What is willful blindness according to the IRS? How is this important in tax cases involving unreported or under-reported income, disclosure of offshore assets and income, FinCEN Form 114 (more commonly referred to as an “FBAR”), and even digital currencies and Non-Fungible Tokens (NFTs)?
In an internal IRS memorandum from May of 2018, POSTS-135605-17, the IRS Office of Chief Counsel concluded the standard of willfulness for the IRS is the same as the standard for willfulness under U.S.C. 5321(a)(5)(C) and includes “not only violations of the FBAR requirements, but willful blindness to the FBAR requirements as well as reckless violations of FBAR filing requirements.”
The notes of this memorandum state willful blindness is established when an individual “takes deliberate actions to avoid confirming a high probability of wrongdoing and [when he] can almost be said to have actually known the critical facts.” In addition, note 2 of this document clearly states the IRS standard for recklessness is met “if the taxpayer (1) clearly ought to have known that (2) there was a grave risk that withholding taxes were not being paid and if (3) he was in a position to find out for certain very easily.” United States v. Vespe, 858 F.2d 1328, 1335 (3d Cir. 1989).
Willfulness is a critical element of any IRS investigation or audit. The key issue for an IRS determination of willfulness is whether or not the taxpayer behaved in a manner that they knowingly, intentionally, and voluntarily violated the known duties presumed of every U.S. taxpayer.
“Voluntary compliance” is the central responsibility of a U.S. taxpayer as it relates to the duty to report all income. Tax avoidance through specific adjustments to income, deductions, and credits is absolutely legal under the U.S. tax code. Compliance is considered voluntary when the U.S. taxpayer reports all foreign and domestic income, files required returns, and pays their taxes in a timely fashion. This includes the duty to obtain all associated forms and instructions, provide accurate and complete information, as well as organize and keep detailed financial records.
In other words, ignorance is not an excuse the IRS is willing to accept.
However, the IRS also considers issues of “willful blindness” on the part of a U.S. taxpayer during an investigation or audit. The IRS uses the legal argument of willful blindness to combat U.S. taxpayer claims of non-willful conduct in FBAR reporting omissions or failure to file. In essence, the IRS argues, “It was your responsibility to understand your responsibilities as a taxpayer, and you obviously had to have made a conscious effort not to learn about your responsibilities and the associated reporting requirements under FinCENs FBAR Form 114, as well as IRS income tax reporting requirements.” Generally speaking, the more educated, well-traveled, and financially savvy a taxpayer is, the greater the likelihood that the IRS will simply assert, “You should have known better,” and “Your conduct represents a willful blindness.”
Recent court cases have demonstrated the veracity with which independent IRS auditors assume and pursue willful misconduct during an IRS audit. The reason is simple: the IRS knows the cost of fighting the legal battle, and defeating the determinations made during your audit are enough to deter most taxpayers.
The legal standard of “willful versus non-willful” is an important distinction, especially as it relates to IRS tax returns, FBAR violations, and associated fines, penalties, and interest. The failure to thoroughly, accurately, and transparently disclose all offshore bank accounts, investment accounts, assets, and real property exposes a U.S. taxpayer to potentially draconian penalties. The maximum penalty is the greater of $100,000 or 50 percent of the highest balance (even if for a day) of qualifying bank and investment accounts within a specific filing timeframe.
Two recent appellate cases, Said v. United States and Kimble v. United States, confirm that a U.S. taxpayer has acted with willfulness if the “responsible person acts with a reckless disregard … such as failing to investigate or correct mismanagement…” as well as “willingness in the context of U.S.C. 5321(a)(5)(C) includes recklessness…” and that a U.S. taxpayer who signs their tax return is “charged with constructive knowledge of its contents.”
Another example from U.S. case law includes a finding of willful blindness when a U.S. taxpayer took advice from a neighbor (that they did not have to pay taxes on offshore interest income) but did not seek to hold the same discussion with their accountant or tax preparer.
If it is likely that a U.S. taxpayer should have been aware, or was “subjectively aware” that they have experienced some form of income or gain, then the agency can infer willful blindness for their failure to report, completely and accurately, the nature and amount of that income and/or gain, and pay appropriate U.S. taxes.
Willful blindness, according to the IRS, is the failure to exercise your responsibilities as a U.S. taxpayer to know the law and your reporting requirements, as well as all sources of income or gain not only here in the United States but around the world. If you are savvy enough to have foreign investments, you are obviously savvy enough to either determine your obligations through forms and instructions or seek the advice of qualified professionals.
Ignorance is no excuse when one is dealing with the IRS.
Allen Barron’s experienced tax attorneys have specific strategies to protect our clients and to hold the IRS accountable to the letter of the law. It begins with the supporting documentation one must provide to support your reasons for being unaware of FBAR reporting requirements or the failure to list an asset or account here or there. The financial implications of unreported or under-reported income or gains can quickly mount into the hundreds of thousands for many taxpayers.
If you are concerned about FBAR compliance or have been contacted by the IRS for an audit we invite you to learn more about the integrated tax, legal, accounting and business consulting services of Allen Barron and contact us or call today to schedule a free consultation at 866-631-3470. Protect yourself against IRS assertions of willful blindness other aggressive tactics of the IRS.
