Sam Brotman, JD, LLM, MBA January 14, 2021 15 min read

Penalties for Non-willful Violations

Often, taxpayers may neglect to comply with the tax code for reasons that have nothing to do with efforts to evade taxes. That is understandable. International tax laws, especially those associated with FBAR, are complicated and confusing.

Many times, a failure to file may be due to a misunderstanding or unawareness of the law. Nonetheless, when it comes to FBAR violations, the penalties can be steep even for those who did not willfully violate the law. 

A non-willful penalty carries a fine of up to $10,000 per year. (See 31 U.S.C. 5321(a)(5)(B)(i)).

While we hope that you have arrived at this resource before any problems with the IRS have arisen, you may be coming here because you have just learned that you did not comply with the FBAR filing requirements. 

If this is the case, then give me a call. Oftentimes, I can pretty quickly get to the root of the problem, which gives me a baseline for building a defense strategy that can lessen the blow from the IRS. 

 

How Does the IRS Define “Non-willful?”

Before we delve into the non-willful compliance programs, we should take a look at how the IRS defines non-wilful. For streamlined programs, the IRS defines non-willful as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirement of the law.” 

You are going to have to prove your case to the IRS (under threat of perjury and punishment) that your actions were not intentional.

Here are some questions that the IRS will hard want answers to: 

  • What kind of evidence is relevant to demonstrate “non-willfulness” when the definition of non-willful conduct can range from negligent conduct to conduct resulting from a good faith misunderstanding of the law?
  • How do you actually prove that you did not know about including offshore income on your U.S. tax return or did not know about the FBAR filing requirement? How can you substantiate your claim?
  • Did the taxpayer have any knowledge of the foreign source income, foreign
  • accounts or foreign assets? Why was there income?
  • What is your level and type of education?
  • Do you have any specialized knowledge of tax rules or finance or awareness that the U.S. requires U.S. persons to report income received from foreign sources on your tax returns?
  • Do you know anything about an FBAR or international information returns, such as a Form 5471?
  • Were you a citizen or resident of the country where the accounts/assets were/are located? If not, why were the accounts opened in that country?
  • If you opened the account, did you do so with a U.S. passport? Was the account opened in a jurisdiction with no bank secrecy laws?
  • What were/are the sources of the funds in the accounts?
  • Is the source of funds traceable to previously taxed income? Were the funds an
  • inheritance? Were the funds from your work in the country where the accounts are located?
  • What type of activities took place with respect to the accounts? Deposits, withdrawals, wire transfers? If so, how frequent were these activities?
  • Were there any trades in the accounts? If so, who managed the accounts?
  • Was there a credit card associated with the account? If so, did you ever use it? If so, how frequently?
  • Has the account ever been moved? If so, why? Was it moved to a tax transparent country or to a jurisdiction with a tradition of bank secrecy?
  • Was an entity used when the account was opened? If so, did the bank require the use of an entity? Was it used to disguise the true identity of the account owner?
  • Did you receive regular statements from the bank? If not, did a relative or friend receive statements or did you instruct the bank to not send any statements to you?

The IRS is also going to want to know about your tax preparer and what information you may or may not have given them:

  • Were you given a tax organizer by your tax preparer and if so, did you fill it out truthfully? Do you have a copy of it?
  • If you did not receive an organizer from the tax advisor, did they ask you about the existence of any offshore accounts or assets, or about any foreign source income?
  • If your tax preparer did not ask you about any foreign income, did you tell them about any offshore accounts, offshore assets, or foreign source income?

As it has been stated before, the IRS is very serious about going after these offshore accounts and wringing as much tax revenue (including penalties) out of them as possible. 

Making one dubious or incomplete answer to any of these (and other) questions, and you could seriously sabotage your chances at passing the non-willful tests and any hope of getting into one of the streamlined programs.

Voluntary Disclosure

For taxpayers doubtful as to whether their conduct will be considered willful, the IRS recommends that the taxpayer enter into the IRS’ Voluntary Disclosure Practice, and to seek advice from attorneys or other tax professionals. 

