The legal standard of “willfulness”: Opt out to avoid high penalties
Under IRS Form 1040, at the bottom of Schedule B, Part III, on Page 2, Question 7(a) states: “at any time during the previous year, did you have any interest in or signatory or other authority over a financial account in a foreign country, such as a bank account, a security account, or other financial account? The answer is either yes or no. If yes, Question 7(b) requires the name of the foreign country (with the account). Question 8 requires confirmation of receipt of distribution from the account, or if the Taxpayer was a grantor of, or transferor to a foreign trust (which requires filing Form 3520).
A willful failure to file a FBAR can lead to a felony of up to 10 years in jail and a $500,000 fine. The IRS must prove willfulness in order to assert the $500,000 monetary penalty and the imprisonment for up to 10 years (see 31 USC 5321(a)(5)(B); CCA 200603026; Eisenstein, 731 F.2d 1540 (CA – 11, 1984)).
If a failure to file is deemed to be part of a criminal activity involving more than $100,000 in a 12-month period, the penalty limit increases to $500,000 with up to 10 years in jail. The issue of whether a failure to file is willful or non-willful is based on the facts of each case. Willfulness has been defined as the voluntary, intentional violation of a known legal duty, see Cheek 498 US 192, 67 AFTR 2d 91-344 (Supreme Court 1991).
A Taxpayer’s good faith belief that he does not have to file (or even his negligent failure to file) can be a defense to the charge of willful failure to file (i.e., a defense to criminal charges). A defense may include that the Taxpayer was advised by his advisor that no FBAR was required.
The major tax crimes in the Internal Revenue Code require that the defendant act willfully. The standard for acting willfully is usually stated as intentional violation of a known legal duty, a statement drawn from the Supreme Court’s cases culminating in Cheek v. United States, 498 U.S. 192 (1991) (and for this reason sometimes referred to as Cheek willfulness). Subsequent cases has further amplified the court ruling in stating that reasonable good faith beliefs may negate the “willfulness” element.
Willfulness must be proven by the IRS under the standard of clear and convincing evidence, which is a very high legal standard to establish. If the Taxpayer knew about the requirement to file, it would affect his defense. If the Taxpayer failed to report the foreign account interest or other income on his income tax return, it would affect his defense.
In many recent cases the government has had difficulty in establishing willfulness for the high draconian FBAR penalty. As a result, we often recommend some taxpayers to opt out of the voluntary disclosure initiative and take their chances with the normal FBAR penalty regime. Assuming that the government cannot meet the high standard in proving a willful failure, the penalty costs could be a substantially less than the large OVDI program penalty.
A recent case determined that signing the tax return does not equate to knowledge of all of its contents, that relying on professionals can negate willfulness, and that making a ‘noisy’ voluntary disclosure is evidence of nonwillfulness. These grounds are significant because the IRS’s current penalty approach to unfiled FBARs is based on the presumption that they can show willfulness in every case and can impose high penalties on all cases.
Depending on the circumstances, we recommend some taxpayers to opt out of the voluntary disclosure initiative and allow us to demonstrate the absence of willfulness and avoid the normal FBAR penalty regime.