Is making a disclosure outside of OVDP a grave mistake for a taxpayer who innocently or mistakenly failed to disclose a foreign bank account ?

Whether or not an individual can safely make a disclosure outside of OVDP is heavily dependent on the facts and circumstances of each individual case. The IRS has threatened to civilly challenge any disclosure made outside of an OVDP or SFOP,SDOP. The important message here is : it is one thing what the IRS can do but totally another what they will do !


The most severe penalty the IRS may assess against a hypothetical taxpayer is a willful failure to file an FBAR under Title 31 U.S.C. Section 5314.  In the case of a willful penalty, the IRS can impose a penalty equal to $100,000 or 50 percent of the amount of the financial “transaction,” whichever is greater. In order to impose the willful penalty under Title 31 U.S.C. Section 5314, the IRS must demonstrate the taxpayer knew that he had a duty to disclose his foreign account on an FBAR, yet intentionally ignored the duty.  I have covered this in earlier posts already but as a reminder, this standard was defined in Cheek v. United States, 498 U.S. 192, 201 (1991).
In Cheek, the U.S. Supreme Court stated that the government must overcome a significant legal hurdle to prove willfulness:

Willfulness … requires the Government to prove that the law imposed a duty on the defendant, that the defendant knew this duty, and that he voluntarily and intentionally violated that duty… “carrying this burden requires negating a defendant’s claim of ignorance of the law or a claim that because of the misunderstanding of the law, he had a good-faith belief that he was not violating any provisions of the tax laws.”

If the taxpayer’s failure to disclose his foreign financial account was not an act undertaken intentionally or in deliberate disregard for the law but instead the failure to disclose the account constituted an understandable omission - the IRS will not successfully assert a willful civil penalty under Section 5314 against the taxpayer.

The IRS could attempt to assess a non-willful penalty under Title 31 U.S.C. Section 5321 against the taxpayer.  In the case of a non-willful FBAR violation, the IRS may assess a penalty of up to $10,000 per violation.  With that said, under Section 5321, no non-willful penalty shall be imposed if the violation was due to “reasonable cause.” At first glance, the defense against a non-willful penalty seems relatively straightforward; all a taxpayer has to demonstrate is that there was a “reasonable cause” for not filing an FBAR informational return in order to satisfy the test provided under Section 5321.  Although the term “reasonable cause” is not addressed in Section 5321, the concept of “reasonable cause” is referred to in the Internal Revenue Manual (IRM).

The IRM includes the following statements to this effect :

1. The [non-willful] penalty should not be imposed if the violation was due to reasonable cause.
2. If the failure to file the FBAR is due to reasonable cause, and not due to the negligence of the person who had the obligation to file, [a penalty should not be assessed].
3. Reasonable Cause and Good Faith Exception to Internal Revenue Code Section 6662 may serve as useful guidance in determining the factors to consider [in assessing FBAR penalties].
4. Although tax regulation[s] for Section 6662 does not apply to FBARs, the information it contains may still be helpful in determining whether the FBAR violation was due to reasonable cause.

In summary, the IRM indicates that an examiner could consider defenses to the Section 6662 penalty in determining whether a taxpayer should be liable for a non-willful penalty.  Internal Revenue Code (IRC) Section 6662 imposes a 20 percent accuracy related penalty to an underpayment of tax due to negligence, while IRC Section 6664(c) states that no penalty shall be imposed if it is shown that there was a reasonable cause for such underpayment.  Therefore, if a taxpayer can show reasonable cause, the Section 6662 penalty will not be imposed.  The reasonable cause exception in a Section 6662 penalty has been generally interpreted to mean the exercise of ordinary business care and prudence.   When an individual exercises ordinary business care and prudence (pays foreign income taxes or withholding taxes on interest and dividend income), the individual will not be liable for the Section 6662 penalty where the understatement results from a mistake of law or fact in good faith and on reasonable grounds. If the taxpayer exercised ordinary business care and prudence by retaining the services of a certified public accountant to prepare his tax returns and as a result of the tax return preparer’s neglect, the taxpayer omitted his foreign financial account from an FBAR. Despite the IRS’s dire warnings, this taxpayer is far better off making a disclosure outside the 2012,14 OVDP instead of agreeing to a penalty structure under that program. This taxpayer should survive an IRS audit without the assessment of a non-willful penalty or for that matter, the assessment of any offshore penalties.

Other examples in which it may be advantageous for non compliant taxpayers to make a disclosure to the IRS outside of a targeted offshore voluntary disclosure program could be :

1. poor English skills

2. Illness

http://taxlawyer.moskowitzllp.com/post/2014/07/08/The-IRSs-Position-Regarding-Disclosures-Made-Outside-a-Targeted-Voluntary-Disclosure-Program.aspx