BE-10 Report: The Overlooked International Reporting Form -The June 30 Deadline is Fast Approaching

By: Matthew D. Lee, Paul E. Campbell and Jeffrey M. Rosenfeld

The Bureau of Economic Analysis (“BEA”), an agency of the U.S. Department of Commerce, is currently conducting a benchmark BE-10 survey that requires the filing of a BE-10 report by any U.S. person that directly or indirectly owned or controlled a foreign affiliate at any time during the U.S. person’s 2014 fiscal year. U.S. residents, limited liability companies, partnerships and corporations generally all qualify as U.S. persons for these purposes. A foreign affiliate is an entity located outside of the U.S. in which a U.S. person owns or controls at least 10 percent of the entity’s voting stock if the entity is incorporated or an equivalent interest if the entity is unincorporated. The purpose of the survey is to provide data regarding U.S. investment abroad and to provide a complete and comprehensive picture of the global impact of U.S. investment on the worldwide economy.

The information obtained and filed pursuant to this survey is confidential and is used only for analytical and statistical purposes. The BEA is prohibited from granting another agency access to the data for tax, investigative, or regulatory purposes. Practically speaking, this means that the information reported on a BE-10 report cannot be disclosed to the Internal Revenue Service for tax compliance purposes.

Initially, a BE-10 report was due no later than May 29, 2015 for U.S. persons required to file less than 50 forms. However, the BEA recently granted an extended due date of June 30, 2015 for all new filers who have not previously filed a BE-10 report.

Failure to file can result in both civil and criminal penalties. Civil penalties can range from fines of $2,500 to $25,000 in addition to injunctive relief requiring compliance. Willful failure to file can result in a penalty of not more than $10,000 and, for an individual, up to one year in prison, or both.

Below are answers to some frequently asked questions concerning the BE-10 report.

Why am I only now hearing about this?

In prior years, only U.S. persons who were contacted directly by the BEA were required to participate in the survey. However, this year’s survey requires a BE-10 report for every U.S. person who owned or controlled a foreign affiliate at any time during the 2014 fiscal year, regardless of whether such U.S. person was contacted by the BEA.

Do I have to file a BE-10 report if I own real property in a foreign country which I currently lease to others?

Generally, yes. As discussed above, a BE-10 report must be filed by any U.S. person which owns or controls a foreign affiliate. For this purpose, a U.S. person that owns real property located in a foreign country is considered to control a foreign affiliate. However, a U.S. person need not file a BE-10 report if such U.S. person owns real estate that is held exclusively for personal use. For example, a primary residence abroad that is leased to others while the owner is a U.S. resident, but which the owner intends to reoccupy, is considered real estate held for personal use.

What if multiple U.S. persons own more than a 10% interest in the same foreign affiliate?

In such a case, the U.S. person with the highest ownership percentage in the foreign affiliate will file a complete BE-10 report, and the other U.S. persons will file only a partial BE-10 report (in accordance with the instructions) and make proper reference to the U.S. person filing the complete BE-10 report.

For example, if eight U.S. persons each own 12.5% of a U.S. limited liability company that, in turn, owns 100% of a foreign affiliate, then the U.S. limited liability company will file the complete BE-10 report, and each of the eight U.S. members of the U.S. limited liability company will file a partial BE-10 report in accordance with the instructions, making proper reference to the U.S. limited liability company’s complete BE-10 report consistent with the rules discussed in the preceding question and answer.

If I own an interest in a U.S. entity that, in turn, owns an interest in a foreign affiliate, must I file a BE-10 report? Must the U.S. entity? Must we both file a BE-10 report?

If a U.S. individual owns more than 50% of a U.S. entity that, in turn, owns a foreign affiliate, then the U.S. business enterprise, not the individual, must file the BE-10 report. However, on its BE-10 report, the U.S. entity will be required to disclose the U.S. individual’s direct investments in the foreign affiliate.

If a U.S. individual owns 50% or less of a U.S. entity that, in turn, owns a foreign affiliate, then the rule mentioned in the preceding paragraph will not apply, and both the U.S. individual and U.S. entity will be required to separately file appropriate BE-10 reports.

How do the consolidation rules work?

If a U.S. corporation is a U.S. reporter, then it must file a BE-10 report on a consolidated basis with its entire U.S. domestic consolidated business enterprise. In other words, the parent corporation (a corporation that is not more than 50% owned by another U.S. reporter) must file (i) a BE-10 report on its own behalf and (ii) a BE-10 report for each U.S. business enterprise, proceeding down each ownership chain from said parent corporation, whose voting securities are more than 50% owned by the U.S. business enterprise above it.

Informal guidance suggests that a U.S. limited liability company or partnership must follow these same consolidation rules despite the fact that the instructions only refer to a U.S. corporation being subject to these rules.

What should I do if I am unable to complete the BE-10 report or I do not have the information necessary to accurately complete the BE-10 report?

Reasonable requests for an extension of the filing deadline will be considered. Extension requests must be received by the BEA no later than June 30, 2015 and enumerate substantive reasons necessitating the extension. The BEA will provide a written response to such requests.

In addition, the instructions to the BE-10 report specifically provide that the data disclosed on the BE-10 reports may be comprised of reasonable estimates based upon the informed judgment of persons in the responding organization, sampling techniques, pro rations based on related data, etc. The instructions require that the U.S. reporter consistently apply estimating procedures used on all BEA surveys.

Once I complete the BE-10 report, will I have any reporting obligations on a moving-forward basis?

Generally, yes. A U.S. person may have an obligation to report to the BEA on a quarterly basis, annual basis, or every five years, depending on the value of the foreign affiliates that were reported on the BE-10 report. Once a U.S. person files the BE-10 report, it is anticipated that the BEA will send the U.S. person a list of all follow-up reports required with applicable deadlines.

Individuals with questions about the BE-10 report should consult experienced counsel to understand the applicable reporting requirements, as well as to ensure proper completion of all applicable BE-10 reports. Blank Rome LLP has significant experience with international compliance matters and can assist individuals in ensuring the proper completion of the BE-10 report.

The instructions to the BE-10 report can be found at https://www.bea.gov/surveys/pdf/be10/BE-10%20Instructions.pdf.

The BE-10 report and the answers to other Frequently Asked Questions can be found at http://www.bea.gov/surveys/respondent_be10.htm.

