When interviewing a taxpayer that has offshore compliance issues with the Internal Revenue Service, practitioners (Attorneys, CPAs, Enrolled Agents) take a myriad of approaches to develop the case to be able to provide a recommendation for compliance. Some practitioners ask that the taxpayer complete an organizer and submit documents for review under legal discovery. Other practitioners have an introductory confidential meeting (whether over the phone or face to face) in order to flesh out the facts and circumstances. They are then are able to provide a recommendation based on this initial interaction.
Based on my experience with these issues and the stories I have heard from other practitioners, I can say that regardless of the approach, practitioners and taxpayers generally have two very different perspectives on the issues that matter the most. In order to help provide transparency and visibility to this somewhat new and complex area of tax law, I will try to highlight these perspectives and provide a baseline of expectations.
The practitioner’s objective is to identify a path to compliance based on the facts and circumstances of the taxpayer. While completing this analysis, the practitioner should also try to determine if the taxpayer is a good fit for representation (Can I provide this person(s) with the best possible outcome?).
Key talking points practitioners should want to address:
- If the taxpayer is abhorrently risk averse, will they accept instruction and advice to file a Streamline submission?
- If the taxpayer is extremely risk tolerant, will they accept instruction advice to file an OVDP submission?
- What kind of timeline is at hand? Has a bank threatened disclosure? Has a John Doe Summons been issued? Will there be an upcoming exchange of information via FATCA or OECD?
- Can the taxpayer produce proper documentation to support compliance from their own personal documentation? If not, can the taxpayer get the documentation from the foreign financial institution?
- How complex will the financial recreation process be for this taxpayer? Does the tax payer have a foreign corporation, partnership or trust? Do I have the technical skills to represent a taxpayer with a highly complex fact pattern?
- How many banks? How many bank accounts? How many foreign jurisdictions? Will I need to translate a foreign language to attain the information?
- Is the taxpayer making a full, complete, truthful and honest representation?
The taxpayer’s perspective could be one of fear and utility. It is also likely that the taxpayer will have conducted background research online and potentially through its personal network of advisers. This information may have resulted in both good and bad advice.
Key talking points that taxpayers should want to address:
- Do I have criminal liability? Am I at risk for being disclosed to the U.S. Government and IRS?
- The OVDP penalty is extremely high (27.5% to 50%), how can I get the 5% penalty?
- How much are the legal and preparation fees for this going to be?
- How many clients has this practitioner represented for matters similar to myself? What are the practitioner’s success rates?
- Based on my facts, how quickly do I need to provide information? What if I cannot get foreign financial institution statements?
- Where can I get copies of my filed tax returns? If I use a historical preparer do I need to tell this person what is going on?
- How does this affect my family?
- What if I do nothing?
First, I will address the practitioner perspective. The questions listed are the tip of the iceberg for most practitioners. In order to provide a proper recommendation, the entire analysis boils down to four inescapable events:
- Interview: If possible, interview the taxpayer or prospective client face to face. Initial consultations over the phone are fine to get the ball rolling but you need to be able to look a prospective client in the eye, face to face, in order to truly determine honesty and accuracy while building a bridge of trust. If unable to meet in person, use Skype or GChat. Most importantly, the practitioner will be able to gauge if the prospective client has the mental fortitude to withstand an IRS Exam and/or a Criminal Investigations or Department of Justice in person examination should the need occur.
- Engagement Letter: Take the time to draft a thorough and comprehensive engagement letter that covers all potential trigger points and outcomes. For example, if the engagement is for OVDP, there should be clauses that detail what happens if the client wants to “Opt-Out” before the closing agreement. Or if the engagement letter is for a Streamline Submission, there should be an informed consent clause notifying and informing the client that there is no criminal immunity or protection from normal IRS examination procedures.
- Penalty Analysis: The penalty analysis is probably the most crucial part of any representation. Under Circular 230, it is the duty of the designated representative or practitioner to illustrate to the client the potential penalties associated with the representation. But on a practical level, it is common sense to demonstrate how the Title 26 Miscellaneous Offshore Penalty compares to the potential penalties based on the facts and circumstances. This is as basic as showing your math from grade school. For example, if a practitioner recommends OVDP at 27.5% but the penalty analysis shows potential informational return penalties max out at 20%, it is fairly clear that the practitioner failed to conduct this critical analysis. The practitioner’s mistake just cost you 7.5%.Here is an example of the spreadsheets used and the complexity of the analysis.
