This week, Fuerst Ittleman David & Joseph is launching a Mini Blog, which will be submitted to its readers on a weekly basis. Unlike its usual Blog, which will continue to be updated here, the Mini Blog will allow FIDJ to communicate with its readers in a short and to-the-point style, delivering critical news updates with just enough commentary to explain why the updates are critical. We believe that this Mini Blog will be a valuable resource for our readers, and will allow subscribers to stay up to date on issues affecting all of our practice areas, including Tax & Tax Litigation, Food Drug & Cosmetic Law, Complex Litigation, Customs Import & Trade Law, White Collar Criminal Defense, Anti-Money Laundering, Healthcare Law, and Wealth & Estate Planning. Additionally, subscribers may sign up to receive only the content relevant to their interests on a subject-by-subject basis. As always, please feel free to reach out to us with comments regarding our content or suggestions regarding how we may better keep you up to date.

Click here to sign up.

Here is a sampling of what you can expect to receive in our Mini Blog:

Food and Drug:

On May 28, 2013, the Alcohol and Tobacco Tax and Trade Bureau (TTB) issued guidelines for voluntary “serving facts statements” that alcoholic beverage manufacturers may include on their packaging. A copy of TTB’s press release can be read here. The serving facts statements are similar to the nutrition panels currently found on non-alcoholic foods and beverages. According to the rule, serving facts statements will include: 1) the serving size; 2) the number of servings per container; 3) the number of calories; and 4) the number of grams of carbohydrates, protein, and fat preserving. In addition, serving fact statements may also include the percentage of alcohol by volume and a statement of the fluid ounces of pure ethyl alcohol per serving. TTB is providing the interim guidance on the use of voluntary serving facts statements on labels and in advertisements pending the completion of rulemaking on the matter. A copy of the TTB Ruling can be read here.

Healthcare:

A new bill in the U.S. House of Representatives, the Medicare Audit Improvement Act of 2013, seeks to amend title XVIII of the Social Security Act to improve operations of recovery auditors under the Medicare integrity program and to increase transparency and accuracy in audits conducted by contractors. A few proposals include limiting the amount of additional document requests, imposing financial penalties on auditors whose payment denials are overturned on appeal and publishing auditor denials and appeals outcomes.

In related news, the Department of Health and Human Services c/o the Centers for Medicare and Medicaid Services  (“CMS”) is proposing to increase the maximum reward for reporting Medicare fraud from “10 percent of the overpayments recovered in the case or $1,000, whichever is less, to 15 percent of the final amount collected applied to the first $66,000,000…” In case you don’t have a calculator handy, that’s a change from $1,000 to a potential maximum windfall of $9,900,000. It’s safe to assume that the number of whistleblower reports of alleged Medicare fraud are going to skyrocket. As the saying goes, you miss 100% of the shots you don’t take.

As decided by the United States Court of Appeals for the Eleventh Circuit, HIPAA preempts Florida’s broad medical records disclosure law pertaining to a decedent’s medical records. In Opis Management Resources, LLC v. Secretary of Florida Agency for Health Care Administration, No. 12-12593 (11th Cir. Apr. l 9, 2013), the 11th Circuit Court of Appeals ruled that Florida’s broad medical records disclosure law did not sufficiently protect the privacy of a decedent’s medical records. The Court noted that Florida allows for “sweeping disclosures, making a deceased resident’s protected health information available to a spouse or other enumerated party upon request, without any need for authorization, for any conceivable reason, and without regard to the authority of the individual making the request to act in a deceased resident’s stead.” In contrast, HIPAA only permits the disclosure of a decedent’s protected health information to a “personal representative” or other identified persons “who were involved in the individual’s care or payment for health care prior to the individual’s death” to the extent the disclosed information is “relevant to such person’s involvement”.

Tax:

On May 29, 2013, the New York Times reported that the Swiss Government will allow Swiss Banks to provide information to the U.S. Government in exchange for assurances that Swiss banks would only be subject to fines and not be indicted in an American criminal case. Per the New York Times,

The New York Times article reports that: But [Ms. Widemer-Schlumpf (Switzerland's finance minister)] said the Swiss government would not make any payments as part of the agreement. Sources briefed on the matter say the total fines could eventually total $7 billion to $10 billion, and that to ease any financial pressure on the banks, the Swiss government might advance the sums and then seek reimbursement…. Ms. Widmer-Schlumpf said the government would work with Parliament to quickly pass a new law that would allow Swiss banks to accept the terms of the United States offer, but said the onus would be on individual banks to decide whether to participate.

This appears to be the beginning of the end of Swiss bank secrecy. If the Swiss relent to the U.S., the European Union will be next in line to obtain the same concession.

Anti-Money Laundering:

Our thoughts on the United States government’s attack on Mt. Gox can be read here, and Bitcoin continues to remain a hot topic all across the internet; see here, here, and here. Another virtual currency, Liberty Reserve, has also made a splash since being shut down by the Feds last week in what many have described as the largest money laundering scheme of all time; see here for details of the takedown, as well as the following articles describing the initial bits of fallout from the Liberty Reserve takedown: online anonymity, anti-money laundering compliance,Barclays Bank involvement, and the not guilty pleas entered by Liberty Reserve’s proprietors on Thursday. We will keep our eyes on these two cases as the fallout continues.

Disclosure: Joseph A. DiRuzzo, III of Fuerst Ittleman David & Joseph represented the taxpayers before the District Court of the Virgin Islands and before the Third Circuit Court of Appeals.

On May 17, 2013, the United States Court of Appeals for the Third Circuit issued its opinion in the case of Cooper v. Comm’r of Internal Revenue, ___ F.3d ____, 2013-1 U.S. Tax Cas. (CCH) P50,331. A copy of the precedential opinion is available here. The opinion is a consolidated one, and decided the cases of four separate taxpayers (Cooper, McGrogan, McHenry, and Huff) who had availed themselves of the Virgin Islands Economic Development Program (EDP).

The Court of Appeals began its opinion by aptly noting the following: “This case is about Taxpayers’ attempt to lawfully reduce their income tax liability by claiming certain tax benefits afforded exclusively to bona fide residents of the United States Virgin Islands.”

The facts of the case are as follows:

Between 2001 and 2004, the Taxpayers claimed that they were bona fide residents of the Virgin Islands and therefore eligible for the tax benefits granted by the EDP. (For more information about the EDP, including a history of the litigation between and among U.S. taxpayers, the IRS and the Virgin Islands Bureau of Internal Revenue, please review our prior blog entries here, here, here, here, here and here.) Consequently, the Taxpayers filed tax returns with the Virgin Island Bureau of Internal Revenue (VIBIR) and paid their taxes only to the Virgin Islands government. However, the Taxpayers did not file federal income tax returns with the IRS. Consequently, in late 2009 and early 2010, the Taxpayers were issued statutory notices of deficiency by the IRS challenging their claims of bona fide residency in the Virgin Islands. The Taxpayers challenged the deficiency notices in the District Court of the Virgin Islands. The District Court granted the IRS’s motion to dismiss on the grounds that the Tax Court was the only proper forum for the Taxpayers’ suits against the IRS and therefore the District Court of the Virgin Islands lacked subject matter jurisdiction to adjudicate the dispute.

After receiving a deficiency notice from the IRS in late 2009, McGrogan, in an effort to avoid double taxation, filed suit in the District Court of the Virgin Islands seeking a refund of taxes paid to the VIBIR. The District Court granted the VIBIR’s motion to dismiss McGrogan’s refund petition because McGrogan filed his claim outside the statute of limitations pursuant to I.R.C. § 6511(a) (statute of limitations for a refund petition expires either three years after the time of filing an income tax return or two years after the time of payment of the tax owed, whichever expires last).

