Introduction

The Internal Revenue Service (IRS) announced a recent third Offshore Voluntary Disclosure Program (OVDP) for U.S. taxpayers with unreported foreign income or financial accounts. The OVDP eliminates potential criminal penalties and greatly reduces the civil (monetary) penalties for U.S. taxpayers with previously undisclosed foreign income and assets. In most cases, U.S. taxpayers participating in the OVDP must pay a penalty equal to 27.5 percent of the highest aggregate balance of their foreign assets since the 2003 tax year. For those who mistakenly failed to disclose their foreign assets, the OVDP may not be necessary and they could be subject to unnecessarily paying 27.5%. This is not to say that these individuals do not need to disclose their previously undisclosed foreign income and assets to the IRS; however, these individuals may be able to get the benefits of OVDP without paying the 27.5%.

The Current Laws Governing the Disclosure of Foreign Accounts

U.S. taxpayers with foreign bank or financial accounts (totaling more than $10,000 at any time of the year) are required to file a Report of Foreign Bank and Financial Accounts (FBAR) by June 30th of the following year in which the account was held. When a taxpayer calculates the highest balance during the year, he or she must use the applicable exchange rate on the last day of the calendar year.

Almost every type of foreign financial account in which a taxpayer has signature authority must be disclosed. This includes annuities and certain life insurance products. In addition, as a general rule, U.S. citizens and residents are taxed on and must report all foreign income received from the foreign accounts. A U.S. taxpayer may even have a filing requirement for foreign accounts in which he does not have a personal beneficial interest in the account. For example, a U.S. taxpayer serving as a power of attorney, nominee, or agent or an employee with signature authority on a foreign account could have a filing obligation.

The Basics of the 2012 OVDP

The 2012 OVDP program provides that participants will be subject to a penalty of 27.5 percent of the highest aggregate amount in all foreign accounts in which they had a financial interest from the 2003 through 2011 tax years. However, in some cases the penalty is reduced to 5 or 12.5 percent.

Participants of the OVDP may only be subject to a reduced 5 percent penalty for accounts not opened by the participant. In addition, the taxpayer must have only had a minimal contact with the account. Minimal contact means that the taxpayer had withdrawn no more than $1,000 per year. Nonresidents who paid taxes in their foreign country and earned less than $10,000 of U.S. source income may also be eligible for the 5 percent penalty.

Participants of the OVDP may be subject to a reduced 12.5 percent penalty if the aggregate value of their previously undisclosed foreign accounts did not exceed $75,000 for the 2003 through 2011 tax years. 

OVDP participants must file all 2003 through 2011 tax returns or amended tax returns. Participants must also pay all back federal taxes and interest on previously undisclosed foreign source income.  Participants must also pay an accuracy related penalty of 20 percent of the outstanding tax liability. In addition, participants will be liable to pay delinquency penalties for failure to timely pay taxes which could reach as high as 25 percent of the tax liability owed per
year.

When Participation in the OVDP is not Necessary

Participation in the OVDP may not be necessary if all foreign income had been previously reported on U.S. tax returns or foreign income is not reportable on a U.S. tax return, but FBARS have not been filed. In these cases, as long as all delinquent FBAR returns are filed with the IRS, the IRS will not likely seek to impose a penalty for failing to timely disclose the foreign bank accounts. However, a persuasive argument must be made convincing the IRS why the FBAR returns were not timely filed.   This exception also applies in cases where a Form 3520 annual return to report transactions with foreign trusts and receipt of certain foreign gifts was not timely filed. Form 3520 must be filed with the IRS when U.S. taxpayers received distributions from foreign trusts, foreign inheritances, or certain foreign gifts.
Situations in which foreign income is earned, but is not reportable income on a U.S. tax return can be tricky. Examples were foreign income may not result in U.S. taxation are as follows:

• A taxpayer establishes a foreign account in which the foreign government does not permit the individual to remove the funds for an extended period of time. These financial accounts are commonly referred to as “blocked accounts.”  In such cases, the IRS may defer foreign source income accrued in such account until it is paid to the U.S. taxpayer;
• A U.S. taxpayer resides, or resided, in a foreign country. While the U.S. taxpayer resided in a foreign jurisdiction he or she participated in a foreign pension trust that is considered to be a qualified plan for U.S. tax purposes. If the United States had a tax treaty in place with the foreign jurisdiction where the trust was located and the tax treaty contains language that provides relief with respect to the earnings of the pension trust, such treaty language may present a barrier to U.S. taxation in regards to distributions received from the foreign trust;
• The U.S. taxpayer has a joint account with a foreign alien and the account is located in a foreign country. All the assets belonging in the account were provided by the alien. In such a case, a position could be taken that the foreign source taxable income should be assigned to the foreign alien and not the U.S. taxpayer.

Above is a partial listing of cases in which foreign source income derived from a foreign account may not be subject to U.S. taxation. It should be noted that just because foreign source income may not be taxable in the U.S does not mean that these sources of income should be excluded from a U.S. tax return. On the contrary, these sources of income must be reported on a U.S. tax return and a disclosure must accompany the tax return with an explanation as to why the foreign source income is excludable from U.S. taxation.

Can the IRS Automatically Assess a Penalty against a U.S. Taxpayer who Innocently or Mistakenly Failed to Disclose a Foreign Bank Account?

Above, we discussed an important exception to participation in the OVDP program. But what about cases where a U.S. taxpayer innocently or mistakenly failed to disclose a foreign account and mistakenly failed to report foreign source income? Is such a taxpayer doomed to pay the 27.5 percent OVDP penalty? And if this taxpayer does not participate in the OVDP, is this taxpayer subject to the more serious willful failure to report a foreign account penalty? The willful failure to disclose a foreign account penalty provides that a taxpayer could be penalized the greater of 50 percent of the value of the undisclosed foreign account per year of omission or $100,000 for each year of omission.

