March 14, 2019

 
 

HOW DOES THE IRS DEAL WITH “ILLEGAL SOURCE INCOME’

The IRS will not launder your illegally gotten gains like some casinos, fake businesses, or banks in notorious tax havens around the world.  The IRS knows how ingenious some of the money laundering schemes can be.  They are not sitting idly by and doing nothing. 

So, that is why you will see statements by the IRS, for example, in their Internal Revenue Manual at I.R.M 9.5.11.9  that “A voluntary disclosure will not automatically guarantee immunity from prosecution; however, a voluntary disclosure may result in prosecution not being recommended.  This practice does not apply to taxpayers with illegal source income.”

Common examples of illegal source income are bribes, embezzlement, illegal drug dealing, or theft.  The list is very long and varies depending on your jurisdiction. 

The IRS knows you have an incentive to hide illegally source income.  Why? You could be in double jeopardy of (1) being taxed by the IRS on the illegal income and the IRS will want payment with all penalties and interest, if not declared on a tax return; AND (2) the illegal scheme can potentially spread to numerous criminal charges.  You can easily find in your nearest federal district court, federal criminal indictments with long lists of charges that start with “Attempted”, “Conspiracy to”, “Possession”, “Fraudulently”, “Perjury” and “Money Laundering” along with a lot of lesser included charges.  The above are only some of the charges, the government can charge you with.;  AND (3) the US government can take your house, car, boat, airplane or any other asset used by you in furtherance of your illegal scheme to make money.  That is called “forfeiture”; AND (4) there is always the possibility of imprisonment. 

So if you have illegal sources of income and are listening to people who advise you can sneak through a streamlined program or voluntary disclosure program by not declaring your illegal sources of income, you are at the very least putting yourself at risk for a perjury charge.  Don’t go that route.  For example, take a look at what you will be signing.  Consider IRS form 14653 entitled “Certificate by United States Person Residing Outside of the US for Streamlined Foreign Offshore Procedures”.  Check out page 1, under the heading NOTE: notice the sentence embedded in that paragraph that states “My failure to report all income, pay all tax, and submit all required information returns, including FBARS, was due to non-willful conduct.  Followed by the request on page 2 to “explain sources of funds in all financial accounts.”  You will be certifying those statements with your signature.  You will be subjected to the IRS review process after you have signed. 

Bottom line, if you are caught between a rock and a hard place, metaphorically speaking, you should get some help.  An attorney can keep your communications with him/her confidential whereas an accountant’s communication is not privileged.  Experience in handling criminal cases, including trials, as well as experience in dealing with IRS personnel is necessary also.  Firms with a high volume of cases may not have the time to devote to your case. 

 
     
  March 11, 2019  
 

HOW DOES THE IRS DEFINE 'WILLFUL' CONDUCT

Two of the most important concepts of taxpayer conduct, that you should know about in US tax law that has pervasive effects on the outcome of any unfiled or delinquent tax returns or forms, for both offshore or domestic taxpayers,  are (1) the “Willful” state of mind and relevant conduct, and (2) “Illegal Source Income”. 

You will be treated very differently by the IRS depending on their investigation.  If you are found on the wrong side of these concepts, penalties can go drastically up, IRS examiners discretion goes down in penalty mitigation, additional taxes assessed, and criminal investigators from several federal agencies can get involved with the end result your freedom could be at stake.  Additional charges like money laundering can be charged. Assets used in furthering criminal acts can be forfeited US.  

For this blog, I am going to stick to the concept of what the IRS means by “Willful”.  The next blog, coming soon, will deal with “Illegal source income”. 

The IRS has published guidance in its Internal Revenue Manual on what evidence supports a willful violation.  In sum, “Willfulness” is a state of mind which can be inferred from your actions in context of the available facts.  Reasonable inferences by the examiner can be made on whether you were willful or not.  It’s not that simple in my experience.  Such “reasonable” inferences by the IRS are usually debatable or may be contested by the taxpayer who develops a detailed factual basis and explanations that, at least, could lead to a conclusion that there is reasonable doubt the taxpayer was not willful.  Criminal lawyers with actual trial experience before juries know the power of creating reasonable doubt in the minds of decisionmakers like judges or juries.  You do not have to prove the client innocent.  Instead you educate the decisionmaker  on the reasons why there is doubt that the accused is really guilty.  Arguing that the client is presumed innocent under US law is part of the argument and the burden is on the prosecution to prove their case beyond a reasonable doubt. 

That being said, I am going to reprint what the IRS considers evidence of willful behavior. It will give you some context in non-FBAR IRS willfulness issues.    It is a one of the more lengthy IRS definitions which shows the IRS’s attempt to eliminate some the fuzziness inherent in gathering evidence of a subjective state of mind – like willfulness.  This is the type of evidence you could be asked to provide.  It is not to be considered an all-inclusive list as each factual situation is different. 