On appeal, the Third Circuit noted that the mitigation provisions in the Internal Revenue Code allow qualifying taxpayers to bring refund claims that would otherwise be barred by the statute of limitations. See I.R.C. § 1311(a). However, according to the Third Circuit, the mitigation provisions did not afford relief to McGrogan because he could not show that a “circumstance of adjustment” had occurred. In short, although McGrogan claimed a circumstance of adjustment for the double inclusion of income, the Internal Revenue Code permits mitigation for the double inclusion of income only if the taxpayer’s claim involves “an item which was erroneously included in the gross income of the taxpayer for another taxable year or in the gross income of a related taxpayer.” I.R.C. § 1312(1). Such a double inclusion did not occur in this case. McGrogan did not allege that he erroneously paid taxes in an incorrect tax year and did not claim to have erroneously paid taxes for a related taxpayer. Rather, McGrogan’s overpayment of taxes is a situation not contemplated by the mitigation statute: payment to the wrong taxing entity.

The Court then went on to discuss the Court of Appeal’s concern “about the possibility of double payment of taxation to the IRS and to the VIBIR in cases such as the ones at issue here. The IRS assured us at oral argument it was willing to participate in the administrative procedure set up by the Tax Implementation Agreement:

[Counsel for the IRS]: At this point I don’t believe there’s any sign that there would be double taxation. We’ve indicated — the IRS has indicated its willingness to participate in competent authority once it is determined how much taxes are owed.

Obviously, if a particular taxpayer wins on their challenge, if they prove that they’re bon[a] fide Virgin Islands residents and they prove that the income in question was Virgin Islands income, there won’t be any double taxation because there won’t be any residual U.S. tax liability. But if, instead, there is determined that, yes, there is U.S. tax liability here because these were not Virgin Islands residents, or their income was not Virgin Islands income and, therefore, not subject to the EDP benefits, then we’ve indicated, as shown in the record cites I gave you for the Cooper notices of deficiency, that we’re willing to go in a competent authority at that point to determine which tax authorities should be getting the money.

“The IRS then qualified the above statement:

[Counsel for the IRS]: I’m not entirely certain what the remedy would be in a situation where someone, unlike the Coopers, failed to do a protective refund claim, failed to take that step to protect their right to go and get money back from the Virgin Islands BIR if, in fact, it is determined that they should have instead paid all of their taxes to [the IRS].

“Counsel for the Taxpayers replied to the IRS’s argument by pointing out that the protective mechanism of a refund claim was set up in 2006, after the time to file a protective income tax return for calendar years 2001 and 2002 had already closed. Therefore, McHenry and McGrogan could not have taken the protective actions advocated by the IRS.

“In view of the statement by the IRS that negotiation would be initiated to prevent double taxation — in the situation we could envisage if, for instance, McGrogan lost his pending case in the Tax Court — we trust that the IRS will live up to its commitment to prevent double taxation.”

Slip op. at p. 19-20, fn.6; (emphasis added).

A copy of the transcript of the oral argument is available here:

So, while this decision was resolved unfavorably for the named taxpayers, the decision has far reaching implications for all taxpayers who are litigating the issue of whether they were bona fide USVI residents. The IRS has now made the affirmative commitment to the Third Circuit that there will be no double taxation. This has effectively removed one of the bargaining chips that the IRS has had in its litigation position. Previously, the standard operating procedure of the IRS was that a taxpayer should settle, and upon settlement the IRS would give the taxpayer credit for taxes paid to the VIBIR. However, if the taxpayer wanted to litigate the residency issue (in the Tax Court for example) then the IRS would not give credit for taxes paid to the VIBIR. Further, based on the IRS’s representation to the Third Circuit, there is no longer the need to sue the VIBIR in an attempt to recoup the taxes paid to the VIBIR in an attempt to remit the previously paid taxes to the IRS.

This case, taken with the Third Circuit’s decision in Vento, see here, and the Tax Court’s decision in Appleton, see here, show that the federal courts have been willing to rebuff the IRS and its litigation position for those who have claimed to be bona fide USVI residents and therefore able to participate in the Virgin Islands Economic Development Program.

The attorneys at Fuerst Ittleman David & Joseph are actively litigating against the IRS, the United States, and the Virgin Islands Bureau of Internal Revenue in Virgin Islands residency cases in the District Court of the Virgin Islands, the U.S. Tax Court, the Third Circuit Court of Appeals, and the U.S. Court of Federal Claims. Additionally, Joseph A. DiRuzzo, III, is licensed to practice in the Virgin Islands and lived on St. Thomas for years before relocating to South Florida. Mr. DiRuzzo is actively litigating federal tax cases (both civil and criminal) on St. Thomas and St. Croix.

You can contact us via email at: contact@fuerstlaw.com, or by telephone at 305.350.5690.

On May 22, 2013, Judge Jacobs writing for the United States Tax Court ruled against the IRS which had taken the position that the statute of limitations did not apply to Virgin Islands taxpayers who filed an income tax return with the Virgin Islands Bureau of Internal Revenue (VIBIR). The case is Appleton and the Government of the United States Virgin Islands v. Commissioner of Internal Revenue, 140 T.C. No. 14, which may be read here. For a background discussion of taxation in the U.S. Virgin Islands, including the Virgin Islands Economic Development Program(EDP) and the ongoing litigation between the IRS and the myriad taxpayers who have availed themselves of the EDP, please see our prior blog posts on these issues  here, here, here, here and here.

The facts of the case are fairly straightforward. The taxpayer, Arthur Appleton, is a United States citizen who resided on the U.S. Virgin Islands and was a bona fide resident under Section 932 of the Internal Revenue Code. The taxpayer claimed an EDP tax credit.  The IRS received copies of the taxpayer’s 2002, 2003, and 2004 returns from the VIBIR, and both the VIBIR and the IRS examined the taxpayer’s income tax returns. The VIBIR proposed no adjustments, but the IRS did, determining that the taxpayer did not qualify for the section 932(c)(4) gross income exclusion. Treating the taxpayer as a nonfiler, on November 25, 2009, the IRS issued the taxpayer a statutory notice of deficiency.

In the Tax Court’s discussion, it observed that Section 7654(e) of the Internal Revenue Code required the Secretary to draft whatever regulations necessary to carry out the provisions of section 932, including prescribing the information which individuals to whom section 932 applies must furnish to the Secretary. The Secretary did not, however, promulgate regulations for the years at issue.

The court also recognized that the instructions to Form 1040 stated that that “permanent residents of the Virgin Islands should use: V.I. Bureau of Internal Revenue, 9601 Estate Thomas, Charlotte Amalie, St. Thomas, VI 00802″ when filing their Form 1040 individual income tax returns.  The court noted that the IRS “concedes that the Forms 1040 petitioner filed with the VIBIR are returns within the meaning of section 6501(a)(1), sufficient to trigger the running of the period of limitations if properly filed.”  The court then went on to state that “[t]he Secretary, using the authority expressly granted to him by section 6091(b)(1)(B), promulgated section 1.6091-3(c), Income Tax Regs., which requires taxpayers like petitioner, residing in a possession of the United States, to file their tax returns as designated on the return forms or in the instructions issued with respect to those forms. The instructions to Form 1040 are explicit: The form is to be filed with the VIBIR.”

In dispensing with the argument that an income tax return filed with VIBIR cannot be an IRS return, the court recognized that the IRS’s position (i.e., that petitioner should have filed two returns–one with the VIBIR and one with the IRS) was undermined by its position that bona fide residents of the Virgin Islands who earn less than $75,000 may satisfy their Federal filing requirements by the single filing of a return with the VIBIR. Thus, even before the start of the Appleton case, IRS had accepted Mr. Appleton’s argument that a return filed with the VIBIR may be both a Federal return and a territorial return.

The Court concluded that the taxpayer proved that the section 6501(a) period of limitations expired before the date the IRS mailed the taxpayer the notice of deficiency.

The implications of the decision are far reaching, and it appears that the IRS’s ability to audit VI taxpayers indefinitely has been seriously undercut by the Tax Court.  We anticipate that the IRS will have to change its litigation position and that a good majority of the cases currently pending in the Tax Court will also be subject to dismissal based on the statute of limitations defense.  However, only time will tell how the IRS will respond and if the IRS will attempt to seek reconsideration and/or appeal.

