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Related-Statute IRC §6103(h) Violation As a Defense Against FBAR Audit

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International tax lawyers should focus not only on substantive, but also on procedural defenses against the results of an FBAR audit. One such potential defense against FBAR audit is a related-statute IRC §6103(h) violation.

Related-Statute IRC §6103(h) Violation: Background Information

In a previous article, I already discussed the fact that IRC §6103(a) limits somewhat the ability of the IRS to use tax returns in an IRS FBAR Audit, because IRC §6103(a) designates all tax return information as confidential. However, IRC §6103(h) provides a limited exception to IRC §6103(a) by allowing IRS employees the disclosure of tax return information for the purposes of tax administration.

Under IRC §6103(b)(4), tax administration is interpreted broadly to cover administration, management and supervision of the Internal Revenue Code and “related statutes”. This means that, if the IRS determines that the Bank Secrecy Act (“BSA”) is a related statute for the purposes of a particular FBAR audit, it can release the tax return information to be used against the taxpayer.

The IRS will deem the BSA as a related statute only if there is a good-faith determination that a BSA violation was committed in furtherance of a Title 26 violation or if such a violation was part of a pattern of conduct that violated Title 26. See IRM 4.26.14.2.3 (07-24-2012). In other words, the tax violation and the FBAR violation has to be related in order for the IRS to disclose tax return information to be utilized in an IRS FBAR Audit.

Related-Statute IRC §6103(h) Violation: Procedural Aspects of Related-Statute Determination

The Internal Revenue Manual (“IRM”) sets forth very specific procedures for making a related-statute determination in the preparation of an IRS FBAR Audit. Generally, this is a two-step process.

First, the examiners are required to prepare a Form 13535, Foreign Bank and Financial Accounts Report Related Statute Memorandum, to establish why the IRS believes that an apparent FBAR violation was in furtherance of a Title 26 violation. Form 13535 must describe tangible objective factors and provide adequate documentation.

Then, Form 13535 goes to the examiner’s Territory Manager. The Territory manager should make his decision at that point. If he believes that the related-statute test was not met, tax returns and return information may not be disclosed for the purposes of starting an IRS FBAR Audit. On the other hand, if the Territory Manager determines that the apparent FBAR violation was in furtherance of a Title 26 violation, then all of the tax returns and tax return information will be released to the IRS agent who conducts the audit.

Can Related-Statute IRC §6103(h) Violation Be Utilized as a Defense in FBAR Audit?

We are now about to answer the question that is at the center of this article: if the IRS fails to follow the IRM procedures for related-party determination pursuant to IRC §6103(h), can it be used as a defense in FBAR Audit? Perhaps, the best way to answer the question above is to look at an analogy of whether the failure to follow IRM procedures for related-party determination under IRC §6103(h) can be utilized to support a claim for damages for unauthorized disclosure under IRC §7431.

Generally, the failure by the IRS to follow IRM procedures and make a related-party determination is likely to be insufficient to support a claim under IRC §7431. In Hom v. United States, 2013 U.S. Dist. LEXIS 142818, 2013-2 U.S. Tax Cas. (CCH) P50,529, 112 A.F.T.R.2d (RIA) 6271, 2013 WL 5442960 (N.D. Cal. 2013), aff’d, 645 Fed. Appx. 583, 2016 U.S. App. LEXIS 5528, 117 A.F.T.R.2d (RIA) 1119, 2016 WL 1161577 (9th Cir. Cal. 2016), the court held that the failure of the IRS to make a related-statute determination as required by the IRM did not provide the plaintiff with a claim for damages under IRC §7431. Rather, a plaintiff would have to prove that the failure to file an FBAR was clearly not in furtherance of a Title 26 violation – i.e. the plaintiff would have to prove that BSA was not a related statute in his case.

If we use this analogy, then it seems that the procedural failures by the IRS to follow the related-party determination under IRC §6103(h) would not be sufficient to be used as a defense in an IRS FBAR Audit. There is a possibility, however, that if the FBAR violation was clearly not related to Title 26, then it may be used as a defense to exclude evidence.

Contact Sherayzen Law Office for Help with Your FBAR Audit

If your FBARs are being audited by the IRS, contact Sherayzen Law Office for professional help. Sherayzen Law Office is an international tax law firm that is dedicated to helping businesses and individuals with their US international tax obligations, including FBARs. We have helped hundreds of US taxpayers around the world and we can help you!

