Monday, November 21, 2016

Online Gambling and FBAR Reporting | Bethesda Tax Lawyer

If you play online poker and keep your playing funds in accounts associated with the games, you may not have considered whether those accounts are FBAR reportable.  Given that the Ninth Circuit issued a ruling earlier this year attempting to clarify the situation, you should probably familiarize yourself with the current state of the law on this subject.  In United States v. Hom (2016), the court ruled on three types of playing accounts that a California district court had previously held were all subject to the FBAR.

In that case, John Hom--a high-stakes gambler--was assessed a total penalty of $40,000 for failing to report his three accounts in 2006 and his remaining account in 2007 ($10,000 per violation).  The three accounts consisted of two accounts tied directly to poker services, PokerStars and PartyPoker (both are still in operation in 2016), and FirePay (an early competitor to PayPal no longer in existence), which transferred money from an account with that service into either his online poker accounts or his Wells Fargo bank account.  

U.S. citizens who maintain accounts with foreign financial agencies are required to file the FBAR.  For this requirement to apply, the funds must be “in a bank, securities, or other financial account” that is “in a foreign country.”  In Hom’s case, it was undeniable that the funds were located in foreign countries since all three services were based offshore.  The relevant question was whether they were held within a “financial agency,” which the court defined as a “financial institution,” a term comprising commercial and private banks as well as licensed senders of money.

In the opinion of the Ninth Circuit, the FirePay account was FBAR-reportable, and that fine should be allowed to stand.  FirePay, which was based in the United Kingdom, had acted as a money transmitter, allowing Hom to move money between his bank account and online poker accounts.  However--and somewhat surprisingly--the court reversed the fines related to the PartyPoker and PokerStars accounts.  Those accounts, the court reasoned, “were used solely to play poker and there is no evidence they served any other purpose for Hom.”  They were not acting as banks, and since the statute and its related regulations failed to define the term, the court consulted the dictionary and determined that no part of the dictionary definition of bank (“an establishment for the custody, loan, exchange, or issue of money, for the extension of credit, and for facilitating the transmission of funds”) could be applied to either of those accounts.  

Though this was an unusual holding--it would seem logical that all of these accounts should be reportable for FBAR purposes, as the district court had originally held--this decision may influence other circuits.  Nevertheless, individuals with concerns about the tax implications of these and other foreign accounts should seek professional advice before determining what they should report to the IRS.


For a free consultation regarding the FBAR or other tax matters, please contact The Law Offices of Aaron P. Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Sunday, October 23, 2016

Intentional Misclassification of Employees | Bethesda Tax Lawyer

My last blog explained the distinction between employees and independent contractors while providing some basic information about the trust fund recovery penalty.  This blog examines the intentional misclassification of employees and its consequences, as well as the operation and assessment of the trust fund tax penalty.  Employee misclassification is an enormous problem nationwide.  A 2012 list of state audits compiled by the National Employment Law Project estimates that the number of misclassified employees in the United States runs into the millions (with nearly 1.2 million such employees working in the two states of Pennsylvania and New York alone!).  

The IRS has issued consumer alerts about fraudulent employment tax practices.  Notable among these are “pyramiding,” or the withholding of employment taxes that are not thereafter submitted to the IRS, and paying employees wholly or impartially in cash without assessing employment taxes.  These and other practices, such as using unreliable or outright criminal third-party payroll services, making frivolous or specious arguments about employee classifications advanced by unscrupulous promoters (a common--and illegal--tax resistance ploy, as noted elsewhere on this blog), or treating employee salaries as corporate distributions, offer strong evidence that an employer is trying to conceal losses or actively stealing money.  Such practices can trigger the application of a civil fraud penalty or a referral to the criminal investigative division.

For a taxpayer--in this case, the employer--to be guilty of fraud, he or she must have willfully attempted to not pay or underreport taxes.  An individual who has willfully attempted to misclassify employees is someone who has acted deliberately, knowingly, and with the specific intent to violate the law.  If the underpayment of tax is due to fraud, a penalty equal to 75% of the portion of the underpayment which is attributable to fraud will be added.  If the taxpayer can establish by a preponderance of the evidence that any portion of this underpayment is not attributable to fraud, that portion will be excepted from the fraud penalty.  IRS examiners will carefully scrutinize the employer’s business practices, looking for “badges of fraud” like the ones I have described here.  Individuals who are genuinely concerned about the classification of their workers--usually because they wish to classify them as independent contractors--can submit Form SS-8 and receive a prospective determination from the IRS, as discussed in my prior blog.  