Before we begin our discussion on this matter, it is important for all our readers to understand that the penalty for willfully failing to disclose a foreign account is not automatic. If a U.S. taxpayer innocently or mistakenly failed to properly disclose a foreign account, the maximum penalty is $10,000, per year, per account. However, this penalty can be removed or abated for reasonable cause. 

If a U.S. taxpayer deliberately established a foreign account to evade U.S. taxes, he or she could be subject to the willful penalty and harsh criminal penalties which include the possibility of a long prison sentence. In order to avoid these draconian penalties, U.S. taxpayers who established an undisclosed foreign bank account to avoid paying U.S. taxes and did not previously disclose the account should consider participation in the 2012 OVDP. In other cases, where a U.S. taxpayer has an undisclosed foreign account or accounts but the account(s) were not established to evade U.S. taxes, whether a taxpayer chooses to enroll in the 2012 OVDP may depend on a number of factors. By far, the most important factor to consider is whether the previously undisclosed accounts can be classified as “willful.”   The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty.  

Willful is a legal concept, one which requires an affirmative act to evade or avoid a known legal requirement. Inadvertent negligence is not willfulness. In a recent case, United States v. Williams, 2010 Dist (ED VA 2010), a taxpayer sent $7 million to a Swiss bank account, checked the box “no” on Schedule B of Form 1040 stating that he did not have an interest in a foreign bank account. The taxpayer pled guilty to one count of tax fraud. The IRS claimed the taxpayer willfully violated the FBAR filing requirement and attempted to assess a willful penalty. The trial court disagreed that the Government’s case showed beyond a preponderance of the evidence standard that Williams’ conduct was willful.  

The court stated the willfulness meant a knowing or reckless violation of a standard, not just a couple of instances of inadvertent neglect. The lesson to be learned from Williams is the failure to report a foreign account does not necessarily mean a taxpayer will be subject to the harsh willful penalty even if the taxpayer specifically checked a box on a tax return denying the existence of a foreign account. The decision in Williams represents an important first step toward imposing discipline to a government seeking to wrongfully extract money from U.S. taxpayers who established or inherited foreign accounts and did not know of the requirements to disclose the account. The government has appealed and the case is tentatively calendared for argument March 20 - 23, 2012 before the Court of Appeals.

The decision as to whether an individual should participate in the OVDP is difficult because there are many factors to weigh and consider, such as applying the willfulness standard(s) as discussed above.  The individual should seek the assistance of a qualified tax attorney who can assist the individual in this process. In any case, whether or not the individual decides to enroll in the 2012 OVDP, the individual must amend his or her tax returns and report any previously undisclosed income and file all delinquent FBARs.  The disclosure should report all foreign source income that was previously omitted and a compelling argument citing facts, circumstances and law as to why all applicable FBAR or offshore penalties should not be assessed. Finally, the U.S. taxpayer making such a disclosure should be prepared to immediately satisfy all tax, interest, and penalties from the failure to disclose foreign source income.

Remember, the Williams case offers a compelling defense against penalties associated with not disclosing a foreign account. However, Williams does not excuse a U.S. taxpayer from disclosing foreign source income that is required to be disclosed and paying all applicable tax on the previously undisclosed income.

Our tax law firm has substantial foreign tax experience in this highly complex area which is now a major government focus.   In December of 2011, our law firm was recognized for our excellence in this area by honoring our senior partner, Stephen M. Moskowitz, Esq. when the government of South Korea invited Steve to speak to its National Congress and National Tax Service on U.S. Foreign Tax Compliance with Offshore Bank Accounts, FATCA and tax penalty assessment and collection procedures.   

We have represented many clients in (and outside of) the 2009 and 2011 Foreign Amnesty Programs.   Now with this 2012 Offshore Voluntary Disclosure Program we look forward to explaining all of your options, providing you with advice as to how to avoid criminal prosecution and legally minimize any payments to the government and make the best decision for you.

Who does the Internal Revenue Service consider a tax preparer? For such a simple question, the answer can be complicated. This is an important question for attorneys, accountants, Enrolled Agents, or other professionals. Tax returns that show substantial understatements due to tax preparer error, whether it be intentional or not, are subject to penalties under §6694 of the Internal Revenue Code. These tax preparer penalties are presumptively valid and the preparer challenging the penalty bears the burden of proving that he or she did not intentionally disregard rule or regulation pertaining to tax law, Internal Revenue Code §6694(b)(2).

Treasury Regulation § 301.7701-15 generally defines a tax return preparer as, “any person who prepares for compensation, or who employs one or more persons to prepare for compensation, all or a substantial portion of any return of tax or any claim for refund of tax under the Internal Revenue Code.”  A person may be deemed a tax return preparer regardless of their education or professional status and regardless of their location (whether the person is within the United States or not) as long as he or she satisfies the definition of a tax return preparer. Treas. Reg. § 301.7701-15(d)(e).

As with any statute, the devil is in the details.  What does the IRS consider “compensation”? What is considered a “substantial portion” of the return? And when would the IRS consider the employer of the tax preparer to be the “real” preparer and apply penalties? Are there any exemptions to this statutory scheme? Finally, how much is the penalty?

To put it simply, if you are paid for your services then you are compensated for your work. But what if you are preparing a tax return for your sister and she decides to babysit your children for the weekend to thank you. Is this compensation?  According to Treasury Regulation § 301.7701-15(f)(1)(xii), it depends on the tax preparers intention. If you prepare a tax return expecting no compensation, then you are not a tax return preparer. If you expect something in return, even if it is insubstantial, then you are a tax return preparer.

A “substantial portion” of the tax return is a little harder to identify.  Any advice given to the taxpayer before the transaction occurs is not considered part of the preparation of the substantial portion of a tax return. Treas. Reg. 301.7701-15(a)(2)(i).  In order for advice to be considered part of the substantial portion of the tax return, it has to be given after the event occurred. For example, if attorney Joe gives advice about a merger (the event) and possible tax consequences before the merger occurs, Joe is not considered a tax preparer. However, if after the merger is completed, Joe continues to give advice, then he is considered a tax preparer at that time.

