On February 23, 2012, the 11th Circuit Court of Appeals reversed an order of the U.S. District Court for the Northern District of Florida holding in contempt the target of a grand jury (“John Doe) who had asserted his Fifth Amendment privilege after receiving a grand jury subpoena.

The relevant facts are as follows.  On April 7, 2011, John Doe was served with a subpoena duces tecum requiring him to appear before a Northern District of Florida grand jury and produce the unencrypted contents located on the hard drives of his laptop computers and five external hard drives. Doe informed the United States Attorney for the Northern District of Florida that, when he appeared before the grand jury, he would invoke his Fifth Amendment privilege against self-incrimination and refuse to comply with the subpoena. Because the Government considered Doe’s compliance with the subpoena necessary to the public interest, the Attorney General, exercising his authority under 18 U.S.C. § 6003, authorized the U.S. Attorney to apply to the district court, pursuant to 18 U.S.C. §§ 6002 and 6003, for an order that would grant Doe immunity and require him to respond to the subpoena.

18 U.S.C. section 6002 can be found here. 18 U.S.C. section 6003 can be found here.

On April 19, 2011, the U.S. Attorney and Doe appeared before the district court. The U.S. Attorney requested that the court grant Doe immunity limited to “the use [of Doe’s] act of production of the unencrypted contents” of the hard drives. Thus, Doe’s immunity would not extend to the Government’s derivative use of contents of the drives as evidence against him in a criminal prosecution.  The court accepted the U.S. Attorney’s position regarding the scope of the immunity to give Doe and granted the requested order. The order “convey[ed] immunity for the act of production of the unencrypted drives, but [did] not convey immunity regarding the United States’ [derivative] use” of the decrypted contents of the drives.

After the hearing adjourned, Doe appeared before the grand jury and refused to decrypt the hard drives. The U.S. Attorney immediately moved the district court for an order requiring Doe to show cause why Doe should not be held in civil contempt. The court issued the requested order, requiring Doe to show cause for his refusal to decrypt the hard drives. In response, Doe explained that he invoked his Fifth Amendment privilege against self-incrimination because the Government’s use of the decrypted contents of the hard drives would constitute derivative use of his immunized testimony which was not protected by the district court’s grant of immunity. An alternative reason Doe gave as to why the court should not hold him in contempt was his inability to decrypt the drives. The court rejected Doe’s alternative explanations, adjudged him in contempt of court, and ordered him incarcerated.

The 11th Circuit held that Doe’s decryption and production of the hard drives’ contents would trigger Fifth Amendment protection because it would be testimonial, and that such protection would extend to the Government’s use of the drives’ contents. According to the 11th Circuit, the district court therefore erred in two respects. First, it erred in concluding that Doe’s act of decryption and production would not constitute testimony. Second, in granting Doe immunity, it erred in limiting his immunity under 18 U.S.C. §§ 6002 and 6003 to the Government’s use of his act of decryption and production, but allowing the Government derivative use of the evidence such act disclosed.

This ruling is significant to those individuals who are currently under IRS and/or U.S. Department of Justice Investigation for failure to comply with the Bank Secrecy Act’s requirement that U.S. Taxpayers who have foreign bank accounts with more than $10,000.00 must file Form TD 90.22-1, commonly referred to as an FBAR.  A copy of an FBAR can be found here.

The 11th Circuit’s decision appears to support Taxpayers’ position that a grand jury subpoena requiring them to identify (and produce bank statements of) foreign bank accounts in which they have signatory authority over or a financial interest in, is in violation of the 5th Amendment.  As the 11th Circuit put it:  “What is at issue is whether the act of production may have some testimonial quality  sufficient to trigger Fifth Amendment protection when the production explicitly or implicitly conveys some statement of fact.”  Slip op. at 13.  “An act of production can be testimonial when that act conveys some explicit or implicit statement of fact that certain materials exist, are in the subpoenaed individual’s possession or control, or are authentic.”  Slip op. at 20. 

A full copy of the decision can be found here.

In respect to FBAR cases, the act of production of the foreign bank account statements conveys an explicit statement that the taxpayer has a financial interest in, or signatory authority over, an undisclosed foreign bank account; the bank statements are within the taxpayer’s possession or control; and that the bank statements (and the information contained therein) is authentic.  This case present a potential arrow in the quiver of taxpayers that are currently (or may be soon to be) litigating against the government.  However, a timely challenge to a grand jury subpoena is crucial, as a failure to timely assert the 5th Amendment may  result in waiving this valuable constitutional right.

The attorneys at Fuerst Ittleman, PL have experience contesting grand jury subpoenas issued to taxpayers for their foreign bank account information.  Senior Tax Associate, Joseph A. DiRuzzo, III, is currently counsel of record in one case in Florida where the government has sought foreign bank records of taxpayers through the use of a grand jury subpoena.  You can contact an attorney by calling us at 305.350.5690 or by email at contact@fuerstlaw.com.