- Assessing Willfulness: The analysis of Willful vs. Non-Willfulness based on the particular taxpayer’s facts and circumstances will dictate the final decision for the path to compliance. I will illustrate the factors that play into this analysis later.
Second, from the taxpayer’s perspective it is important to educate and overcome misinterpretations.
- Criminality will always be an issue with offshore related tax issues. That being said, taxpayers should not lose focus on the draconian civil penalties for failing to properly come into compliance (see the Zwerner case).
- If you were to ask 100 taxpayers facing these issues if they want the 27.5% penalty or the 5% penalty, I would dare say all 100 would say 5%. Now if I were to ask those same taxpayers if they want 2.75% or 5% with the potential to reach 300% (failure to file FBAR penalty (50%) multiplied by the six year statutory period) or 200% (again see Zwerner), what do you think they would say? Taxpayers should not focus on the penalty type until after they receive the penalty analysis breakdown from their practitioner. This is the real cost-benefit analysis.
- Fees will always vary because each of these situations is very unique. Always inquire about the following:
- What is the total fee and what components does it encompass?
- What is the legal representation fee and what does it cover?
- What is the tax preparation fee and what does it cover? Amended returns? FBAR reports? Informational reports? Financial recreation?
- Do these fees increase if the financial recreation is highly complex?
- Always vet the practitioner prior to signing an engagement. Will the representation be an attorney, CPA or enrolled agent? Do you need an attorney? If not, why not? Did the practitioner properly explain confidentiality and privilege under the IRC 7525? How many foreign jurisdictions has the practitioner provided representation for previous clients? How many foreign financial institutions? Does the practitioner have foreign language capability? How extensive is the dedicated international team? What are their credentials?
- A holistic approach should be taken to each case. For example, in cases where the taxpayer receives an inheritance from a deceased parent, most practitioners focus on the taxpayer. But what about the deceased parent. If deceased parent was a US citizens or green card holders their estate may have liability. What about children that have signature authority only? This is quite common within the immigrant community where in the foreign home based country everyone within the family has their name attached to the account.
- Doing nothing is never an option. Once you learn that you are non-compliant you must act. Failure to do so immediately moves a taxpayer from potentially non-willful to willfulness.
The last point I want to make revolves around willfulness. Developing facts and circumstances is key. Simply saying that you were ignorant of the law or did not know that you had an obligation to file is not enough (no bad motive needed and see Willful Blindness).
Here is general breakdown of behavior that has indicia of willfulness vs. non-willfulness:
|Leaning Toward Willful Behavior||Leaning Toward Non-Willful Behavior|
|More than $1 million and did not seek advice||Only signature authority over the foreign bank account|
|Statement by the person that he knew the filing requirements||Inherited account|
|Steps taken to conceal the account||Full compliance after notification of FBAR reporting requirements|
|Source of the funds in the account cannot be explained or traced||Tax compliance|
|Purpose of the foreign account cannot be explained (Why not U.S. account-cash hoard)||Relied upon the advice of a tax return preparer, a CPA, an attorney, or another qualified tax professional.|
|FBAR for a previous year, or incomplete FBAR for current year (Previously-filed FBARs do not include all foreign accounts)||Foreign account disclosed to return preparer|
|Prior FBAR compliance action or violations persist after notification of FBAR reporting requirements||Business reason for the foreign account|
|Return preparer asked about foreign accounts and person lied||Family or business connection to the foreign country|
|Failed to disclose the account or income for many years||Person owns the account in his name|
|Hold mail or dedicated bank cell phone||Minimal account touches (deposits/withdrawals)|
|Opened the foreign bank account||HAB or HYEB @ $800K or less within the covered period|
|Tax non-compliance||General accidental American scenario|
|Relied upon the advice of a promoter, foreign banker, or other
unqualified tax professional
|No business reason for the foreign account|
|No family or business connection to the foreign country|
|An offshore entity owns the account|
|Illegal income in the foreign account|
|Participated in an abusive tax avoidance scheme|
|Many account touches (deposits/withdrawals)|
|Closing account and transferring funds with a tax haven foreign jurisdiction from a large bank to a small bank or from one tax haven jurisdiction to another (ex. Switzerland to Israel).|
About Five Stone Tax Advisers
Five Stone Tax Advisers has years of experience negotiating directly with the IRS to get the best possible outcome for you. Our International Tax Advisory and Compliance unit has a team of tax attorneys, certified public accountants and enrolled agents that form a single sourced point of contact that will provide services for all the legal, compliance and financial reconstruction aspects of these cases.