DOJ Announces Four More Swiss Bank Resolutions

DOJ logoLate yesterday, the Justice Department announced that it had reached resolutions with four more Swiss banks under the terms of the DOJ Swiss Bank Program. The latest banks to resolve their U.S. tax issues are the following:  Société Générale Private Banking (Lugano-Svizzera); MediBank AG; LBBW (Schweiz) AG; and Scobag Privatbank AG.

Yesterday’s announcement brings the total Swiss bank resolutions to seven to date. The Justice Department previously announced resolutions with BSI SA, Vadian Bank AG, and Finter Bank Zurich AG.  More than 100 Swiss banks previously notified the Tax Division that they wished to enroll in the program.

In the DOJ press release announcing the resolutions, Acting Assistant Attorney General Caroline D. Ciraolo made the following statement:

Today’s agreements reflect the Tax Division’s continued progress towards reaching appropriate resolutions with the banks that self-reported and voluntarily entered the Swiss Bank Program. The department is currently investigating accountholders, bank employees, and other facilitators and institutions based on information supplied by various sources, including the banks participating in this Program. Our message is clear – there is no safe haven.

Richard Weber, Chief of IRS-Criminal Investigation (CI) made the following statement about the resolutions:

These four additional bank agreements signal a change in terrain for offshore banking. No longer is it safe to hide money offshore and expect that it will not be discovered. ‎ IRS CI Special Agents will continue to follow the money to find those who circumvent the offshore disclosure laws and hold them accountable.

The Swiss Bank Program, which was announced on August 29, 2013, provides a path for Swiss banks to resolve potential criminal liabilities in the United States.  Swiss banks eligible to enter the program were required to advise the Tax Division by December 31, 2013, that they had reason to believe that they had committed tax-related criminal offenses in connection with undeclared U.S.-related accounts.  Banks already under criminal investigation related to their Swiss-banking activities and all individuals were expressly excluded from the program. Under the program, banks are required to:

  • Make a complete disclosure of their cross-border activities;
  • Provide detailed information on an account-by-account basis for accounts in which U.S. taxpayers have a direct or indirect interest;
  • Cooperate in treaty requests for account information;
  • Provide detailed information as to other banks that transferred funds into secret accounts or that accepted funds when secret accounts were closed;
  • Agree to close accounts of accountholders who fail to come into compliance with U.S. reporting obligations; and
  • Pay appropriate penalties.

Swiss banks meeting all of the above requirements are eligible for a non-prosecution agreement.

According to the terms of the non-prosecution agreements signed today, each bank agrees to cooperate in any related criminal or civil proceedings, demonstrate its implementation of controls to stop misconduct involving undeclared U.S. accounts and pay the penalties in return for the department’s agreement not to prosecute these banks for tax-related criminal offenses.

The Justice Department announcement provided the following details about each bank’s U.S.-related accounts and practices related thereto:

Société Générale Private Banking (Lugano-Svizzera) SA (SGPB-Lugano) was established in 1974 and is headquartered in Lugano, Switzerland.  Through referrals and pre-existing relationships, SGPB-Lugano accepted, opened and maintained accounts for U.S. taxpayers, and knew that it was likely that certain U.S. taxpayers who maintained accounts there were not complying with their U.S. reporting obligations.  Since Aug. 1, 2008, SGPB-Lugano held and managed approximately 109 U.S.-related accounts, with a peak of assets under management of approximately $139.6 million, and offered a variety of services that it knew assisted U.S. clients in the concealment of assets and income from the Internal Revenue Service (IRS), including “hold mail” services and numbered accounts.  Some U.S. taxpayers expressly instructed SGPB-Lugano not to disclose their names to the IRS, to sell their U.S. securities and to not invest in U.S. securities, which would have required disclosure and withholding.  In addition, certain relationship managers actively assisted or otherwise facilitated U.S. taxpayers in establishing and maintaining undeclared accounts in a manner designed to conceal the true ownership or beneficial interest in the accounts, including concealing undeclared accounts by opening and maintaining accounts in the name of non-U.S. entities, including sham entities, having an officer of SGPB-Lugano act as an officer of the sham entities, processing cash withdrawals from accounts being closed and then maintaining the funds in a safe deposit box at the bank and making “transitory” accounts available, thereby allowing multiple accountholders to transfer funds in such a way as to shield the identity and account number of the accountholder.  SGPB-Lugano will pay a penalty of $1.363 million.

Created in 1979 and headquartered in Zug, Switzerland, MediBank AG (MediBank) provided private banking services to U.S. taxpayers and assisted in the evasion of U.S. tax obligations by opening and maintaining undeclared accounts.  In furtherance of a scheme to help U.S. taxpayers hide assets from the IRS and evade taxes, MediBank failed to comply with its withholding and reporting obligations, providing “hold mail” services and offering numbered accounts, thus reducing the ability of U.S. authorities to learn the identity of the taxpayers.  After it became public that the Department of Justice was investigating UBS, MediBank hired a relationship manager from UBS and permitted some of that person’s U.S. clients to open accounts at MediBank.  Since Aug. 1, 2008, MediBank had 14 U.S. related accounts with assets under management of $8,620,675.  MediBank opened, serviced and profited from accounts for U.S. clients with the knowledge that many likely were not complying with their U.S. tax obligations.  MediBank will pay a penalty of $826,000.

LBBW (Schweiz) AG (LBBW-Schweiz) was established in Zurich in 1995.  Since August 2008, LBBW-Schweiz held 35 U.S. related accounts with $128,664,130 in assets under management.  After it became public that the department was investigating UBS, LBBW-Schweiz opened accounts from former clients at UBS and Credit Suisse.  Despite its knowledge that U.S. taxpayers had a legal duty to report and pay tax on income earned on their accounts, LLB permitted undeclared accounts to be opened and maintained, and offered a variety of services that would and did assist U.S. clients in the concealment of assets and income from the IRS.  These services included following U.S. accountholders instructions not to invest in U.S. securities and not reporting the accounts to the IRS and agreeing to hold statements and other mail, causing documents regarding the accounts to remain outside the United States.  LBBW-Schweiz will pay a penalty of $34,000.