Criminal investigations for employment tax evasion have remained steady between 2014 and 2016, averaging about 120 cases a year with a 75% incarceration rate (18 months is the average sentence convicted parties are assigned to serve).  The Fiscal Policy Institute released a study in 2007 noting that the most egregious intentional misclassifications of employees occur in the delivery, trucking, building maintenance, janitorial, agricultural, home health care, and janitorial industries.  However, the rise of the “gig economy” and the emergence of alternative means of payment, such as Bitcoin, has surely altered that assessment.  At any rate, employers in these fields, or small business owners in general, would be well advised to consult with the IRS, a CPA, or a tax attorney if they are genuinely concerned about what their best practices should be.


In general, this entire area of taxation represents a minefield for the unwary.  Beyond concerns arising from outright fraud and other criminal activities, employers must understand the crucial distinction between trust fund-related and non-trust fund related taxes.  There are four types of employment taxes, with two classified as trust fund-related taxes and two as non-trust fund related taxes. The first two consist of the employee’s federal income taxes and the 50% share of Federal Insurance Contributions Act (“FICA”) taxes an employer is required to withhold from employee’s wages (these constitute the employee’s contributions to the Social Security and Medicare programs he or she will rely on during retirement). Non-trust fund taxes are those paid by the employer:  unemployment taxes, which the employee can redeem if he or she is laid off through no fault of his or her own, and the employer's 50% contribution to the employee’s FICA taxes.

Given the amounts and types of money at stake, an incompetent or criminal-minded person who is responsible for payroll can wind up in significant trouble. In addition to imposing stiff penalties and interest on delinquent employment taxes, under Internal Revenue Code section 6672 the IRS can assert personal liability (i.e., the 100% trust fund recovery penalty that is triggered by intentional misclassification) for the trust fund portion of the delinquency on any and all of these “responsible persons.” A responsible person could be anyone who has the power to ensure the trust fund taxes are paid on time, and may include middle managers, payroll supervisors, and comptrollers at the employee’s company as well as high-ranking officials at third-party payroll companies.

The IRS can assert and enforce personal liability for the trust fund portion against any number of responsible persons simultaneously and will likely try to hold as many persons as possible liable. Even filing for bankruptcy won’t eliminate or reduce this liability.  Moreover, the federal Department of Labor and many state departments of labor have also begun aggressively campaigning against misclassification of employees, with 27 states as of 2015 having passed “presumptive employee status” statutes that require employers to prove that their workers are truly independent contractors.  

In sum, employers seeking to maintain workforces comprised of low-risk, low-cost independent contractors must tread carefully.  Federal and state governments, along with the IRS, have devoted considerable time and resources to ensuring that employers who are trying to exploit today’s fast-evolving economy must nevertheless comply with relevant labor and revenue laws.  For a free phone consultation regarding the trust fund recovery penalty, payroll taxes, or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Sunday, July 31, 2016

The Trust Fund Recovery Penalty--Employee Classification | Bethesda Tax Lawyer



One of the many tax risks faced by owners of businesses is the trust fund tax penalty. With the IRS’s current focus on payment and collections of employment taxes, owners may wind up with a notice from the service inquiring about their Social Security, Medicare, and income tax withholding from employees wages. IRC 6672 provides the Service with the authority to collect 100% of the employee's portion of the unpaid or uncollected taxes from the responsible person(s) personally. This has been defined very broadly by the courts and can encompass multiple managing officers or employees. There are many reasons why a business owner might run afoul of IRC 6672, and I will cover them in a series of posts for this blog, including an explanation of how these penalties work as well as certain IRS programs that may benefit owners facing employment audits. In this entry, I intend to discuss the basic but critical distinction between independent contractors and employees. Business owners who improperly classify their workers and do not withhold the appropriate payroll taxes are at risk of being penalized.

Some readers of this blog may have noticed that wrestlers formerly employed by World Wrestling Entertainment recently sued that company. One of the arguments made in this lawsuit is that the decades-long distinction between independent contractors and regular employees, in which wrestlers were characterized as independent contractors, is legally incorrect. The owners of the WWE, like the owners of other businesses, classified their workers as independent contractors because it meant they did not have to pay employment taxes on behalf of these workers or offer them various other benefits.

