What is this phenomenon known as double counting? Why is it important? If you are shepherding clients through the OVDP program, or you are going through the program yourself, it is critical that you understand what it means and the governing principles behind it. Otherwise, you could be paying an offshore penalty that is exponentially higher than what it ought to be.
This article will explain the principles behind double counting and what type of supporting evidence the taxpayer must produce in order to prove double counting to the satisfaction of the IRS. As is my ordinary practice, I will make use of a hypothetical.
As a refresher, the offshore penalty is determined by isolating the highest aggregate balance during the disclosure period, which typically consists of the last eight years for which the tax return due date has passed. That balance becomes the base to which the 27.5% penalty applies (or 50% in certain cases).
John is a U.S. citizen with undisclosed foreign bank accounts. He has applied to OVDP. His disclosure period is 2006 to 2013. He has identified tax year 2012 as the year that contains the highest aggregate balance.
In 2012, John had three unreported foreign accounts at three different banks: Bank A, Bank B, and Bank C. Excluding interest, the total value of the principal (i.e., cash) in all three accounts was $ 1,750,000. As of March 1, 2012, the balances in the accounts were $ 1,000,000 (USD), $ 500,000 (USD), and $ 250,000 (USD), respectively. See the chart below:
| Account | Balance | Date |
| A | $ 1,000,000 | March 1, 2012 |
| B | $ 500,000 | March 1, 2012 |
| C | $ 250,000 | March 1, 2012 |
| TOTAL | $ 1,750,000 | March 1, 2012 |
On March 2, 2012, John transferred $ 200,000 (USD) from Account A to Account B. As a result, his balance in Account A decreased from $ 1,000,000 to $ 800,000 and his balance in Account B rose from $ 500,000 to $ 700,000. See the chart below:
| Account | Balance | Date |
| A | $ 800,000 | March 2, 2012 |
| B | $ 700,000 | March 2, 2012 |
| C | $ 250,000 | March 2, 2012 |
| TOTAL | $ 1,750,000 | March 2, 2012 |
On April 2, 2012, John made a second transfer. He transferred $ 200,000 (USD) from Account A to Account C. As a result, his balance in Account A decreased from $ 800,000 to $ 600,000 and his balance in Account C rose from $ 250,000 to $ 450,000. The balance in Account B remained the same. See the chart below:
| Account | Balance | Date |
| A | $ 600,000 | April 2, 2012 |
| B | $ 700,000 | April 2, 2012 |
| C | $ 450,000 | April 2, 2012 |
| TOTAL | $ 1,750,000 | April 2, 2012 |
The first issue is to determine the highest balance in each account for tax year 2012. These are the amounts that John must report on his FBAR. For Account A, the highest balance was $ 1,000,000, reached on March 1, 2012. For Account B, the highest balance was $ 700,000, reached on March 2, 2012. And for Account C, the highest balance was $ 450,000, reached on April 2, 2012. See the chart below:
| Account | Highest Balance | Date |
| A | $ 1,000,000 | March 1, 2012 |
| B | $ 700,000 | March 2, 2012 |
| C | $ 450,000 | April 2, 2012 |
At first blush, it would appear as though the maximum aggregate balance of all three foreign accounts for 2012 is $ 2,150,000 (USD) (i.e., $ 1M + $ 700,000 + $ 450,000). Or is it? A simple comparison of the maximum aggregate balance of all three accounts and the total value of cash in all three accounts reveals that there is a huge discrepancy. For example, the maximum aggregate balance of all three accounts is $ 2,150,000, whereas the total value of the assets in all three accounts is $ 1,750,000, a difference of $ 400,000.
Might there be a “double counting” issue? Hell yeah!
Let’s break this down into smaller parts and examine each part separately. As a remind, 2012 is the year during the OVDP disclosure period that contains the highest aggregate balance. Therefore, we can put all other years off to the side and focus exclusively on 2012.
The critical issue here is whether John must use the “inflated” maximum aggregate balance of $ 2,150,000 as the base to which the 27.5% offshore penalty applies. Or, may he account for “double counting” in determining his maximum aggregate balance?
The answer to this question means the difference of more than one hundred thousand dollars in John’s offshore penalty.
If “double counting” is prohibited, then John’s offshore penalty is $ 591,250 (i.e., 27.5% of $ 2,150,000). But if “double counting” is fair game, then John’s offshore penalty is $ 481,250 (i.e., 27.5% of $ 1,750,000), a difference of $ 110,000. This is a stark difference.
The answer to this question lies in the “Questions and Answers” OVDP pamphlet. Question number 37 asks, “If a taxpayer transferr[s] funds from one unreported account foreign financial account to another during the voluntary disclosure period, will he have to pay the offshore penalty on both accounts?” The answer is “no,” any duplication will be removed before calculating the offshore penalty. To reduce this concept to its bare bones, all that the taxpayer needs to know is that double counting may be taken into consideration in determining each year’s maximum aggregate balance.