Headquartered in Basel, Switzerland, Scobag Privatbank AG (Scobag) was founded in 1968 to provide financial and other services to its founders, and obtained its banking license in 1986.  Since August 2008, Scobag had 13 U.S. related accounts, the maximum dollar value of which was $6,945,700.  Scobag offered a variety of services that it knew could and did assist U.S. clients in the concealment of assets and income from the IRS, including “hold mail” services and numbered accounts. Scobag will pay a penalty of $9,090.

The DOJ noted that in accordance with the terms of the Swiss Bank Program, each bank mitigated its penalty by encouraging U.S. accountholders to come into compliance with their U.S. tax and disclosure obligations.  While U.S. accountholders at these banks who have not yet declared their accounts to the IRS may still be eligible to participate in the IRS Offshore Voluntary Disclosure Program, the price of such disclosure has increased.

Most U.S. taxpayers who enter the IRS Offshore Voluntary Disclosure Program to resolve undeclared offshore accounts will pay a penalty equal to 27.5 percent of the high value of the accounts.  On August 4, 2014, the IRS increased the penalty to 50 percent if, at the time the taxpayer initiated their disclosure, either a foreign financial institution at which the taxpayer had an account or a facilitator who helped the taxpayer establish or maintain an offshore arrangement had been publicly identified as being under investigation, the recipient of a John Doe summons or cooperating with a government investigation, including the execution of a deferred prosecution agreement or non-prosecution agreement.  With today’s announcement of these non-prosecution agreements, noncompliant U.S. accountholders at these banks must now pay that 50 percent penalty to the IRS if they wish to enter the IRS Offshore Voluntary Disclosure Program.

The Justice Department released the following documents as part of its announcement:

FinCEN issues $1.5 million Penalty against Pennsylvania Bank for AML Violations

By: Matt Lee & Jed Silversmith

On February 26, 2015, the Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) issued an assessment of a civil money penalty totaling $1,500,000 against First National Community Bank (“FNCB”), which is located in Dunsmore, Pennsylvania. The penalty was issued in conjunction with the Office of the Comptroller of the Currency, which is FNCB’s primary regulator. The penalty was premised on FNCB’s failure to file suspicious activity reports (“SARs”) stemming from the “Kids for Cash” scandal.
The “Kids for Cash” scandal involved payoffs that two state court judges received. The payoffs were made by an operator of a juvenile detention facility. The two judges, Mark Ciavarella and Senior Judge Michael Conahan, sentenced thousands of juveniles to excessive terms of incarceration for petty crimes. In exchange, they received payments from the facility operator. Conahan pleaded guilty and Ciavarella was convicted after a jury trial. Conahan had received $2,600,000 in bribes. He was sentenced to a term of 17.5 years.

FinCEN’s assessment of a civil money penalty against FNCB was premised on the bank’s anti-money laundering violations. Conahan had banked at FNCB. The notice focused on three “red flags” missed by the bank: (1) a law enforcement subpoena submitted in 2007 for information related to Conahan and other individuals and entities; (2) activity occurring as early as 2005, involving many large, round-dollar transactions often occurring on a single day; and (3) an abnormal volume of activity compared to account balances.

According the assessment, Conahan deposited the bribe proceeds into a business bank account for company named Pinnacle. The agency took FNCB to task for not taking note that in 2005, Conahan purchased a condominium as an investment and then refinanced the unit three months later. According the assessment, Conahan reported a substantial increase in the condominium and was able to perform a “cash out” refinancing. Further, FinCEN’s assessment stated: “From 2004 to 2005, Conahan’s and Ciavarella’s incomes nearly quadrupled, purportedly as a result of rental income from the condominium purchased through Pinnacle.” FinCEN also noted that the size, frequency, and type of deposits into the Pinnacle account should have also alerted regulators.

In a press release announcing the assessment, Jennifer Shasky Calvery, the director of FinCEN, said: “FNCB’s failure to file timely suspicious activity reports may have deprived law enforcement of information valuable for tracking millions of dollars in related corrupt funds.”

According to Bloomberg, Conahan sat on the FNCB’s board. Attorneys for the bank told Bloomberg that bank officials were unaware of Conahan’s role in the “Kids for Cash” scandal. “The way his account was viewed is the way any judge’s account would be viewed and it is unfair to imply that his account would be handled differently with regard to whether he was on the board,” the bank’s attorney told the wire service.

Given the isolated nature of the account, one has to wonder whether FinCEN’s decision to take an enforcement action stemmed from the fact that Conahan was a member of FNCB’s board. The penalty appears disproportionate to the financial side of the transaction. Given Conahan’s abuse of trust, it is hard to quantify the true harm that he caused.

IRS Clarifies Requirements for Streamlined Filing Procedures

On October 9, 2014, the Internal Revenue Service published additional guidance clarifying the requirements for participation in the Streamlined Filing Compliance Procedures.  (See prior coverage of the new procedures announced in June 2014 here.)  Here are links to the new guidance published on the IRS website:

  • Updated general description of Streamlined Filing Compliance Procedures here;
  • Updated instructions for taxpayers residing in the United States here;
  • Frequently asked questions for domestic taxpayers here;
  • Updated instructions for taxpayers residing outside the United States here;
  • Frequently asked questions for taxpayers residing outside the United States here.

The IRS also released frequently asked questions for the Delinquent International Information Return Submission Procedures (available here).  In a notable change, the IRS now states that these procedures are available to taxpayers even if they have unreported income:

The Delinquent International Information Return Submission Procedures clarify how taxpayers may file delinquent international information returns in cases where there was reasonable cause for the delinquency. Taxpayers who have unreported income or unpaid tax are not precluded from filing delinquent international information returns. Unlike the procedures described in OVDP FAQ 18, penalties may be imposed under the Delinquent International Information Return Submission Procedures if the Service does not accept the explanation of reasonable cause. The longstanding authorities regarding what constitutes reasonable cause continue to apply, and existing procedures concerning establishing reasonable cause, including requirements to provide a statement of facts made under the penalties of perjury, continue to apply. See, for example, Treas. Reg. § 1.6038-2(k)(3), Treas. Reg. § 1.6038A-4(b), and Treas. Reg. § 301.6679-1(a)(3).

We will analyze this guidance and provide further analysis in future posts.