Additionally, as we previously blogged, the U.S. Court of Appeals for the Third Circuit in the Vento case established the legal test for those who claim to be bona fide USVI residents under IRC section 932 (2004).  The implication of Appleton and Vento decisions working in tandem is that USVI residency is a low threshold to meet, and once one is a USVI resident the statute of limitation should prevent the IRS from assessing additional tax, penalties and interest.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive civil and criminal tax litigation experience and are currently litigating a large number of Virgin Islands tax cases before the Tax Court.  You can reach at attorney by calling us at 305.350.5690 or by emailing us at: contact@fuerstlaw.com.

In line with our recent coverage of the Internal Revenue Service’s initiatives to pursue illegal offshore tax havens, on May 16, 2013 a Florida couple – Drs. David Leon Fredrick and Patricia Lynn Hough – was indicted by a federal grand jury in Fort Myers, FL for conspiring to defraud the IRS. A U.S. Department of Justice press release on the indictment can be found here. Our recent coverage of the IRS’s recent efforts to pursue offshore tax evasion, including IRS’s John Doe Summons to Wells Fargo seeking information about the First Caribbean International Bank, may be reviewed here, here, here, and here.

According to the Department of Justice, the couple, both of whom work as physicians in the Sarasota area, conspired with a Swiss citizen currently under indictment in the Southern District of New York, and a banker from the United Bank of Switzerland (“UBS”) to defraud the IRS. The indictment goes on to describe that the couple used nominee entities and undeclared bank accounts in their names and the names of the nominee entities at several foreign banks, including UBS, for the purposes of illegal tax evasion. It is further alleged that the couples’ assets and income, including proceeds from real estate sales for more than $33 million, were deposited into undeclared foreign bank accounts. The Department of Justice claims the couple instructed Swiss bankers via email, telephone, and in-person meetings to make investments and funds transfers to undeclared accounts at UBS. Those undeclared funds were then allegedly used to purchase an airplane, several homes in North Carolina, a Florida condominium, and funds transfers of over $1 million to relatives.

The couple was additionally charged with falsifying tax returns between 2005 and 2008 by substantially underestimating their income and failing to report their foreign accounts. A trial date has yet to be set, but the charges carry the possibility of imprisonment for up to five years for the conspiracy charges and three years for each false tax return filing. The charges also carry penalties of $250,000 for each count.

This indictment offers a real world example of the severe consequences that U.S. taxpayers can face for the non-disclosure of foreign accounts to the IRS. Individuals who believe that they may be in violation of foreign account disclosure requirements under United States tax law should take a moment to read our discussion regarding the mitigation of possible criminal culpability, penalties, and fines under the IRS’s Offshore Voluntary Disclosure Program (“ODVP”) which can be found in Part II of our discussion of the IRS’s initiatives to curb offshore tax evasion in the Caribbean.

Furthermore, as noted in the Department of Justice’s press release, U.S. citizens, resident aliens, and legal permanent residents alike should be aware of their obligations to report their financial interest in, or signatory authority over, a foreign account in a particular year on Schedule B of the U.S. Individual Tax Return, Form 1040, when filing their tax returns.

This issue is a critical one for U.S. taxpayers holding foreign accounts, as well as the professionals advising them. The IRS is continuing to ensure that offshore tax evasion is eradicated and, based on recent history, it appears to have no intentions of leaving any stone unturned.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers who have undisclosed foreign bank accounts and have availed themselves of the IRS’s voluntary disclosure program. We also have considerable experience litigating against the Department of Justice and the IRS in civil and criminal tax matters. We will continue to monitor the development of this issue, and we will update this blog with relevant information as this issue continues to develop. You can reach an attorney by calling us at 305-350-5690 or emailing us at contact@fuerstlaw.com.

In our most recent discussion of the IRS’s Offshore Enforcement Initiatives, found here, we discussed the John Doe Summons recently issued by the U.S. Department of Justice to Wells Fargo seeking information about First Caribbean National Bank and how it could affect foreign account holders in the U.S. We went on to discuss the IRS’s Offshore Voluntary Disclosure Program (“OVDP”), how it worked, and some issues that foreign account holders and foreign entities should consider when deciding whether or not to participate in the program. In this article, we explore how the most recent John Doe summons made its way to the Caribbean and why the IRS has become so interested in pursuing offshore account holders. We begin our discussion with a brief history of what has transpired since the establishment of the IRS’s OVDP back in 2009.

The IRS’s Criminal Manual has encouraged the voluntary disclosure of hidden offshore accounts for many years preceding the establishment of the OVDP. However, prior to the 2009 OVDP, the IRS had no formalized method for determining penalties. This lack of uniformity in making penalty determinations resulted in non-compliant taxpayers being reluctant to disclose information that would expose them to unpredictable financial liability. In response to these concerns and to promote transparency and uniformity, the IRS established the OVDP as a centralized means of processing voluntary disclosures that offered a uniform penalty structure, consistency, and predictability for taxpayers; see IRS discussion of OVDP objectives here.

The IRS’s efforts to increase offshore account transparency through the OVDP have been extremely successful. Since the establishment of the OVDP, the IRS and Tax Division of the Department of Justice have collected a wealth of data regarding previously undisclosed accounts and used this information to aggressively pursue U.S. taxpayers attempting to evade U.S. taxes and violate the Bank Secrecy Act.

Most notably, in February 2009, the Union Bank of Switzerland (“UBS AG”), Switzerland’s then largest bank, entered into a deferred prosecution agreement with the Department of Justice on charges of conspiring to defraud the United States by impeding the IRS. As part of this agreement, UBS AG paid the U.S. $780 million and surrendered data for nearly 5,000 U.S. clients who held United States securities in UBS AG accounts. Due to the intense pressure from U.S. law enforcement, most Swiss banks appear to have abandoned the practice.

Wegelin & Co. (“Wegelin”), the oldest Swiss private bank, saw this as an opportunity to capture market share and allegedly, at the direction of senior management, made efforts to attract old UBS AG clients. Under the assumption that there was no nexus between itself and the U.S. and its compliance with Swiss laws, Wegelin believed itself to be safe from exposure to U.S. prosecution. However, as noted in our previous discussion on this topic, when foreign banks assist U.S. taxpayers in committing tax evasion, a lack of physical nexus is irrelevant.

Wegelin guessed wrong and paid the ultimate price. In January 2013 the bank plead guilty to facilitating U.S. tax evasion by helping over 100 U.S. taxpayers hide more than $1.2 Billion in undeclared assets between 2002 and 2011. In total, Wegelin was required to pay the U.S. about $74 million in restitution, fees, and penalties and was ultimately forced to close. We previously reported on Wegelin’s indictment here and the final penalty issued to Wegelin here.

The success of the OVDP is unquestionably influencing the IRS’s continued focus on tracking down individuals involved in illegal offshore tax evasion. Following UBS AG’s deferred prosecution agreement, the flood gates opened for voluntary disclosure, resulting in the IRS collecting a treasure trove of information and forcing approximately 38,000 disclosures and well over $5 billion in taxes, interest, and penalties. Undoubtedly, the huge volumes of information and disclosures in the wake of the UBS AG indictment are leading to increased identification of key players and institutions that facilitate illegal offshore account activity for U.S. taxpayers.

The continued success of this program has clearly led the IRS to keep the OVDP active indefinitely; see the IRS’s announcement regarding the program remaining open indefinitely here. The IRS’s commitment to the initiative is clear; it seems to have found a formula for promoting disclosure of hidden foreign accounts that is working and it has no intentions of easing up.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers who have undisclosed foreign bank accounts and who have availed themselves of the IRSs voluntary disclosure program. We will continue to monitor the development of this issue, and we will update this blog with relevant information as often as possible. You can reach an attorney by calling us at 305-350-5690 or emailing us at contact@fuerstlaw.com.

Introduction

On April 30, 2013, the United States Department of Justice issued a “John Doe Internal Revenue Code” summons to Wells Fargo Bank, as a provider of correspondent bank services for Canadian Imperial Bank of Commerce’s First Caribbean International Bank (“FCIB”), requiring it to turn over records relating to accounts held at FCIB by United States Taxpayers between 2004 through 2012.  The issuance of this summons is one of the aftershocks of the UBS AG debacle that destroyed Switzerland’s bank secrecy laws. [A discussion on this issue can be found here]. You can read more about the Department of Justice’s John Doe summons to Wells Fargo here.

