Federal case after federal case continues to come out providing real-life examples of the pitfalls of filing a Streamlined Filing Compliance Procedure (“SFCP”) with the IRS when the facts suggest willfulness rather than non-willfulness. This is not surprising because the distinction between willful and non-willful behavior is not clear. Indeed, because most federal courts have recognized that willful conduct includes not only intentional conduct—but reckless conduct as well—tax professionals and tax professionals alike must exercise extreme caution in vetting all of the relevant facts to ensure that they can support their conclusion of non-willfulness.
The recent Flint decision from the United States Court of Federal Claims is a great example of what can go wrong in making an ill-advised SFCP submission. See Flint v. U.S., No. 21-1202T (Fed. Cl. Aug. 23, 2022). In that case, the taxpayer failed to file FBARs regarding significant holdings in foreign accounts. After the taxpayer’s husband passed away, the taxpayer attempted to regain compliance through the IRS’s Streamlined Domestic Offshore Procedures (“SDOP”). However, the IRS flagged the submission and ultimately assessed the maximum willful FBAR penalties against her because the IRS determined that the taxpayer was willful: a conclusion that can result in, similar to here, the taxpayer being removed from the SFCP.
This article discusses the Flint decision. Prior to a discussion of that case, however, this article provides some background on FBAR penalties and the SFCP. After discussing the conclusions in Flint, it provides some helpful insights for tax professionals and taxpayers who want to seek refuge under the SFCP.
FBAR Penalties and the IRS’s Streamlined Filing Compliance Procedures
Title 31 houses the Bank Secrecy Act (the “BSA”). The BSA requires U.S. residents or citizens to keep records and/or file reports when the resident or citizens makes a transaction or maintains a relationship with a foreign financial agency. The report—in these instances—is referred to as an FBAR.
The BSA is not a toothless statute. Indeed, the failure to file a timely and proper FBAR can result in significant civil penalties. If the failure was non-willful, the FBAR civil penalty is generally no more than $10,000 (adjusted for inflation). However, “[i]n the case of any person willfully violating, or willfully causing any violation of” the FBAR reporting requirement, the FBAR penalty may be increased to the greater of 50% of the balance in the account at the time of the violation or $100,000 (adjusted for inflation)[i].
As the Supreme Court has recognized, the term “willful” is a term of many differing meanings.[ii] For criminal statutes, “willful” generally has that term’s recognized meaning: intentional conduct or acts. For civil statutes, however, the term “willful” has been interpreted more broadly to include not only intentional acts, but reckless acts as well. This interpretation of the term to include recklessness causes many headaches in the FBAR statute, primarily because taxpayers are liable for a much lower FBAR penalty if the conduct is due to mere negligence or inadvertence.
The IRS Streamlined Filing Compliance Procedures
The SFCP was created in 2012 and continues today. Generally, the SFCP is available to U.S. taxpayers who meet the specific requirements of the SFCP. Significantly, the SFCP is not required or mandated by any federal statute or regulation—rather, it is a creature of the IRS, which created the program to promote voluntary disclosure of foreign accounts.