The Affordable Care Act, which was the signature piece of legislation passed during the Obama administration, has raised costs for some business owners by requiring them to offer health insurance benefits to their employees. As such, owners concerned about these added costs may go out of their way to classify or reclassify the workers they employ as independent contractors. This can save them time and money, since it places many administrative burdens back on the workers, but the IRS carefully polices these classifications and may penalize employers who improperly label their workers as independent contractors.

The IRS offers guidelines for employers seeking to determine whether their workforce consists of independent contractors or employees. There is no bright-line test, but factors such as control of workplace performance, the presence of a pension plan or a vacation time schedule, and the provision of employer-owned tools may lead to a determination that an owner’s workforce is made up of employees. Employers who are concerned about this issue can complete Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” which will allow the IRS to make the decision for them, but it may be several months before a decision is rendered.

Several “best practices” can help employers avoid complications involving the IRS. If a workforce does consist primarily of independent contractors, the employer should be diligent and thorough about filing the necessary Form 1099-MISC paperwork and getting contractors to complete their Form W-9s. Relationships with these workers should be documented thoroughly in each employee’s HR file--noting, for example, that a construction contractor is “required to provide his own tools and vehicles.” Employers and their HR employees should also stay abreast of recent developments in the law involving important companies such as Uber (e.g., Berwick v. Uber, a California Labor Commission decision, classifying an Uber driver as an employee rather than an independent contractor). By staying on top of paperwork and keeping up with recent trends in employment law, employers can potentially avoid a determination that they have intentionally tried to misclassify their employees to avoid paying employment taxes. Such an intentional misclassification will trigger the trust fund recovery penalty, which will be discussed in my next blog.

For a free phone consultation regarding the trust fund recovery penalty, payroll taxes, or other tax matters, please contact the Law Office of Aaron P Richter, a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Sunday, June 26, 2016

FBARs are Due June 30th | Bethesda Tax Lawyer

It's your annual friendly reminder that the 2015 FBAR (FinCEN Form 114) is due June 30th.  If you are a US resident for tax purposes, and you have foreign assets, there is a good chance you need to file this form.

The FBAR is now filed electronically on the BSA website. You can find the form and filing instructions, here.

The penalties failing to file the FBAR are steep.  If you have any foreign accounts and do not think you are required to file; at least contact someone to verify that you are correct.

For a free phone consultation regarding the FBAR, or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Monday, June 13, 2016

The Taxation of Bitcoin and Other Digital Currency | Bethesda Tax Lawyer

Bitcoin, a virtual currency that uses cryptography to secure transactions and control the creation of new units of value, seems poised to become the next step in tax evasion, replacing tax havens maintained by law firms like Mossack Fonseca & Co.  As many people employed in the fast-growing technology sector look for ways to conceal their earnings, Bitcoin would seemingly offer them another benefit in addition to those provided by the shell corporations disclosed in the Panama Papers:  they would also allow the possessor of the currency to manage his money without the aid of a financial institution or law firm.  The IRS has increased its scrutiny of offshore accounts and has become more adept at discovering taxpayer income that has not been reported, as discussed elsewhere on this blog, but Bitcoin servers present an extra-judicial challenge unlike anything seen before.  


As use of this virtual currency increases, taxpayers need to understand how the IRS treats Bitcoin. Employees receiving wages in Bitcoins--as some tech sector workers now demand--must have these wages reported on a W-2, and pay income tax withholding and payroll taxes.  Independent contractors who are paid in Bitcoins must receive Form 1099s from employers contracting their services.  The IRS treats payments made via Bitcoin like other payments made in property. For a cash basis taxpayer, income is recognized (received) when the coins are transferred to her account, not when the coin is sold. The Bitcoin then has a basis equal to the value of the work provided. When the Bitcoin is eventually sold, the rules which govern stock and barter transactions are applied.


