A recent tax court case had many of us excited about the government losing an FBAR penalty case and the impact it could have for taxpayers. Unfortunately, upon further review, while the taxpayer deserves congratulations for his impressive and complete win, this particular case was limited in scope. At no point in the case were FBAR penalties ever assessed, but instead were used as a threat of possible criminal prosecution. That is, while the case of Youssef Youssefzadeh involved the threat of potential FBAR criminal penalties, they never materialized.
While it wasn't necessarily a heavy blow to FBAR penalties or the IRS (who administers the FBAR), that doesn't mean we don't like the decision. Actually, we're quite happy to see the Tax Court put some teeth back on the Bill of Rights. And by that I mean the actual Bill of Rights, not the meaningless Taxpayer Bill of Rights.
What it takes to win against the IRS
You're going to have to bear with me, this case has some rather in-depth details. The facts are as follows:
- The taxpayer — Youssef Youssefzadeh — filed his 2011 1040 (tax return) and a Schedule B including total reported interest. The name of the taxpayer was redacted (probably either blank, blacked out, or listed as "other") and Part III of the Schedule B was left blank (where a taxpayer would indicate whether they had foreign accounts that would necessitate an FBAR).
- Included with the return, the taxpayer included a 5th Amendment invocation against self-incrimination (a person can't be compelled to witness against themselves).
- The IRS, upon seeing the return, warned the taxpayer of a frivolous return penalty.
- Despite the warning, the taxpayer refused to back down, leading the IRS to assess them with the frivolous return policy.
- The taxpayer, having been assessed the penalty, filed a timely collections due process (CDP) request which they lost on appeal.
- Finally, after all of the back-and-forth, the case went to Tax Court.
To assess the frivolous penalty, the IRS had to show that (1) the document was a tax return, (2) the omitted information was substantial enough to prevent the judging of whether the assessment was correct, and (3) the taxpayer's position proved to be frivolous or showed a desire to impede the administration of the Internal Revenue Code.
This was obviously a 1040 (tax return) and the redaction/blank Part III was okay. The return had all the other pertinent information; most importantly, it had the dollar amounts, and it sounds like the numbers were accurate. This shouldn't be overlooked – the accuracy of the numbers is very important.
The only information that we know was not included was the name of the payer of the accurate interest amount and the answer to the question of whether the taxpayer held a foreign account with an FBAR obligation. Most significantly, the return was SUBSTANTIALLY correct.
Now — for the third prong — the IRS tried to rely on IRS Notice 2010-33 (which indicates that a 5th Amendment assertion is frivolous because the IRS says it is frivolous) but, as cited by the Tax Court, this Notice conflicts with SCOTUS rulings allowing 5th Amendment assertions for tax returns in certain circumstances.
Even though certain situations allow for a 5th Amendment assertion, the taxpayer has to have "reasonable cause" for his fear of criminal prosecution — it cannot be hinged on some random or remote possibility. Right here is where the FBAR takes the stage! The Tax Court took into serious consideration the language of the FBAR statutes which make it a crime to willfully avoid filing an FBAR. Thanks to the legitimate fear of criminal prosecution, which was upheld by the court, the taxpayer had a legitimate reason for his actions, and his 5th Amendment invocation stood.
Winning an FBAR tax court case
Now, as I see it, the most important factors for Youssef's (the taxpayer) success are as follows:
- The taxpayer submitted a timely-filed return, a timely-filed CDP hearing, and — we can assume — exhausted administrative remedies. Very groovy for a pro se litigant to get this right.
- The return was substantially correct and could have been processed as it was. In the end, the administration of the Internal Revenue Code and 1040 are about income numbers. The numbers were accurate and put on the timely-filed return. Nothing about the 5th Amendment invocation would have prevented the IRS from administering the tax code. The Tax Court noted how the taxpayer was not "one of those tax protesters" that put zeros on all the lines. So, for this case, it would seem to be a legitimate claim of a legal and constitutional right rather than a general protest against the tax code.
An argument could be made that refusing to put the payer name on Schedule B and refusing to answer Part III does make the return substantially incorrect. That information would allow the IRS to know whether other forms were required, namely the Form 8938 which, if unfiled, tolls the statute of limitations indefinitely. That, to be sure, is no small thing.
- The Tax Court made a minor mistake with the FBAR requirement. The court said on page 5 that "the lines that redacted ask for information that trigger the duty to file an FBAR." We know that the Schedule B itself does not trigger the FBAR requirement, but acts as the constructive notice of the requirement. We've successfully made this argument many times and we expect to be able to continue to do so.
- Additionally, because pedantics are what we do: in Footnote 1, the Tax Court gives the form as TD-F 90-22.1, which was true at the time, but said form no longer exists — it is now FinCEN 114 (the FBAR).
- But, and this is what is particularly interesting, we have a tax court — a creature of Title 26 of the code — ruling on a Bank Secrecy Act Title 31 consequence, which is really something of a 5th Amendment consequence. So, would someone claiming that tax law affects more laws than any other legal branch be incorrect? This isn't just my way of saying that tax lawyers are the lawyers' lawyer, but yeah… we are.
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