To make a successful submission under the SFCP, the taxpayer must:
certify, in accordance with the specific instructions [of the SFCP] that the failure to report all income, pay all tax and submit all required information returns, including FBARs (FinCEN Form 114, previously Form TD F 90-22) was due to non-willful conduct. Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of law.[iii]
Significantly, a submission under the SFCP does not mean that the IRS will not examine the submission and select it for examination. Quite the contrary, the IRS warns: “[T]he streamlined filing process will not culminate in the signing of a closing agreement with the IRS . . . [but rather] returns submitted under the streamlined procedures may be subject to IRS examination, additional civil penalties, and even criminal penalties, if appropriate.”[iv]
In addition to the non-willful certification, taxpayers must also meet other strict requirements of the SFCP, which is actually broken down into two programs (which have two sets of requirements): the Streamlined Foreign Offshore Procedures (for non-residents) and the SDOP (for residents). For the SDOP, requirements include:
(1) for each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed (the ‘covered tax return period’), file amended tax returns, together with all required information returns (e.g., Forms 3520-3520-A, 5471, 5472, 8938, 926, and 8621), (2) for each of the most recent 6 years for which the FBAR due date has passed (the ‘covered FBAR period’), file any delinquent FBARs (FinCEN Form 114, previously Form TD F 90-22.1), and (3) pay a Title 26 miscellaneous offshore penalty. The full amount of the tax, interest, and miscellaneous offshore penalty due in connection with these filings should be remitted with the amended tax returns.[v]
Taxpayers who meet all of the requirements of the SDOP obtain various benefits under the program. Perhaps most significantly, such taxpayers are not required to pay certain penalties associated with late-filed information returns (including FBARs, Forms 3520, etc.). Rather, these taxpayers are required to pay a much-reduced Title 26 miscellaneous offshore penalty of 5% of the value of the undisclosed foreign assets. But, again, on this the IRS warns:
If returns properly filed under these procedures are subsequently selected for audit under existing audit selection processes, the taxpayer will not be subject to accuracy-related penalties with respect to amounts reported on those returns, or to information return penalties or FBAR penalties, unless the examination results in a determination that the original return was fraudulent and/or that the FBAR violation was willful.[vi]
The Facts in Flint
Given the background above, you can probably guess where the Flint decision is going. In that case, Margaret Jones (“Mrs. Jones”) was a citizen of Canada and the United States. She and her husband, Jeffrey L. Jones (“Mr. Jones”) held foreign accounts which were not previously disclosed to the IRS on Schedules B of their tax returns or on FBARs.
Neither of the Joneses had a higher-level education—they had no formal tax, accounting, financial, or legal training. After Mr. Jones passed away, Mrs. Jones became aware of the reporting risks associated with the foreign accounts and filed amended returns for the Joneses’ 2011 and 2012 tax years. The amended returns reported all income from the foreign accounts and also checked the boxes “yes” on the Schedules B regarding their ownership in the foreign accounts during the applicable tax years.
After Mrs. Jones filed the amended returns, she also made an SDOP submission to the IRS. The SDOP submission included the 2011 and 2012 amended returns and an original 2013 return. As part of the SDOP, Mrs. Jones filed FBARs for 2008 through 2013 and also submitted a certification (on IRS Form 14454) asserting that she was non-willful in failing to report all her foreign income and assets on all appropriate tax forms. Mrs. Jones also made a $156,795.26 Title 26 miscellaneous offshore penalty payment to the IRS. Significantly, the FBARs reported maximum account balances from 2008 through 2013 ranging from $1.55 million to $3.13 million.
After Mrs. Jones made the SDOP submission, the IRS selected it for examination. The examination eventually resulted in the assessment of willful FBAR penalties against Mrs. Jones. When Mrs. Jones passed away, the executors of her estate (the “Estate”) filed suit against the United States in the Court of Federal Claims seeking a return of the $156,795.26 Title 26 miscellaneous offshore penalty payment. In a separate lawsuit outside the Court of Federal Claims, the Estate also sought an abatement of the willful FBAR penalties.
The Court’s Decision
The Estate brought two claims against the United States. First, the Estate claimed that the IRS’s SFCP program resulted in a breach of contract, requiring the IRS to return the $156,795.26 Title 26 miscellaneous offshore penalty. Second, the Estate claimed that the United States’ failure to return the miscellaneous offshore penalty constituted an illegal exaction.
Regarding the breach of contract claim, the Estate alleged in its complaint the following:
The IRS made an offer to Mrs. Jones, she accepted the offer and paid the IRS consideration of $156,795.26 along with signing a verified statement of non-willfulness. The government then breached the contract by assessing FBAR penalties under a ‘willful blindness’ theory, far above the 5% MOP agreed to penalty amount.
After the complaint was filed, the United States moved to dismiss it on the theory that the Estate had “failed to state a claim for breach of contract because Mrs. Jones’s submission of Form 14654 did not create a contract with the IRS and even if it had, the IRS did not breach the purported contract.” On this issue, the Court of Federal Claims found in favor of the United States—i.e., that no contract had been formed. The court stated:
The specific language of Form 14654 by its terms explicitly reserves the ability for the IRS to conduct further examination and assess additional penalties if Mr. Jones’ behavior was found to be willful after examination. When Mrs. Jones signed the Form 14654, she also agreed to the following language included in the Form 14654, which states: ‘I recognize that if the Internal Revenue Service receives or discovers evidence of willfulness, fraud, or criminal conduct, it may open an examination or investigation that could lead to civil fraud penalties, FBAR penalties, information return penalties, or even referral to Criminal Investigation.’ Moreover, the Form 14654 explicitly reserves to the IRS the right to conduct such an examination and assess further penalties without regard to the previous amount paid as the Miscellaneous Offshore Penalty and without indicating in the Form 14654 the amount or extent as to which penalties may be assessed following such an examination and finding of willfulness. Moreover, while the Form 14654 requires the applicant to make representations to the IRS regarding the applicant’s willfulness in failing to report foreign financial assets, the IRS’s reservation of the right to further examine the conduct of the applicant does not bind the IRS to the applicant’s representations.