The analysis of what constitutes a “substantial portion of the tax return” does not end there. The IRS also looks at “substantial” in a much more practical way.  For example, in the infamous case, Goulding v. United States, 957 F.2d 1420 (7th Cir. 1992), Goulding was tax return preparer for a partnership return. The IRS concluded that Goudling was also the tax return preparer for an individual return of a partner even though Goulding did not prepare that individual’s return. The partnership return constituted only one line on the individual taxpayer’s return.  How can this be substantial? The IRS concluded, and the 7th Circuit agreed, that the one line represented a substantial portion of the taxpayer’s income and overall tax liability. See also Treasury Regulation §301.7701-15(b)(3)(iii) for an example in the corporate context.

When do you, as an employer, become liable for the tax preparation of your employee?  As an example, in Schneider v. U.S., 257 F.Supp.2d 1154 (2003), Schneider was a Certified Public Accountant that had an employee prepare a substantial portion a client’s return that Schneider signed.  There was an understatement of income determined by the IRS due to an incorrect assessment of business deductions. The court held that, “[…] being an employer of one or more persons who prepare a tax return for compensation is sufficient to qualify one as an income tax preparer.” 257 F.Supp.2d 1154, 1160.  Schneider received the penalty.  Have you ever signed a return prepared by your employee?

Volunteering your time or performing perfunctory mechanical functions in the preparation of tax returns excuse a tax preparer from penalties associated with preparation because of policy reasons. Treasury Regulation § 301.7701-15(f) lists who is not a tax return preparer. People who are employees of the IRS, people who provide assistance under the Volunteer Income Tax Assistance (VITA) program established by the IRS, and any organization sponsoring or administering a program established help the elderly (provided that the program follows established guidelines), are just some of the examples of preparers who are not considered tax preparers.

The tax return preparer penalty, depending on your intent, is equal to the greater of $1,000 or 50% of the income derived or to be derived by the tax return preparer (Treas. Reg. § 1.6694-2(a)) or equal to the greater of $5,000 or 50% of the income derived or to be derived by the tax return preparer (Treas. Reg. § 1.6694-3(a)).  If you are liable for a penalty as a tax return preparer with the intent to deceive the IRS, you would have to pay at least $5,000 or half of the income you earned, whichever is higher.

As the above examples reveal, whether or not you will be considered a tax return preparer is plain confusing. Other contexts, such as what happens if you are an employer who does not sign the tax return, have not been addressed in this blog.  It is of paramount importance to understand how this area of law can be argued and defended.   If you are accused, it is extremely important to defend and overcome the allegations because they can cost you far more than the above monetary penalty, they can cost you your license and livelihood.    Please contact Moskowitz LLP at (415) 394-7200 or via our Tax Law Firm's website if you have any concerns or questions regarding this complicated aspect of the tax law.

Introduction

The recent crackdown by the Internal Revenue Service (IRS) on United Sates taxpayers with previously undisclosed foreign bank accounts and unreported foreign income has resulted in an unprecedented wave of criminal prosecutions. The IRS’ initiative may also result in criminal convictions and deportations of many United States noncitizen taxpayers.

This article discusses the immigration consequences of a tax crime conviction associated with failing to disclose an offshore account and failing to disclose foreign interest income.

This article begins with a brief history of federal prosecutions of U.S. citizens with unreported foreign accounts foreign accounts; it then discusses the typical federal tax crimes U.S. citizens and noncitizen taxpayers could be charged with when foreign bank accounts and foreign source income is not disclosed on a U.S. tax return; the article goes on to discuss how noncitizen taxpayers could potentially face deportation in connection with failing to disclose an offshore account and any applicable foreign interest. The article concludes with the importance of selecting a competent criminal tax attorney and potential strategies that may be utilized by a defense counsel to reduce the risk of deportation of a noncitizen in the context of an undisclosed foreign accounts and undisclosed foreign income.

Background

In July of 2008, the IRS issued a John Doe summons on United Bank of Switzerland AG (UBS) in Switzerland. The summons was a demand to UBS to receive information on United States taxpayers who held foreign accounts with that bank. On February 18, 2009, UBS entered into a deferred prosecution agreement with the U.S. Department of Justice. As part of the agreement, UBS has agreed to turn over in regards to approximately 500 U.S. holders of UBS accounts. The United States Department of Justice has opened criminal investigations of many of these account holders. On August 19, 2009, the United States and the Swiss government entered into an agreement in which to turn over information relating to additional U.S. holders of UBS accounts. The agreement reach on August 19, 2009 interprets the current United States and Switzerland tax treaty to allow the Swiss Government to turn over to the Department of Justice information in cases of “continued and serious tax offenses.” This agreement was approved by the Swiss Parliament and is expected to result in the disclosure of an additional 4,450 U.S. holders of UBS accounts.

During the 2010 calendar year, the IRS and the Department of Justice announced it will begin to pressure other foreign banks to disclose the names of U.S. account holders. The turnover of this information will likely result in the criminal prosecution by the U.S. Department of Justice of many individuals who previously failed to properly disclose offshore accounts and foreign source income.

On March 24, 2011, California’s “Voluntary Compliance Initiative II” was enacted as part of Bill 86, which was signed by Governor Jerry Brown. Under the terms of the Voluntary Compliance Initiative II, certain taxpayers with “hidden or disguised offshore accounts” are encouraged to amended their previously filed state tax returns and pay all tax interest in exchange from relief of certain California civil and criminal penalties. California residents who fail to participate in the amnesty program and are ultimately caught with unclosed foreign accounts or income are subject to criminal prosecution.

Reporting Requirements and Federal Tax Obligations of Noncitizens along with Potential Criminal Penalties

We will begin by discussing the income tax obligations of all noncitizen residents in the United States. Internal Revenue Code Section 7701(a)(30) provides a broad definition of the term “United States persons.” Section 7701(a)(30) provides that “United States persons” shall include all citizens of the United States as well as all residents of the United States. If a noncitizen of the United States resides in the United States, he or she can be characterized for federal income tax purposes as a “United States person.” The Internal Revenue Code goes on to say that all “United States persons” are required to disclose all their worldwide income, including income from all foreign sources. This includes interest income earned from foreign bank or financial accounts.

