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Another turn at Cheek: Willfulness and non-US residents

A. Background

Since 2012, US citizens1 living in Canada (and elsewhere outside the US) have had two options to address income tax non-compliance issues: the Offshore Voluntary Disclosure Program (“OVDP”) and the Streamlined filing procedure (“Streamlined”). The more comprehensive OVDP program offers criminal amnesty after pre-clearance, extensive disclosures, and a mandatory penalty payment. Streamlined presents a less onerous path of fewer filings and reduced (or eliminated) penalty. Originally, Streamlined was available only to nonresident taxpayers as defined by the terms of the program.2 On June 18, 2014, the IRS announced modifications to the streamlined filing procedure.3 One modification was the establishment of the “Streamlined Domestic Offshore Procedures.” This program opens the Streamlined filing procedures to US resident taxpayers, and was intended for US resident taxpayers who had failed to disclose offshore assets, but whose failure to disclose had been “non-willful.”4 Our firm wrote about these modifications which can be viewed here.

A second modification was the introduction of a “non-willfulness” requirement for both domestic and offshore streamlined filers. In their streamline submissions, taxpayers must certify that their failure to comply with their (offshore or domestic) obligations was “due to non-willful conduct.” The IRS has issued forms for this certification. Foreign streamline filers use Form 14653. Domestic streamline filers use Form 14654.

On paper, the “non-willful” analysis for domestic filers and offshore filers seems identical.5 However, differences between offshore and domestic streamline filers mean that the “non-willful” standard will apply differently for the two groups. Domestic streamline filers by definition have filed US taxes. They are certifying that their otherwise compliant tax filings were incomplete due to non-willful conduct. Taxpayers residing outside of the United States use the streamline filing procedure to address an overall failure to file US tax returns during a period of non-US residency.6 For these foreign taxpayers, this difference will be reflected in the application of the “non-willful” standard to US and non-US taxpayers.

B. Willfulness in general

Although defined in the negative, the non-willful standard is related to the meaning of “willful” as it appears in both the Internal Revenue Code (“IRC”) and the Bank Secrecy Act (“BSA”). Many provisions of both the IRC and the BSA criminalize or penalize acts or failures to act only if such acts or failures are “willful.” The US Supreme Court has explained that in requiring a willful violation, “Congress… softened the impact of the common law presumption [of knowledge of the law] by making specific intent to violate the law an element of certain criminal tax offenses.”7 Congress and the courts recognize the complexity of the tax law, which cannot realistically be subject to the centuries old precedent that ignorance of a [violated] law does not excuse the violation.

Courts have struggled to determine the precise contours of this more limited “willful” standard. The US Supreme Court observed that willful is “a word of many meanings” with a construction “influenced by its context.”8 In the context of the IRC and the BSA, the US Supreme Court has interpreted a willful violation to be the “intentional violation of a known legal duty.” This means that a willful violation exists if the taxpayer/defendant: 1) knows there is a law prohibiting their (in)action and 2) intends to violate that prohibition.

C. Current application

Domestic Streamline filers have complied with some but not all of their filing obligations. That partial compliance can make it more difficult to claim ignorance of the unmet obligations. The most obvious example is line 7a of Schedule B, which asks a direct “yes” or “no” question about ownership of foreign bank accounts. There are other issues as well. Consulting on US tax issues, deliberately sending assets offshore and signing a US return under penalties of perjury have all been scrutinized by the courts.9 The context will differ in each case, but in general completing a Schedule B and obtaining professional advice are standard features of a domestic taxpayer’s experience.

However, for taxpayers in Canada (and elsewhere outside the United States), “non-willfulness” is not used to distinguish between different obligations. Rather, the issue for these taxpayers is whether they were aware of their general obligation to file US tax returns. This issue was addressed by the US Supreme Court in Cheek.

Cheek was a US resident and a commercial airline pilot charged with willfully failing to file income tax returns for six years. Cheek claimed that his failure to file was not “willful” because during the relevant years he had believed that that the IRC was unconstitutional. He had reached this conclusion through attending a number of “tax protestor” seminars and conducting his own research. Cheek argued he could not “knowingly” violate a law which he believed to be unconstitutional (i.e. not apply). The US Supreme Court agreed, stating very clearly that a taxpayer “cannot be aware that the law imposes a duty on him” if he “is ignorant of [the law], misunderstand[s] the law, or believe[s] the law does not apply to him.”10 Importantly, the US Supreme Court ruled that even a subjective misconception of applicable law can negate a finding of willfulness.

The complexity of US tax law and other factors make it even easier for the US citizen in Canada11 to be confused or misinformed about their US tax obligations.12 This confusion is obviously far more reasonable than subscribing to tax-protestor perspective. Under the Cheek reasoning, this is a crucial factor in assessing “non-willfulness.” US citizens resident in Canada are unlikely to present the issues of partial compliance exhibited in the US-domestic context. Taxpayers and their advisors should be mindful of this distinction in considering recent judicial and administrative developments.

In summary, taxpayers who are non-residents of the US should carefully consider the advantages currently available under the current streamlined procedures. It is also important to realize that as time goes on, the analysis of these factors may produce different results. It is crucial that taxpayers take advantage of favorable factors while they are still available.

1 Long term permanent residents of the US (“green card” holders) are also affected by these issues.
2 The IRS was “aware that some US taxpayers living abroad . . . failed to timely file US federal income tax returns or [FBARs]” due to a lack of knowledge of their legal obligations. The Streamlined program was designed to “allow taxpayers who are low compliance risks to get current with their tax requirements without facing penalties or additional enforcement action.” IR-2012-65, June 26, 2012.
3 IR-2014-73, June 18, 2014
4 To be eligible for Streamlined Domestic Offshore Procedures, US resident taxpayers must: 1) fail to meet the applicable non-residency requirements for Streamlined Foreign Offshore Procedures; 2) have previously filed a US tax return for the most recent three years for which the due date (including extensions) has passed; 3) have failed to report gross income from a foreign financial asset and pay the required tax and may have failed to file an FBAR and/or another “international information return” in a failure 4) not due to willful conduct.
5 Both Form 14653 and 14654 contain the following language: “[m]y failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-willful conduct. I understand that non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.” The IRS has repeatedly indicated its non-willingness to further elaborate on the meaning of non-willfulness.
6 This is implicitly acknowledged by the IRS. Offshore streamlined filers are not required to have filed returns for the previous three years, unlike domestic streamlined filers.
7 Cheek v. US, 498 US 192, 200 (1991). This presumption of the common law was the basis for the well-known general rule that “ignorance of the law or a mistake of law is no defense to criminal prosecution.” Cheek at 199.
8 Ratzlaf v. US, 510 US 135, 141 (1994).
9 The two most recent cases to address these issues are US v. Williams, 489 F. App’x 655 (4th Cir. 2012) and US v. McBride, 908 F. Supp. 2d 1186 (D. Utah 2012). Other factors regularly referenced by the IRS are setting up trusts, foudations or other structures, instructing banks to not mail account materials, use of a non-US passport, personal visits to manage accounts, patterns of failing to file FBARs, selective filing of FBARs, use of code words in telephone conversations, use of debit/credit cards or other repatriation strategies and transferring of funds between multiple foreign accounts.
10 Cheek at 202.
11 The Instructions to the Form 1040NR refer to the following concepts in describing who must file a tax return: US trade or business, source of income, treaty exemptions, the alternative minimum tax, international social security agreements and the Health Insurance Marketplace. Thankfully, constitutional issues for most of these items were settled long ago.
12 As international enforcement efforts increase, particularly under FATCA, it is likely that this factor will lose some of its significance.