On December 7, 2011, Louis Alba pled guilty to criminal tax charges (Internal Revenue Code section 7202) for failing to remit to the IRS employment taxes (FICA and/or FUTA) withheld from employee wages in the amount of almost $780,000 over approximately six years.   The case is United States v. Alba, case # 2:11-cr-730 (Eastern District of New York).

While the incident leading to Mr. Alba’s conviction is not uncommon, the prosecution is nevertheless instructive. Indeed, in tough economic times, business owners sometimes view employment taxes as a way to improve cash flow and use money collected from employees in the form of FICA and/or FUTA taxes as a de facto government bridge loan.  However, as revealed by this case, the IRS views this as stealing money from the employees who have contributed to social security, and the IRS can, and has, prosecuted those “responsible persons” in the business who have the obligation to ensure that employee withholdings go to the IRS.

The language of Internal Revenue Code section 6672(a) states:

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over. No penalty shall be imposed under section 6653 [IRC Sec. 6653] or part II of subchapter A of chapter 68 [IRC Sections 6662 et seq.] for any offense to which this section is applicable.

The language of Internal Revenue Code section 7202 states:

Any person required under this title to collect, account for, and pay over any tax imposed by this title who willfully fails to collect or truthfully account for and pay over such tax shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $ 10,000, or imprisoned not more than 5 years, or both, together with the costs of prosecution.

As these statutory provisions make clear, section 6672(a) substantially tracks section 7202, and make available to the government criminal penalties for those that failure to collect and/or remit employment taxes.

If you have serious questions about this case or how it may apply to you or your business, feel free to contact us via telephone 305.350.5690 or email  contact@fuerstlaw.com for a confidential consultation.

On February 21, 2012, in Kawashima v. Holder, the Supreme Court affirmed the deportation of Mr. Kawashima, who pleaded guilty to one count of “willfully making and subscribing a false tax return” in violation of IRC §7206(1), and Mrs. Kawashima, who pleaded guilty to one account of “aiding and assisting in the preparation of a false tax return” in violation of IRC §7206(2).  A copy of the court’s decision is available here.

Specifically, the Supreme Court found that convictions under IRC §§7206(1) and (2) where the Government’s revenue loss exceeded $10,000, qualified as aggravated felonies pursuant to 8 U.S.C. §1101(a)(43)(M).  Because 8 U.S.C. §1227(a)(2)(A)(iii) provides that “[a]ny alien who is convicted of an aggravated felony at any time after admission is deportable,” the Supreme Court found that the Kawashimas convictions necessitated deportation. 
8 U.S.C. §1101(a)(43)(M) defines an aggravated felony as:

1. Involves fraud or deceit in which the loss to the victim or victims exceeds $10,000; or
2. Is described in section 7201 of title 26 in which the loss to the Government exceeds $10,000. 

Notably, the provision specifically cites to crimes under IRC §7201 and does not mention IRC §7206, the statute relating to the Kawashimas’ convictions.  Consequently, the classification of the Kawashimas crimes as “aggravated felonies” occurred pursuant to 8 U.S.C. §1101(a)(43)(M)(i) as crimes “involving fraud and deceit.”

The Kawashimas asserted that “textual differences between Clause (i) and Clause (ii) [of 8 U.S.C. §1101(a)(43)(M)] indicate that Congress intended to exclude tax crimes from Clause (i).”  Kawashima at 7.  The Supreme Court appeared to find Congress’s specific mention of tax crimes under IRC §7201 in Clause (ii) of 8 U.S.C. §1101(a)(43)(M) to be insignificant in its analysis.   

The difference in language does not establish Congress’ intent to remove tax crimes from the scope of Clause (i).  Clause (i) covers a broad class of offenses that involve fraud or deceit.  Clause (i) thus uses correspondingly broad language to refer to the wide range of potential losses and victims. Clause (ii), on the other hand, is limited to the single type of offense described in IRC §7201 (relating to tax evasion), which, by definition, can be only one type of loss (revenue loss) to one type of victim (the Government.)  Congress’ decision to tailor Clause (ii)’s language to match the sole type of offense covered by Clause (ii) does not demonstrate that Congress also intended to implicitly circumscribe the broad scope of Clause (i)’s plain language.

Id. (emphasis added).

Furthermore, the Supreme Court found it irrelevant that neither fraud nor deceit are formal elements to procure a conviction under IRC §7206. 

IRC §7206 provides in pertinent:

Any person who—

(1) Declaration under penalties of perjury
Willfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter; or

(2) Aid or assistance
Willfully aids or assists in, or procures, counsels, or advises the preparation or presentation under, or in connection with any matter arising under, the internal revenue laws, of a return, affidavit, claim, or other document, which is fraudulent or is false as to any material matter, whether or not such falsity or fraud is with the knowledge or consent of the person authorized or required to present such return, affidavit, claim, or document;
. . . shall be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 3 years, or both, together with the costs of prosecution.