For example, if you provided $500 in work on June 1, 2016, for which you received 1 Bitcoin in June of 2016, you have income in 2016 (either W-2 or 1099-Misc) of $500.00, and the coin now has a basis of $500.00.  Now assume that you exchanged that coin in 2017 for cash $750 or traded it for a new TV. In 2018, you will have a capital gain of $250 because the increase in value is taxable. Capital gains are calculated by taking the basis in the property (Bitcoin here) from the value of the property or cash received, thus $750-$500=$250 capital gain. Here, the gain will be long-term, because the Bitcoin was sold more than a year after it was received. However, if the coin lost value, dropping to $250 in 2017, and you exchanged it for cash or a television worth $250 that year, the loss in value would be treated as a capital loss and could be used only to offset other capital gains.


That said, it seems inevitable that savvy tax-evaders who wish to avoid detection may soon transition to using Bitcoin.  So far, enforcement mechanisms allowing state and federal revenue services to track the deployment of Bitcoins are in their infancy.  One expert estimated that if even 1% of funds currently sitting in offshore accounts were transferred to Bitcoin, the value of this virtual currency could increase substantially (currently, a single Bitcoin is worth roughly $580).


In addition to the tax issues, there may be foreign account reporting requirements depending on where or how the digital currency is held. IRS has publically stated that bitcoin does not have to be reported on the FinCen Form 114 (the FBAR). However, the IRS could change its opinion on Bitcoin and require FBAR reporting in future years. Another concern is FATCA reporting. While  the IRS has stated Bitcoin does not have to be reported on the FBAR, it has not stated that it is not a foreign asset for purposes of Form 8938. Depending on where and how your digital currency is held, there is a good possibility that it will be a specified foreign assets and will be reported.


Taxpayers considering a decision of this sort, or taxpayers who have already moved their offshore holdings to Bitcoin, need to recognize that the IRS will eventually develop means of dealing with such activities.  As a reminder, tax evasion and intentional failure to file tax returns are felonies with punishments ranging from financial penalties to jail time. Furthermore, the IRS has an unlimited statute of limitations to assess taxes and penalties for unfiled or fraudulently filed tax returns.  As such, those taxpayers not currently in compliance with their IRS’ reporting requirements should develop a strategy to become compliant as quickly as possible.


For a free phone consultation regarding Bitcoin, the FBAR, or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Tuesday, May 24, 2016

Assessment and Collections of FBAR Penalties | Bethesda Tax Lawyer

The IRS continues to zealously pursue the collection of foreign assets and accounts, so taxpayers need to understand how the Report of Foreign Bank and Financial Accounts (FBAR) and FBAR penalties work.  The enforcement of the FBAR is derived from the Bank Secrecy Act, which was passed by Congress in 1970 to combat money laundering and tax evasion.  This is important because it means the Internal Revenue Service cannot use the traditional tax collection measures contained in the Internet Revenue Code to collect the penalty.  Instead, they must refer the matter first to the Bureau of Fiscal Services, the primary accounting division of the US government, and then to the Department of Justice, which will sue to collect the money (a judgment in their favor makes the government a “super creditor” with broad power to recover the debt).  There is a six-year statute of limitations governing these violations, which will begin to run regardless of whether a report was filed (i.e., 6 years from the due date of the FBAR to assess penalties).

FBAR penalties are proposed and determined by the examining Revenue Agent (the IRS), and the penalty assessment can be contested in IRS Appeals. If appeals are unsuccessful, the US Tax Court does not have jurisdiction to hear FBAR cases. The only option to judicially contest the fines is through the federal courts -- this is done in either the US Court of Federal Claims or Federal District Court. The US Government has two years from the date penalties were assessed, or the person was convicted of an FBAR penalty, to sue for collection of the debt. If a judgment is not obtained, the Government has an unlimited statute of limitations for offsetting payments (i.e., the IRS can keep your social security payments and any future tax refunds until the full payment of the liability).

The penalty structure is determined by the type of violation.  Statutory penalties for FBAR violations are $10,000 per account per year for non-willful violations or the greater of 50% of the highest annual account value, or $100,000, per account per year for willful violations. Persons who have acted badly or willfully--as described in previous blogs--can utilize the Offshore Voluntary Disclosure Program, which offers an offshore penalty of 27.5% in lieu of other possible penalties.  Streamlined filing compliance procedures can be used by people living outside the US who were unaware of their US tax obligations, who face no penalties, or for people living in the US who acted non-willfully, who are liable for a penalty of 5% in lieu of other applicable penalties.

