Part 2: Be careful what you “Fix For” – Mr. Kentera meets Mr. #FBAR in the “Twilight Zone”

cross-posted from citizenshipsolutions.ca

by John Richardson

Introduction …

This post is one more of a collection of FBAR
posts on this blog. The most recent FBAR posts are here and here.

The “unfiled FBAR” continues to be a problem for certain Homeland
Americans with “offshore accounts” and all Americans abroad, who
continue to “commit personal finance abroad”.

The above tweet references a recent post which discussed how to
“fix past compliance problems“. The introduction
included:

This blog post will hopefully encourage those with U.S. tax
issues to consider whether they can deal with minor/unintentional FBAR
violations as a “stand alone single problem”. There may be no need to
escalate and expand one single problem into a multi-dimensional full
blown tax problem that may end up with unintended and unanticipated
costly professional fees as well as undue time spent! Read on and learn
why. Keeping a calm head is most important, even if it is most difficult
to do in the face of the scary situation of not being in compliance with
the U.S. tax and regulatory regime.

Introducing Mr. and Mrs Kentara – When the innocent enter the
“Twilight Zone” …

The facts (as reported by Virginia La Torre Jeker in her outstanding
analysis) …

In Kentera v. United States, 2017 U.S. Dist. LEXIS 12450 (ED
WI 2017), the US District Court dismissed a complaint filed by a husband
and wife living in California. The Kentera’s were seeking review of FBAR
nonwillful penalties asserted by the IRS. The nonwillful FBAR penalties
were assessed pursuant to an audit after the couple withdrew from the
IRS’ 2011 Offshore Voluntary Disclosure Initiative (OVDI).

The facts of the case are taken from the plaintiff’s complaint, which
can be read here. In summary, they are as follows:

In 1984, after the death of his father, the plaintiff-husband, Milo
Kentera, inherited a Swiss foreign bank account at Banque Cantonale de
Geneve (Swiss Account). The account was automatically transferred to the
plaintiff at the death of his father, so the plaintiff did not take any
action in creating this account. Sometime soon afterwards, Milo added
his wife’s name to the Swiss Account. The balance in the account was
under USD10,000 through 2004 but increased somewhat in 2005-06 going
over the USD10,000 FBAR filing threshold. The Swiss Account increased
significantly in 2007 upon the sale of the plaintiff’s parents’
Montenegro real property. Some of the sales proceeds were distributed to
plaintiff Milo and deposited in the Swiss Account, with the balance paid
to Milo’s siblings.

Neither of the plaintiffs were well-versed in US tax matters. The
husband was a pharmacist and his wife was a homemaker. Since 1984 when
the account was inherited, the plaintiffs always disclosed the Swiss
Account to their various accountants on tax organizers and always
disclosed the account on their federal income tax returns (Schedule B).
However, when the account first exceeded USD 10,000 in 2005, their first
accountant failed to prepare or file an FBAR for the plaintiffs. Their
second accountant continued this FBAR failure for a number of years
despite the fact he clearly knew of the existence of the account from
the prior tax returns given to him by the plaintiffs; he also failed to
ask if any foreign interest was earned on the account, and consequently,
interest income was omitted. In 2010, a third accountant acknowledged
the existence of the Swiss Account on the plaintiffs’ return and
included interest income from the Account, but she also failed to
prepare or file an FBAR. Please note, certainly a tax professional
should have been well aware of the FBAR filing rules by the time a 2010
FBAR should have been filed (i.e., June 30 2011). At this time the first
IRS OVDI had been in full swing, having been initiated in 2009 and many
professional and non-professional articles were written about the
problems with FBAR.

