Is it possible to submit to the IRS using the streamlined filing compliance procedures and have it rejected?
U.S. taxpayers (citizens and residents) who have international transactions, foreign financial accounts, and/or interests in foreign entities are subject to a variety of reporting requirements under federal tax law. Taxpayers who fail to submit these information returns in a timely manner and in the right manner run the real possibility of incurring heavy civil fines. However, through the Streamlined Filing Compliance Procedures ("SFCP"), the IRS has provided a limited amnesty to some qualifying taxpayers to restore compliance—at lower civil penalty rates.
However, not every taxpayer is eligible for the SFCP. Those who "willfully" neglected to submit foreign information returns or to pay U.S. tax on overseas income, for instance, are ineligible. Moreover, if the IRS determines that a taxpayer's SFCP application omits critical information, the taxpayer may be ruled ineligible even though they are otherwise eligible. The IRS often audits the submissions made through the programme because taxpayers have a compelling incentive to use it rather than alternative strategies for getting back into compliance. If an SFCP filing is marked by the IRS for further investigation, the federal district court ruling in Jones v. U.S., No. CV-19-04950-JVS (C.D. Cal. May 11, 2020), provides an insight into what may go wrong.
The Jones neglected to disclose all of their interests in foreign accounts as was covered in more detail below. According to the Bank Secrecy Act ("BSA"), U.S. citizens are required to file FBARs to disclose the total amount of their foreign accounts if it exceeds $10,000 at any time during the tax year.
Civil fines may apply to taxpayers who file FBARs after the deadline or report inaccurate information. The civil penalties depend on whether the non-filing or wrong filing was the result of deliberate or negligent behaviour. The line between intentional and non-willful behaviour is frequently hazy, as the court observes in Jones.
The BSA allows the IRS to impose civil penalties as high as 50% of the foreign account balances at the time of the violation, or when the FBAR was due, if a taxpayer's actions are shown to be intentional. According to the law, the IRS may additionally impose a 50% willful penalty for each tax year, with the exception of the FBAR penalty's statute of limitations.
If a taxpayer's actions are determined to be not willful, the penalty is $10,000 per infraction instead of $20,000. (adjusted for inflation). Federal courts are now divided over the correct definition of "violation" in the context of non-willful penalties. According to certain federal courts, the word refers to $10,000 per late disclosure of a foreign bank account; however, other federal courts have ruled that it refers to per-year or per-FBAR form. The Supreme Court granted certiorari in Bittner to end the disagreement; as a result, the matter ought to be decided more clearly next term.
US v. Jones
For a while, Mr. and Mrs. Jones had been married. While Mrs. Jones was born in Canada, Mr. Jones was born in New Zealand. Neither had a college degree nor a lot of familiarity with accounting or tax laws in the United States.
In 1969, The Jones obtained American citizenship. Mr. and Mrs. Jones had eleven international accounts throughout the relevant years (2011 and 2012), including three in Canada and eight in New Zealand. Three of the international accounts (two in Canada and one in New Zealand) were in Mrs. Jones' sole name, while the remaining four foreign accounts were held jointly by the Jones. Mr. Jones had exclusive ownership of four of the New Zealand accounts.
Until Mr. Jones passed away on March 11, 2013, the Joneses always filed joint income tax forms, including for 2011. The Jones failed to disclose sizable sums of foreign income associated with the overseas accounts on their tax forms. Additionally, the Jones failed to file FBARs and stated on Schedules B that they had no interests in any foreign accounts.
The Jones' tax returns were prepared by a CPA. The CPA lacked FBAR preparation skills, and he didn't inquire whether the Jones had any foreign accounts.
Mrs. Jones was chosen as Mr. Jones' executor after his death. Mrs. Jones didn't find out about Mr. Jones' private accounts in New Zealand until after his passing. Mrs. Jones employed attorneys to help with the estate's management. Mrs. Jones promptly submitted an FBAR for 2012 disclosing the overseas accounts based on their legal counsel. In addition, she submitted updated tax forms for 2011 and 2012 that included a disclosure of all undisclosed foreign income from the accounts.
About two years later, Mrs. Jones also submitted an SFCP submission to the IRS that included the following items: (1) amended joint income tax returns for 2011 and 2012 that she had already filed, as well as an original income tax return for 2013; (2) FBARs for 2008 through 2013; (3) a non-willful narrative signed under penalty of perjury; and (4) payment of the miscellaneous Title 26 penalty in the amount of $156,795.26. Based primarily on her individual accounts and her combined accounts with Mr. Jones, Mrs. Jones calculated the Title 26 penalty. She left out Mr. Jones' several overseas accounts in New Zealand.
The SFCP submission was chosen by the IRS for inspection. The Jones court stated that Mrs. Jones' Streamlined filing "did not list, and did not pay a 5 percent penalty on Mr. Jones' foreign accounts" as the reason for the inspection. Following the examination, the IRS attempted to impose willful FBAR penalties of $1.52 million against Mr. and Mrs. Jones. Mrs. Jones sued the government of the United States for failing to eliminate or decrease the willful FBAR penalty in her individual capacity and in her capacity as executor of Mr. Jones' estate. The parties all filed motions for summary judgement on their claims after the conclusion of discovery.
The Jones court emphasised the BSA's broad definition of "willfulness." The court said more clearly as follows:
Despite the fact that [the BSA] lacks a definition for the term "willfulness," courts deciding civil tax cases have ruled that someone is acting willfully if they show a careless disregard for a legal obligation. It is an issue of fact as to whether someone wilfully disregarded a tax reporting requirement. Recklessness is a measure of behaviour that poses an unreasonable risk of harm that is either known or so obvious that it should be known, according to an objective criterion. Willfulness need not be proven in a civil context to have an improper motive or evil intention. Evidence of such willful blindness is sufficient to demonstrate willfulness when a taxpayer makes a deliberate effort to avoid learning about reporting responsibilities. Willfulness can also be demonstrated by drawing conclusions from actions taken with the intention of hiding or deceiving sources of income or other financial information.
The court in Jones refused to grant either party's petition for summary judgement due to the broad meaning of willfulness. There were, in fact, facts both in favour of and against a judgement of willfulness, the federal court reasoned. The Jones filed Schedules B and ticked the "no" box when asked if they had interests in foreign accounts, among other favourable facts for the United States; additionally, the Jones got statements from their international banks but never gave those statements to their CPA for tax preparation. The court made the following favourable observations regarding the Jones: (1) the Jones relied on a CPA who was not aware of the FBAR reporting requirements; and (2) after learning of the missed FBAR filing, Mrs. Jones quickly filed amended tax returns and voluntarily submitted the late FBARs through the SFCP.
The court concluded that a trial was required in order to reach a final decision about Mr. and Mrs. Jones's liability for willful FBAR fines.
The Jones ruling demonstrates that the IRS routinely monitors SFCP submissions and disqualifies individuals who do not meet the requirements. Taxpayers who intend to submit an SFCP submission should be knowledgeable with the program's standards as well as the distinction between willfulness and non-willfulness. Without making these crucial decisions, taxpayers who submit an SFCP run the danger of additional civil penalties and an expensive IRS audit after the submission has been completed.