There is something of a slight legal gray area regarding the nature of civil fines related to these matters.  In 1998, in US v. Bajakajin, the Supreme Court held that the forfeiture of $350,000 as a penalty for attempting to leave the US with $350,000 in currency--without reporting any of it, as is required for all movements of international currency in excess of $10,000--violated the Eighth Amendment’s prohibition on the imposition of “excessive fines.”   However, in the 2015 case US v. Moore, a district court in Washington held that a $40,000 penalty in an FBAR case did not constitute an “excessive fine” under the Eighth Amendment (the taxpayer had been assessed four years of maximum nonwillful penalties).  Although US v. Moore has not reached the Supreme Court and perhaps never will, it appears that the current penalty structure for FBAR violations will withstand Eighth Amendment scrutiny--although defendants will surely make this argument among others when contesting their penalties in court.

For a free phone consultation regarding the FBAR or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Tuesday, May 10, 2016

FBAR Penalties for Failure to Maintain Foreign Account Records | Bethesda Tax Lawyer

One of the most common FBAR problems arise from a failure to keep required records.  The reporting requirements are not onerous, but taxpayers who are managing multiple accounts or making complicated business transactions can sometimes end up running afoul of the FBAR’s reporting requirements.  Anyone who has a financial interest in a foreign bank account must keep records that contain information regarding the name under the account is maintained, the number that designates the account, the name and address of the foreign financial institution where the account is maintained, the type  of account, and the value of the account.  Federal law requires that these records be kept for five years from the June 30 due date for filing the FBAR for that calendar year and be kept available for inspection as provided by law.  

Obviously, accidents can happen.  Employees entrusted with filing the FBAR report may mishandle it, individuals with dozens of international bank accounts might lose track of their money, and life circumstances (health problems, relationship troubles, etc.) could make it difficult to manage a large and diffuse financial portfolio. The Internal Revenue Manual gives the example of a taxpayer who has failed to report the existence of five small foreign accounts with a combined balance of $20,000 for all five accounts, but properly reported the income from each account and made no attempt to conceal the existence of the accounts.  In this instance, the underlying facts and circumstances would determine whether the examiner imposes civil FBAR penalties or merely sends the FBAR warning letter (“Letter 3800, Warning Letter Respecting Foreign Bank and Financial Accounts Report Apparent Violations”).

In most of these situations, a non-willful penalty amount up to $10,000 is the likely remedy, with mitigation factors applied to the penalty, such as reasonable cause for the violation or proper reporting of the account balance.  In more extreme cases, such as when a taxpayer goes out of his or her way to remain completely ignorant of the extent of his financial holdings or deliberately conceals them, the burden falls on the IRS to demonstrate willfulness of the violations, which could trigger a $100,000 penalty or 50% of the balance in the account at the time of the violation.  

For a free phone consultation regarding the FBAR or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation. 

Sunday, April 24, 2016

Willfulness and FBAR Penalties -- Non-willful Actions and Reasonable Cause | Bethesda Tax Lawyer

In this blog, I’d like to examine the differences between non-willful conduct which can trigger an IRS penalty, and non-willful conduct for which reasonable cause can be given, which offers grounds for why penalties should not be assessed.  An understanding of these differences can be critical to avoiding FBAR penalties or at least serve to make the taxpayer aware of circumstances under they might be imposed.  

Non-willful conduct is defined by the IRS a “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.”  It carries with it lighter penalties than willful behavior and can help taxpayers demonstrate eligibility for streamlined domestic offshore procedures but, absent a showing of reasonable cause, cannot entirely obviate these penalties.  

In the recent decision Moore v. US, a US district court examined a taxpayer’s failure to file his FBARs and offered some clarification regarding what constitutes reasonable cause in a situation where the taxpayer’s failure to comply was non-willful in nature.  In that case, James Moore maintained high-balance overseas bank accounts in the Bahamas and Switzerland for many years but filed no Report of Foreign Bank and Financial Accounts until 2009.  


Moore tried to remedy this in 2009 after having learned of the OVDP program (which I have blogged about, here) amending several years of tax returns and filing FBARs to accompany them.  After several years of negotiation with the IRS, Moore opted out of OVDP and was assessed a fine.  Following some back-and-forth negotiation, the IRS imposed a $10,000 penalty, and Moore’s attorney offered arguments for why Moore had reasonable cause to believe he was not violating the law.  