Offshore Tax Enforcement Update: Foreign Bank Account Disclosure Deadline Is June 30, 2014

By: Matthew D. Lee and Jeffrey M. Rosenfeld

Annual Filing Deadline Approaching

The annual deadline for filing FinCEN Form 114, Report of Foreign Bank and Financial Accounts (commonly known as the “FBAR” form), is fast-approaching. Any U.S. taxpayer with a financial interest in, or signature or other authority over, a foreign bank account (which includes bank, security, and other types of financial accounts, including certain foreign life insurance policies) is required to file the FBAR form if the aggregate value of the account (or accounts) exceeded $10,000 at any time during the 2013 calendar year, subject to certain exceptions. The FBAR filing requirements apply to all types of taxpayers with offshore bank accounts, including individuals, corporations, partnerships, LLCs, trusts, and estates (with some exceptions). Corporate officers with signature authority over corporate bank accounts located in a foreign country must also file the FBAR form in their individual capacity.

The FBAR filing deadline is June 30, 2014. No extensions of time to file the FBAR are available. Significant criminal and civil penalties may be imposed for the failure to timely file the FBAR form.

As opposed to last year when the FBAR could be filed in paper form, all FBARs are now required to be filed electronically through the Treasury Department’s BSA E-Filing System. The Treasury Department’s BSA E-Filing System can be accessed at http://bsaefiling.fincen.treas.gov/main.html.

Murky Guidance on Whether Digital Currency Must Be Included on the FBAR

The Internal Revenue Service (“IRS”) has yet to release any formal guidance on whether a Bitcoin account is required to be reported on an FBAR. However, during a recent IRS webinar entitled “Reporting of Foreign Financial Accounts on the Electronic FBAR,” an IRS representative stated that taxpayers do not need to include Bitcoin accounts on their 2013 FBAR. The IRS representative cautioned that the IRS could change this policy in the future, and we further caution that any such informal guidance is not binding on the IRS.

Conversely, a federal district court in California, in a case captioned United States v. Hom, 2014 U.S. Dist. LEXIS 77489 (N.D. CA 2014), recently upheld an FBAR penalty assessment against an individual who failed to report his interest in a FirePay, PokerStars and PartyPoker account. Such decision appears to conflict with the informal IRS guidance on Bitcoin accounts. Individuals with similar online poker accounts should file an FBAR if, at any time during 2013, they had $10,000 or more in the online poker account.

The new guidance on Bitcoin and online poker accounts illustrate the need for taxpayers to consult with a tax advisor to determine the extent of their FBAR filing obligations. As the use of digital currency continues to increase, the IRS is likely to revisit its guidance and practices. As evident from the recent guidance on Bitcoin and online poker accounts, the rules relating to digital currency are often not intuitive.

FATCA Implementation Deadline Is Just around the Corner

Meanwhile, the start date for implementation of the Foreign Account Tax Compliance Act (“FATCA”) is July 1, 2014. FATCA is a new information reporting regime pursuant to which foreign bank and financial institutions will annually report information to the IRS about their U.S. account holders. Foreign financial institutions that refuse to report such information will face a stringent 30 percent withholding tax on U.S. source payments as a penalty for non-compliance. To date, over 77,000 foreign financial institutions have registered with the IRS and indicated their agreement to report information to the IRS pursuant to FATCA, and nearly 80 foreign countries have either formally signed treaties with the U.S., or are actively negotiating such agreements, in order to implement FATCA’s information sharing requirements. FATCA is expected to provide the IRS with information regarding thousands of accounts held by U.S. taxpayers at financial institutions located around the globe.

Major Changes to Offshore Voluntary Disclosure Program and Related Initiatives

Taxpayers who are not compliant with their prior year FBAR or income tax reporting obligations with respect to foreign bank accounts may wish to take advantage of the IRS Offshore Voluntary Disclosure Program (“OVDP”), an amnesty program designed to encourage U.S. taxpayers with undisclosed foreign bank accounts to come into compliance with U.S. tax laws and avoid criminal prosecution. This program permits eligible taxpayers with undisclosed foreign bank accounts, and unreported income associated with those accounts, to avoid criminal prosecution in return for the payment of back taxes, interest, and penalties. Currently, there is no deadline for participation in the OVDP, although the IRS has stated that it could end the program, or modify its terms, at any time. To date, more than 45,000 taxpayers have come into compliance voluntarily through the OVDP and predecessor programs, paying about $6.5 billion in taxes, interest, and penalties.

On June 18, 2014, the IRS announced significant changes to the OVDP and related programs, including modifications to the existing “Streamlined Filing Compliance Procedures.” According to IRS Commissioner John Koskinen, “[t]he new versions of our offshore programs reflect a carefully balanced approach to ensure that everyone pays their fair share of taxes owed. Through the changes we are announcing today, we provide additional flexibility in key respects while maintaining the central components of our voluntary programs.”

To briefly summarize the changes, taxpayers who can certify that their failure to file an FBAR and/or report income from an offshore bank account was non-willful may be eligible for a reduced penalty framework. On the other hand, taxpayers whose failure to file FBARs and reporting offshore income was willful can be subject to an increased penalty, up to 50 percent of the maximum aggregate balance of their offshore holdings. Previously, such taxpayers were subject to a penalty calculated at 27.5 percent of their foreign accounts.

Individuals with questions about FBAR reporting, or who are considering making a voluntary disclosure to the IRS regarding foreign bank accounts, should consult experienced tax counsel to understand the benefits and risks of the voluntary disclosure process. Blank Rome’s FBAR and FATCA compliance team has significant experience with offshore reporting obligations, the IRS voluntary disclosure programs, and the Foreign Account Tax Compliance Act, and can assist individuals in navigating these reporting regimes.

High Court Opens Door To IRS Personnel Examination

Today’s blog was first published in the June 19, 2014 edition of Law360. To learn more, please click here or visit www.law360.com. Reprinted with permission from Law360.

The U.S. Supreme Court issued a unanimous opinion Thursday in United States v. Clarke (No. 13-301) addressing the standard that must be satisfied before a taxpayer can question Internal Revenue Service personnel about its reasons for issuing a summons. The standard announced by the court, in an opinion authored by Justice Elena Kagan, requires a taxpayer to show “specific facts or circumstances plausibly raising an inference of bad faith” before a taxpayer may examine IRS officials.

“Naked allegations of improper purpose are not enough,” the court held. Instead, “[t]he taxpayer must offer some credible evidence supporting his charge.”