When it comes to determining whether a taxpayer will be recommended for criminal prosecution, it is fruitless for a taxpayer to deduce what the outcome will be for them based on previous, similar cases that came before the IRS. (See IRM 9.5.11.9 - Voluntary Disclosure Practice). 

The IRS states that “[t]he Voluntary Disclosure Practice creates no substantive or procedural rights for taxpayers.”

Given the difficulty in determining willfulness and the potential consequences that can result from being held criminally liable, this is certainly one issue that you would not want to tackle alone. 

Whether or not you decide to retain our firm to assist you, you would be doing yourself a great disservice to try to face this on your own. If your conduct is considered non-willful, then it is worthwhile to determine your eligibility for the SFOP or SDOP program. These programs will be discussed in the next and final chapter of this book. 

Penalties will not be imposed if there was “reasonable cause” for violating the law, and if the amount of the transaction or the balance in the account at the time of the transaction was properly reported. (See 31 U.S.C. 5321(a)(5)(B)(ii)). 

What constitutes reasonable cause will depend on the nature of the violation. However, some facts that will be taken into consideration are whether the taxpayer relied on professional advice, and whether the taxpayer knew or should have known of the violation. See 26 CFR § 1.6664-4 to read through the guidance that the IRS uses in determining reasonable cause. 

Relying on the advice of a CPA or attorney evidently would be considered “reasonable” but the Supreme Court has placed some limits on this reliance. In U.S. v. Boyle, 469 U.S. 241 (1985), it was held that it was unreasonable for an executor of an estate who worked with an attorney to have failed to file Form 706 (estate tax form) because the filing deadline statute was “unambiguous.” 

Similarly, a taxpayer’s failure to review his tax filings, even if prepared by a professional, may also be deemed unreasonable. Additionally taxpayers that could not file on time despite having “exercised ordinary business care and prudence” will be deemed to have reasonable cause for not filing. (See also Treas. Reg. 301.6651-1(c)(1)).  

Furthermore, taxpayers unable to pay their liability on time despite having “exercised ordinary business care and prudence” will also be deemed to have reasonable cause for their non-compliance. 

The non-willful penalty has been limited to a $10,000 penalty per open year, regardless of the number of accounts. Unfortunately, the government has taken the position that the fine can be applied to each non-disclosed account. 

Thus, in practice, some courts have held that penalties can be placed on multiple accounts while on the other hand, the Eastern District of Texas has recently held that only one penalty can be imposed per FBAR filing. (See United States v. Bittner, 4:19-cv-415 (E.D. Tex. Jun. 29, 2020)). 

While Texas’ recent ruling may shift the way these penalties are applied, taxpayers should operate under the assumption that they may be penalized on each account that they do not report. 

As mentioned previously, the IRS has generally operated under a circumscribed policy limiting the application of the penalty to its full extent. However, depending on the facts and how egregious the violations are, the IRS may push the penalties further than they normally do. 

The IRS has had cases go in their favor in this area, but these FBAR penalty cases are still being litigated.

For now, this means that if you have three foreign bank accounts that fall under FBAR reporting obligations, you could potentially be fined $30,000 (3 accounts x $10,000 fine) for every year that you did not fulfill your filing requirements. 

This stacking of penalties under the non-willful penalty imposes a pretty severe punishment on taxpayers who unintentionally failed to file.

 

Conclusion

While non-willful disclosure is not quite as severe as willful disclosure, nonetheless, it can still carry penalties. You and your tax preparer (if you used one) will have to provide valid answers to some hard questions from the IRS.

One solution is to enter into the IRS’ Voluntary Disclosure Program, which will demonstrate good faith to the IRS and allow you to get into compliance. It will not come cheap as you will need to file outstanding forms and there still might be penalties. 

I always urge taxpayers who are not sure of their FBAR status to come in for a consultation. Together, we can determine your status and create a plan to get you back in compliance.

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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