Does the Payment of a Title 26 Offshore Penalty Through the Streamlined Procedures Create an Enforceable Contract with the IRS?

The Streamlined Filing Compliance Procedures is an Internal Revenue Service (“IRS”) program, which, according to the IRS website, isa available to United States taxpayers holding foreign accounts not previously disclosed to the IRS, in order to promote voluntary disclosure of those accounts and to resolve existing tax obligations, including certain penalties related to those previous failure to disclose those foreign accounts. While the Streamlined Procedures are detailed on the IRS website, the Streamlined Procedures are not discussed in the Internal Revenue Code or its regulations.

This article discusses whether the payment of the 5 percent miscellaneous penalty establishes an enforceable contract claim in which the IRS would be foreclosed from assessing a greater civil penalty.

An Overview of the IRS Streamlined Procedures

According to the IRS website, the Streamlined Procedures:

Are available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part. The streamlined procedures are designed to provide to taxpayers in such situations with

1. A streamlined procedure for filing amended or delinquent returns, and
2. Terms for resolving their tax and penalty procedures for filing amended or delinquent returns, and
3. Terms for resolving their tax and penalty obligations.

To Participate in the Streamlined Procedures Taxpayers Must:

Certify, in accordance with the specific instructions set forth below, that the failure to report all income, pay all tax and submit all required information returns, including FBARs (FinCEN Form 114, previously Form TD F 90-22. According to the IRS website, “the streamlined filing process will not culminate in the signing of a closing agreement with the IRS,” resolving all potential liability related to foreign accounts, but rather “returns submitted under the streamlined procedures may be subject to IRS examination, additional civil penalties, and even criminal liability, if appropriate.”

The Streamlined Procedures are divided into two sets of procedures, distinguished by the “residency” of the taxpayers eligible to participate: non-United States “residents” are eligible to participate in the Streamlined Foreign Offshore Procedure, while United States “residents” are able to participate in the Streamlined Domestic Offshore Procedures. The IRS website contains further information specific to the Streamlined Domestic Offshore Procedures:

U.S. taxpayers (U.S. citizens, lawful permanent residents, and those meeting the substantial presence test of IRC section 7701(b)(3)) eligible to use the Streamlined Domestic Offshore Procedures must (1) for each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed (the “covered tax return period”), file amended tax returns, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621), (2) for each of the most recent 6 years for which the FBAR due date has passed (the “covered FBAR period”), file any delinquent FBARs (FinCEN Form 114, previously Form TD F 90-22.1), and (3) pay a Title 26 miscellaneous offshore penalty. The full amount of the tax, interest, and miscellaneous offshore penalty due in connection with these filings should be remitted with the amended tax returns.

The Title 26 miscellaneous offshore penalty is equal to 5 percent of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period. For this purpose, the highest aggregate balance/value is determined by aggregating the year-end account balances and year-end asset values of all the foreign financial assets subject to the miscellaneous offshore penalty for each of the years in the covered tax return period and the covered FBAR period and selecting the highest aggregate balance/value from among those years.

A foreign financial asset is subject to the 5-percent miscellaneous offshore penalty in a given year in the covered FBAR period if the asset should have been, but was not, reported on an FBAR (FinCEN Form 114) for that year. A foreign financial asset is subject to the 5-percent miscellaneous offshore penalty in a given year in the covered tax return period if the asset should have been, but was not, reported on a Form 8938 for that year. A foreign financial asset is also subject to the 5-percent miscellaneous offshore penalty in a given year in the covered tax return period if the asset was properly reported for that year, but gross income in respect of the asset was not reported in that year.

The IRS Website Additionally States That:

If returns properly filed under these procedures are subsequently selected for audit under existing audit selection processes, the taxpayer will not be subject to accuracy-related penalties with respect to amounts reported on those returns, or to information return penalties or FBAR penalties, unless the examination results in a determination that the original return was fraudulent and/or that the FBAR violation was willful.

Finally, the IRS website provides “Specific Instructions” for the Streamlined Offshore Procedures, provides as follows:

Complete and sign a statement on the Certification by U.S. Person Residing in the U.S. (Form 14654) certifying: (1) that you are eligible for the Streamlined Domestic Offshore Procedures; (2) that all required FBARs have now been filed; (3) that the failure to report all income, pay all tax, and submit all required information returns, including FBARs, resulted from non-willful conduct; and (4) that the miscellaneous offshore penalty amount is accurate. You must maintain your foreign financial asset information supporting the self-certified miscellaneous offshore penalty computation and be prepared to provide it upon request. You must submit an original signed statement and attach copies of the statement to each tax return and information return being submitted through these procedures. You should not attach copies of the statement to FBARs. Failure to submit this statement, or submission of an incomplete or otherwise deficient statement, will result in returns being processed in the normal course without the benefit of the favorable terms of these procedures.

Does the Payment of a 5 Percent Penalty Establish an Enforceable Contract?