The case arose out of an IRS examination of Dynamo Holdings Limited Partnership focusing on interest expenses reported on the 2005 through 2007 income tax returns. When the three-year statute of limitations was about to expire, Dynamo agreed to a one-year-long extension, and later to a second one-year extension with the IRS. Dynamo refused, however, to grant the IRS a third extension.

Shortly after being refused the third extension, the IRS issued summonses to five individuals seeking information about Dynamo’s tax liabilities. Four of the five individuals refused to comply with the summonses. Two months later, the IRS issued a Final Partnership Administrative Adjustment that increased Dynamo’s tax liability, and Dynamo filed suit in Tax Court contesting the adjustment. Three months later, the IRS initiated summons enforcement proceedings in the district court.

The enforcement proceedings focused on whether the IRS acted in good faith in issuing the summonses. An IRS agent submitted an affidavit that attested to the required factors to obtain enforcement of an IRS summons pursuant to United States v. Powell, 379 U.S. 48 (1964): (1) there was a legitimate purpose for the investigation; (2) the summons inquiry is relevant to the purpose; (3) the IRS does not already have the information sought; and (4) administrative steps required by the Internal Revenue Code have been followed.

Seeking to demonstrate that the IRS acted in bad faith, the summoned individuals claimed that the IRS issued the summonses for two improper purposes: (1) as retribution for Dynamo’s refusal to agree to a third statute of limitations extension; and (2) as an inappropriate end-around the limited discovery rules in Tax Court in order to obtain additional evidence to use against Dynamo in that proceeding. The individuals argued that they were entitled to question IRS personnel to explore these issues.

The district court denied the taxpayers’ requests and ordered them to comply with the summonses. On appeal, the Eleventh Circuit reversed, holding that the district court abused its discretion in refusing to allow the IRS agents in question to be examined.

Following established circuit precedent, the court of appeals reasoned that “requiring the taxpayer to provide factual support for an allegation of an improper purpose, without giving the taxpayer a meaningful opportunity to obtain such facts, saddles the taxpayer with an unreasonable circular burden, creating an impermissible ‘Catch 22.’” The individuals therefore could “question IRS officials concerning the Service’s reasons for issuing the summons[es].”

Notably, the appellate court’s ruling was an anomaly, as every other circuit addressing the issue (including the First, Third, and Seventh Circuits) had held that bare allegations of improper motive were insufficient to justify examination of an IRS agent. The Supreme Court granted certiorari to resolve the conflict, and firmly guided the Eleventh Circuit back into the fold by holding that “some credible evidence” of alleged improper motive must be adduced before IRS agents may be examined.

Specifically, the taxpayer must come forward with “specific facts or circumstances plausibly raising an inference of bad faith.” Because direct evidence will rarely be available, circumstantial evidence is sufficient, but “[n]aked allegations” are not. This standard, the court reasoned, should sufficiently protect a summons dispute from turning into a fishing expedition. Because the Eleventh Circuit never assessed the facts and circumstances submitted by the summoned individuals in support of their bad-faith claims, the court vacated the decision and remanded for further proceedings.

The Supreme Court’s decision is not surprising in that it aligned the Eleventh Circuit with other federal circuits, but it is surprising in that it adopted a formulation of the summons enforcement standard that is different from the standards already in use by other circuits. Crafting its own standard, the court now requires a showing that “plausibly rais[es] an inference of bad faith” or improper motive.

Justice Kagan’s opinion also provided guidance regarding the appropriate standard of review for appellate courts in summons enforcement proceedings. First, a court of appeals must review for abuse of discretion a trial court’s decision as to whether an examination of IRS agents is warranted. But, the court cautioned, a district court’s decision in this regard is entitled to deference only if based upon the correct legal standard. Second, the district court is not entitled to deference as to legal issues as to what qualifies as an improper purpose for issuance of an IRS summons.

The court’s limited opinion focused almost entirely on the legal standard and refrained from deciding any other aspect of the case. For example, the court did not opine as to whether issuing a summons to gain an unfair advantage in Tax Court litigation or to retaliate against a taxpayer for refusing to further extend the statute of limitations are improper motives for issuing a summons. Instead, the court left those issues to be decided by the court of appeals on remand, noting that both are legal issues for which no deference is due the district court.

The court also chose not to opine as to whether the evidentiary proof of bad faith submitted by the individuals (primarily, two sworn declarations) would satisfy the new standard.

One declaration set forth the timeline of Dynamo’s refusal to extend the statute of limitations and the issuance of the summonses, thereby implying the retributive nature of the summonses. The other described how IRS attorneys who were handling the Tax Court litigation were present when the one individual complied with the summons, and the initial investigating agents were not, tending to show the summons’ purpose was to support the Tax Court litigation.

Whether these are in fact improper motives, and whether declarations of this type are a sufficient basis to meet the new standard, will have to be addressed on remand as well as by lower courts now that the legal standard for challenging a summons enforcement has been clarified by the Supreme Court.

Recent Sentences for Federal Tax Crimes in 2014 – Part 2

On Friday, we posted a review here of sentences imposed on defendants in 2014 for Foreign Bank Account, Tax Evasion, and Employment Tax crimes. In this post, we review sentences imposed on defendants in cases involving False Tax Returns and Tax Return Preparers.

False Tax Returns

Liquor store operator Bashar Saroki had pleaded guilty to filing a false tax return for 2009 and offering drug paraphernalia for sale. Despite reporting very little income in 2009, from 2007 to 2011 Mr. Saroki had sold more than $1 million in cutting agents used to dilute narcotics from his home and the Golden Star Party Store in Detroit. Mr. Saroki was sentenced to 30 months in prison and one year supervised release. [DOJ press release here].

Benjamin Green, III, had been convicted by a Connecticut jury of making a false claim against the U.S. and obstructing the administration of internal revenue laws. Mr. Green filed his 2008 individual tax return claiming a fraudulent Original Issue Discount (“OID”), where he claimed significant amounts of OID interest income and federal tax withholdings in order to obtain a tax refund of over $600,000. Mr. Green later attempted to hinder the IRS’s efforts to collect the wrongly-issued refund by, among other things, hiding property in a nominee entity. Mr. Green was sentenced to 51 months in prison with three years of supervised release and ordered to pay $582,074.50 in restitution. [DOJ press release here].