The Internal Revenue Code requires “United States persons” to disclose interests in foreign bank accounts and foreign source interest income on a Form 1040. For example, Part III of Schedule B of Form 1040 requires “United States persons” to check a box “yes” or “no” in regards to whether the individual at any time during the calendar year had “an interest in or signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account. This question then directs the individual to the form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR).

If a “United States person” fails to report income from a foreign financial account and fails to report the existence of an offshore financial account either on the Form 1040 and/or the FBAR, he or she is subject to a list of potential criminal penalties. First, an individual could be prosecuted for federal tax evasion. Tax evasion is defined as the willful attempt to defeat or evade a federal tax due and owing, or evasion of the payment of a tax assessed.¹ (Later in this article we will discuss the immigration law consequence if it is determined that the tax loss to the United States Government exceeds $10,000).

Second, the filing of a false tax return or making a false statement on a tax return may result in prosecution for filing a false tax return.² In order to be convicted of filing a false tax return, the IRS or Department of Justice must prove that an individual willfully signed and filed a tax return, or other document such as an FBAR that he or she did not believe to be true and correct in a material matter.³ A defendant may also be prosecuted for filing of a false tax return if the prosecution proves that the individual willfully aided or assisted in the preparation of a tax return, affidavit, claim, or other document that is fraudulent or false as to any material matter with knowledge that the document would be submitted to the IRS.⁴

Third, an individual could be charged in a conspiracy to defraud the United States. An individual can be charged in a conspiracy to defraud the United States if two or more persons agree to commit a substantive offense against the United States or to defraud the United States, and if the commission of the overt act was in furtherance of the conspiracy.⁵

Fourth, an individual may be criminally prosecuted for the willful failure to file an FBAR.⁶ If the failure to file occurs during the violation of another law or is part of a pattern of any illegal activity involving more than $100,000 in a 12-month period, there are increased criminal penalties.⁷

Finally, nonresident taxpayers that fail to disclose offshore income are subject to various penalties determined under state law.

Immigration Consequences of Federal Convictions for Tax Offenses

Individuals who are not United States citizens, including those lawfully admitted for permanent residence (green card holders) are subject to deportation from the United States based on certain criminal convictions, including a conviction for “aggravated felony.”⁸ An “Aggravated felony” is defined to include offenses that “(i) involves fraud or deceit in which the loss to the victim or victims exceeds $10,000; or (ii) is described in section 7201 of Title 26 (relating to tax evasion) in which the revenue loss to the Government exceeds $10,000.”⁹ Aliens in the United States, regardless of status, who are convicted of an aggravated felony are not eligible for review from deportation or asylum.¹⁰

As discussed above, a nonresident or alien residing in the United States must disclose their offshore account and income generated from that account on a U.S tax return annually. Failure to do so may result in the alien being convicted of at least one federal or state tax crime. If an alien were to suffer a criminal conviction for not disclosing a foreign account and/or foreign source income, not only could the alien face incarceration and serious fines, such a criminal conviction can result in loss of child custody, termination of pension benefits, and even deportation from the United States. Clearly, there are far broader implications for an alien convicted of a tax crime than for U.S. citizens. Consequently, it is crucial for all noncitizens with previously undisclosed foreign bank accounts or foreign source income to have proper competent legal counsel that can advise them about the immigration consequences of a criminal conviction associated with a tax crime.

Importance of Competent Counsel

Unfortunately, in many cases, criminal attorneys representing noncitizen taxpayers are not properly equipped with knowledge of immigration law to competently assist their clients. Such a case was highlighted in Padilla v. Kentucky, 130 S Ct. 1473 (2010). In Padilla v. Kentucky, a long-time lawful permanent resident was charged with drug offense. The defendant was charged with the transportation of marijuana in Kentucky state court. The defendant accepted a plea bargain after the defendant’s attorney assured that he did not have to worry about immigration status since he had been in the country so long.¹¹ In reality, the defendant’s plea bargain rendered him deportable with no opportunity for relief. The defendant attempted to challenge his guilty plea. The Kentucky court refused to allow the defendant to change his guilty plea and concluded that deportation was collateral to the plea and refused to allow the defendant to change his plea. The United States Supreme Court disagreed and overturned the lower state court.

What needs to be taken away from the Padilla is an attorney representing a noncitizen in felony type case needs to be well versed in immigration law. This is particularly the case when such an attorney is negotiating a plea agreement for his or her client and is advising the client in regards to a guilty plea. There are legitimate practical objections which require a defense counsel to tell noncitizen clients about when making a decision to plead guilty. These consequences tend to be scattered randomly throughout a jurisdiction’s code and regulations, and all too many criminal attorneys are unfamiliar with them. Justice Stevens, writing for a five-justice majority, held that “our law has enmeshed criminal convictions and the penalty of deportation… And, importantly, recent changes in our immigration law have made removal nearly an automatic result for a broad class of noncitizen offenders.”¹² As such, there is now a duty imposed on every criminal defense attorney representing noncitizen clients that pending criminal charges may result in deportation from the United States. Preserving the “client’s right to remain in the United States may be more important to the client than any potential jail sentence.”¹³ Criminal attorneys that represent noncitizens in matters involving the failure to properly disclose offshore bank accounts or foreign income must have a full understanding of immigration law.

Only criminal defense attorneys with an understanding of immigration law can best serve assure a positive outcome of such a case. Such an attorney can bring in the potential consequence of deportation in the process so the interests of his client are best served. In particular, defense counsel “may be able to plea bargain creatively with the prosecutor in order to craft a conviction and sentence that reduces the likelihood of deportation.”¹⁴

The lesson learned from the Padilla case is that all attorneys representing clients before the IRS, department of justice, or state taxing agency in matters involving previous undisclosed offshore accounts or foreign source income should inquire about the citizenship of their clients. In cases where an attorney is representing a noncitizen, the attorney should either be well versed in immigration law or associate with counsel who is competent in immigration law. The attorney must be prepared to immediately discuss the consequences of a criminal conviction with his or her client.