Because First Caribbean operates in 18 Caribbean countries, it is inevitable that the issuance of the Department of Justice’s summons will reveal thousands upon thousands of U.S. account holders who reside in the United States, and particularly South Florida.  It is also inevitable that some of these U.S. account holders will be prosecuted for failing to disclose their accounts overseas.  Additionally, it is virtually certain that the Department of Justice will start issuing John Doe summonses to other banking institutions that maintain correspondent accounts.

Because of the urgent nature of this issue for holders of foreign accounts who may be unaware of their reporting requirements, and the consequences of failing to report their foreign accounts, over the course of several articles we will present a comprehensive overview of the IRS’s most recent efforts to thwart offshore tax evasion and raise money for the government through tax collection efforts. Additionally, we will explore the intricacies of this issue attempt to explain exactly what the IRS is doing here.

In this article, Part I includes a discussion of what exactly a “John Doe Summons” is and what effects the summons issued to FCIB may have on foreign account holders. Part II of this article focuses on immediate actions expected “violators” can/should take to insulate themselves from prosecution.

Part I:
The John Doe Summons: Who is John Doe?

So what exactly is a John Doe Summons and why is it particularly dangerous for US taxpayers with accounts abroad?

First, “[f]or the purpose of ascertaining the correctness of any return, making a return where none has been made, [or] determining the liability of any person for any internal revenue tax…”, the Internal Revenue Code empowers the Secretary of the Treasury, or its delegate, “[t]o summon the person liable for tax or required to perform the act…or any person having possession, custody, or care of books of account containing entries relating to the business of the person liable for tax or required to perform the act, or any other person the Secretary may deem proper…to produce such books, papers, records, or other data, and to give such testimony…as may be relevant or material to such inquiry.” 26 U.S.C. §§ 7602(a), 7701(11). The IRS power to summon extends even to those situations in which the identity of the taxpayer is unknown. 26 U.S.C. § 7609(f). Where the IRS seeks to summon information that pertains to an unknown taxpayer and is in the custody of a third party, the United States must first make a showing to a court that: 1) its investigation relates to an ascertainable class of persons; 2) a reasonable basis exists for the belief that these unknown taxpayers may have failed to comply with Internal Revenue Laws; and 3) the United States cannot obtain the information sought from another readily available source. Id.

The unknown or unspecified name of the target taxpayer gives rise to the notion of “John Doe.” The IRS defines a John Doe Summons as “any summons where the name of the individual taxpayer under investigation is unknown and therefore not specifically identified.” John Doe summonses are utilized by the IRS primarily to identify individuals participating in activities that would violate internal revenue laws or the Bank Secrecy Act and have most recently been utilized to uncover information regarding foreign accountholders who are illegally failing to report their offshore assets under U.S. tax law. Because the summons allows the IRS to seek information about unspecified taxpayers, the IRS commonly uses them as a means to collect information on an extraordinarily broad scale from financial institutions wherever located.

Although maintaining an offshore account is perfectly legal, United States tax law requires that a Foreign Bank Account Report or (“FBAR”) be filed with the United States Treasury for any citizens holding foreign accounts with balances exceeding $10,000.00 at any time during the calendar year. Under the FBAR regulations, deliberate failure to report a foreign account with a value that exceeds the threshold amount can result in penalties up to 50 percent of the amount in the account at the time of the violation. Of late, the IRS has been making concerted efforts to ensure that taxpayer who evade these reporting requirements are punished and John Doe Summonses have been the IRS’s weapon of choice.

In this most recent summons, IRS served Wells Fargo’s San Francisco branch which maintains correspondent accounts for the Barbados-based FCIB. Correspondent accounts are bank deposit accounts maintained by one bank for another. Typically, correspondent accounts are held by foreign banks without branch offices in the U.S. that do business in U.S. dollars. The United States Department of Justice is expecting that this summons will produce significant information about the account holders as well as the amount of money moved through their accounts. Beyond the identification of tax evaders, the John Doe summons also requires Wells Fargo to produce its own internal anti-money laundering compliance reports.

In a U.S. Department of Justice Press release found here, Kathryn Keneally, Assistant Attorney General for the Justice Department’s Tax Division, stated as follows: “The Department of Justice and the IRS are committed to global enforcement to stop the use of foreign bank accounts to evade U.S. taxes…This John Doe summons is a visible indication of how we are using the many tools available to us to purse this activity wherever it is occurring. Those who are still hiding should get right with their country and fellow taxpayers before it’s too late.” IRS Acting Commissioner Steven T. Miller went on to say that “[t]his summons marks another milestone in international tax enforcement…our work here shows our resolve to pursue these case in all parts of the world regardless of whether  the person hiding the money overseas chooses a bank with no offices on U.S. soil.”

The summons to Wells Fargo naturally begs the question of whether the U.S. government can assert jurisdiction over foreign banks that have no branches or employees within the United States. In response, the U.S. government maintains that despite a bank employee never stepping foot on U.S. soil, if a foreign bank’s employees knowingly assist a U.S. taxpayer evade tax filing obligations, the bank itself can and will be held criminally liable. The way the U.S. Department of Justice sees it, if there is any conspiracy to violate U.S. tax law, the fact that the conduct took place overseas is irrelevant. IRS’s success in pursing illegal offshore account activity in Switzerland which led to the closure of the historic Swiss bank Wegelin & Co., which we previous discussed here and here, is instructive on this point. What is even more damning for FCIB is that its correspondent accounts held at Wells Fargo’s San-Francisco branch further established the nexus – however limited – between it and the U.S. 

This John Doe summons will result in significant exposure to prosecution for foreign account holders, banks, bankers, and account facilitators such as insurance companies, lawyers, accounts and investment advisors who the IRS has suspected of facilitating tax evasion in the United States. Given the nature of the new international information sharing agreements, the disclosure of account names and information is becoming more frequent and intrusive. For example, the Foreign Account Tax Compliance Act  (“FATCA”) was implemented in 2010 to encourage non-U.S. financial institutions to “voluntarily” disclose their U.S. account holders to the IRS and requires foreign financial institutions to report information about financial accounts held by U.S. taxpayers, or held by foreign entities in which U.S. taxpayers hold a substantial ownership interest directly to the IRS. [See IRS press release here.]

These IRS initiatives to identify individuals evading taxes are moving forward, and as such, foreign account holders and those associated with facilitating those accounts both domestically and abroad will need to prepare themselves to quickly become compliant with U.S. tax laws or prepare for a legal battle with the IRS.

Part II:
The Offshore Voluntary Disclosure Program

We now look more closely at the IRS’s Offshore Voluntary Disclosure Program and what steps suspected holders of unreported offshore accounts can immediately take to mitigate penalties, fines, and possible criminal prosecution.

In 2009, as a means of encouraging U.S. taxpayers to report previously undisclosed income, the IRS created the first offshore disclosure initiative. This initiative was coined the Offshore Voluntary Disclosure Program (“OVDP”) and was a response to the IRS prosecution of wealthy Americans who evaded taxes with the help of UBS AG (located in Switzerland) along with information obtained from disclosures of former UBS AG banker Bradley Birkenfeld in 2008.[ We have previously blogged on the OVDP here, here, and here] This program was considered a success, reportedly collecting over $4 Billion between its inception in 2009 and 2011 and nearly $5 Billion to date. Furthermore, the OVDP has resulted in over 34,500 disclosures and led to information that has assisted the IRS in furthering its investigation into other offshore tax jurisdictions. [See IRS press release on OVDP success here.] Consequently, in 2012, the IRS decided to eliminate any deadlines and kept the program as an open ended vehicle for investigating tax evasion and collecting tax revenue.

The OVDP currently focuses on the main vehicles of offshore tax evasion – unreported foreign financial accounts and unreported foreign entities, examples of which include depositing unreported and untaxed income into foreign accounts and/or omitting investment income earned from the foreign account on tax returns.  Under the OVDP, current tax evaders are encouraged to report previously undisclosed foreign accounts through reduced penalties and elimination of criminal prosecution risks for evasion.

