Lessons Learned from Manafort Conviction that Every Taxpayer Should Know
The conviction of former Trump campaign chairman Paul Manafort on eight counts of financial crimes marks the first trial victory of Special Counsel Robert Mueller’s probing investigation into President Trump’s associates. After four days of deliberating, the jury found Manafort guilty of five counts of filing false tax returns on tens of millions of dollars in Ukrainian political consulting income, one count of failing to report foreign bank accounts in 2012, and two counts of bank fraud. U.S. District Judge T.S. Ellis III declared a mistrial on ten other counts (three of which were foreign bank account charges) that the jury was deadlocked on.
The conviction set off a domino effect. On the heels of Manafort’s conviction, Michael Cohen, President Trump’s former personal attorney, pleaded guilty to campaign finance crimes and other charges, including tax evasion and making a false statement to a financial institution. He faces between four and five years in prison when he returns to court for sentencing on December 12, 2018.
Against the backdrop of all of the juicy and salacious political gossip generated by this verdict is a serious tax lesson — one that is deceptively simple but that has ensnared enough defiant taxpayers in the coils of the criminal justice system to be taken lightly. And that is the temptation to hide money in offshore accounts to avoid paying U.S. taxes.
As a way of background information, the U.S. government requires its citizens and residents to report their worldwide income, regardless of where it is earned. As may come as a surprise, the authority for U.S. worldwide taxation is not found in the Internal Revenue Code. Nor is it found in any piece of legislation passed by Congress. Instead, it is found in a little-known U.S. Supreme Court case by the name of Cook v. Tait, 265 U.S. 47 (1924). In an opinion that has been widely criticized as obscure and unintelligible, the Supreme Court of the United States interpreted the U.S. Constitution to allow worldwide taxation of nonresident U.S. citizens.
What does this have to do with foreign bank accounts? Gross income includes a staggering number of items, from salary and wages to interest income earned by bank accounts, domestic or foreign, no matter how light. The definition of gross income found in I.R.C. § 61(a)(1) demonstrates how sweeping it is: “ … income from whatever source derived, including (but not limited to) ‘compensation for services, including fees, commissions, fringe benefits, and similar items.’”
The interest generated by Manafort’s foreign accounts was anything but light. Relying on emails and other documents, the government proved that Manafort concealed millions of dollars in Ukrainian political consulting fees in offshore accounts. Overall, he avoided paying more than $ 16 million in taxes. As if that was not enough to shock the conscience of the jury, then what he did with that money sure did. In a move that made the “Wolf of Wall Street” look like a charitable fundraiser, Manafort used the money that he owed in taxes to support a lavish lifestyle, from a $ 15,000 ostrich jacket to luxury suits to elaborate real estate — all of which was funded through offshore wire transfers from shell companies based in Cyprus and elsewhere.
On top of the requirement to report interest income generated by one’s foreign bank account is the requirement to report the account itself if it meets certain conditions on what is commonly referred to as a Foreign Bank Account Report or “FBAR” for short. The FBAR requirement is hardly new. It is a creature of the Bank Secrecy Act, which was passed back in the 1970s. The IRS did not begin to enforce FBAR reporting as relentlessly as it now does until 2003, when its value as both a revenue-raising tool and as an information-gathering tool in the fight against terrorist financing was realized.
Its value as a revenue raising tool lies in the fact that civil FBAR penalties are not based on the amount of unreported interest income generated by the account which could be as modest as a “Benjamin,” but instead on the closing balance in the unreported account as of the last day of filing the FBAR. The financial disparity between these two amounts is often huge. For example, willful FBAR penalties are the greater of $ 100,000 or 50% of the closing balance in the account as of the last day of filing the FBAR.
Considering the fact that FBAR penalties are assessed per account, and not per year, an examination spanning multiple years could drive a taxpayer’s FBAR liability into the penalty stratosphere, even if the unreported interest income was mere peanuts! For this reason, FBAR penalties are considered to be as heavy-handed as the 800-pound gorilla of civil tax penalties: the 75% civil fraud penalty.
As bad as the civil penalties for failing to file an FBAR might be, the crime of failing to file an FBAR packs an even worse punch. A person convicted of failing to file an FBAR faces a prison term of up to ten years and criminal penalties of up to $ 500,000.
In order for a defendant to be found guilty of willfully failing to file an FBAR, the government must prove four elements beyond a reasonable doubt:
(1) First, the defendant was a United States person;
(2) Second, the defendant had a financial interest in or signature or other authority over any foreign financial accounts, including bank, securities, or other types of financial accounts, in a foreign county;
(3) Third, the aggregate value of these financial accounts exceeded $ 10,000 at any time during the calendar year; and
(4) Fourth, the defendant willfully failed to file a Report of Foreign Bank and Financial Accounts (“FBAR”).
As Manafort found out the hard way, it is not hard for the government to win a criminal FBAR case, especially with evidence as compelling as that relied upon in his case.
In order to avoid a fate as daunting as Manafort’s, be sure to disclose all of your income and your foreign accounts. In theory this sounds all well and good, but what if your transgressions stem from prior years? How do you get “right” with the IRS without giving them the ammunition they need to smoke you at trial?
When it comes to unreported foreign bank accounts, relief is spelled with the acronym “OVDP,” and not “R-O-L-A-I-D-S.” For nearly a decade, the IRS has run its Offshore Voluntary Disclosure Program (OVDP), a type of tax amnesty program for those whose conduct in failing to file an FBAR teeters closer to the extreme end of the willfulness spectrum. While the program does not provide an ironclad guarantee of immunity from prosecution, it generally results in prosecution not being recommended. This program has helped to replenish the coffers of the U.S. Treasury to the tune of more than $ 10 billion.