The court also went further and held that even if there had been a contract, there was no breach by the United States. Specifically, the court concluded that there was sufficient evidence to support the IRS’s determination that Mrs. Jones had acted recklessly or with willful blindness. More specifically, the facts showed that Mrs. Jones failed to: (1) advise her tax preparer of the foreign accounts each tax year; and (2) check the boxes “yes” regarding her interests in foreign accounts.[vii] In finding against Mrs. Jones, the court used specific statements that Mrs. Jones had made as part of her SDOP submission.
The Estate also did not win on its second claim of illegal exaction. On this issue, the Court of Federal Claims held that the Estate had failed to file a refund claim with the IRS requesting a refund of the Title 26 miscellaneous offshore penalty. And the Court of Federal Claims held that this was a jurisdictional requirement to invoking the jurisdiction of the court to entertain the merits of the illegal exaction claim.
In prior posts, I have spoken at length on the risks of submitting an improper SFCP submission to the IRS, particularly where there are certain “bad” facts or no facts to support an argument that the conduct was non-willful. (See posts: Common Mistakes in Submitting an IRS Streamlined Filing Compliance Procedure Submission: And a Discussion of Professional Malpractice, The Rahman Case is a Cautionary Tale of What Can Go Wrong under the IRS Streamlined Filing Compliance Procedures, and The Evolving Standard of “Willfulness” in FBAR Cases: Where are We Now?) The Flint decision is yet one more unfortunate lesson.
Prior to making a submission under the SFCP, taxpayers and tax professionals should thoroughly vet out all relevant facts regarding the willfulness or non-willfulness determination. For example, our firm has a constantly updated questionnaire that we ask our clients which considers the relevant federal court decisions on willfulness and non-willfulness. We also engage in rigorous discussions with our clients to ensure that we are aware of all risks associated with the potential SFCP submission so that we may make a reasoned legal determination as to whether the conduct falls within the SFCP requirements (i.e., non-willfulness) or outside such requirements (i.e., willfulness, including recklessness and willful blindness). Given the current state of the law, taxpayers with large foreign account balances and those who have historically checked the boxes “no” on Schedule B regarding foreign accounts run the highest risk of not qualifying for the SFCP. Extreme caution should be exercised regarding making a SFCP submission for these taxpayers unless there are significant facts that support and tilt the scales in favor of non-willfulness. Taxpayers who are unsure should always consult with a tax attorney who is knowledgeable on these types of submissions prior to making one themselves.
With all of that said, I trust that those readers who remain in reading this final paragraph must have an interest in international tax matters, similar to the attorneys at Freeman Law. Accordingly, for those who are interested, our firm is having our second annual Freeman Law International Tax Symposium on October 20 and 21, 2022, which will be held virtually. The symposium will qualify those in attendance for 14 hours of CLE, CPE, and CE and includes well-recognized speakers and panelists, such as a prior Chief Counsel of the IRS, a former Acting Assistant Attorney General of the U.S. Department of Justice Tax Division, and many others in government and private practice. I hope to see you there (virtually, of course).
Freeman Law’s international and criminal tax attorneys have advised hundreds of taxpayers in streamlined filings and voluntary disclosures. Our team can help businesses and individuals manage critical tax risks and make sense of complex international tax compliance rules. Schedule a consultation or call (214) 984-3000 to discuss your streamlined filing or voluntary disclosure concerns or questions.
[i] See 31 U.S.C. § 5321(a)(5)(C), (D).
[ii] Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47 (2007).
[vii] See, e.g., Landa v. U.S., 153 Fed. Cl. 585 (2021) (willfulness shown when the taxpayer “failed to disclose [a] foreign account to his accountant and never asked his accountant how to report the income from the foreign account”).