The general concept of the Streamlined Procedures is that a taxpayer pays a 5 percent miscellaneous penalty in exchange for the IRS not to assess additional penalties. The question is whether the payment of the 5 percent penalty constitutes a valid binding contract. In order to characterize the payment of the Title 26 penalty paid through the Streamlined Procedures as an enforceable contract, a participating taxpayer must establish privity of contract with the United States government. To have privity of contract with the United States government, the party seeking to enforce the agreement “must show that either an express or implied-in–fact contract underlies the claim.” See Park Prop. Associates., L.P. v. United States, 916 F.3d 998, 1002 (Fed. Cir. 2019), cert. Denied, 140 S. Ct. 857 (2020). The required elements to demonstrate an express or implied contract are: (1) mutuality of intent to contract; (2) consideration; and (3) lack of ambiguity in offer and acceptance, and (4) the government representative whose conduct is relied upon must have actual authority to bind the government in contract. See City of El Centro v. United States, 922 F.2d 816, 820 (Fed. Cir. 1990).

For a Streamlined Procedure to be treated as a binding contract, the Form 14654 would need to be treated as an offer from the IRS (or United States Government) to the participating taxpayer in which the taxpayer would accept the offer by completing the Form 14654 and submitting it to the IRS, and for which the participating taxpayer pays consideration to the IRS in the form of a Miscellaneous Offshore Penalty. In return, the IRS would promise not to assert other penalties against the participating taxpayer for failure to report foreign financial assets on his or her prior tax returns. The problem with attempting to characterize a Streamlined submission as a contract is that a submission is subject to review, examination, and potential penalties. Arguably, the Streamlined Procedures establish the existence of a binding contract. However, the specific language of Form 16654 by its terms explicitly reserves the ability for the IRS to conduct further examination and assess additional penalties if the participating taxpayer’s behavior is found to be willful after the examination. When a participating  taxpayer signs a Form 14654, he or she agrees to the following language included in the Form 14654, which states: “I recognize that if the Internal Revenue Service receives or discovers evidence of willfulness, fraud, or criminal conduct, it may open an examination or investigation that could lead to civil fraud penalties, FBAR penalties, information return penalties, or even referral to Criminal Investigation.” (capitalization in original). Moreover, the Form 14654 explicitly reserves to the IRS the right to conduct such an examination and assess further penalties without regard to the previous amount paid as the Miscellaneous Offshore Penalty and without indicating in the Form 14654 the amount or extent as to which penalties may be assessed following such an examination and finding of willfulness. Moreover, while the Form 14654 requires the applicant to make representations to the IRS regarding the applicant’s willfulness in failing to report foreign financial assets, the IRS’s reservation of the right to further examine the conduct of the applicant does not bind the IRS to the applicant’s representations.

Thus, even if the Streamlined Procedures establish a contract in a Form 14654, the IRS reserves the right to conduct and assess further penalties if it determines that a participant “willfully” failed to timely disclose foreign financial assets and/or foreign income to the IRS. As a result, any potential contract defenses would be inapplicable if the IRS determines a Streamlined participant “willfully” failed to timely disclose foreign financial assets or foreign source income. The term willfulness for income tax purposes is broadly defined as the voluntary, intentional violation of a known legal duty. The term willfully in the international tax and international penalty context includes “conduct marked by careless disregard whether or not one has the right so to act.” See United States v. Murdock, 290 U.S. 389, 395, 54 S. Ct. 223, 78 L.Ed 381 (1938). This construction reflects common law usage, which treated actions in “reckless disregard” of the law as “willful” violations. See W. Keeton, D. Dobbs, R. Keeton & D. Owen, Prosser and Keeton on Law of Torts, Section 34, p. 212 (5th Ed. 1984). On the other hand, the term non-willful for purposes of international tax and international penalties has been defined as non-compliance due to negligence, inadvertence, or a misunderstanding of the law.

For purposes of the Streamlined Procedures, it is far more important to determine if a participant’s non-compliance can be classified non-willful rather than focusing on contract defenses. Anyone considering making a submission through the Streamlined Procedures should have a qualified international tax attorney review their facts and circumstances to make a determination if their conduct can be considered  “willful” by the IRS or a federal court. This determination should be made prior to making a Streamlined Procedures submission.

Conclusion

A Streamlined Procedures submission is an IRS program that allows eligible U.S. taxpayers to come into compliance with their tax obligations and foreign reporting requirements. The program is specifically designed for individuals whose previous non-compliance was non-willful. Meaning that the non-compliance was due to negligence, inadvertence, or a misunderstanding of the law. Anyone considering making a submission through the Streamlined Procedures should have an analysis performed by a qualified international tax attorney to determine how their past non-compliance can be interpreted by the IRS and a federal court.

Diosdi and Liu, LLP has successfully made hundreds of Streamlined Submissions and offshore filings.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & Liu, LLP. Anthony has substantial experience advising foreign and domestic technology companies regarding the U.S. tax consequences of digital content and cloud transactions. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.

He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.