Defining Aggravated Felony

As discussed above, an aggravated felony results in automatic removal from the United States without any possibility of discretionary review by the immigration court. Generally, in the past, the immigration court was limited to looking to the language of the statute under which the defendant was convicted to determine whether the offense is an aggregated felony. The immigration court could not consider the underlying facts and circumstances of the case in which the defendant was convicted. Such a review was known as the “categorical approach.”¹⁵ Recently, the United States Supreme Court seemed to have relaxed this rule somewhat in Nijhawan v. Holder, 129 S. Ct 2294, 2300 (2009). In Nijhawan v. Holder, the United States Supreme Court discussed whether a defendant’s conviction for conspiracy to commit fraud was an aggravated felony under 8 U.S.C. Section 1101 Section 1101(a)(43)(M)(i). The Court ultimately decided that it was appropriate to examine the specific circumstances surrounding the defendant’s crime to determine the amount of the loss to the victim. The Court went on to say “the requirement that the offense was “in which was appropriate to examine the specific circumstances surrounding the defendant’s crime to determine the amount of the loss to the victim.¹⁶ Accordingly, in decided whether to remove a noncitizen, the immigration court will now look to the statutory language of the offense to determine whether it involved “fraud or deceit,” and then will analyze the record of the criminal proceeding to determine whether the offense involved a loss to the government of more than $10,000.

Applying this view of statutory interpretation, the Supreme Court has unambiguously classifies a conviction under Section 7201 in which a loss to the government exceeds $10,000. Consequently, if a noncitizen is convicted of the tax crime of willful attempt to defeat or evade tax due and owing, or evasion of the payment of a tax assessed, the immigration court will determine that the noncitizen committed an “aggravated felony.” With that said, the Supreme Court is silent as to whether any other tax crimes could be classified as an “aggravated felony. The Ninth Circuit Court of Appeals has weighed in on this controversy.

In Kawashima v. Holder, 593 F.3d 979, 985 (9th Cir. 2010), the Ninth Circuit Court of Appeals stated that the filing of a false return or the willful aiding or assisting in the preparation of a return or any other material matter to the IRS under Sections (1) and (2) of 26 U.S.C. Section 7206 necessarily involves fraud or deceit “because the provisions require the government to prove either that the defendant ‘willfully’ subscribed to a statement in a tax return he did not believe to be true, or that the defendant ‘willfully’ aided and assisted in the making of a false or fraudulent return”¹⁷ Given that 8 U.S.C. Section 1101(a)(43)(M)(i) has defined an “aggravated felony” to include an offense that involves “fraud or deceit,” noncitizens that are convicted under 26 U.S.C. Section 7206 which involves a loss of $10,000 or more in the 9th Circuit will likely be found guilty of an aggregated felony in the 9th Circuit.

Following the Ninth Circuit Court of Appeal’s position in Kawashima v. Holder, in the offshore context, the offense of failure to file an FBAR under 31 U.S.C. Section 5322 may also appear to involve fraud or deceit. The mens rea required for a conviction under Section 5322 is willfulness.¹⁸ The element of 8 U.S.C. Section 1101(a)(43)(M)(i) is likely satisfied of “fraud or deceit” because the knowing and intentional failure to file an FBAR can be characterized as the deceitful attempt to hide information from the government. Given that the mens rea required under Section 5322 seems to be in line with Section 1101(a)(43)(M)(i), it is possible a court in the Ninth Circuit will find a conviction under Section 5322 amounts to a aggravated felony.

How is Counsel to Proceed in Tax Cases?

The first step defense counsel should ask when representing nonresident in potential prosecution of a tax crime or the failure to disclose a foreign bank account is does the loss to the government exceed $10,000. If the tax loss involves tax loss to the government that exceeds $10,000 and relates to an offense described in Section 7201 or Section 7206 in the Ninth Circuit, counsel should be prepared to engage the prosecution early may attempt to structure a plea accordingly to avoid removal. Parties frequently agree on tax loss during plea negotiations, and under appropriate circumstances may be able to stipulate to a tax loss of not more than $10,000.¹⁹

Defense counsel will face a far more difficult task in representing a noncitizen defendant accused of other federal or state tax crimes that could be characterized as Section 1101(a)(43)(M)(1) offense. This is because defense counsel must be prepared to determine if the charged offense could be classified as an “aggravated felony.” In order to determine which if any federal or state tax crimes could be classified as an “aggravated felony” under 8 U.S.C Section 1101(a)(43)(M), we must look more closely at the statutory language of subsection (M). The Third Circuit Court of Appeals took the position determining whether any tax offense can be classified as an “aggravated felony” cannot “be answered solely by looking at the language (of subsection (M) itself.”²⁰ The Third Circuit went on to say subsection (M)(ii) clearly and unambiguously classifies a conviction under Section 7201 as an aggravated felony, but is silent as to any other tax offenses.

The Appeals Court than asked:

Why does subsection (M) include both a general provision encompassing “fraud and deceit” and a specific provision directed solely at the offense of federal tax evasion? If subsection (M)(i) applies to tax offenses(s), what is the purpose of subsection (M)(ii)? Does the juxtaposition of subsections (M)(i) and (M)(ii) signal an intent to exclude other tax offenses from the definition of aggravated felonies in (M)(i).²¹

The Third Circuit of Appeals determined that subsection (M)(i) is a general provision and subsection (M)(ii) is a specific provision that only applies to federal tax offenses. Under this analysis, specific provisions of the statute govern the general provisions of the statute. The majority in Third Circuit Court of Appeals stated in no uncertain terms tax evasion is the “capstone” of tax law.²² Consequently, in the view of the Third Circuit, only a Section 7201 offense could be characterized as an aggravated felony.²³

Then Appeals Court Judge Samuel Alito dissented from the majority on the ground that he believed subsection (M)(i) was unambiguous and that the offense of filing a false return is an act involving fraud or deceit. Judge Alito stated if Congress had not intended subsection (M)(i) to apply to tax offenses, Congress would have provided so in the statute. The Ninth Circuit Court of Appeals went on to follow Judge Alito’s dissent and determined that the filing of false tax returns under Section 7206 is an aggravated felony under subsection M(i). The Ninth Circuit Court of Appeals explained that “Congress has often realized its inability to anticipate every possible type of case, and may have added subsection (M)(i) to ensure that no tax evasion case fell outside subsection (M)’s definition of an aggravated felony.”