Before John can pop the cork on the bottle of champagne and begin celebrating, he must take heed of a caveat, that seemingly subtle, has far-reaching effects. In fact, it has reared its ugly head in more than just a few OVDP cases. The answer to question number 37 explicitly states that the burden of establishing duplication – i.e., that funds were transferred from one account to another – is on the taxpayer.
Before John can adjust his maximum aggregate balance from the “inflated” $ 2,150,000 watermark to the “true” $ 1,750,000 watermark he must provide adequate documentation to substantiate both transfers: (1) the $ 200,000 transfer from Account A to Account B and (2) the $ 200,000 transfer from Account A to Account C. Unless he can do that, he is what soldiers from the Civil War would call, “S-O-L.”
How might John do that? To borrow a famous quote from the movie, All the President’s Men: “[By] following the money.” Let’s use the “Account A-Account B” transfer as an example. Recall that the “Account A-Account B” transfer occurred on March 2, 2012 and that it was in the amount of $ 200,000. Examining agents recommend producing the following documents.
First, a copy of the March 2012 “Bank A” statement showing a $ 200,000 withdrawal from Account A on March 2, 2012. Assuming it was an electronic transfer, the Bank A statement might even identify the routing number of the bank to which this money was sent, along with the account number of the account. Second, a copy of the March 2012 “Bank B” statement showing a $ 200,000 deposit. While it is unlikely that the $ 200,000 will be credited to Account B on the very same day that it was withdrawn from Account A (i.e., March 2, 2012), the fact remains that the Account B statement should still reflect a deposit date that is close in time to the withdrawal of funds from Account A.
After isolating the transactions on both bank statements, John should highlight them for the examiner so that they stand out among the sea of all other transactions. That way the examiner will not have to go on a “fishing expedition” to identity the relevant transactions, for which he will be eternally grateful. This, in turn, will make it more likely that the examiner will accept the taxpayer’s claim of “double counting” without becoming an obstructionist or by demanding additional supporting documentation.
But what if there are no account statements? Or what if the account statements are woefully inadequate? In that case, receipts can be used to validate the transactions. By receipts, I’m referring to an official withdrawal slip from Bank A showing a withdrawal in the amount of $ 200,000 and an official deposit slip from Bank B showing a deposit in that same amount. As in the case of the account statements, the dates reflected by these receipts must be close in time. Of course, it goes without saying that the $ 200,000 withdrawal from Account A must have occurred before the deposit of $ 200,000 to Account B.
Will John be able to meet his burden of establishing duplication? Assuming that he has one of the two types of documentation to support his position, then the answer is, “yes.” In that case, his maximum aggregate balance will be $ 1,750,000, resulting in an offshore penalty of $ 481,250 (27.5% of $ 1,750,000).
Let’s throw in a monkey wrench. What if, instead of transferring funds from Account A, John closes Account A altogether? For example, assume that John closes Account A and transfers $ 500,000 to Account B and $ 500,000 to Account C. Recall that Account B had an initial balance of $ 500,000 and Account C had an initial balance of $ 250,000. Let’s assume that the transfer occurs on June 1, 2012.
Can John account for “double counting” in this hypothetical too? The new balances, as of June 1, 2012, are reflected in the chart below:
| Account | Balance | Date |
| A | 0 | June 1, 2012 |
| B | $ 1,000,000 | June 1, 2012 |
| C | $ 750,000 | June 1, 2012 |
| TOTAL | $ 1,750,000 | June 1, 2012 |
The first issue is whether John must report Account A on his 2012 FBAR, despite the fact that it was closed. The answer is “yes.” In fact, not only must he report Account A on his FBAR, he must report $ 1,000,000 as the highest balance for Account A.
What about the highest balances for John’s remaining accounts? The “highest balances” for all three accounts can be found in the chart below:
| Account | Highest Balance |
| A | $ 1,000,000 |
| B | $ 1,000,000 |
| C | $ 750,000 |
The maximum aggregate balance is now a whopping $ 2,750,000, $ 1,000,000 more than the total value of John’s assets in these accounts. May John account for double-counting so as to reduce his maximum aggregate balance from the “inflated” amount of $ 2,750,000 to the “true” amount of $ 1,750,000? The difference is even more stark in this example than in the previous one.
On the one hand, if double counting is not permitted, then John’s offshore penalty would be $ 756,250 (i.e., 27.5% of $ 2,750,000). On the other hand, if double counting is permitted, then John’s offshore penalty would be $ 481,250 (i.e., 27.5% of $ 1,750,000). That is a difference of $ 275,000.
Luckily, the answer is “yes.” John may account for double counting here too. But just as in the hypothetical above, he has the burden of proof. Specifically, he must prove that he closed Account A and transferred half-a-million dollars to Account B and half-a-million dollars to Account C before any duplication will be removed.
If you have a double-counting issue, don’t leave it to chance. It could mean the difference between a happy and healthy retirement and one that is disappointing. Call the attorneys at DeBlis Law for a thorough and meticulous review of your “double-counting” issue.
One Response
Thank you for the thorough information on double counting while reporting on fear. It turns max values for each account have to be reported and if asked, be able to show proof that it was a account to account transfer.