The court’s decision, in which Moore was held to have committed non-willful violations for which the IRS penalty was appropriate, offered some clarification regarding what constituted reasonable cause under these circumstances.  By examining what constituted reasonable cause in other aspects of IRS tax procedure, the court concluded that “reasonable cause” existed when a violation of the FBAR occurred despite the exercise of ordinary business care and prudence.


Moore, however, had offered no objective evidence indicating he had exercised this standard.  Rather, on previous occasions, he had indicated to tax preparers that he had no interest in foreign accounts.  The court also determined that he knew of the Foreign Accounts and Trusts requirement, as he had occasionally followed it in past years.  Based on this standard, the sort of evidence needed to trigger a finding of “reasonable cause” is unlikely to be something that most taxpayers facing FBAR penalties possess.  For example, evidence of a conversation between the tax preparer and the taxpayer in which the taxpayer clearly and unequivocally states that he has foreign accounts and trusts, but the tax preparer tells him not to worry about it, would meet this standard.  This sort of strong objective evidence can demonstrate “reasonable cause,” but in its absence, the chief issue facing the taxpayer may likely be a determination of whether his noncompliant conduct was willful or non-willful, which I have discussed in previous blogs. 

The IRS offers a reduced penalty (5%) for taxpayers (through the Streamlined Program) if they can show that their actions related to the non-disclosure of their foreign accounts were not willful. This means that a person entering the Streamlined programs does not have to show reasonable cause and only has to show that his actions were not a result of willful actions nor willful blindness.

For a free phone consultation regarding the FBAR, OVDP, or other tax matters, please contact The Law Office of Aaron P Richter, a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.






Saturday, April 16, 2016

The Panama Papers | Bethesda Tax Lawyer

This week, I’d like to begin examining the Panama Papers, a leaked set of over 11 million confidential documents that describe the activities of 210,000 corporate entities overseen by the Panamanian law firm Mossack Fonseca.  Although only a handful of US citizens were named in the papers, this case offers an opportunity to evaluate a truly impressive example of outright tax fraud and willfully noncompliant behavior.

Internal Revenue Manual 4.26.16.6.5.1 states that the test for willfulness is “whether there was a voluntary, intentional violation of a known legal duty, which is demonstrated “by the person’s knowledge of the reporting requirements and the person’s conscious choice not to comply with the requirements.”  Examples of willful behavior include filing an FBAR but omitting one of several foreign bank accounts, filing the FBAR in earlier years but failing to file the FBAR in subsequent years when required to do so, and failing to file the FBAR after being sent a warning letter explaining the FBAR filing requirement.  Evidence of a willful violation is rarely direct, because willfulness is a state of mind, but is instead established by drawing reasonable inferences from available facts.  

However, in the Panama Papers case, Mossack Fonseca engaged in extremely willful tax evasion, constructing some of the elaborate shell companies yet discovered.  These companies, which boasted intricate, multi-level, and multi-national corporate structures, enabled clients to “operate behind an often impenetrable wall of secrecy.” To best accomplish this, Mossack Fonseca would move from jurisdiction to jurisdiction when incorporating its shell companies, abandoning those jurisdictions that had taken steps to become more compliant with international standards regarding these entities.  They preferred to incorporate in jurisdictions with minimal to nonexistent rules regarding disclosure, and they tried to perform as little due diligence in these jurisdictions as possible.  

Half of Mossack Fonseca’s shell companies were incorporated in the British Virgin Islands, a jurisdiction noted for its particularly lax tax regime.  Setting up companies in this and other loosely-regulated locales is a simple process, requiring the payment of a fee and the description of the purpose of the company (usually “investment” and “wealth management” are specified).  Estimates place the amount of wealth “offshored” in this manner at between $21 and $32 trillion dollars, with tax havens like the BVI accounting for a staggering 50 percent of all world trade.

Some have attributed the lack of US citizens among Mossack Fonseca clients to be the result of the effectiveness of the Foreign Account Tax Compliance Act (FATCA), FBAR, and other stiffened offshore reporting requirements.  That said, jurisdictions such as Panama and the BVI may always remain havens for willful non-compliance with reporting regulations, and may have to be dealt with more harshly, such as via sanctions,  to further discourage this behavior.  