The lesson to be learned from Judge Alito’s dissent and the Ninth Circuit’s recent opinion in Kawashima v. Holder opinion is simple, unless defense counsel is representing a noncitizen taxpayer in the Third Circuit, counsel must be cognizant of the fact that any federal or even state tax crime involving a tax loss of over $10,000 can be determined to be an aggravated felony. As such, defense counsel should carefully consider whether the particular offense charged involves fraud or deceit and a tax loss of $10,000. This is the case for both federal and state tax crimes charged. In cases where the defendant has been charged with willfully failing to file an FBAR, defense counsel should attempt to avoid an aggravated felony designation by arguing that the act itself did not cause any loss to the government.

Only after defense counsel has closely examined all the facts of the case, should defense counsel begin meaningful dialogue with the prosecution. If possible, defense counsel should be prepared to distinguish the mens rea of the offenses that his or her client faces from that of Sections 7201 and 7206 of Title 26. Only after defense counsel has adequately prepared his or her defense should begin negotiations with the government.

1. See 26 U.S.C. Section 7201.
2. Unlike tax evasion under Section 7201, this federal tax crime does not have an element requiring a tax deficiency.
3. See 26 U.S.C. Section 7206(1).
4. See 26 U.S.C. Section 7206(2).
5. See 18 U.S.C. Section 371.
6. See 31 U.S.C. Section 5322(a).
7. See 31 U.S.C. Section 5322(b).
8. See 8 U.S.C. Section 1227(a)(2)(A)(iii).
9. See 8 U.S.C. Section 1101(a)(43)(M).
10. It should be noted that an alien may also be subject to deportation from the United States if he or she committed a felony involving moral turpitude within five years after the date of admission to the United States. See 8 U.S.C. Section 1227(a)(2). Some federal courts have held that tax fraud or tax evasion involves moral turpitude. However, unlike in situations of an aggravated felony, there is a specific date upon which an alien may no longer face deportation. In addition, an alien may petition the immigration court requesting a “cancellation of removal.”
11. 130 S.Ct at 1478.
12. 130 S. Ct. at 1481.
13. 130 S. Ct. at 1483.
14. 130 S. ct. at 1486.
15. See Singh v. Ashcroft, 383 F.3d 144, 147-48 (3d Cir. 2004).
16. 130 S. Ct. 736 (2009).
17. Id. At 983.
18. Willfulness means that the defendant acted with the knowledge that the conduct in question was unlawful.
19. This approach is limited by the need for the stipulation of facts accompanying a plea agreement to accurately portray the facts underlying the offense. See U.S.S.G. Section 6B1.4(a) (Stipulation of facts must “not contain misleading facts”). 
20. Lee v. Ashcroft, 368 F.3d 218 (3d Cir. 2004).
21. Id. At 222.
22. Id at 224.
23. Kawashima v. Holder, 593 F.3d 979, 985 (9th Cir. 2010).

The Disclosure Dilemma

With the 2011 Offshore Voluntary Disclosure Initiative coming to a close on August 31, 2011, many U.S. citizens, green card holders, visa holders and other residents with undisclosed overseas accounts are wrestling with whether to disclose their foreign bank account(s) and other foreign financial activity. This includes those who have filed so-called “quiet disclosures” in the hopes that they will be overlooked by the IRS. Still yet, some people are deciding to gamble on the chance that the IRS will not ever discover their offshore accounts. But the civil and criminal penalties are severe for both non and quiet disclosure and taxpayers should understand these risks before passing on the benefits of the 2011 Offshore Voluntary Disclosure Initiative before it ends on August 31, 2011.

Quiet Disclosure

The IRS treats a quiet disclosure as a crime. A quiet disclosure occurs when a taxpayer files an amended return and pays taxes and interests on a previously unreported offshore account and otherwise does not notify the IRS. In past years, the IRS has not prosecuted taxpayers who file amended returns voluntarily through a quiet disclosure. However, the IRS has made it clear this time around that a quiet disclosure is not a disclosure at all. In fact, the IRS recently announced in a voluntary disclosure question and answer publication the following about quiet disclosures:

"Taxpayers are strongly encouraged to come forward under the Voluntary Disclosure Practice to make timely, accurate and complete disclosures. Those taxpayers making 'quiet' disclosures should be aware of the risk of being examined and potentially criminally prosecuted for all applicable years."

Local Disclosure

A local disclosure allows protection to taxpayers who have partial information required by the IRS for participating in the 2011 Offshore Voluntary Disclosure Initiative or otherwise have a case for forgiveness without paying the OVDI penalty of 25% of the highest balances. The tax lawyers at Law Offices of Stephen Moskowitz, LLP have helped many clients make local disclosures by providing what limited information the client has to the local IRS Criminal Investigation Division in an act of good faith. Depending on the situation, local disclosures of this nature may result in discounted penalties and fines. More importantly, local disclosure affords the taxpayer all the constitutional protections normally provided a person in a criminal proceeding.

Do Nothing?

Deciding not to participate in the 2011 Offshore Voluntary Disclosure Initiative is an extremely risky tactic. While you might save some money upfront in IRS taxes and penalties by not disclosing, ask yourself, is it worth the worry of being caught and facing a costly prosecution? Remember, willful failure to pay taxes on a qualifying offshore account could result in imprisonment of up to 10 years and financial penalties which could be far in excess of your investments and assets.