If you’re considering seeking shelter in the OVDP bunker, time is of the essence. This program is being phased out and will officially end on September 28, 2018. The IRS Streamlined program, a close cousin to the OVDP, will remain in effect. However, unlike OVDP, Streamlined requires the taxpayer to certify — under penalties of perjury — that his failure to file an FBAR was not willful in nature. There are a few more parade of horribles that make streamlined a risky proposition. First, it does not cloak the taxpayer in a veil of immunity from criminal prosecution. And second, streamlined submissions are subject to audits which can be more painful than a root canal.
Nevertheless, if you satisfy the requirements of streamlined, the penalties associated with this program are very attractive (ranging from “zero” for a Streamlined Foreign submission to five percent for a Streamlined Domestic submission) and significantly less than what one might pay in FBAR penalties if the taxpayer attempts a “quiet disclosure” and is subsequently assessed willful and/or non-willful FBAR penalties.
Another hard lesson learned from Manafort pertains to IRS access to information. If there is any question in your mind about whether they can get it, a five-letter acronym will erase any doubt. It’s called the Foreign Account Tax Compliance Act (FATCA) and it can wrap you around the IRS axle faster than you can say the name, “Jack Robinson.”
FATCA penalizes foreign banks if they don’t turn over information pertaining to their U.S. account-holders. Non-compliant foreign financial institutions face a mandatory 30% withholding on payments from U.S.-based financial institutions.
Much to the chagrin of U.S. taxpayers, the vast majority of foreign banks have acquiesced, thumbing their noses at the long-standing tradition of bank secrecy, even at the expense of alienating U.S. customers who have banked with them for generations. The IRS’s reputation as a goliath of information gathering doesn’t end with FATCA. This is only the tip of the iceberg. In addition to FATCA, the U.S. has accumulated a torrent of information from 50,000 voluntary disclosures, whistleblowers, banks under investigation and cooperative witnesses that could fill up a football stadium.
The bottom line: resolve your tax issues before the IRS comes calling. The metaphor that I like to use here is the hunting of a fox by a thirsty bloodhound. If the bloodhound has already detected the scent of the fox and is hot on his trail, then the fox is “squat.” In tax parlance, if the IRS learns about your unreported foreign accounts before you have voluntarily disclosed them, any possibility of a voluntary disclosure gets thrown out with the bathwater.
This is not to say that you can’t hold money and investments outside of the United States. Overseas financial accounts are maintained by U.S. taxpayers for a variety of legitimate reasons, from investment purposes to convenience and access if the taxpayer decides to relocate to inheritance from a recently deceased relative back in the “old country.” The point is that you must disclose them.
Here are some helpful tips when it comes to certifying non-willful conduct for purposes of a streamlined submission. Negligence, inadvertence, or oversight is the standard. Intent to conceal or to evade taxes, on the other hand, will get you a one-way ticket to “Club Fed.”
The IRS’s offshore Streamlined program requires taxpayers to:
“Provide specific reasons for your failure to report all income, pay all tax, and submit all required information returns, including FBARs. If you relied on a professional advisor, provide the name, address, and telephone number of the advisor and a summary of the advice. If married taxpayers submitting a joint certification have different reasons, provide the individual reasons for each spouse separately in the statement of facts.”
If you knew you were supposed to report, the IRS may claim you were willful. In making out a claim of willfulness, the IRS relies upon the theory of “willful blindness,” which is easily misunderstood.
Under the theory of willful blindness, a jury may infer willfulness whenever a taxpayer intentionally fails to inquire and learn about his or her filing obligations. In other words, instead of proving that the defendant intentionally violated a known legal duty, the government need only show that “the defendant consciously avoided any opportunity to learn what the tax consequences were.” United States v. Bussey, 942 F.2d 1241, 1428 (8th Cir. 1992).
When it comes to the crime of failing to file an FBAR, the only thing that a taxpayer need know is that he has a reporting requirement. And if the taxpayer has that requisite knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR.
If you don’t want to be the next cooked goose on the IRS’s chopping block, here is a laundry list of items that you’ll want to avoid:
- Avoid checking the box off “no” on Schedule B in response to the question, “Do you have an interest in or signature authority over a financial account in a foreign country?” when, in fact, you do.
- Avoid failing to report a foreign account in a later year when you have the obligation to do so despite having filed an FBAR in an earlier year. This reveals that you knew that you had an FBAR-reporting obligation in the later year.
- Avoid holding an account in such a way as to conceal ownership. For example, is it in the name of a “foreign shell corporation or foreign trust,” or some other entity that would make it difficult for the IRS to learn your true identity as the owner? Is the account a numbered account?
- Avoid using coded language, such as asking your private banker, “can you download some tunes for us?” or note that your “gas tank [was] running empty” when you required additional cash to be deposited.
- Avoid filing some tax forms and not others.
- Avoid keeping two sets of books.
- Avoid instructing bank personnel to hold back your bank statements and refrain from mailing them to you in the U.S. (if the U.S. residence was listed as your primary residence).
You get the idea. Even if you can explain one isolated incident of failing to report a foreign account, repeated occurrences over a period of years will almost always turn an otherwise inadvertent and utterly benign omission into reckless or deliberate conduct. And when that happens, it will not be long before you hear the sound of the IRS’s drums beating and their guns going off — right outside your door.