With regard to Mr. Kawashima’s conviction under IRC §7206(1), the Supreme Court stated:

Although the words ‘fraud’ and ‘deceit’ are absent from the text of IRC §7206(1) and are not themselves formal elements of the crime, it does not follow that his offense falls outside of [8 U.S.C. §1101(a)(43)(M)(i)].  The scope of that clause is not limited to offenses that include fraud or deceit as formal elements.  Rather Clause (i) refers more broadly to offenses that “involve” fraud or deceit – meaning offenses that necessarily entail fraudulent or deceitful conduct . . . Because Mr. Kawashima’s conviction established that ‘he knowingly and willfully submitted a tax return that was false as to a material matter,’ he therefore committed a felony that involved ‘deceit.’ 

Id at 5. (emphasis added).

With regard to Mrs. Kawashima’s conviction under IRC §7206(2), the Supreme Court stated that her conviction “establishes that, by knowingly and willfully assisting her husband’s filing of a materially false tax return, Mrs. Kawashima also committed a felony that involved ‘deceit.’”  Id. at 6.

In its holding, the Supreme Court has refused to acknowledge the ambiguity of 8 U.S.C. §1101(a)(43)(M), is facially open to more than one interpretation.  While recognizing this ambiguity, Justice Ginsberg stated in her dissent:  

If the two proffered constructions of subparagraph (M) are plausible in roughly equal measure, than our precedent directs us to construe the statute in the Kawashimas’ favor . . .  We resolve doubts in favor of the alien because deportation is a drastic measure. 

Id. at 3.  (emphasis added).
In her dissent, Justice Ginsberg also identified numerous other offenses, which pursuant to the Court’s analysis, would now be deemed “aggravated felonies” requiring deportation.

Many federal tax offenses, like IRC § 7206 involve false statements or misleading conduct.  See, e.g., §7202 (failing to truthfully account for and pay taxes owed).  Conviction of any of these offenses, if the Court’s construction were correct, would render an alien deportable.  So would conviction of state and local tax offenses involving false statements . . . [S]ee, e.g., Del. Code Ann., Tit. 30 §574 (2009) (submitting a tax return false as to any material matter is a criminal offense); D.C. Code §47-4106 (2001-2005) (same); Ala. Code §40-29-114 (2003) (same); Va. Code Ann. §58.1-1815 (2009) (willfully failing to account truthfully for or pay certain taxes is a criminal offense.).

Id. at. 8. (emphasis added).

Following Justice Ginsburg’s logic, it becomes likely that immigration proceedings may now be initiated in a variety of instances where deportation was previously little more than a remote threat.  Not only foreign persons residing in the U.S., but return preparers, accountants, immigration lawyers, tax lawyers, and criminal defense lawyers should be aware of this decision and govern themselves accordingly.

If you have any questions regarding tax crimes under IRC §7206, IRC §7201, or any other tax provision, please contact Fuerst Ittleman, PL at contact@fuerstlaw.com.

On February 22, 2012, Joseph A. DiRuzzo, III, Esq., CPA, a senior tax associate at Fuerst Ittleman, filed a Petition for Writ of Certiorari in the United States Supreme Court in United States v. John M. Crim. Mr. Diruzzo’s Petition is available here.

The Petition seeks to review a decision of the Third Circuit Court of Appeals, which affirmed in part, and vacated and remanded in part, a judgment of conviction for a violation of 18 U.S.C. section 371 (a Klein conspiracy) and a violation of 26 U.S.C. section 7212(a) (interfering with the due administration of the Internal Revenue Code).  The Third Circuit’s decision is available here.

The background of the case is as follows.  On November 28, 2006, an indictment was filed against John Michael Crim (“Crim”) and other co-defendants, charging them in Count One with conspiracy to defraud the United States in violation of 18 U.S.C. § 371.  On April 24, 2007, a superseding indictment was filed against the Crim and other co-defendants, charging them again with conspiracy to defraud the United States in violation of 18 U.S.C. § 371.  Crim was also charged in Count Two of the Superseding Indictment with corruptly endeavoring to interfere with the administration of the Internal Revenue laws in violation of 26 U.S.C. § 7212(a). 

Count One of the superseding indictment alleged that Crim was the co-founder of an organization known as the Commonwealth Trust Company (“CTC”).  Count One charged as follows: “[f]rom at least January 2000 through at least July 2003, in the Eastern District of Pennsylvania and elsewhere, defendants [Crim and co-defendants] conspired and agreed, together with others known and unknown to the grand jury, to commit an offense against the United States, that is, to defraud the United States by impeding, impairing, obstructing, and defeating the lawful functions of the [IRS] of the Department of the Treasury, in the ascertainment, computation, assessment, and collection of income taxes.”

Count One further alleged that: “CTC marketed two domestic fraudulent trust packages and one offshore fraudulent trust package to its clients. The domestic trust packages consisted of a Pure Trust Organization (“PTO”) and a Private Company Trust (“PCT”). The offshore trust package consisted of an Internationally-based Corporation (“IBC”). In the domestic trust PCT system, CTC instructed clients to remove funds earned from legitimate businesses and, instead of paying income tax on those funds, to divert that income through a series of domestic trusts under the clients’ control. CTC represented to its clients that, by diverting the income through a series of trusts, the clients could escape paying taxes on that income or could significantly reduce the amount of taxes they owed. CTC also instructed clients to transfer assets they already owned into CTC’s other domestic fraudulent trust package, the PTO, to conceal and protect real and personal property from IRS levies and seizure attempts.” Count One alleged that Crim was the Head Trustee of CTC, a member of the CTC Executive Board, and a promoter of CTC trust products.