New Jersey roofing contractor Kenneth Morton, of Kenal Enterprises LLC, had pleaded guilty for filing a false return in tax years 2007, 2008, and 2009. Rather than deposit checks for his business in a business account, Mr. Morton cashed approximately $1 million in checks per year at a check cashing agency. Mr. Morton was sentenced to one year and one day in prison and one year of supervised release and ordered to pay $241,412 in restitution. [DOJ press release here].

Steven Frank Boitano, of Boitano, Sargent & Lily in California, had pleaded guilty to failing to file tax returns for 2005 through 2007 and then was found guilty by a jury for filing false returns for 2001 through 2003. Despite being a tax return preparer and certified public accountant, Mr. Boitano failed to file personal tax returns from 1991 through 2007. Only after an IRS audit was commenced did he file returns for the years 2001, 2002, and 2003, and in those returns, Mr. Boitano claimed to have made tax payments, which he never actually made, that resulted in a false claim for a refund. Mr. Boitano was sentenced to 41 months in prison and ordered to pay over $180,000 in restitution. [DOJ press release here].

Tax Return Preparers

Massachusetts tax return preparer Michael Edwards, of Boston Financial Associates, had pleaded guilty to obstruction and wire fraud for misleading an IRS auditor who was reviewing one of his client’s returns. He had given the auditor false documentation that would appear to support the returns that were being investigated. Mr. Edwards also pleaded guilty to having misappropriating nearly $800,000 in tax refunds from two of his clients. Mr. Edwards was sentenced to 36 months in prison and three years of supervised release and ordered to pay restitution of $573,518. [DOJ press release here].

New York tax return preparer Ranti Azeez-Taiwo, of Lot Associates Inc. in Staten Island, was found guilty by a jury of 16 counts of assisting in the preparation of false income tax returns for clients for the tax years 2006 through 2010. Without his clients’ knowledge, Mr. Azeez-Taiwo prepared returns that claimed false expenses and charitable donations, which caused, in some cases, the clients to pay fines and interest to the IRS because of the false returns prepared by Mr. Azeez-Taiwo. Mr. Azeez-Taiwo was sentenced to 18 months in prison and one year of supervised release and ordered to pay $24,802 in restitution. [DOJ press release here].

Georgia tax return preparer Irene Tamika Smith, of Quick Tax, conspired to file false tax returns by purchasing other people’s identities that she then sold to others who used the identities to claim false dependents on tax returns in order to obtain a higher refund. Ms. Smith was sentenced to 33 months in prison and ordered to pay $566,171 in restitution.   [DOJ press release here].

Detrick and Natashia Tucker, husband and wife owners of T&T Express Tax, a tax return preparation business in Georgia, had pleaded guilty to assisting in the preparation of false returns and conspiring to defraud the government by filing false returns. As the main tax preparer at the business, Ms. Tucker prepared returns with inflated refunds by incorrectly claiming the Earned Income Tax Credit and creating false business information, for the purpose of securing more clients for the business. Mr. Tucker had obtained an IRS electronic filing number for the business and allowed Ms. Tucker to use this number to file false returns. Ms. Tucker was sentenced to 46 months in prison and ordered to pay over $1.4 million in restitution. Mr. Tucker was sentenced to one year and one day in prison and ordered to pay about $66,000 in restitution. [DOJ press release here].

Arizona tax return preparer Margarita Gomez, of M & M Tax Service, had pleaded guilty to impeding the administration of internal revenue laws. Ms. Gomez had caused to have filed, sometimes without identifying herself as the return preparer, returns that claimed false refunds, which she had directed to be transmitted to her. She intentionally solicited clients who did not have a legal status to work or live in the U.S. and prepared false W-7 forms and other documentation. Ms. Gomez was sentenced to 30 months in prison and ordered to pay $200,408 in restitution. [DOJ press release here].

IRS RELEASES BITCOIN GUIDANCE; MAY HAVE A CHILLING EFFECT ON VIRTUAL CURRENCY

Last week, the IRS released IRS Notice 2014-21 (the “Notice”), its first guidance on the income tax treatment of virtual currency, including, bitcoin. A copy of the notice can be obtained at http://www.irs.gov/pub/irs-drop/n-14-21.pdf.

There are three important points to note from the Notice:

1. A Potential Accounting Nightmare For Bitcoin Spenders. According to the Notice, bitcoin is treated as property, not currency, for income tax reporting purposes. This position has far-reaching implications for any taxpayer that invests in, and regularly spends, bitcoin. As property, gains recognized on the disposition of bitcoin investments is subject to tax, similar to the income tax treatment of sales of stock. However, unlike stock, bitcoin is disposed of in everyday, mundane transactions. For example, several coffee shops in the U.S. accept bitcoin as payment. Every time a U.S. taxpayer pays with bitcoin he/she has a taxable transaction that must be reported at the end of the year on the individual’s income tax return. The amount of gain or loss recognized on such a transaction will require taxpayers to keep very detailed records of all bitcoin that is purchased and subsequently disposed of. The Notice does not indicate that there is a de minimis exception to the rule.

2. If Bitcoin is in a Foreign Account, an Even Bigger Nightmare. Whether a bitcoin account is subject to the FBAR reporting rules is an issue that practitioners are struggling with. We do not attempt to tackle this issue in this post (but plan on addressing this at a later time). However, assuming, solely for these purposes, that a bitcoin account is subject to the FBAR reporting rules, paying for a cup of coffee using bitcoin can cause the account to become a non-compliant asset for purposes of the Offshore Voluntary Disclosure Program (“Program”). The Program, pursuant to FAQ 17, permits taxpayers who are tax compliant, but merely failed to file a FBAR, to avoid the strict penalty structure of the Program and simply file back-FBARs without penalty. If bitcoin was used to pay for goods or services, and the transaction was not reported on a taxpayer’s income tax return, then the bitcoin account is not tax compliant, and the taxpayer would not be able to rely on FAQ 17. If the taxpayer decides to clear up past noncompliance through the Program, the taxpayer’s bitcoin account may be subject to the 27.5% penalty.

3. Bitcoin Investors Rejoice. The Notice is not bad news for all taxpayers who invest in bitcoin. By treating bitcoin as property, gains on the sale of bitcoin that are held for longer than one year are eligible for the lower capital-gains rate. Note this rule does not apply to taxpayers who hold bitcoin as inventory or who buy and sell bitcoin as part of a trade or business.

