorney, I offer this word of advice. While it’s not impossible to snatch victory from the jaws of defeat by discouraging CI from referring a case to the Department of Justice for prosecution, it does not happy to frequently. And while that outcome would necessarily eliminate the risk of a conviction along with any of the collateral consequences that flow therefrom, what can never be overlooked is the emotional toll that a criminal tax investigation has on the taxpayer and his family.

Very simply, lengthy criminal tax investigations have been known to destroy families. Looking back, every criminal tax defendant at some point asks themselves why they didn’t previously do things “the right way” when they had the opportunity to avoid the criminal justice system.

What Should I Do?

Now is the time to take a step back, and carefully review your situation. Once you submit your application to either Streamlined Filing Compliance Procedure, you may no longer participate in the OVDP. Similarly, if you submit an OVDP voluntary disclosure letter on or after July 1, 2014, you are no longer eligible to participate in the streamlined procedures.

Taxpayers currently participating in an IRS OVDP who meet the eligibility requirements for the Streamlined Filing Compliance Procedures can request transitional treatment if they can objectively certify their “non-willful” status. Such taxpayers need not affirmatively opt out of the OVDP. Instead, they retain the ability to resolve their issues within the OVDP. To the extent that the IRS rejects their non-willful certification and they are denied transitional treatment, they can always opt out later.

Taxpayers not currently participating in an OVDP who meet the eligibility requirements for the streamlined procedures should likewise consider requesting streamlined treatment if they can objectively certify their “non-willful” status.

Conclusion

The streamlined procedures seem to represent the first attempt by the government to acknowledge that not every taxpayer is the modern-day equivalent of the tax-dodging mobster, Al Capone.

If you are uncertain or confused, be sure to consult with an experienced tax attorney. The consequences of not getting it right are far too severe to “try it out on your own” just so you can save some money. Don’t be penny wise and pound foolish!

In accordance with Circular 230 Disclosure