In the “manner and means” segment of the superseding indictment, Count One alleged that it was part of the conspiracy that Crim and others “met with taxpayers within the Eastern District of Pennsylvania and elsewhere to solicit and maintain clients for CTC’s offshore and domestic trust packages by falsely representing that taxpayers could lawfully avoid paying income taxes by placing their income and assets into CTC’s trust packages.”

Count Two charged that, on May 10, 2002, in Lancaster, Pennsylvania, Crim and other co-defendants corruptly endeavored to obstruct and impede the due administration of the Internal Revenue laws by speaking at a conference to CTC clients at which the defendants intended to cause the fraudulent use of CTC products by teaching the CTC clients how to engage in sham paper transactions that would result in the concealment from the IRS of clients’ property and of their receipt of income.  According to the Superseding Indictment, all of this violated 26 U.S.C.  § 7212(a).

On January 7, 2008, the trial began against Crim and co-defendants Taylor, Paul Crim, and Brownlee, before the Honorable Anita B. Brody and a petit jury.  On January 25, 2008, the District Court charged the jury. On January 28, 2008, the jury returned guilty verdicts against Crim on Count One (18 U.S.C. § 371) and Count Two (26 U.S.C. § 7212(a)).  On July 7, 2008, the District Court sentenced Crim to 96 months imprisonment on Count One and Count Two, with each count to be run concurrently.  Restitution was ordered to the government in the amount of $17,242,806.57. 

Mr. DiRuzzo did not represent any of the defendants at trial but was retained by Mr. Crim for representation before the United States Supreme Court. The Petition for Writ of Certiorari presents the following discrete questions:

Whether, in light of the Court’s holding in United States v. Aguilar, 515 U.S. 593, 132 L. Ed. 2d 520, 115 S. Ct. 2357 (1995), and its progeny, the Court of Appeals erred in failing to conclude that the “Omnibus Clause” of 26 U.S.C. § 7212(a) requires the prosecution prove that a criminal defendant have (i) knowledge of some pending Internal Revenue Service action of which the criminal defendant was aware, and (ii) that there be a “nexus” between a criminal defendant’s actions and the actions taken by a third-party, which is also contrary to a decision of another circuit.

The Petition argues that the Third Circuit’s opinion is contrary to the decisions of the Supreme Court of the United States, in Aguilar, and is in conflict with the Sixth Circuit Court of Appeal’s decision in United States v. Kassouf, 144 F.3d 952 (6th Cir. 1998), which held that “due administration of the Title [26] requires some pending IRS action of which the defendant was aware.”  Id. at 957. 

The attorneys at Fuerst Ittleman handle cases involving complex litigation (including income tax litigation) at the District Courts, the Court of Federal Claims, Circuit Courts, and if necessary in the U.S. Supreme Court.  You can reach an attorney by emailing us at contact@fuerstlaw.com, or by calling us at 305.350.5690.

Discussing the constitutionality of civil penalties under the False Claims Act (“FCA”), a federal district judge in the Eastern District of Virginia has refused to impose a $50.2 million fine against a company for its fraudulent conduct.

Last summer, a jury found the company liable on two claims, including a government claim for which the company had already paid hundreds of thousands of dollars in a 2003 antitrust case. After the jury made its finding, the government asked the Federal District Court to impose a $24 million civil penalty, instead of the $50.2 million civil penalty mandated by the FCA.  The government took the position that it was “exercising their prosecutorial discretion” in asking for a lesser amount than the $50.2 million, and argued that the $24 million penalty was “unquestionably within the constitutional limit of the Excessive Fines Clause of the Eighth Amendment.” The U.S. District Court, according to the government, had no authority to reduce the number civil penalties below the amount the statute required.

The Court based its decision to award no civil penalty on two factors. First, the Court ruled that the penalty required by the statute was “grossly disproportionate” to allegations that the company defrauded the government.  The Court also ruled that it lacked the power to create a penalty other than the one permitted by statute: “The court is driven to its conclusion that it must simply refuse to enforce the mandated penalty after finding it unconstitutional under the facts of this case, and not substitute its own fashioned penalty, in large part due to the structure and language of the FCA itself.” The Court further wrote that it was unwilling “to rewrite the FCA, as given to this court, in order to fashion a constitutional civil penalty under the facts of this case.”

A full copy of the opinion is available here.

The attorneys at Fuerst Ittleman have extensive experience litigating against the government regarding the False Claims Act.  You can reach an attorney by emailing us at  contact@fuerstlaw.com or by calling us at 305.350.5690.