Justice Department Criticized for Not Sufficiently Pursuing Offshore Tax Evaders, and IRS-Criminal Investigation Reports Its FY2013 Accomplishments

The Senate Permanent Subcommittee on Investigations released a report earlier this week entitled “OFFSHORE TAX EVASION: The Effort to Collect Unpaid Taxes on Billions in Hidden Offshore Accounts.”  The report is generally critical of the Justice Department’s efforts in pursuing individuals who hold offshore accounts that have not yet been disclosed to the IRS.  Although we have not yet fully digested the lengthy report, here are some findings that are noteworthy:

  • “Switzerland has continued to severely restrict the ability of Swiss banks to disclose the names of U.S. customers with undeclared Swiss accounts.  As a result, the United States has obtained few U.S. names and little account information.”
  • The Justice Department has sought documents from Credit Suisse and the other 14 Swiss banks currently under criminal investigation only through treaty requests.  The request for Credit Suisse was derailed by a Swiss Supreme Court ruling that found that part of the treaty request was unenforceable.  As a result, “the United States has obtained the names of only about 230 U.S. clients with hidden accounts at Credit Suisse,” which is “less than 1 percent of the over 22,000 U.S. accountholders with Swiss accounts at Credit Suisse.”  For the other 14 Swiss banks, the Justice Department has made treaty requests for at least two of the banks and that yielded “few U.S. client names and little account information.”
  • “By relying on the restrictive treaty process and refraining from using U.S. remedies enforceable in U.S. courts to obtain information directly from the 14 Swiss banks, DOJ essentially ceded control of the document process to Swiss regulators and Swiss courts that value bank secrecy and are willing to prohibit disclosure of bank information essential to effective U.S. investigations and prosecutions of U.S. tax evasion involving Switzerland.”
  • While a total of 34 Swiss bankers and professionals have been indicted “for aiding and abetting U.S. tax evasion, the vast majority of those defendants have yet to stand trial. Most continue to reside in Switzerland, without facing any public U.S. extradition request to require them to face U.S. criminal charges.” None of the seven indicted Credit Suisse bankers have been prosecuted. 
  • The Justice Department’s “decision to refrain from taking enforcement action against Credit Suisse over the past five years is part of a larger failure by the United States to obtain from the Swiss the names of the tens of thousands of U.S. persons who opened undeclared accounts in Switzerland and have not yet paid taxes on their hidden assets.”
  • “Despite constructing a 2013 program to enable hundreds of Swiss banks to apply for non-prosecution agreements or non-target letters, DOJ did not obtain any agreement in return from the Swiss Government to permit any of those Swiss banks to furnish U.S. client names to the United States.”
  •  While the implementation of FATCA will cause information on current accountholders to be disclosed to the U.S., there are a number of loopholes that reduce its effectiveness.  For instance, “the FATCA regulatory loopholes will require disclosure of only the largest dollar accounts; they will permit banks to ignore, in most cases, bank account information that is kept on paper rather than electronically; they will allow banks to treat accounts opened by offshore shell entities as non-U.S. accounts even when the entity is owned by a U.S. taxpayer; and the remaining disclosure requirements can be easily circumvented by U.S. persons opening accounts below the reporting thresholds at more than one bank.”

Yesterday, Deputy Attorney General James M. Cole and Assistant Attorney General, Tax Division, Kathryn Keneally appeared before that Subcommittee to respond to the criticism.  Cole noted that currently approximately 400 and 500 people per month are being entered into the IRS’s voluntary disclosure program, which has already caused over 43,000 taxpayers to pay over $6 billion in back taxes and penalties since 2009.  In addition, the Subcommittee should “expect additional developments in the coming months” on other ongoing cases.  See Tom Schoenberg and David Voreacos, Senate Hearing Likely to Flush Out More U.S. Tax Evaders (Bloomberg, Feb. 26, 2014).  Also, according to their prepared joint statement, the Justice Department is not only focused on activities in Switzerland but has now expanded its investigation to banking activities in India, Israel, Liechtenstein, Luxembourg, Barbados, and other Caribbean countries.

Finally, also this week, the IRS released its Criminal Investigation Annual Business Report for fiscal year 2013.  In general, CI reported more investigations, more recommended prosecutions, more indictments and informations filed, more convictions, and more custodial sentences.  The conviction rate was reported at 93.1%, of which 80.1% received a sentence that included incarceration.  Other noteworthy statistics for 2013 include:

  • Those convicted of tax fraud by way of the use of identity theft are sentenced to an average of 38 months in prison.
  • There were 207 convictions of tax return preparers, who were sentenced to an average of 27 months in prison.
  • Over 2,500 money laundering and Bank Secrecy Act investigations were initiated.
  • Nearly $1 billion in assets were seized or forfeited.
  • A Cyber Crime Unit was established “that will allow CI to proactively identify and pursue tax, money laundering, identity theft and other financial crimes in the virtual world.”

IRS Announces Annual List of “Dirty Dozen” Tax Scams

With the 2014 tax filing season in full swing, the IRS announced today its annual listing of what it calls the “Dirty Dozen” tax scams.  The Service publishes this list annually in order to remind taxpayers to use caution during tax season to protect themselves against a wide range of schemes ranging from identity theft to return preparer fraud.  “Taxpayers should be on the lookout for tax scams using the IRS name,” said IRS Commissioner John Koskinen. “These schemes jump every year at tax time. Scams can be sophisticated and take many different forms.  We urge people to protect themselves and use caution when viewing e-mails, receiving telephone calls or getting advice on tax issues.”

The following are the Dirty Dozen tax scams for 2014:

1.  Identity Theft.  Tax fraud through the use of identity theft tops this year’s Dirty Dozen list, just as it did in 2013.  According to the IRS, identity theft occurs when someone uses your personal information, such as your name, Social Security number or other identifying information, without your permission, to commit fraud or other crimes.  In many cases, an identity thief uses a legitimate taxpayer’s identity to fraudulently file a tax return and claim a refund.  The IRS has a special section on IRS.gov dedicated to identity theft issues, including YouTube videos, tips for taxpayers and an assistance guide.  For victims, the information includes how to contact the IRS Identity Protection Specialized Unit.  For other taxpayers, there are tips on how taxpayers can protect themselves against identity theft.

