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Another Casualty in the War Against Offshore Investments

Written by Subject: Imperialism

Carl Zwerner, an 87-year-old resident of Florida, is the latest poster child for the IRS vendetta against offshore investments.

Last week, a federal jury found that Zwerner had "willfully" failed to disclose the existence of a Swiss bank account in 2004, 2005, and 2006. (Federal law requires individuals with signature or "other" authority over foreign accounts with an aggregate value that exceeds $10,000 to make an annual disclosure on the foreign bank account reporting form, or FBAR.)

For failing to do so, the jury imposed a civil penalty for each of the three years that it found Zwerner willfully failed to disclose the account. The total penalty was 50% of the peak value of the account for each of those three years – $2.24 million in all. That amount far exceeds the peak value of the account – $1.55 million – during those years.

Keep in mind that the $2.24 million penalty against Zwerner is in addition to back taxes, interest, and penalties that he already paid for the earnings in this account from 2004-2007.

But it could have been worse; the original IRS assessment against Zwerner came to a whopping $3.5 million. The IRS also didn't seek criminal penalties, including possible imprisonment, against him.

In his defense, Zwerner claimed he didn't realize until 2008 that he was supposed to report the account. But the IRS used the answers he gave his accountant on an annual tax organizer he completed to rebut his claim of ignorance. Every year, Zwerner answered "no" to a question in the organizer asking, "Do you have an interest in or signature authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?"

Zwerner claims that since he held the account through a foundation, he thought that neither the account nor its income was reportable. But according to the IRS, the use of an offshore entity to hold an unreported foreign account is an additional badge of fraud to prove willfulness. Evidently, the jury agreed.

Zwerner also suffered from both bad advice and bad luck. According to his response to the civil complaint filed against him, once he learned that he was supposed to file the FBAR, he contacted a Miami law firm to represent him before the IRS. Zwerner claims that the law firm advised him to file amended tax returns for the years 2004-2006 and pay whatever back taxes, interest, and penalties applied. Once he did so, Zwerner claims to have believed the voluntary disclosure was completed. It wasn't.

It turns out that Zwerner's lawyer never completed the voluntary disclosure by identifying him to the IRS and making a full admission of his non-compliance. In effect, this meant that Zwerner unknowingly made a "quiet disclosure" – simply filing amended returns showing previously unreported foreign accounts or income.

As I've noted in a previous letter, the IRS is more likely to audit taxpayers who make quiet disclosures. That's apparently what happened here. In 2010, the IRS began an audit of Zwerner's returns.

To make matters worse, Zwerner's timing was lousy, costing him nearly $2 million. He made his voluntary disclosure in 2008, before the IRS started its first formal "offshore voluntary disclosure program" (OVDP). Even if Zwerner's disclosure had been completed properly, he wouldn't have been entitled to lower civil penalties. He would only have avoided possible criminal penalties. If he had waited and entered the first OVDP in May 2009, he might have gotten away with a mere 20% penalty on the highest value of the account. He would have paid out $310,000, not $2.24 million, to the IRS.

Zwerner also claims the IRS agent in charge of auditing his tax returns browbeat him into signing a statement admitting that he willfully failed to file the FBAR forms and pay tax on the earnings in the account. Only after the agent threatened to have him criminally indicted for tax evasion did Zwerner say he was willing to sign the statement

There's some support in the court record for Zwerner's claim of IRS misconduct. The agent stated that Zwerner "refused to join the voluntary disclosure program because he was scared he may be subject to criminal penalty." The record shows that's simply not true. Indeed, Zwerner retained a lawyer and made what he believed was a voluntary disclosure well before the 2009 OVDP even began. He also tried to enter the 2011 OVDP but was rejected because by then his returns were already under audit.

Worst of all, Zwerner, a wealthy investor and the current director of a Florida bank, opted for a jury trial. Jurors don't typically consist of libertarians who believe taxation is theft. It's obvious that the jury considered him a sophisticated investor who was aware, or at least who should have been aware, of the FBAR filing rules.

The Zwerner case marks the first published occurrence that the IRS has successfully imposed multiple-year 50% penalties on a single account. Unless the judge in the case rejects the jury verdict as constituting an "excessive fine," you can count on the IRS using this strategy in future cases.

Do you have unreported offshore income or accounts? If you do and would like to take advantage of the OVDP or any other amnesty program the IRS offers, consult with a qualified attorney (not an accountant). This arrangement provides attorney-client privilege to keep your discussions private. The attorney can then retain an accountant to prepare the necessary returns and decide whether you should participate in the program.

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