If you have unreported offshore income, stop “whistling past the graveyard” thinking you will not be discovered by the IRS. Let the experienced tax lawyers at the Law Office of Stephen Moskowitz, LLP assess your personal situation and explain to you your options so that you can make an educated decision. Call us today for a free, no obligation, attorney-client privileged consultation.

If you searched for IRS OVDI, you are aware that the Department of Justice and the Internal Revenue Service have instituted massive campaignes in the last couple of years to find and collect tax on worldwide income, ivnestment, and assets.     As a result of these campaigns the DOJ and IRS designed the 2011 Offshore Voluntary Disclosure Initiateive.     The State of California has recently developed its own program.   

The federal program offers benefits to encourage taxpayers to disclose foreign accounts now, including but not limited to ownership interests in foreign entities such as corproations, partnerships, trusts, wire transfers, annuitities or life insurance plans, etc.  By participating, individuals may avoid the risk of IRS detection and criminal prosecution and mitigate severe monetary penalties.  The deadline for particiaption in this program is August 31, 2011.     

This 2011 OVDI may provide an excellent opportunity for individuals to come into ttax compliance and void serious punishments.   However, participation in the program may also result in an investigation and/or audit by the criminal investiagtion division of the IRS, in which full and complete dislosure and ooperation is essential in order to utilize this OVDI and not invite other possible criminal and civil actions.    Note that participation in OVDI does not offer amnesty for other crimes uncovered in the investigation.     Further absent full and complete disclosure and cooperation, the government may find cause for failure to supply information, false statements, etc.    Finally, while non-participation in the program may be a calculated avenue for some, it potentially leaves individuals vulnerable to criminal prosectuion for counts including but not limited to, FBAR violation, consipiracy, perjury, tax evasion, failure to supply information, etc.  

We are currently representing many individuals in light of the offshore disclosure inititatives and we invite you to contact us.

Proceeds from a settlement involving an employment-related discrimination case may be taxable to the employee under some circumstances and not taxable in others.  

Non-taxable settlement amounts: 

• Medical expenses associated with medical distress;
•  Emotional distress, pain or suffering resulting from a physical injury;
• Personal injury or sickness; and
• Legal costs associated with the case.

Taxable settlement amounts:

• Lost wages;
• Emotional distress, pain or suffering not resulting from a physical injury; and
• Punitive damages. 

It is important to know which proceeds are taxable since the worth of a settlement may depend heavily on whether that settlement amount will be decreased by the payment of income taxes.  For example, if characterized as punitive damages, a $200,000 settlement may not be as desirable as a $165,000 settlement characterized as payment for personal injury. 

Taxability of Emotional Distress Damages

Unfortunately, not everyone involved with an employment discrimination case is familiar with the most desirable settlement characterization for tax purposes, and even if they are, they may not be able to properly characterize the settlement to pass IRS scrutiny.  One problematic characterization for many employees is that of emotional distress.  One type of emotional distress is taxable and another type is not.  In an important employment discrimination case, Wells v. Commissioner, the United States Tax Court further distinguished the types of emotional distress and created a two-part test for determining taxability, as follows:

Wells v. Commissioner: Two-part test for emotional distress in discrimination cases

The plaintiff/employee had an altercation with a supervisor and subsequently filed a discrimination claim.  She took leave from work while being treated by a therapist to emotionally recover from stress allegedly caused by this altercation.  Ten months after the altercation (eight months of which were spent on leave) she was terminated by her employer.  In a settlement, the employee agreed to receive $175,000 and the settlement agreement noted that it was for emotional distress and not for wages—likely an attempt to ensure that it would not be taxable.   

However, the Tax Court held that damages for emotional distress (even physical symptoms of emotional distress) are not excludable from ordinary income if they were caused by a non-physical injury such as discrimination.  In deciding whether an amount is taxable, the court will look first at the express language of the settlement agreement and what it states the amount was paid to settle; and second to the intent of the payor, and all the facts and circumstances of the case (including the original complaint).  In Wells v. Commissioner, because the settlement agreement expressly declared the amount to be for emotional distress (not caused by physical injury) the amount was taxable as ordinary gross income.  

Properly Characterizing Settlement Agreements

Both employers and employees should be careful about the characterization of settlement amounts and be diligent in filing information with the IRS and state. A tax attorney can assist the parties in crafting a demand, complaint or settlement that may make the difference between an award non-taxable rather than taxable.  Although the tax attorney would always prefer to be part of the case from the beginning, if you have already received your settlement or judgment you want to consult with a tax attorney to determine if your payment can be characterized as non-taxable in whole or in part and if your related expenses are tax deductible.

Some recent court decisions and legislation give the IRS more flexibility to apply a six-year audit statute of limitations in more of its cases.  The IRS even argues for no statute of limitation for audits in cases involving fraud or deceit.  This article discusses the various audit periods enforced by the IRS and when an extended audit statute of limitations may apply.  

Three-Year Statute of Limitations for Tax Audit

Generally, the IRS has three years to audit a tax return from the later of the due date or filing date.  If a tax return is filed, for example, on February 1^st, the statute of limitations begins running on April 15^th (the due date) and runs for three years.  If a tax return is filed after the due date, the state of limitations begins running on the actual filing date for three years.  Generally, once the three-year statute of limitations has run, the IRS cannot audit the tax return, unless the tax return is covered by one of the extensions.

Six-Year Audit Statute of Limitations for “Substantial Understatement of Income”

The IRS has six years to audit a tax return if it includes a “substantial understatement of income.”  A substantial understatement of income is defined as the omission of 25% of a taxpayer’s gross income.       

Six-Year Audit for Returns Having the Effect of Substantial Understatement of Income

While it is clear that a simple omission of 25% or more of gross income qualifies as a substantial understatement of income, it is unclear whether incorrect or fraudulent reporting of certain other numbers having the effect of a substantial understatement of income will allow for a six-year statute of limitations.  The IRS advocates for the latter, especially in circumstances involving an overstated basis in assets.   