2.  Pervasive Telephone Scams.  According to the IRS, there has been a recent increase in local phone scams across the country, with callers pretending to be from the IRS in hopes of stealing money or identities from victims.  These phone scams include many variations, ranging from instances from where callers say the victims owe money or are entitled to a huge refund.  Some calls can threaten arrest and threaten a driver’s license revocation.  Sometimes these calls are paired with follow-up calls from people saying they are from the local police department or the state motor vehicle department.

3.  Phishing.  Phishing is a scam typically carried out with the help of unsolicited email or a fake website that poses as a legitimate site to lure in potential victims and prompt them to provide valuable personal and financial information.  Armed with this information, a criminal can commit identity theft or financial theft.  Note that the IRS does not initiate contact with taxpayers by email to request personal or financial information.

4.  False Promises of “Free Money” from Inflated Refunds.  Scam artists routinely pose as tax preparers during tax time, luring victims in by promising large federal tax refunds or refunds that people never dreamed they were due in the first place.

5.  Return Preparer Fraud.  According to the IRS, about 60 percent of taxpayers will use tax professionals this year to prepare their tax returns.  Most return preparers provide honest service to their clients.  But, some unscrupulous preparers prey on unsuspecting taxpayers, and the result can be refund fraud or identity theft.  We have previously posted (see here and here) on the Service’s recent aggressive enforcement efforts to shut down fraudulent return preparers.

6.  Hiding Income Offshore.  Over the years, numerous individuals have been identified as evading U.S. taxes by hiding income in offshore banks, brokerage accounts or nominee entities and then using debit cards, credit cards or wire transfers to access the funds. Others have employed foreign trusts, employee-leasing schemes, private annuities or insurance plans for the same purpose.  The IRS uses information gained from its investigations to pursue taxpayers with undeclared accounts, as well as the banks and bankers suspected of helping clients hide their assets overseas. The IRS works closely with the Department of Justice (DOJ) to prosecute tax evasion cases.

Since 2009, tens of thousands of individuals have come forward voluntarily to disclose their foreign financial accounts, taking advantage of special opportunities to comply with the U.S. tax system and resolve their tax obligations. And, with new foreign account reporting requirements being phased in over the next few years (namely, FATCA), hiding income offshore is increasingly more difficult.  The IRS has collected billions of dollars in back taxes, interest and penalties so far from people who participated in offshore voluntary disclosure programs since 2009.

7.  Impersonation of Charitable Organizations.  Another long-standing type of abuse or fraud is scams that occur in the wake of significant natural disasters.  Following major disasters, it’s common for scam artists to impersonate charities to get money or private information from well-intentioned taxpayers.  Scam artists can use a variety of tactics. Some scammers operating bogus charities may contact people by telephone or email to solicit money or financial information.  They may even directly contact disaster victims and claim to be working for or on behalf of the IRS to help the victims file casualty loss claims and get tax refunds.

8.  False Income, Expenses, or Exemptions.  Another scam involves inflating or including income on a tax return that was never earned, either as wages or as self-employment income in order to maximize refundable credits.  Additionally, some taxpayers are filing excessive claims for the fuel tax credit.  Farmers and other taxpayers who use fuel for off-highway business purposes may be eligible for the fuel tax credit.  But other individuals have claimed the tax credit although they were not eligible.  Fraud involving the fuel tax credit is considered a frivolous tax claim and can result in a penalty of $5,000.

9.  Frivolous Arguments.  Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe.  The IRS has a list of frivolous tax arguments that taxpayers should avoid.  Those who promote or adopt frivolous positions risk a variety of penalties.  For example, taxpayers could be responsible for an accuracy-related penalty, a civil fraud penalty, an erroneous refund claim penalty, or a failure to file penalty.  The Tax Court may also impose a penalty against taxpayers who make frivolous arguments in court.  Taxpayers who rely on frivolous arguments and schemes may also face criminal prosecution for attempting to evade or defeat tax.  Similarly, taxpayers may be convicted of a felony for willfully making and signing under penalties of perjury any return, statement, or other document that the person does not believe to be true and correct as to every material matter.  Persons who promote frivolous arguments and those who assist taxpayers in claiming tax benefits based on frivolous arguments may be prosecuted for a criminal felony.

10.  Falsely Claiming Zero Wages or Using False Form 1099.  Filing a phony information return is an illegal way to lower the amount of taxes an individual owes.  Typically, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 is used as a way to improperly reduce taxable income to zero.  The taxpayer may also submit a statement rebutting wages and taxes reported by a payer to the IRS.  Sometimes, fraudsters even include an explanation on their Form 4852 that cites statutory language on the definition of wages or may include some reference to a paying company that refuses to issue a corrected Form W-2 for fear of IRS retaliation.  Filing this type of return may result in a $5,000 penalty.

11.  Abusive Tax Structures.  Abusive tax schemes have evolved from simple structuring of abusive domestic and foreign trust arrangements into sophisticated strategies that take advantage of the financial secrecy laws of some foreign jurisdictions and the availability of credit/debit cards issued from offshore financial institutions.  IRS Criminal Investigation (CI) has developed a nationally coordinated program to combat these abusive tax schemes. CI’s primary focus is on the identification and investigation of the tax scheme promoters as well as those who play a substantial or integral role in facilitating, aiding, assisting, or furthering the abusive tax scheme (e.g., accountants, lawyers).  Secondarily, but equally important, is the investigation of investors who knowingly participate in abusive tax schemes.

The Abusive Tax Schemes program encompasses violations of the Internal Revenue Code and related statutes where multiple flow-through entities are used as an integral part of the taxpayer’s scheme to evade taxes.  These schemes are characterized by the use of Limited Liability Companies (LLCs), Limited Liability Partnerships (LLPs), International Business Companies (IBCs), foreign financial accounts, offshore credit/debit cards and other similar instruments.  The schemes are usually complex involving multi-layer transactions for the purpose of concealing the true nature and ownership of the taxable income and/or assets.

12.  Misuse of Trusts.  Trusts also commonly show up in abusive tax structures.  These transactions promise reduced taxable income, inflated deductions for personal expenses, the reduction or elimination of self-employment taxes and reduced estate or gift transfer taxes.  These transactions commonly arise when taxpayers are transferring wealth from one generation to another.  Questionable trusts rarely deliver the tax benefits promised and are used primarily as a means of avoiding income tax liability and hiding assets from creditors, including the IRS.