For a free consultation regarding the FBAR or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Saturday, April 2, 2016

Willfulness and FBAR Penalties -- Civil Fraud | Bethesda Tax Lawyer

In today’s blog post, I want to examine the indicators of fraud (sometimes called “badges of fraud,” though the terms are interchangeable) that can potentially trigger a criminal referral.  These indicators/badges of fraud are extremely important, among other places, during FBAR investigations.  I have written about the FBAR at length in previous posts--you can read these posts here and here --and the presence of fraud in an FBAR investigation can alter the dynamic considerably.  When a finding of fraud is made, IRS criminal investigations may become involved; civil penalties increase to 75% of the additional tax due and there is an unlimited statute of limitations to audit a return.

The IRS fraud handbook offers a comprehensive if hardly exhaustive list of these indicators/badges, and taxpayers with an inadequate or confused understanding of their financial situation--usually sole proprietors or small businesses with a small chain of command--often run afoul of them either through an attempt to inflate expenses and understate income or simply through sheer recklessness.  Offenses are sometimes tied to Chapter 9 of Title 18 of the U.S. Code, as consumers in bankruptcy proceedings may trigger fraud investigations because they are transferring assets for no consideration, leading an extravagant lifestyle, and failing to file the required income tax returns.  

Although there are many potential indicators/badges of fraud, a handful of them are particularly common and will attract the attention of IRS examiners.  Shell companies that hire employees and lease them back to the parent corporation, companies that withhold taxes from employees but fail to pay them to the government, the payment of cash wages, excise tax fraud, and the use of fictitious subcontractors as a way of paying employees off the books are all extremely common indicators of fraudulent activity.  Revenue agents and revenue examiners are familiar with such behaviors and can very quickly assess and stereotype organizations that are engaging in them.  

Once these fraud indicators/badges are discovered, IRS revenue agents will consult with their group manager and a Fraud Technical Advisor (FTA) to determine if a Fraud Development Recommendation should be filed.  From there, agents will request returns--excepting, of course, those returns that have not been filed that have raised the suspicion of fraud.  The IRS strives to avoid the perception that it is using a civil examination process to develop a criminal case against the taxpayer.  That said, once the appropriate referral paperwork is complete, the revenue agent will forward the case to the FTA, who will recommend a criminal investigation, if necessary.  At this point, evidence gathered in the case, including tax returns and a consideration of the taxpayer’s demographic profile, will determine what further subsequent steps are taken, such as additional investigation and prosecution.  

The best way to avoid this situation is to keep detailed business records and avoid the business practices listed here or outlined in the IRS fraud handbook.  However, once an IRS investigation begins, taxpayers wishing to avoid or reduce civil and criminal penalties are advised to consult with an experienced tax attorney to explore the options available to them.


For a free phone consultation regarding this subject or other tax matters, please contact The Law Office of Aaron P Richter, a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Wednesday, March 16, 2016

Willfulness and FBAR Penalties -- Willful Blindness | Bethesda Tax Lawyer

In my previous blog on FBAR penalties, I discussed willful behavior.  This week, I will be examining what constitutes willful blindness, an important sub-category of willful behavior, followed in a week by an analysis of non-willful actions.  Understanding the distinction between these two categories--willful blindness and non-willful actions--is critical because only non-willful actions would enable you to enter a streamlined program and avail yourself of reduced penalties.

If taxpayers could protect themselves from FBAR penalties through deliberate ignorance of filing requirements, many would undoubtedly do so.  However, the leading cases on this subject demonstrate that ignorance of these complicated tax laws is no excuse.  Taxpayers sophisticated enough to maintain offshore accounts and engage in other complicated transactions are assumed to be reasonably educated and thus aware of the basic rules governing these matters.  To make an analogy to the sporting world, former University of North Carolina men’s football coach Butch Davis, who had remained deliberately ignorant of all recruiting and academic matters in order to protect himself and his team from possible NCAA violations, was fired by his employer for exhibiting the athletic equivalent of willful blindness.

In the 2012 case United States v. Williams, the 4th Circuit held that a taxpayer who signed his tax return was charged with constructive knowledge of its contents.  Williams, the taxpayer, had exhibited willful blindness by going to great lengths to avoid familiarizing himself with FBAR reporting requirements, never reading the forms he signed or the instructions related to those forms.  In the court’s opinion, Williams had made a conscious effort to conceal or mislead his sources of income and other financial information.  