On February 15, 2012, the Financial Crimes Enforcement Network (“FinCEN”) issued an Advisory to U.S. financial institutions advising them of their obligations under the Bank Secrecy Act (“BSA”) when dealing with foreign-located money services businesses (“MSBs”). A copy of FinCEN’s advisory can be read here.

The advisory comes several months after FinCEN implemented new rules defining which businesses qualify as MSBs subject to the anti-money laundering regulations of the BSA. As we previously reported, on July 21, 2011, FinCEN published a final rule which amended the definition of “money services business” under 31 C.F.R. § 1010.100(ff) to clarify that it is the activities performed within the U.S. by a business which will cause it to be classified as a MSB regardless of the business’s physical location. The rule change arose out of the recognition that the Internet and other technological advances make it increasingly possible for businesses to offer MSB services in the U.S. from foreign locations.

The definition of MSB has been rephrased to state: “[a] person wherever located doing business, whether or not on a regular basis or as an organized or licensed business concern, wholly or in substantial part within the United States” as a currency dealer, currency exchanger, check casher, money transmitter, and/or a seller, issuer, and redeemer of traveler’s checks, money orders, or prepaid access cards. As a result of this change, foreign-located businesses engaging in MSB activities within the U.S. are subject to the rigorous requirements of the BSA, even if the foreign based MSB has no physical presence in the U.S. The final rule also required each foreign-located MSB to appoint a person residing in the U.S. as an agent for service of legal process.

In its Advisory, FinCEN advises U.S. financial institutions to reevaluate their own anti-money laundering (“AML”) programs if they provide financial services or engage in financial transactions with foreign-located MSBs. FinCEN further suggests that U.S. financial institutions look to its earlier guidances, such as FinCEN’s 2005 Intra-agency Interpretive Guidance on Providing Banking Services to MSBs Operating in the U.S. and FinCEN’s 2010 Advisory on Informal Value Transfer Systems, in order to ensure that the foreign-located businesses they are dealing with are not operating as unregistered or unlicensed MSBs. FinCEN also reminded financial institutions that provide services to foreign-based MSBs of their obligations to file Suspicious Activity Reports (“SARs”) should they become aware that their customers are operating as unregistered or unlicensed MSBs.

If you have questions pertaining to the BSA, anti-money laundering compliance or how to ensure that your business maintains regulatory compliance at both the state and federal levels, contact Fuerst Ittleman PL at contact@fuerstlaw.com.

On February 10, 2012, the Florida Department of Revenue Issued a Tax Warrant on the Florida Supreme Court at its 500 S. Duval St., Tallahassee addresses in the amount of $1,949.19.  However, while the warrant has raised speculation that it was issued to Florida Supreme Court itself, it was actually issued to the Florida Supreme Court Historical Society, Inc. a non-profit with the same address as the Florida Supreme Court. 

A copy of the tax warrant is available here.

Aside from its misleading draftsmanship, the significance of the tax warrant is that the Florida Department of Revenue continues to aggressively look to raise funds.  The attorneys at Fuerst Ittleman have extensive experience addressing State of Florida and other local tax issues in addition to federal tax issues.  You can contact an attorney by emailing us at  contact@fuerstlaw.com.

On February 7, 2012, the Financial Crimes Enforcement Network (“FinCEN”) announced final rules requiring non-bank residential mortgage lenders and originators to establish anti-money laundering (“AML”) programs and comply with suspicious activity report (“SAR”) regulations. The final rule will be effective 60 days after its publication in the Federal Register. A copy of the final rule can be read here.

As we previously reported, prior to the finalization of this rule, the only mortgage originators that FinCEN regulations required to file SARs were banks and insured depository institutions. However, FinCEN mortgage fraud reports have shown that non-bank mortgage lenders and originators initiated many of the mortgages that were the subject of bank SAR filings. By extending AML and SAR requirements to non-bank mortgage lenders and originators, FinCEN hopes to mitigate and minimize the risks and vulnerabilities that have been exploited by criminals in the past including false statements, straw buyers, fraudulent flipping, and identity theft. As explained by FinCEN, “the new regulations likely will significantly increase the number of mortgage related SAR filings; give law enforcement and regulators more comprehensive data on specific crimes; and provide government and industry a more complete perspective on mortgage related crime trends nationwide.”

The new rules come as part of a broader effort by FinCEN and multiple federal agencies to combat mortgage fraud. Since 2009, the Financial Fraud Enforcement Task Force has coordinated multiple federal agencies, the Department of Justice and State and local law enforcement partners in collaborative efforts to prosecute mortgage fraud and financial crimes. On November 3, 2011, FinCEN announced a proposal to extend AML and SAR compliance requirements to Fannie Mae, Freddie Mac, and Federal Home Loan Banks. Most recently, in January 2012, the Department of Justice announced the creation of the joint DOJ and SEC Residential Mortgage-Backed Securities Working Group which will focus its efforts on prosecuting abuses in the residential-mortgage backed securities market.