Sometime in approximately September 2011, the plaintiffs entered the
recently announced IRS 2011 OVDI program. They amended tax returns to
include omitted interest income from the Swiss Account and filed
completed FBARs for the 6 year period, 2005-2010. In August 2013, the
IRS provided Plaintiffs with a Form 906, Closing Agreement assessing a
miscellaneous penalty of $90,092. The complaint stated that plaintiffs
“withdrew” from the OVDI program the following month. I believe the
plaintiffs “opted out” of the program, but am not sure. They were soon
the subject of examination by an IRS agent. The IRS agent recommended
that plaintiffs be assessed non-willful FBAR penalties under the Bank
Secrecy Act, and later proposed assessing the penalties as follows:

1) As to the husband, Milo Kentera: $500 for calendar year 2006; and
$10,000 per year for calendar years 2007, 2008, 2009, and 2010, for a
total penalty of $40,500.

2) As to the wife, Lois Kentera: $500 for calendar year 2006; and $2,500
per year for calendar years 2007, 2008, 2009, and 2010, for a total
penalty of $10,500; and

Plaintiffs protested the penalties at IRS conferences, but their
protests fell on deaf ears and the IRS sent each of the plaintiffs a
letter of an “appeals determination,” upholding the IRS’ proposed FBAR
penalties against each of them. The plaintiffs then filed the complaint
in District Court. In their complaint, plaintiffs asserted that the IRS
incorrectly assessed the FBAR penalties. First, on grounds that the Bank
Secrecy Act prohibits the imposition of an FBAR penalty if the violation
was “due to reasonable cause.” 31 U.S.C. § 5321(a)(5)(B)(ii)(I). [I note
here that the statute requires not only “reasonable cause” but also that
“the amount of the transaction or the balance in the account at the time
of the transaction was properly reported”.]

My initial thoughts …

The facts suggest that Mr. and Mrs. Kentera were people who believed in
compliance with the law. The history of their tax filings suggests a
conscious effort to comply with the applicable laws. They also (like
everybody) were completely at the mercy of their tax advisers. The
“offshore account” (which was not opened by them) was disclosed to their
tax preparers. The tax preparers failed to advise Mr. and Mrs Kentera to
file their FBAR (a requirement that few in 2011 knew about).

This series of events took place during the
“2011 IRS Reign of FBAR Terror“. At this time many
lawyers and accountants strongly recommended that people (1) correct
their mistakes (the
nonwillful ones that were the result of not knowing
about Mr. FBAR) and (2) correct those mistakes by agreeing to the
OVDP/OVDI penalty program (that is/was analagous to a form of
“Civil Forfeiture“).

The evidence strongly suggests that Mr. and Mrs. Kentera were ordinary
people, trying to do the “right thing”. They were victimized by advice
to enter OVDI and then victimized by the IRS because they entered OVDI.
(To get a sense of the context of how people were victimized by trying
to do the “right thing”, read Phil Hodgen’s April 5, 2011 post
here. There were many other posts written during
this period. To see how Green Card holders were victimized by the OVDI
program see
here and
here.)

How could the IRS possibly assess this kind of FBAR
penalty?

All “armchair quarterbacks” must remember the context in which
individual decisions were made. In 2011, there were NO
streamlined compliance procedures. There were no
delinquent FBAR submission procedures. There were no
Delinquent Information Return Procedures.

That said, there was also NO requirement that people enter
OVDI.

Tragically those who tried the hardest, and acted most quickly, to fix
their non-compliance problems were the most harshly treated. (In fact,
the history of the IRS assault on Americans abroad has shown that that
those who did NOT rush to fix their problems fared much better. You may
remember the
“This is your last best chance to come into
compliance” threats directed to those (including Americans abroad)
with offshore non-U.S. bank accounts.)

To put it simply: The Kentera’s were victims of their
desire to be in compliance with the law. It is regrettable that their
law abiding sentiments coincided with the 2011 atmosphere of
threats from the IRS and fear mongering from
the compliance industry.

Why OVDP is extremely danagerous …

To enter OVDI or OVDP is to enter a program where you interact with the
IRS outside the provisions of the Internal Revenue Code. You agree to
interact with the IRS outside the framework of the existing laws. OVDP
is appropriate for ONLY the very small group of people who may face
serious penalties and (criminal) punishment.) OVDP is completely
inappropriate for Americans abroad (where all of their assets are
foreign and all assets are therefore subject to penalty assessment).