James v. United States, a district court case arising out of Florida in 2012, offered an instance of a taxpayer who had understandably erred when failing to file Form 3520, which applies to foreign trusts and the receipt of certain foreign gifts.  The IRS had not issued regulations related to that form, and the court concluded that the taxpayer had made a good faith effort to comply with the existing law and could not be reasonably expected to know of this particular requirement.  In James, there was no evidence that the taxpayer had gone to the same lengths as the taxpayer in Williams; in fact, the available evidence examined by the court suggested that he had exercised the ordinary care and prudence expected of similarly situated individuals.

However, in United States v. McBride, the Utah District Court articulated a more exacting standard, reasoning that taxpayers had constructive knowledge of all instructions related to the tax forms that they sign:  “‘It is reasonable to assume that a person who has foreign bank accounts would read the information specified by the government in tax forms,’ including the reference on Schedule B to the FBAR.”  McBride goes a step further than either of these cases, seemingly imposing a willful FBAR penalty on anyone who signs a federal tax return with a Schedule B attached and fails to file a required FBAR.  

Individuals who might find themselves in a position to incur FBAR penalties should avail themselves of an experienced tax practitioner’s assistance in filing their taxes.  The chief lesson from all of these cases is that taxpayers should try to stay reasonably informed of all reporting requirements, keep a detailed narrative of their transactions, and, should they face IRS action, seek the aid of a tax attorney as soon as possible.  

For a free phone consultation regarding this subject or other tax matters, please contact The Law Office of Aaron P Richter, a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Sunday, February 28, 2016

Willfulness and FBAR Penalties, was Your Non-Disclosure Entirely Innocent? | Bethesda Tax Lawyer


In my previous blogs about the OVDP, SDOP, and the SFOP, I explained how deciding which disclosure program to enter was dependent upon your exposure to willful FinCen Form 114 (FBAR) penalties.  If your actions did not rise to the level of willful behavior, then you should enter one of the streamlined programs.  However, the IRS has not provided a bright-line test for willfulness or non-willfulness.  Thus, to qualify for the Streamlined programs, you must show that your actions were not intentional nor were they due to an intentional disregard of the laws (willful blindness). I am dividing this discussion into three posts. This post will cover the topic of willful behavior, followed in a few weeks by blogs addressing willful blindness and non-willful actions.

IRS examiners will recommend steep penalties for each year in which the FBAR filing and recordkeeping violation was willful, so understanding this term is very important.  Internal Revenue Manual 4.26.16.6.5.1 states that the test for willfulness is “whether there was a voluntary, intentional violation of a known legal duty, which is demonstrated “by the person’s knowledge of the reporting requirements and the person’s conscious choice not to comply with the requirements.”  A “conscious choice not to file the FBAR” is sufficient to constitute a willful violation.  Examples of willful behavior include filing an FBAR but omitting one of several foreign bank accounts, filing the FBAR in earlier years but failing to file the FBAR in subsequent years when required to do so, and failing to file the FBAR after being sent a warning letter explaining the FBAR filing requirement.  Evidence of a willful violation is rarely direct, because willfulness is a state of mind, but is instead established by drawing reasonable inferences from available facts.  Various financial documents, such as statements from foreign bank accounts and prior FBAR warning letters, can indicate that a violation was willful.  The burden of proof for this determination is on the government (see Ratzlaf v. United States, 510 U.S. 135 (1994), holding that “the Government must prove that the defendant acted with knowledge that his conduct was unlawful”).  

Per the recent case of United States v. McBride (DC Utah 2012), a district court in Utah noted that the appropriate evidentiary standard for a determination of willfulness for the purposes of the FBAR was a “mere preponderance of the evidence” rather than the higher bar of “clear and convincing evidence,” reasoning that greater protection was unnecessary since no important individual rights or interests are present in FBAR cases, which “only involve money.”  The district court then noted that even individuals such as McBride, who may have believed they were legally justified in withholding FBAR reporting information, were nonetheless guilty of a violation if they failed to disclose required information.  This decision seems to indicate that willfulness penalties are a matter of strict liability:  the taxpayer is guilty of a violation for non-disclosure even if he believed he did not have to make the disclosure.  

Taxpayers facing willful FBAR violations should seek counsel at the earliest stage of an audit so that they can prepare narratives that indicate their violations were not the result of willful behavior.  Subsequent posts on this blog will address willful blindness and non-willful actions.  

For a free phone consultation regarding this subject or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.