From the IRS Internal Revenue Manual:

Willful FBAR Violations - Evidence

  1. Willfulness can rarely be proven by direct evidence, since it is a state of mind.  It is usually established by drawing a reasonable inference from the available facts.  The government may base a determination of willfulness on inference from conduct meant to conceal sources of income or other financial information.  For FBAR purposes, this could include concealing signature authority, interests in various transactions, and interests in entities transferring cash to foreign banks.
  2. Documents that may be helpful in establishing willfulness include:

    1. Copies of statements for the foreign bank account.
    2. Notes of the examiner’s interview with the foreign account holder/taxpayer about the foreign account.
    3. Correspondence with the account holder’s tax return preparer that may address the FBAR filing requirement.
    4. Documents showing criminal activity related to the non-filing of the FBAR (or non-compliance with other BSA provisions).
    5. Promotional material (from a promoter or offshore bank).
    6. Statements for debt or credit cards from the offshore bank that, for example, reveal the account holder use funds from the offshore account to cover everyday living expenses in a manner that conceals the source of the funds.
    7. Copies of any FBARs filed previously by the account holder for FinCEN Query printouts of FBARs.
    8. Copies of information Document Requests with requested items that were not provided highlighted along with explanation as to why the requested information was not provided.
    9. Copies of debit or credit card agreements, and fee schedules with the foreign bank, which may show a significantly higher cost than typically associated with cards from domestic banks.
    10. Copies of any investment management or broker’s agreement and fee schedules with the foreign bank, which may show significantly higher costs than costs associated with domestic investment management firms or brokers.
    11. The written explanation of why the FBAR was not filed, If such a statement is provided.  Otherwise note in the workpapers whether there was an opportunity to provide such a statement.
    12. Copies of any previous warning letters issued or certifications of prior FBAR penalty assessments.
    13. An explanation, in the workpapers, as to why the examine believes the failure to file the FBAR was willful.

  3. Documents available in an FBAR case worked under a Related Statute Determination under Title 26 that may be helpful in establishing willfulness include:
    1. Copies of documents from the administrative case file (including the Revenue Agent Report) for the income tax examination that show income related to funds in a foreign bank account was not reported. 
    2. A copy of the signed income tax return with Schedule B attached, showing whether or not the box pertaining to foreign accounts is checked or unchecked.
    3. Copies of tax returns (or RTVUEs or BRTVUs) for at least three years prior to the opening of the offshore account and for all years after the account was opened, to show if a significant drop in reportable income occurred after the account was opened.  (Review of the three years’ returns prior to the opening of the account would give the examiner a better idea of what the taxpayer might have typically reported as income prior to opening the foreign account).
    4. Copies of any prior Revenue Agen Reports that may show a history of noncompliance.
    5. Two sets of cash T accounts (a reconciliation of the taxpayer’s sources and uses of funds) with one set showing any unreported income in foreign accounts that was identified during the examination and the second set excluding the unreported income in foreign accounts.
    6. Any documents that would support fraud (See IRM 4.10.6.2.2 for a list of items to consider in asserting the fraud penalty).

The courts have also recently weighed in on what constitutes willful behavior by a US taxpayer.  In all cases before the IRS, case law should be thoroughly researched for the differing nuances from IRS language.  I find the factual recitations in case law to be much more detailed and nuanced than what the IRS provides in their procedures manual.  So if I take on a new case a detailed factual development is a must.  There are a fair amount of cases discussing willfulness in past years.  Recently a case did come down from the US Court of Claims defining willful behavior.  You can find this instructive case at Kimble v. United States, Court of Claims No. 17-421 – FBAR Willfulness Penalty Case. 

In conclusion, the potential for an IRS finding of willfulness  in US taxpayers who are non-filers or delinquent in tax filings has to be taken seriously.   The issue cannot be brushed off as being easily solvable.  This issue should first be addressed BEFORE you even think about entering any IRS Voluntary Disclosure or Streamlined Programs. 

 
     
 

February 13, 2019

 
 
INTERNATIONAL TAX PLANNING FOR US FOREIGN RESIDENTS WHO ARE NATIONALS OF A FOREIGN COUNTRY WITH NO TAX TREATY WITH THE US

According to the IRS website the United States has 58 tax treaties with countries or jurisdictions.  Elimination of double taxation on the taxpayer(s) is one of the goals of a tax treaty. Double taxation is assessment by two countries on the same source of income. This makes for very unhappy taxpayers and with some tax planning can be avoided.

The underlying basis for double taxation stems from the jurisdictional basis on which a country asserts or enforces its right to tax.  The jurisdictional basis of the US tax system is based on citizenship or nationality and residency.  The US income taxation system extends to the worldwide income of taxable persons which includes foreign residents who have become US residents by either the green card test or the substantial presence test.  See pages 3 and 4 of IRS Publication 519 , “U.S. Tax Guide for Aliens”  for a more detailed description of these two tests. You can download the publication at www.irs.gov

What is interesting is the number of countries that are NOT on the IRS treaty list. One example is Colombia, which is in the process of negotiation of a tax treaty with the US, but the treaty has not been signed and is not in force.  Colombia’s basis for jurisdiction to tax income is based on citizenship or nationality only. The source of the income to be taxed is income sourced from Colombia. 

Without a tax treaty between Colombia and the United States that addresses the issue of double taxation, a Colombian national with substantial income earned in Colombia and who met the substantial presence test for a taxable person in the US could be taxed by both Colombia and the US. 

Tax planning before one gets into such a predicament is essential.  The substantial presence test with the counting of days over either a 3 year or 1 year period can be controlled by the taxpayer to eliminate the possibly of becoming a foreign resident in the US.  Also,  planning your connections to your country of nationality to meet the “Closer Connection to a Foreign Country” exception to the substantial presence test is another planning opportunity.  Also, make sure that any US immigration forms you file (i.e. I-485 Petition to Adjust Status) do not contradict the evidence that you are a foreign non-resident of the US.