The compliance date for the new rule is six months after its publication in the Federal Register. If you have questions pertaining to FinCEN regulations, anti-money laundering compliance or how to ensure that your business maintains regulatory compliance, contact Fuerst Ittleman PL at contact@fuerstlaw.com.

Since the 1970s the United States Congress and the Internal Revenue Service has been seeking ways to collect tax money which they are convinced is being hidden in offshore tax havens.  These early efforts resulted in the requirement for US taxpayers to file a report of Foreign Bank and Financial Accounts called the FBAR.  Additionally, a compliance regime was foisted on foreign financial institutions through the qualified intermediary regulations, which the IRS issued on its own authority – essentially foreign financial institutions agree to come under the IRS umbrella for purposes of US tax enforcement of foreign accounts.

This compliance process was not satisfactory to the Congress who felt there was some US$100 billion over a 10-year period lost in taxes.  The IRS upped the ante by utilising criminal indictments of foreign banks and foreign bankers.  The US government felt justified in proceeding with this direct attack rather than going through its cumbersome tax treaty procedures.  It is fair to say that these actions were viewed by the foreign financial institutions as highly divisive, creating tension and ill will between the United States and foreign financial and non-financial institutions.

Amid these efforts by the Congress, through the Internal Revenue Service, to bring virtually the entire financial world under the United States taxing authority, they also used a carrot approach whereby in 2009 and then again in 2011 the IRS offered the Offshore Voluntary Disclosure Program (OVDP).  This allowed US taxpayers to voluntarily disclose to the IRS that they hold offshore accounts that have not been reported and provided means to civilly settle the affair and avoid potential criminal charges that stick.

For 2009, 2010 and 2011, the IRS reports that they have collected US$4.4 billion and they have closed, as of now, 95 per cent of the cases from the 2009 program.  This encompasses some 33,000 voluntary disclosures as a result of this voluntary disclosure initiative.  On January 9, 2012, the IRS reopened the Offshore Voluntary Disclosure Program since the IRS is fervently looking for an easy way to deal with otherwise unreported offshore financial accounts.

Between the 2009 Offshore Voluntary Disclosure Program and 2011, Congress enacted the Foreign Account Compliance Tax Act (FACTA).  As reported by the Financial Times in 2010, “Tens of thousands of banks, fund managers, insurers and hedge funds face having to give the names of US clients with at least US$50,000 of assets to the Internal Revenue Service under the Foreign Account Tax Compliance Act, passed in March.”

In a New York Times story just three weeks ago, a former international tax policy advisor for the Treasury Department was quoted as saying: “The FACTA story is really kind of insane.”  Also the head of global tax compliance at Deloitte in New York is quoted as saying: “They’re trying to force every financial institution in the world to sign onto this regime.”

A backlash has resulted in a growing number of foreign financial institutions and non-financial institutions refusing to have American customers and some are even reducing owning American securities.  As a consequence, the Internal Revenue Service has extended the deadlines for the registration of foreign financial and non-financial institutions with the Internal Revenue Service until June 30, 2013.  It has been reported that the IRS is struggling to provide detailed guidance by the end of 2012.

Ongoing Efforts

While the difficulties of the US in dealing with foreign financial and non-financial institutions because of FACTA remains, the IRS is proceeding with its already established procedures applicable to US taxpayers.  This includes the FBAR reporting requirement (involving Form TD 90-22.1), which is filed with the US Treasury.  Separately, there is now FACTA reporting requirements, involving a new Form 8938, which is the Statement of Specified Foreign Financial Assets.  This will be part of a taxpayer’s regular tax return filed with the IRS.  A significant amount of financial information must be reported whether or not there is taxable income.  These two separate reporting rules exist side by side.  The FACTA rules are tax rules.  The FBAR rules are Treasury Department, Bank Secrecy Act rules.

What is expected to be confusing is that there is a great deal of overlap between the two forms in reporting overlapping information.  Many of the definitions used in the forms are different for each form.  In this regard, if taxpayers are not using a foreign tax specialist previously, they will need to have one now.

Along with this new heightened and intrusive regime the IRS is stepping up the attention it gives to the tax returns of foreign corporations under Form 1120-F.  This follows the restructuring by the Internal Revenue Service of the Large and Midsize Business Division to what is known now as the LB&I.  As stated by IRS Commissioner Shulman: “The realigning organization will let us focus on high risk international compliance issues and handle these cases with greater consistency and efficiency as we continue to increase our work in this area.”  

This effort will directly impact foreign entities having any financial relationship with the United States, which may involve any form of income shifting and inbound financing by foreign entities.  Also being examined are foreign companies doing business in the United States through a branch or a subsidiary which has not been reporting as a business/permanent establishment situation.  

The IRS is also taking a more direct approach in dealing with taxpayers.  The new efforts are to execute a subpoena on the US taxpayers and require them to provide foreign account information.  Concomitant with that effort, the IRS, should it have the correct information, will proceed with a direct levy on an office or branch of a bank engaged in the banking business in the United States with which the taxpayers under the microscope has a foreign account.  Apparently, following the reasoning that since dollars are a fungible commodity, it follows that it would be impossible to distinguish a taxpayer’s dollars held in an account in a foreign institution when there are dollars being held in its related US sitused institution.  