For example, by entering into the OVDP, the IRS will waive FBAR non-compliance penalties. Foreign Bank Account Report (“FBAR”) violations range from $10,000 per account per year of unreported foreign bank accounts exceeding $10,000 during any point in a calendar year to the greater of $100,000 or 50 percent (50%) of the maximum balance of the foreign account exceeding $10,000. In contrast, the ODVP rates general degrees of willful tax evasion, and penalizes tax evaders based upon the underlying severity of the evasive acts. The threshold limits are a respective 27.5%, 10%, and 5% of the maximum foreign account balance based on the three different levels of willfulness.

Beyond its focus on FBAR violations, OVDP also looks to unreported foreign entities. Tax evasion schemes created through sophisticated foreign trusts, corporations, and partnerships that do not report this foreign entity to IRS on annual tax returns are susceptible to between $10,000 and $50,000 in penalties. OVDP however, affords the same 27.5%, 10%, and 5% mitigated penalties for disclosures of foreign business entities.

Individuals and businesses fearful of being identified of illegally evading taxes through undisclosed foreign financial accounts must ultimately assess the prospective risk of penalties and/or criminal prosecution when reviewing their foreign accounts and should consider whether the OVDP is their best option for solving their tax issues. When making this assessment, foreign account holders should be mindful of the following rules under OVDP:

• The 27.5%, 10%, and 5% penalties apply to all assets related to tax evasion.
• The OVDP only covers the most recent 8 tax years.
• The OVDP penalties apply to all tax evasion-related assets that may be both directly and indirectly owned by the tax payer. i.e. the beneficiary of a foreign trust account  that maintains $500,000 will be applied under OVDP the same as a $50,000 car purchased with funds from a non-compliant FBAR account.

When making this final decision we suggest that foreign accountholders contact a competent professional with specialization in offshore disclosures, FBAR compliance, and asset protection to ensure that the accountholder is making the decision that is best suited for his or her specific financial situation.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers who have undisclosed foreign bank accounts and who have availed themselves of the IRSs voluntary disclosure program. We will continue to monitor the development of this issue, and we will update this blog with relevant information as often as possible. You can reach an attorney by calling us at 305-350-5690 or emailing us at  contact@fuerstlaw.com.

Introduction:

In a March 28, 2013 decision, New York’s highest state court, the New York State Court of Appeals, held that New York’s “click-through” nexus statute, Tax Law § 1101 (b)(8)(vi), does not violate the United States Constitution under either the Commerce Clause or Due Process Clause. [A copy of the opinion can be found here.] This click-through nexus statute, typically referred to as the “Internet Tax”, extends state income taxability to internet retailers who employ website owners residing in New York to advertise for them. The growing popularity of click-through nexus liability and general e-commerce taxability nationwide has become problematic for major ecommerce sites such as Overstock and Amazon, and resulted in significant increases in tax exposure for internet retailers that utilize click-through advertising to increase traffic to their websites.

What is a “Click-Through” Nexus?

So what exactly is this “click-through” or “affiliate” Nexus? In 2008, New York was the first state to enact this form of legislation. The basic premise of this legislation is to update the way in which state governments assert sales and use tax guidelines to reflect advancements in modern technology. The New York legislature was able to accomplish this by amending the Tax Law. More specifically, the New York legislators amended the statutory definition of “vendor” under this law to include:

A person making sales of tangible personal property or services taxable under this article (“seller”) shall be presumed to be soliciting business through an independent contractor or other representative if the seller enters into an agreement with a resident of his state under which the resident, for a commission or other consideration, directly or indirectly refers potential customers, whether by a link on an internet website or otherwise, to the seller, if the cumulative gross receipts from sales by the seller to customers in the state who are referred to the seller by all residents with this type of an agreement with the seller is in excess of ten thousand dollars during the preceding four quarterly periods.

(Tax Law § 1101 (b)(8)(vi)). This definition was further clarified by a memorandum issued by the New York Department of Taxation and Finance [a copy of the memorandum can be found here] which made it clear that the presumption of taxation is rebuttable if the web site owner did not engage in any solicitation in New York that would result in a finding of nexus under constitutional standards.

Amazon and Overstock’s Failed Attempt to Challenge Tax Law

The establishment of this “click-through” nexus was challenged by two of the biggest internet retailers, Amazon.com and Overstock.com two days after the statute was enacted in New York in 2008. Both retailers argued that although they ship items to buyers worldwide (including New York), neither has any employees who work or reside in New York and neither maintains offices or property in New York. On the other hand, both Amazon and Overstock maintain affiliate programs whereby associates can maintain links to the respective retailers home pages in turn for a commission based on sales.

Amazon challenged the Tax Law on the grounds that it was an unconstitutional violation of Commerce, Due Process, and Equal Protection clauses. Overstock filed a complaint raising the same issues. These challenges were dismissed in both instances at the trial level. On appeal, the New York Supreme Court affirmed portions of the dismissals, but reinstated the case to determine if the statute violated the Commerce or Due Process Clauses. Amazon and Overstock then appealed their facial constitutional challenges to New York’s highest court, the New York State Court of Appeals.

In deciding the case, the New York State Court of Appeals wrote that it was bound by the U.S. Supreme Court’s holding in Quill Corp. v. North Dakota 504 U.S. 298 (1992), which found that physical presence in the state itself did not need to be substantial in order to establish a nexus with that state. All that is required is more than a “slight presence.” In Quill, the Supreme Court found that a mail-order business that solicited business in a state absent any other physical presence was sufficient to satisfy the nexus requirement. Drawing parallels between Quill‘s mail-order business and the internet retailers’ in-state solicitations, the New York Court of Appeals found that the presence requirement was satisfied so long as economic activities were performed in the state by a seller’s employees or on its behalf. As such, no facial violation of the Commerce Clause occurred.

Similarly, the New York Court of Appeals found that there were no facial violations of Due Process under Quill. The Court of Appeals determined the Commerce and Due Process challenges to be “closely related” and noted that physical presence was not necessary to trigger the Due Process Clause. In support of this holding, the Court of Appeals noted that under Amazon and Overstock’s compensation schemes, New York website owners were paid directly for referrals that resulted in purchases. The Court of Appeals determined that this direct correlation between compensation and referrals illustrated that New York residents were encouraged to actively solicit customers in the state, thus subjecting them to state taxes.

Growing Popularity of Internet Taxation

New York is not the only state that is aggressively moving toward the expansion of click-through taxation. Since 2008, click-through nexus statutes have grown in popularity and spread to several other states. Many states have similarly revised their definitions of terms such as “vendor,” “maintaining a place of business,” and “doing business in” to include remote sellers into their definition of characters susceptible to that respective state’s nexus requirement. Currently, Arkansas, California, Colorado, Connecticut, Georgia, Illinois, New York, North Carolina, Rhode Island, and Vermont have similar click-through statutes. Additionally, Florida, Hawaii, Indiana, Iowa, Kansas, Maine, Massachusetts, Michigan, Minnesota, Mississippi, New Mexico, Pennsylvania and West Virginia have introduced nexus legislation that target remote sellers.

The complete erosion of internet tax exemptions seem to be imminent as states that are in desperate need of funds are looking for new ways to collect additional tax dollars. However, this trend is not just prevalent in state legislatures. In fact, there is currently an Internet Sales Tax law called the “Marketplace Fairness Act” advancing through the United States Congress that would effectively allow 45 states and the District of Columbia to demand that online retailers collecting more than $1million per year in sales collect sales tax on all purchases – irrespective of the internet retailer’s physical presence in a specific state.

This bill is expected to pass the Senate soon and has been projected to result in the collection of between $22 billion and $24 billion in additional tax revenue. The National Retail Federation and many brick-and-mortar retailers are supporting these initiatives due to the loss of traditional retail sales to the online marketplace. They also argue that uniform taxation across these different sales channels could help level the playing field between all retailers.