But, once you enter OVDP …

In my humble opinion, Mr. and Mrs. Kentera were subjected to this
penalty because they entered OVDI. Because, they entered the program,
there must have been a presumption that they somehow “deserved to be
there”. As Virgina La Torre Jeker
points out:

The point to be taken is the IRS’ apparent lack of sympathy
with the taxpayers’ arguments concerning “reasonable cause”. It will be
remembered that the IRS has discretion to assess FBAR penalties after
taking into account all the facts and circumstances. See the IRS Manual
regarding FBAR penalties
here. Current IRS procedures state that an examiner
may determine that the facts and circumstances of a particular case do
not justify asserting a penalty and that instead an examiner should
issue a warning letter. The IRS has established penalty mitigation
guidelines, but examiners may determine that a penalty is not
appropriate or that a lesser (or greater) penalty amount than the
guidelines would otherwise provide is appropriate. Examiners are
instructed to consider whether compliance objectives would be achieved
by issuance of a warning letter; whether the person who committed the
violation had been previously issued a warning letter or has been
assessed the FBAR penalty; the nature of the violation and the amounts
involved; and the cooperation of the taxpayer during the
examination.

For more about FBAR penalties and the “FBAR Penalty Mitigation
Guidelines”, see the discussion by Michael Deblis
here.

What happened was that Mr. and Mrs. Kentera “signed up” to pay an FBAR
penalty when there is a good chance that one would never have been
imposed in the first place!

Incredible! What should/could have resulted in a “warning
letter” resulted in a full blown FBAR penalty (plus the professional
fees to attempt to reverse the penalties).

Why did people do it? Why did people enter OVDI in the first
place?

The problem of people being “ushered into OVDI/OVDP” by their advisers
has been the subject of much discussion. See the following discussion of
Jack Townsend’s blog:

Presumably, the couple entered OVDI on the advice of an
attorney and, ultimately, were assessed an FBAR penalty. What do you
suspect the actual likelihood (not potential) of an FBAR penalty would
have been had the non-willful couple never entered OVDI — and just
filed corrected FBARs with an explanation that a mistake had been
made?

I’m a bit curious why there was omitted income, given that
the account was (we are told) consistently disclosed on the taxpayers’
return, but mostly I’m curious why they were in OVDI in the first place.
Presumably the taxpayers and their counsel could have predicted from the
outset that they would need to opt out if they were unwilling to pay the
25% offshore penalty; and I generally see little merit in going into
OVDP if you know (or should know) in advance that you’ll be opting out.
Obviously, the compete set of facts (most of which we don’t know) is
critically important, so I’m certainly not purporting to reach any
conclusions, but I think it’s fair to at least wonder if a non-program
disclosure might have been more appropriate in this instance. I do
vividly recall that some practitioners were vehemently opposed to the
whole notion of a “quiet disclosure,” although I do not recall any
coherent reason ever having been advanced for such
opposition.

Conclusion: “Look Before You Leap …

I certainly agree with Virgina La Torre Jeker’s conclusion which states:

The IRS disposition of the case was disappointing, to say
the least. One has to ask why, on these facts, the taxpayers joined OVDI
in the first place? My guess is that the fear factor was ramped up
significantly and they may not have been given full detailed advice by
their tax advisor as to all of the possible options, risks with each one
and so on. One must also remember that at the time the taxpayers joined
OVDI, the Streamlined options did not exist. The case demonstrates that
one must be very careful in taking actions. Get a second or even third
opinion.”

Yes, yes and yes!!

If you have FBAR problems …

Get a second or third opinion! Be careful what you fix for!

(For those who want further reading (including the details) see the
following court documents:

United States Motion to Dismiss –
here.
Memorandum in Support of United States Motion to Dismiss –
here.
Mr. & Mrs. Kentera’s Brief in Opposition to United States Motion to
Dismiss –
here.
United States Reply to Mr. & Mrs. Kentera’s Opposition Brief –
here)

John
Richardson