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IRS FBAR Audits Caused by Tax Returns | FBAR Audit Lawyer

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IRS FBAR Audits can lead to catastrophic consequences for noncompliant US taxpayers. While there may be a numbers of factors that influence the IRS decision to commence such an audit, one of the leading sources of the IRS FBAR Audits are the US tax returns. In this article, I would like to explore the main types of documents that the IRS is searching for during a tax return examination in order to uncover the information that may lead to the commencement of IRS FBAR Audits (I will not discuss here the right of the IRS to disclose US tax return information for Title 31 FBAR Audit; this topic is reserved for a subsequent article).

IRS FBAR Audits and IRS Title 26 Examinations

From the outset, it should be made clear that filing of US tax returns does not automatically lead to IRS FBAR Audits. Rather, a great percentage of the IRS FBAR Audits arise from the IRS Title 26 Examinations of these returns– i.e. IRS examinations and audits of US tax returns pursuant to the various provisions of the Internal Revenue Code. During these examinations, the IRS analyzes the audited tax returns and may uncover information related to FBAR non-compliance which usually serves as a cause of the subsequent FBAR audit.

Tax Return Information that May Trigger IRS FBAR Audits

So, what kind of evidence is the IRS looking for that may trigger IRS FBAR audits? First and most logical is Schedule B, particularly looking at whether box in Part III (which has questions related to foreign accounts and foreign trusts) is checked. If there is a discrepancy between the information provided to the IRS and Schedule B, this may lead to IRS FBAR Audits.

Second, foreign income documents from the tax examination administrative case file (which includes the Revenue Agent Reports). Here, the IRS is looking for income related to foreign bank and financial accounts that was not reported. A combination of unreported foreign income and undisclosed foreign accounts is precisely the toxic mix that lays the foundation for IRS FBAR Audits.

Third (and this is a very interesting strategy), copies of tax returns for at least three years before the opening of the offshore account and for all years after the account was opened, to show if a significant drop in reportable income occurred after the account was opened. The analysis of the returns for three years before the opening of the account would give the examiner a better idea of what the taxpayer might have typically reported as income before the foreign account was opened. This strategy shows just how analytical and creative the IRS can be in looking for cases that should be subject to IRS FBAR Audits.

Fourth, copies of any prior Revenue Agent Reports that may show a history of noncompliance. This strategy confirms once again the notion that a large history of noncompliance may lead to more frequent IRS examinations, including IRS FBAR Audits.

Fifth, IRS is also looking into “cash accounting’ – two sets of cash T accounts (a reconciliation of the taxpayer’s sources and uses of funds) with one set showing any unreported income in foreign accounts that was identified during the examination and the second set excluding the unreported income in foreign accounts.

Finally, the IRS makes a connection between tax fraud and FBAR noncompliance – the IRS is looking at any documents that would support fraud in commencing IRS FBAR Audits. Such documents include: false explanations regarding understated or omitted income, large discrepancies between actual and reported deductions of income, concealment of income sources, numerous errors which are all in the taxpayer’s favor, fictitious records or other deceptions, large omissions of certain types of income (personal service income, specific items of income, gambling winnings, or illegal income), false deductions, false exemptions, false credits, failure to keep or furnish records, incomplete information given to the return preparer regarding a fraudulent scheme, large and frequent cash dealings that may or may not be common to the taxpayer’s business, and verbal misrepresentations of the facts and circumstances.

Of course, the IRS is not limited to these six types of tax return documents; however, this is the most common evidence that the IRS uncovers during a tax return examination that may lead to subsequent IRS FBAR Audits.

Contact Sherayzen Law Office for Legal Help with IRS FBAR Audits

If you are subject to an IRS FBAR Audit or a tax return examination that involves foreign assets and foreign income, or you have undisclosed foreign assets and you are looking for a way to bring your legal situation into compliance with US tax laws, then contact the international tax law firm of Sherayzen Law Office, Ltd. Sherayzen Law Office is one of the best law firms in the world dedicated to helping US taxpayers with foreign assets and foreign income. Our highly experienced team of tax professionals, headed by an international tax attorney Eugene Sherayzen, provides effective, knowledgeable and reliable legal and tax help to its clients throughout the world, and we can help you deal with any IRS problem.

Contact Us Today to Schedule Your Confidential Consultation!