Small businesses and e-commerce sites, on the other hand, are not as thrilled. There are approximately 9,600 individual tax jurisdictions throughout the United States, all of which have unique tax laws and regulations. While there is significant infrastructure and software to help businesses keep track of the different applicable tax regulations, one can expect significant switching costs for implementation and training – costs that will likely hit small internet businesses and start-ups the hardest.

In support of small business e-commerce sites, EBay has most recently become a part of the efforts to fight these proposed taxing schemes. Recently, EBay CEO, John Donahoe, urged EBay’s merchants to write their respective congressmen and express their disagreement with the legislation. Donahoe has made the claim that the proposed tax legislation would be harmful to small businesses and suggested that the threshold for this tax be raised from the proposed $1 million per year in sales to $10 million per year in out-of-state sales and less than 50 employees. This proposal that could be considered reasonable when, as John Donahoe noted, Amazon makes more than $10 million of sales every 90 minutes.

Concluding Thoughts

As this issue progresses, it will be interesting to see how courts will reconcile internet tax legislation like the Marketplace Fairness Act with the “more than a slight” presence requirement outlined in the Quill holding. The expansion of internet taxation seems to be inevitable, and in the event that the Marketplace Fairness Act becomes law, there will be even less of a connection between the respective taxing jurisdictions and internet retailers. Consequently, we may see the Quill case interpretation broadened; further altering the historic interpretation of the Commerce Clause to keep pace with modern technology.

While consumers and small businesses will likely feel the effects of this proposed legislation the most, it is important to note that irrespective of internet retailers’ presence, the responsibility has been on consumers to report uncollected taxes on internet purchases from day one – a responsibility that has for the most part been ignored. In the states’ defense, they are not creating any new responsibility to pay taxes or arbitrarily taxing retailers, but rather attempting to reconfigure legislation so as to ensure that these sales taxes are actually being collected. From an economic standpoint, this should not be very shocking. About $20 billion in uncollected tax funds are being left on the table, an amount that is too large for states desperately seeking additional revenue to overlook any longer. Long story short, it looks like the free ride may be over for savvy shoppers and the internet retailers who have shifted tax savings to their customers.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience litigating against the IRS and the U.S. Department of Justice and have appeared before the U.S. Tax Court, the various U.S. District Courts, the U.S. Court of Federal Claims, and the various U.S. Courts of Appeal. You can contact an attorney by emailing us at contact@fuerstlaw.com or by calling us at 305.350.5690.

Disclosure: Joseph A. DiRuzzo, III of Fuerst Ittleman David & Joseph was part of the trial team that representedthe taxpayers in the June 2010 bench trial in the District Court of the Virgin Islands.

On April 17, 2013, the United States Court of Appeals for the Third Circuit overturned, in part, the ruling of the District Court of the Virgin Islands that the taxpayers were not bona fide U.S. Virgin Islands residents under I.R.C. section 932. The case is V.I. Derviates ex. rel. Vento v. Director of Virgin Islands Bureau of Internal Revenue, et al., case nos. 11-2318, 11-2319, 11-2320, 11-2321, 11-2322,11-2603, 11-2618, 11-2619, 11-2620, 11-2621, 11-2622, 11-2623,11-2624, 11-2625, 12-1416 and 12-1417. The Third Circuit’s precedential decision is available here.

The Vento case is a major win for taxpayers fighting the IRS over Virgin Islands residency and has major implications for those taxpayers who took tax credits for participating in the Virgin Islands Economic Development Program (EDP).

The facts of the case are as follows:

Richard and Lana Vento are married and filed a joint 2001 tax return with the VIBIR. In May 2001, the Ventos (through a limited liability company they controlled) contracted to buy Estate Frydendahl, a residential property on St. Thomas, for $7.2 million. Estate Frydendahl—which included a five-bedroom main house and several outlying buildings, including three two-bedroom cottages with kitchens—was sold furnished, and the transaction closed on August 1, 2001. At the time of purchase, the sellers were living in some of the outlying buildings, but the main house was vacant.

The Ventos hoped that renovations to Estate Frydendahl could be completed in time for them to move in by Christmas 2001. Progress was slow, however, and the Ventos grew frustrated. Consequently, in the late fall of 2001, Lana Vento brought in Dave Thomas, a construction manager whom she had previously hired to work in Hawaii, to supervise the project. In December 2001, Thomas travelled to the Virgin Islands and concluded that the main house at Estate Frydendahl was 50 percent livable, but the normal amenities, including water and electricity, did not work properly or consistently.

The Vento family (including Richard and Lana, as well as their daughters Nicole Mollison, Gail Vento, and Renee Vento) was on St. Thomas for the holiday season in December 2001. Nicole Mollison returned to Nevada with her husband and children on December 26, 2001, while the other Vento family members and guests stayed on St. Thomas through New Year’s Eve. Afterwards, the Ventos began to split their time between the Virgin Islands and the mainland. Lana visited the Virgin Islands most frequently because she was overseeing the construction efforts at Estate Frydendahl. She would spend between one and six weeks at a time there, then leave for another six weeks. During the first five months of 2002, Richard spent 35 days in St. Thomas, 23 days in San Francisco, and 41 days in Nevada. Richard also spent considerable time in Hawaii in 2002.

In addition to purchasing Estate Frydendahl, Richard became interested in participating in the Virgin Islands’ Economic Development Program (EDP), which offers very favorable tax treatment to certain approved Virgin Islands companies. Based on legal advice Richard received regarding the EDP between May 2001 and August 2001, he founded three companies in the Virgin Islands: (1) Virgin Islands Microsystems, which was to perform nanotechnology research; (2) Edge Access, which was to build internet access devices; and (3) VI Derivatives, LLC, which the VIBIR and IRS later deemed a sham partnership. Ultimately, only Virgin Islands Microsystems was approved to receive EDP benefits, and that approval did not occur until 2002.

In 2005, the Virgin Islands Bureau of Internal Revenue (VIBIR) issued Notices of Deficiency and Final Partnership Administrative Adjustments (FPAAs) to Richard Vento, Lana Vento, Nicole Mollison, Gail Vento, and Renee Vento and partnerships they controlled, assessing a deficiency and penalties of over $31 million against the Ventos and approximately $6.3 million against each of their three daughters (Nicole, Gail, and Renee). The VIBIR also concluded that two Vento-owned partnerships, VI Derivatives, LLC and VIFX, LLC were shams and disregarded them for tax purposes.

That same year, the IRS issued FPAAs that were nearly identical to those issued by the VIBIR. Significantly, however, the IRS also issued FPAAs to two other Vento-controlled partnerships. The Taxpayers challenged the VIBIR’s and IRS’s Notices of Deficiency and FPAAs in several separate proceedings in the District Court of the Virgin Islands.

The United States, on behalf of the IRS, intervened in the cases between the Taxpayers and the VIBIR, arguing that the Taxpayers should have filed and paid their 2001 taxes to the IRS instead of the VIBIR because they were not bona fide residents of the Virgin Islands.

In June 2010, the District Court in the Virgin Islands conducted a bench trial. The sole issue at trial was whether the Taxpayers were bona fide residents of the Virgin Islands as of December 31, 2001. The District Court held that they were not, and the Taxpayers, joined by the VIBIR, appealed.

The Virgin Islands taxation statutory scheme is known as the “Mirror Code,” under which the Internal Revenue Code is applied to the Virgin Islands merely by substituting “Virgin Islands” for “United Sates” throughout the Internal Revenue Code. However, Virgin Islands residents are subject to different tax filing requirements than other United States citizens. Under the version of 26 U.S.C. § 932(c) applicable in these appeals, taxpayers who are “bona fide resident[s] of the Virgin Islands at the close of the taxable year are required to” file an income tax return for the taxable year with the Virgin Islands. 26 U.S.C. § 932(c) (1986).

Thus, bona fide Virgin Islands residents who fully report their income and satisfy their obligations to the VIBIR do not pay taxes to the IRS. See Abramson Enters., Inc. v. Gov’t of Virgin Islands, 994 F.2d 140, 144 (3d Cir. 1993), available here. This is true even if the bona fide Virgin Islands resident is also a resident of the mainland United States. Slip op. at 19 (emphasis added).

