Is Mental Incapacity a Defense to Tax Penalties and FBAR Penalties? by Sanford Millar

A highly contested issue in the United States Tax System is conservatorship. Sanford Millar examines this issue and provides two distant taxpayer examples and how a mental impairment of “willfulness” can affect the situation. The examples and explanation begins,

Example:  (1) Assume a U.S. resident taxpayer is eligible for the Streamline Domestic Procedure because his/her actions were “non-willful” due to mental incapacity.  The Streamline Domestic Procedure requires the filing of three (3) years of amended or late original returns, six (6) of late FBAR’s the payment of the underpaid income tax and a five (5%) percent FBAR penalty calculated based upon the highest single year account  balances at the end of each calendar year for  the aggregate offshore accounts.  If we assume a constant balance of $1 million USD then the FBAR penalty would be $50,000 USD.  Contrast this FBAR penalty with the situation in Example 2.

Example:  (2) assume the same facts except that the taxpayer cannot satisfy the “non-willful” criteria due to an absence of medical evidence or third party statements.  Under these circumstances the taxpayer would have to consider the Offshore Voluntary Disclosure Program (OVDP).  Under the OVDP the taxpayer would need to file eight (8) years of amended or original income tax returns and FBAR’s and pay an FBAR penalty of either twenty-seven and one half (27.50%) percent or fifty (50%) of the highest single year account balances of the aggregate offshore accounts and of the proceeds of those accounts (such as the value of acquired art works or business interests).  The determination of whether the FBAR penalty is 27.50% or 50% is based upon whether the financial institution is a Department of Justice “listed”   foreign financial institution.  For simplicity purposes we will assume that that the foreign financial account balances are a constant $1 million USD for all covered years.  Then the FBAR penalty would be either $275,000 USD or $500,000 USD versus $50,000 USD if the taxpayer qualified for the Streamline Domestic Procedure.  If the taxpayer used the proceeds of the unreported account to purchase appreciating assets, the value of those assets would have to be included in the penalty calculation.

It is therefore very important for a the tax attorney representing the taxpayer to obtain the most comprehensive medical reports possible and statements from percipient third party witnesses to  document the taxpayer’s state of mind at the earliest possible date, not just the current moment. A skilled forensic psychiatrist should be able to help in this regard.  The tax attorney needs to evaluate the circumstantial evidence and then recommend which approach fits the facts.  The attorney will, in addition to reviewing the medical evidence and third party statements, if any, need to do a comprehensive review and analysis of the financial records to determine whether the taxpayer was or was not using the foreign financial account, directly or by use of a linked credit card or debit card or indirectly through the use of a co-account signatory (such as a family member or fiduciary).

Continue reading the full opinion here: Is Mental Incapacity a Defense to Tax Penalties and FBAR Penalties?

Posted by Allison Trupp, Associate Editor, Wealth Strategies Journal

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