Federal Courts Examine Six-Year Statute of Limitations: Grapevine Imports, Ltd.

Some federal circuit courts (the Fourth, Fifth and Ninth, California is in the Ninth circuit) have ruled that the IRS must stick to its three-year statute of limitations in most situations.  However, in March, 2011 in Grapevine Imports, Ltd., v. United States, the U.S. Court of Appeals for the Federal Circuit held that an overstatement of basis does give the IRS six years if that overstatement has the effect of a substantial understatement of income.  As additional courts review this Grapevine Imports ruling, we may see the IRS gaining similar victories.

HIRE Act’s Six-Year Statute of Limitations Period

As part of the new HIRE Act, passed March 18, 2010, any tax return in which a taxpayer fails to report income higher than $5,000 in foreign financial assets is subject to a six-year statute of limitations for audit rather than the general three-year statute.  This applies to any income tax returns filed after March 18, 2010 or any income tax returns that still had a running statute of limitations on March 18, 2010.

No Statute of Limitations for Some Tax Returns

There is no statute of limitations on certain returns.  Returns that are deemed fraudulent under IRS definitions may be audited at any time.  Also, if a tax return was never filed, the statute of limitations never begins to run and the audit can come at any time.  Although many circumstances extend the statute of limitations for the government to audit and collect from the taxpayer, refund checks will not be paid after three years.  Lastly, Californians should be aware that the general statute of limitations is actually four years (barring fraud, non-filing, or substantial understatement of income) for the California Franchise Tax Board.  

Deciding which statute of limitation applies to your tax controversy can be a challenging task that may be vigorously challenged by the government.  The experienced attorneys at The Law Offices of Stephen Moskowitz, LLP can help you determine if you have a legitimate statute of limitations defense barring the IRS or State from pursuing your case.  Allowing our law firm to represent you in a case with a statute of limitations issue may save you a great deal of time and money in the long run.  Call us today at 1-888-829-3325 for your free attorney-client privileged consultation.  

Many people believe in the myth of the “audit lottery.”  The audit lottery myth encourages the perception that the IRS chooses returns to audit at total random.  Under a completely random system, taxpayers who have accurate and correct information on their tax returns would have the same chance of being audited as taxpayers who have missing, incorrect or false information.  

However, the audit lottery is a wished for myth.  While even the IRS’ own characterization of the selection process may further the audit lottery myth with the use of the words “random selection” for only one minor audit selection process.

IRS Commissioner Doug Shulman Declares Audit Lottery a Myth

In a speech at the National Press Club in April, 2011, IRS Commissioner Doug Shulman declared that while he has heard people refer to the “audit lottery,” the “process is far from random.”  The IRS uses “sophisticated risk models” to identify compliance problems.  The statistical formula noted above is actually not meant to help randomize things but to use the IRS’ “cumulative knowledge and data…to model the risk of tax avoidance.”

This means that those who are using certain strategies to avoid tax liability are far more likely to be audited than those who do not, since the IRS has formulas based on certain “norms” to detect common fraudulent strategies.  While a taxpayer who gets an audit notice may suspect or be told that the tax return was chosen randomly, that is probably not the case.  The selection processes used by the IRS are actually targeted at those tax returns that the IRS believes have a likelihood of tax avoidance or fraud.  

IRS Audit Selection Processes

Among the processes for selecting which tax returns will be audited:

1. D.I.F. [Discriminant Income Function].  This is an IRS computer program that examines all tax returns filed for a statistical variation of what the IRS believes is the “normal average amount”.  DIF has sixty-six different categories, some of them secret, to determine which tax returns have the most “audit potential”; i.e. the most likely to be wrong.  Among the DIF categories that are not secret is the total income:

     Income: the higher the income, the more likely the person is to be audited; although the IRS insists that everyone has a potential for being audited, even the lowest paid person without any deductions can me audited,

     Deductions: the total deductions, as well, as the type of deduction, as well as the percentage of the deductions as compared to the national statistical model,

    Losses: especially business and real estate losses,

    Self Employed People: the IRS believes that the self-employed person has a far greater opportunity to falsify his or her tax return in many ways, such as not reporting all of their income, or inflating or creating deductions, or deducting personal expenses as business expenses.

2.  Document Matching.  Various entities (e.g., employers, retirement funds, and banking institutions) that make certain payments to taxpayers must submit tax forms to the IRS with the amounts paid.  If the payee files a tax return with amounts that do not match what the IRS has received from the payor, the payee or the payor may be audited.      

3.  Related Examinations.  If the tax return of a certain taxpayer is being audited, the associates, business partners, or others involved with the audited taxpayer may also be selected for audit.

4.  Random Selection.  The IRS sometimes selects returns based on a statistical formula.  

5.  TCMP.  This is a special extremely detailed audit where every line of the tax return is scrutinized to determine the effectiveness of the D.I.F. program and to adjust the D.I.F. program as needed.

Audit Attorney

If you are facing an IRS or State audit, our experienced attorneys at The Law Offices of Steve Moskowitz, LLP want to help.  We have represented numerous clients through the complex and often frightening experience of having your previous tax returns audited and scrutinized by the Government in an audit.  Call us today for your free attorney-client privileged consultation.  

Frank McCourt, the embattled owner, was accused by Major League Baseball of being responsible for his and the Dodgers' financial trouble.  It is evident that the May payroll for the team is in jeopardy and McCourt, vowing to protect his rights, blames MLB. Read more on Steve's Sports and the Law Blog on Comcast SportsNet.

Why is the NFL Appealing and is the Temporary Stay Reasonable? 

The National Football League is a nine billion dollar business.  You would think that with that financial power that a collective bargaining agreement could be reached when the time comes to negotiate.  It wasn’t and with the expiration of the current agreement on March 3, 2011, a lockout came into play. Read more on Steve's Sports and the Law Blog on Comcast SportsNet.