As outlined by the Third Circuit, the meaning of “residency” may vary according to context. Martinez v. Bynum, 461 U.S. 321, 330 (1983). In the tax context, residency requires far less than domicile. Sochurek v. Comm’r, 300 F.2d 34, 38 (7th Cir. 1962); see also Croyle v. Comm’r, 41 T.C.M. (CCH) 339 (1980) (“[T]he citizen need not be domiciled in a foreign country…in order to be classed as a resident for Federal income tax purposes.”) Furthermore, while a person can have only one domicile, he can be a resident of multiple places at the same time.

As the Third Circuit explained, the intent to become a resident is not necessarily the intent to make a fixed and permanent home. Rather, it is the intent to remain indefinitely or at least for a substantial period in the new location. According to the Third Circuit, both Richard and Lana Vento intended to become Virgin Islands residents as of December 31, 2001. That intent was evidenced by their purchase of Estate Frydendahl and their ongoing business interests in the Virgin Islands. “And while the Ventos undoubtedly were motivated to live in the Virgin Islands because of its relatively favorable tax system, there is nothing unlawful or deceitful about choosing to reside in a state or territory because of its low taxes. Therefore, the District Court erred when it held that those motivations counseled against the Ventos‘ bona fide residency claims.” Slip op. at 31-32 (emphasis added).

The Ventos’ purchase and renovation of Estate Frydendahl showed that, by the end of 2001, they planned to remain in St. Thomas at least for a substantial period. Months before the end of 2001, the Ventos purchased Estate Frydendahl for $6.75 million, and began a renovation process that would eventually cost them another $20 million. This substantial outlay, approximately three times the size of the tax controversy in this case, was deemed by the Third Circuit to be strong evidence that the Ventos were not purchasing a sham property to avoid paying taxes, but rather that they had a bona fide intent to remain indefinitely or at least for a substantial period in the Virgin Islands. Richard Vento’s establishment of business interests in the Virgin Islands further supported his claim of bona fide residency.

Under Sochurek, a taxpayer’s unlawful tax evasion motives can clearly be considered evidence against bona fide residency. However, in this case, the Third Circuit held that the Ventos’ desire to take lawful advantage of more favorable tax treatment in the Virgin Islands did not undermine their claim of bona fide residency. Significantly for all pending Virgin Islands tax cases, the Third Circuit held as follows:

[A] taxpayer’s sincere desire to change his residency in order to take advantage of lawful tax incentives does not undermine his claim of bona fide residency. If anything, such a motivation would support the taxpayer’s intent to establish bona fide residency, which is a prerequisite for taking advantage of the lawful tax incentives.

Slip op. at 33-34; (emphasis added).

In refuting the IRS’ claim of improper motive in establishing a residency in the Virgin Islands, the Court acknowledged the well-settled proposition that “[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.” citing Gregory v. Helvering, 293 U.S. 465, 469 (1935). Furthermore, the Court reiterated that “a taxpayer’s legitimate tax avoidance motives should not be held against him.” Slip op. at 37 citing Lerman v. Comm’r, 939 F.2d 44, 45 (3d Cir. 1991).

The Third Circuit faulted the District Court’s decision that the Ventos only moved to the Virgin Islands so they would be able to file tax returns with the VIBIR and not the IRS. The District Court’s decision was erroneous because that is precisely what Congress intended. The purpose of 26 U.S.C. § 932(c) is to “assist the [Virgin] Islands in becoming self-supporting” by “providing for local imposition upon the inhabitants of the Virgin Islands of a territorial income tax, payable directly into the Virgin Islands treasury. If a taxpayer decides to move to the Virgin Islands because he would prefer to file his taxes with the VIBIR rather than the IRS, that taxpayer is helping the Virgin Islands become self-supporting, so his move does not upon its face lie[] outside the plain intent of [§ 932(c)].”  Slip op. at 37. The Third Circuit concluded: “Using [the Ventos] desire to subject themselves to the mirror code as evidence that they did not intend to comply with it would be both incongruous and contrary to the Congressional scheme.”  Slip op. at 38.

Turning to physical presence, the Court viewed IRC § 932 as merely requiring that a taxpayer be a bona fide resident of the Virgin Islands at the close of the taxable year. Id. § 932(c)(1)(A) (1986). As stated by the Court:

Under the terms of § 932, a taxpayer can take advantage of its provisions even if he became a bona fide resident of the Virgin Islands only on the last day of the taxable year.

Slip op. at 40. Therefore, the Ventos’ presence or lack thereof in the Virgin Islands in the first part of 2001 sheds little light on their eligibility for § 932(c), which requires only that they be bona fide residents of the Virgin Islands at the end of 2001. Slip op. at 40.

In addition to being a huge win for the taxpayer and a huge loss for the IRS, this case is nothing short of a landmark in the longstanding dispute between the IRS and numerous individuals and entities which have attempted to participate in the Virgin Islands Economic Development Program. The IRS intervened in the District Court and essentially fought against the taxpayers and the Virgin Islands. The Third Circuit rebuffed the IRS and in doing so provided clear guidance regarding how participants in the Virgin Islands Economic Development Program are to be treated when faced with the claims of the IRS that they were not bona fide Virgin Islands residents and/or did not properly claim an EDP tax credit. Further, the fact that the taxpayers have multiple residences and moved to the Virgin Islands to participate in the Virgin Islands EDP will not be viewed against them, all of which strongly contradicts the IRS’s position that if a taxpayer has a residence in the 50 States he cannot be a bona fide Virgin Islands resident.

The attorneys at Fuerst Ittleman David & Joseph are actively litigating against the IRS, the United States, and the Virgin Islands Bureau of Internal Revenue in Virgin Islands residency cases in the District Court of the Virgin Islands, the U.S. Tax Court, the Third Circuit Court of Appeals, and the U.S. Court of Federal Claims. Additionally, Joseph A. DiRuzzo, III, is licensed to practice in the Virgin Islands and actually lived on St. Thomas for years before relocating to South Florida. Joseph A. DiRuzzo, III, is actively litigating federal tax cases (both civil and criminal) on St. Thomas and St. Croix.

You can contact us via email at: contact@fuerstlaw.com, or by telephone at 305.350.5690.

As has been widely reported, the United States District Court for the Southern District of New York sentenced Wegelin & Co, the oldest Swiss private bank, to pay an additional $58 million after it admitted to helping wealthy Americans evade taxes. The press release issued by the U.S. Attorney’s Office for the Southern District of New York is available here. Our prior report on the Wegelin indictment is available here and our prior report on the Wegelin guilty plea is available here.

As noted in the press release

Together with the April 2012 forfeiture of more than $16.2 million from WEGELIN’s U.S. correspondent bank account, this amounts to a total recovery to the United States of approximately $74 million. WEGELIN pled guilty in January 2013 to one count of conspiracy to defraud the IRS, file false federal income tax returns, and evade federal income taxes before U.S. District Judge Jed S. Rakoff, who also imposed today’s sentence. This case represents the first time that a foreign bank has been indicted for facilitating tax evasion by U.S. taxpayers and the first guilty plea and sentencing of such a bank.

Manhattan U.S. Attorney Preet Bharara said: “Wegelin has now paid a steep price for aiding and abetting tax fraud that should be heeded by other banks, bankers, and advisers who engage in the same conduct. U.S. taxpayers with undeclared accounts – wherever those accounts may be – should know that their bank may be next, and they should pay what they owe the IRS before we come find them.”

Wegelin, which had $25 billion in assets at the end of 2010, said at the time of its guilty plea in January said it would close.

Reuters described the March 4 hearing as follows:

During Monday’s hearing, [District Court Judge] Rakoff followed prosecutors’ recommendations and imposed a $22.05 million fine and ordered $20 million in restitution. He also entered an order finalizing $15.82 million in forfeitures, which he preliminarily approved at the time of the guilty plea.

But while Rakoff approved the plea deal, he said there was a “funny tension” between the U.S. Justice Department’s decision not to seek the maximum $40 million fine and its assertion Wegelin acted with “extreme willfulness.”