IRS Taxpayer Advocate Enters the Fray

The Taxpayer Advocate Service (TAS) is an independent organisation within the IRS. It was enacted into law by Congress who understood that taxpayers may be having problems with the Internal Revenue Service system and needed a government funded organisation to advocate on their behalf.  The TAS not only handles individual problems and tries to resolve them within normal IRS channels but also deals with large scale or systemic problems that can affect a large number of taxpayers.

On January 6, 2012, the National Taxpayer Advocate, Nina Olson, invoked a rarely used administrative tool to try and force the IRS, and its LB&I and small business/self-employed divisions to change their audit procedures with regard to the offshore involuntary disclosure program.  In a very rare taxpayer advocate directive (TAD,) the NTA ordered disclosure and revocation of an IRS memo to its frontline examiners.  The point of controversy involved a published set of facts and questions by the IRS in its explanation of the Offshore Voluntary Disclosure Program.  The taxpayer advocate is authorised by Congress to issue TADs so that as a watchdog enforcing actions against the IRS the TADs would have some teeth.  The consequence is that Congress is trying to give the taxpayer advocate directive powers to force IRS compliance on issues that the advocate deems abusive or inequitable to taxpayers.  Presently, neither of the commissioners of LB&I or SB/SE have acquiesced to the taxpayer advocate directives.   The matter now is for Commissioner Shulman who will make the decision.  The report which can be found in 2012 TNT 4-1 is well worth reading.

Impact on Foreign Investment Funds

Many, if not most foreign investment managers and fund managers feel that they are not involved in selling reportable assets to Americans.  However, one of the little known provisions of the complex Internal Revenue Code relates to what is known as passive foreign investment companies (PFIC).  Essentially, the Internal Revenue Code says that if an American investor owns even one share of a foreign corporation or a deemed foreign corporation that is the fund investment entity, then the US shareholder is treated as owning a PFIC and must report that as part of his annual tax return.  

The Hiring Incentives to Restore Employment Act (HIRE) as passed in 2010 amended the Internal Revenue Code and added a new section dealing with information with respect to foreign financial assets.  Under Section 6038(D), any individual who during the taxable year held an interest in any specified foreign financial account, the taxpayer is required to attach to his or her income tax return for the taxable year certain required information.  This information is in respect to each foreign financial asset if the aggregate of all the individual specified assets exceed US$50,000.  To accompany this, the IRS has released Form 8938 dealing directly with the specified foreign assets and also Form 8621 dealing with PFICs or a qualified electing fund.  Needless to say, many professionals kindly refer to the Internal Revenue Codes foreign tax position as complex while others perhaps in humor or perhaps in seriousness refer to those same provisions as insane or bizarre.  Nonetheless, the reality is that US taxpayers who do have various forms of these specified foreign assets will be paying a great deal more in fees for the preparation of their annual tax return.

Impact on US Tax Compliant Ex-Pats

At the end of 2011, The Wall Street Journal had an article which observed that US persons that are considered ex-pats will soon discover that it is going to be hard to maintain foreign assets.  The impact of FACTA on foreign financial institutions is that they are required to collect a 30 per cent tax on any ‘pass through’ transactions made with foreign institutions that are not in compliance with this new regime.  As a spokesman for Deloitte stated: “It’s their responsibility to withhold that money and send it to the US.”  The article further states that, “in response, some foreign banks have said they will close all their American clients investment accounts rather than incur the expense of complying.  That move could prompt even fully tax compliant Americans who reside abroad to renounce their citizenship rather than face this prospect.”

The article does reveal one unquestionable fact about the US foreign tax administration.  That is, even without this extensive and complex burden on the IRS, Congress has continually and vastly underfunded the IRS.  For all the complexity of tax codes and requirements placed on the Internal Revenue Service, it doesn’t have enough money, and no manpower.  Congress seems to be in the mood to continue to pile on duties on to the IRS, which make a difficult problem worse.  Nonetheless, the Internal Revenue Service will do its best to go forward and taxpayers are expected to comply.

Virtually all the developed countries of the world are in the position whereby budgeted national expenses far exceed their ability to collect tax revenues.  As a result, there are increased efforts aimed at enforcing tax compliance which the US and other governments claim will actually raise revenue to offset the growing amount of national debt.  

Practitioners throughout the world will need to prepare and understand exceedingly complex law.  Many foreign financial and non-financial institutions will soon have to make a decision in the relatively near future as to whether they will comply with the United States extending its authority over them or whether they will take some other actions.

US taxpayers, whether in the United States or living outside the United States, are expected to comply fully with the US tax law.  The IRS, by establishing a third voluntary disclosure program, is encouraging taxpayers to come forward and bring the assets held in foreign accounts back into compliance. In return, the taxpayer will be relieved of the potential for extraordinary civil penalties and the possibility of criminal prosecution as well.  