Rakoff said even including the $16.3 million the government recovered in April 2012 by seizing money in Wegelin’s U.S. correspondent account, the bank will be giving up just 12 percent of the 560 million Swiss francs ($613 million) it earned after it sold most of its assets to regional Swiss bank Raiffeisen last year.

“Not much pain there, is there?” Rakoff said.

Rakoff, who has previously rejected U.S. Securities and Exchange Commission settlements with Citigroup Inc and Bank of America Corp, ultimately accepted the proposal, which prosecutor Daniel Levy called “very substantial.”

What does the prosecution mean for U.S. taxpayers? While it remains to be seen, it appears that the U.S. Government’s attempt to increase the pressure on U.S. taxpayers and foreign banks that have assisted U.S. taxpayers with skirting their reporting obligations has not slowed at all. In fact, it appears to be increasing. The result is that U.S. taxpayers who still are attempting to hide their assets out of the country to avoid U.S. taxation may be losing their window of opportunity to make amends and pay civil penalties and avoid criminal prosecutions.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in navigating the world of offshore bank accounts and the reporting requirements of U.S. taxpayers with the IRS. One can contact an attorney by emailing us at contact@fuerstlaw.com or by calling us at 305.350.5690.

On February 25, 2013, the United States Court of Appeals for the Third Circuit in the case of Crispin v. Commissioner, ___ F.3d ___, 2013 U.S. App. LEXIS 3852 (3d Cir. 2013), available here, affirmed the decision of the Tax Court (Crispin v. Comm’r, T.C. Memo 2012-70, available here) which held, among other things, that the CARDS tax shelter did not result in an ordinary loss deduction for the taxpayer. The Third Circuit described the CARDS transaction as follows:

A CARDS transaction is a tax-avoidance scheme that was widely marketed to wealthy individuals during the 1990′s and early 2000′s. It purports to generate, through a series of pre-arranged steps, large “paper” losses deductible from ordinary income. First, a tax-indifferent party, such as a foreign entity not subject to United States taxation, borrows foreign currency from a foreign bank (a “CARDS Loan”). Then, a United States taxpayer purchases a small amount, such as 15 percent, of the borrowed foreign currency by assuming liability for a an equal amount of the CARDS Loan. The taxpayer also agrees to be jointly liable with the foreign borrower for the remainder of the CARDS Loan and so the taxpayer purports to establish a basis equal to the entire borrowed amount.

The Commissioner contends that that step in the CARDS transaction “is predicated on an invalid application of the … basis provisions of the Internal Revenue Code.” (Appellee’s Br. at 4.) Specifically, I.R.C. § 1012 (available here) provides that a taxpayer’s basis in property is generally equal to the purchase price paid by the taxpayer. That purchase price includes the amount of the seller’s liabilities assumed by the taxpayer as part of the purchase, on the assumption that the taxpayer will eventually repay those liabilities. See Comm’r v. Tufts, 461 U.S. 300, 308-09 (1983) (available here) (noting that a loan must be recourse to the taxpayer to be included in basis). But in a CARDS transaction, the Commissioner argues, the taxpayer and the foreign borrower agree that the taxpayer will repay only the portion of the loan equal to the amount of currency the taxpayer actually purchases.

Finally, the taxpayer exchanges the foreign currency he purchased for United States dollars. That exchange is a taxable event, and the taxpayer claims a loss equal to the full amount of his supposed basis in the CARDS Loan, less the proceeds of the relatively small amount of currency actually exchanged. The taxpayer uses that loss to shelter unrelated income. The general structure of a CARDS transaction is well and thoroughly set forth in Gustashaw v. Commissioner, 696 F.3d 1124, 1127-28, 1130-31 (11th Cir. 2012), (available here)

We have previously blogged about the Gustashaw case, available here. Ultimately, the Third Circuit held in that case as follows: “In this case, there was ample documentary and testimonial evidence that contradicted Crispin’s account of the business purpose of his CARDS transaction, and the Tax Court did not abuse its discretion in deciding  not to credit Crispin’s evidence…” Consequently, the taxpayer was not entitled to the ordinary loss deduction.

Interestingly, the Third Circuit noted a circuit split regarding the imposition of the gross valuation misstatement penalty in § 6662(h), available here. A the Third Circuit described:

Our sister circuits are divided as to whether the valuation misstatement penalty applies to tax deductions that have been totally disallowed under the economic substance doctrine. Compare Fidelity Int’l Currency Advisor A Fund, LLC v. United States, 661 F.3d 667, 671-75 (1st Cir. 2011) (holding that the penalty is applicable), Zfass v. Comm’r, 118 F.3d 184, 190 (4th Cir. 1997) (same), Gilman v. Comm’r, 933 F.2d 143, 151 (2d Cir. 1991) (same), and Massengill v. Comm’r, 876 F.2d 616, 619-20 (8th Cir. 1989) (same), with Heasley v. Comm’r, 902 F.2d 380, 383 (5th Cir. 1990) (holding that when the IRS totally disallows a deduction, the underpayment is “not attributable to a valuation overstatement” but rather to claiming an improper deduction), Gainer v. Comm’r, 893 F.2d 225, 228 (9th Cir. 1990) (same), and Todd v. Comm’r, 862 F.2d 540, 543 (5th Cir. 1988) (holding that the penalty was inapplicable when the deficiency was not due to overstated basis but to a failure to place property into service). However, Crispin’s reliance on Todd and Gainer is misplaced because they do not state the law of this Circuit. See Merino v. Comm’r, 196 F.3d 147, 157-159 (3d Cir. 1999) (holding that the valuation misstatement penalty applies to property acquired in a transaction found to lack economic substance and expressly declining to follow Todd and Heasley).

Our reasoning as to the applicability of the valuation misstatement penalty finds support in the recent decision of the United States Court of Appeals for the Eleventh Circuit in Gustashaw, supra. In that case, the taxpayer conceded the tax deficiency that the Commissioner had assessed as a result of the disallowance of a CARDS Loan loss, so the economic substance issue was not before the Court, but the taxpayer contested the penalties. Applying the “majority rule,” the Eleventh Circuit held that the 40 percent penalty applies “even if the deduction is totally disallowed because the underlying transaction, which is intertwined with the overvaluation misstatement, lacked economic substance.” 696 F.3d at 1136. Also, the Fifth and Ninth Circuits “have questioned the wisdom of their positions” in Todd, Heasley, and Gainer because those positions create the “anomalous result” of relieving a taxpayer of the penalty when a deduction is disallowed because it is so egregious that it is improper for a reason other than valuation, such as a lack of economic substance, See Bemont Investments, L.L.C. ex rel. Tax Matters Partner v. United States, 679 F.3d 339, 355 (5th Cir. 2012) (Prado, J., concurring) (noting that the “Todd/Heasley rule,” by “[a]mplifying the egregiousness of the scheme — to the point where the transaction is an utter sham — could … , perversely, shield the taxpayer from liability for overvaluation”); Keller v. Comm’r., 556 F.3d 1056, 1061 (9th Cir. 2009) (recognizing that the rule as expressed in most Circuits, including Merino, is a “sensible method of resolving overvaluation cases” because it “cuts off at the pass what might seem to be an anomalous result — allowing a party to avoid tax penalties by engaging in behavior one might suppose would implicate more tax penalties, not fewer[,]” but acknowledging that, “[n]onetheless, in this circuit we are constrained by Gainer“).

The Crispin case, on its face, looks like a total loss for the taxpayer. However, given that in the Fifth and Ninth Circuits taxpayers can successfully attack the valuation misstatement penalty when the underlying deduction has been totally disallowed by the IRS, the Circuit divide on this issue could provide fertile ground to push back on the IRS in tax shelter litigation. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience litigating against the IRS and the U.S. Department of Justice in the U.S. Tax Court, the U.S. Court of Federal Claims, the various U.S. District Courts and Courts of Appeals in both civil and criminal tax cases. You can contact us by emailing us at: contact@fuerstlaw.com or by telephone at 305.350.5690.