It is really unknown what the consequences will finally be as a result of the US Government’s efforts to use extreme tax compliance methods for revenue enhancement as well as to deal with other egregious international crimes.  That will be an unfolding story which will likely dramatically impact the course of global financial relationships as well as the definition of what is a sovereign nation.

This article was originally published in the IFC Review February 2012 e-Journal.  For the original article and more information, visit www.ifcreview.com.

Last year the Internal Revenue Service (IRS) Taxpayer Advocate released Taxpayer Advocate Directive 2011-1 speaking out against the IRS’s failure to implement Frequently Asked Question (FAQ) 35 of the 2009 Offshore Voluntary Disclosure Program (OVDP) to numerous taxpayers.

OVDP FAQ 35 provides that: 

[IRS] [v]oluntary disclosure examiners do not have discretion to settle cases for amounts less than what is properly due and owing.  These examiners will compare the 20 percent offshore penalty to the total penalties that would otherwise apply to a particular taxpayer.  Under no circumstances will a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes.

Under existing law, United States (US) persons are generally required to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, (FBAR) disclosing their interest in foreign financial accounts and report income generated from these on their US income tax returns.  Notwithstanding the potential for criminal prosecution, the maximum civil penalty for willful FBAR violations can amount to the greater of $100,000.00 or 50 percent of the account balance for each violation for each year; the maximum civil penalty for non-willful violations amounts to $10,000.00 per violation and no penalty if the taxpayer qualifies under the reasonable cause exemption. 

Additionally, under “existing statutes,” various non-willful FBAR violations call for the implementation of reasonable cause, placing the burden of proving willfulness on the IRS.  Also, the IRS’s application of existing statutes requires the imposition of lower penalty amounts for certain taxpayers with relatively low account balances under the IRS’s “mitigation” guidelines.  Thus, under the rubric of OVDP FAQ 35, program participants with non-willful FBAR violations or relatively low account balances believed that they would not be required to pay a penalty greater than that that they would have been liable for under existing statutes.

On March 1, 2011, however, the IRS “clarified” FAQ 35 directing examiners to stop accepting less than the 20 percent offshore penalty under the program, regardless of whether a taxpayer would be liable for a lower penalty under existing statutes, except under narrow circumstances.  Even during those instances in which the IRS was applying existing law, it did not consider reasonable cause and assumed that a taxpayer’s failure to file an FBAR was subject to the maximum penalty for willful violations unless the taxpayer could prove that the violation was not willful. 

Following the IRS’s clarification of FAQ 35, the Taxpayer Advocate highlighted various problems related to this change.  First, the Taxpayer Advocate stated that several of the 2009 OVDP participants entered into the program relying on its original terms and with the idea that they would be treated like similarly situated taxpayers.  Instead, the IRS applied the original FAQ 35 to those taxpayers whose applications were processed prior to March 1, 2011, while applying the clarified FAQ 35 to those taxpayers whose applications were processed after March 1st.  By doing so, and though no fault of the taxpayer, those cases that were processed before March 1, 2011, received a better deal than those processed thereafter. 

The Taxpayer Advocate then argued that a court may require the IRS to follow FAQ 35, if the Court determines that the taxpayer relied to his or her detriment on FAQ 35.  Particularly, the Taxpayer Advocate stated that the court may base its decision on the “Accardi” doctrine or similar legal theories based on the “duty of consistency” or “equality of treatment.”  Often, courts acknowledge that taxpayers generally may not rely on the Internal Revenue Manual (IRM) or similar types of guidance; however, when taxpayers have reasonably relied on IRS procedures, courts have required the IRS to follow its procedures in an effort to avoid inconsistent results.  Even though the Accardi doctrine is limited to situations in which taxpayers have detrimentally relied on the government’s procedures, one may argue that several taxpayers relied to their detriment when seeking participation in the 2009 OVDP.

Next, the Taxpayer Advocate argued that the IRS did not publish its March 1, 2011, memo clarifying FAQ 35 as required by the Freedom of Information Act (FOIA).  Specifically, the Taxpayer Advocate states that an item that is not properly published and does not otherwise give “timely” notice to the taxpayer may not be “relied on, used, or cited” by the IRS against a taxpayer.  Thus, the IRS’s March 1st memo may be invalid and the IRS’s use and reliance on it may constitute a second FOIA violation.

Finally, the Taxpayer Advocated argued that the IRS’s new FAQ 35 damages the IRS’s credibility with practitioners and taxpayers alike thereby reducing voluntary compliance and participation in future initiatives. 

After the Taxpayer Advocate’s outcry against the new FAQ 35, there have been several communications between the IRS and the Taxpayer Advocate office in an effort to resolve their dispute.  The most recent communication required a response from the IRS on January 26, 2012; that has not yet been published.

Fuerst Ittleman will continue to monitor the exchange between the IRS and the office of the Taxpayer Advocate for more developments.  You may also monitor these exchanges here.  If you have any questions regarding the 2009 OVDP or offshore voluntary disclosure generally, please contact us at contact@fuerstlaw.com.

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