Of the recent changes made to the streamlined procedures, none have received as much attention – or stirred up as much debate – as the new rule requiring certification of non-willfulness as a condition for gaining entry. This blog focuses on the requirement of the new streamlined procedures that the failure to report income from a foreign financial asset not be willful. This requirement cuts to the heart of the new procedures.

As a way of background information, in order to qualify for the streamlined compliance procedures, U.S. taxpayers must certify that “the failure to file tax returns, report all income, pay all tax, and submit all required information returns, including FBARs, resulted from non-willful conduct.”

The key part of the certification form is the following:

My failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-willful conduct. I understand that non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.

I recognize that if the Internal Revenue Service receives or discovers evidence of willfulness, fraud, or criminal conduct, it may open an examination or investigation that could lead to civil fraud penalties, FBAR penalties, information return penalties, or even referral to Criminal Investigation.

Under what circumstances can a taxpayer certify that his failure to report foreign financial assets and pay all taxes due with respect to those assets was not willful? As a preliminary matter, it goes without saying that the taxpayer must familiarize himself with the definition of “willful.” Only then will he be able to determine whether his conduct was not willful.

Unfortunately, willfulness is an elusive term. While it may be easy to define – as an “intentional violation of a known legal duty” – it is not easy to apply when it comes to the myriad of circumstances that exist in the offshore arena. As courts have noted, “willful” is a “chameleon” which changes in tone and color according to the Code section involved and the circumstances.

To make matters worse, the IRS’s discussion of willfulness vis-à-vis the new streamlined procedures only muddies up the already murky waters by defining it in the negative without first establishing a baseline definition for its root word, “willfulness.” Instead of starting out with a definition for “willfulness” and then working its way up to a definition of the term in its negative form (here “non-willfulness”), as is the standard practice of most English dictionaries, the IRS does it backwards. It defines “non-willfulness” in vague and abstract terms, falsely assuming that the “average Joe” not only is well-versed in but has a deep and thorough understanding of the legal definition of willfulness along with all of its nuances.

Taxpayers are left with the unenviable task of having to interpret the meaning of such legal terms as “negligence,” “inadvertence,” “fraud,” and “mistake” – which the IRS relies on exclusively to define non-willfulness – with nothing more than a Webster dictionary at their disposal. The danger this poses is that taxpayers may fall into the trap of interpreting these terms according to their common, ordinary, and everyday use. But as tax professionals know all too well, these are legal terms of art with precise definitions.

The best way I’ve seen the concept of willfulness explained is by Jack Townsend, author of “Tax Crimes.” Professor Townsend views the path between willfulness and non-willfulness as lying on a continuum.

The steps described by Professor Townsend provide keen insight into the process that a taxpayer must go through in order to determine whether his conduct falls on the non-willful end of the continuum or on the dreaded willful end. However, these steps are but a few among the many.

The following is some practical advice on how to prepare your explanation of non-willful conduct. First, you must tell your “story,” which must consist of more than just blanket denials. For example, you can shout from the rooftop that you were “non-willful” from now until eternity, and even shed a tear along the way, but unless you explain why your conduct did not run afoul of willful blindness, the IRS is likely to view this as being nothing more than self-serving.

Second, your certification should include “objective supporting evidence.” In a Forbes article entitled, “Am I Non-Willful Under The OVDP Streamlined Procedures?,” Charles Rettig, an expert in the field of foreign asset reporting wrote, “What objective evidence might exist to appropriately demonstrate a lack of personal knowledge by the taxpayer about their foreign reporting requirements?”

Third, you must directly confront the presumption, as unfair as it might seem, that the IRS will impute a sinister motive to your failure to report your foreign bank account(s): namely, that you were willfully blind. If there is any doubt in your mind, look no further than the comments of Caroline Ciraolo (acting Assistant Attorney General pending approval of the nomination of Cono Namororato to be AAG) at the Federal Bar Association Annual Conference:

“We are taking particular interest if we find evidence of an account holder claiming non-willful conduct in a streamlined compliance filing or delinquent submission only to find that evidence produced by the Category 2 banks suggests otherwise. We are using information gleaned from the program to open new investigations, pursue new targets around the globe, and we will continue to do so as the information is developed.”

For those unfamiliar with the concept of “willful blindness,” this is a good time for a brief digression. Under the theory of willful blindness, willfulness may be attributed to a person who has made a conscious effort to avoid learning about the FBAR reporting and record keeping requirements. For example, the failure to learn of the filing requirements coupled with other factors – such as efforts taken to conceal the existence of the accounts and the amounts involved – may lead to a conclusion that the violation was due to willful blindness. However, the mere fact that a person checked the wrong box, or no box at all on Section III of Schedule B is not sufficient, by itself, to establish that the FBAR violation was due to willful blindness.

According to Mr. Rettig, two critical questions must be answered in order to rebut the presumption that a taxpayer made “a conscious effort to avoid learning about the FBAR reporting and record keeping requirements”:

(1) “Should the taxpayer have inquired of their return preparer about the need to report an interest in a foreign financial account?”

(2) “Should the preparer have gone beyond providing a tax organizer that recites the Schedule B reference relating to an interest in a foreign financial account and perhaps explained what types of foreign interests are reportable?”

Fourth, you should explain why you didn’t “intentionally violate a known legal duty,” citing facts that support that assertion. Remember: blanket denials will not suffice.

Fifth, sift through all of the “bad” facts that the IRS may lump into the willful blindness category to see if you can either neutralize these pestilent facts or turn them into “good” facts. By anticipating what facts are likely to raise red flags, you will be better equipped to draft a thoughtful explanation to rebut allegations of a sinister or deceitful motive. This is the best antidote for avoiding ambush.

As you can see, you must thoroughly invest in due diligence to avoid the IRS’s punishments, which have been known to drive many a sane taxpayer to the brink of insanity. This is where I make the following disclaimer: taxpayers must tread very carefully and not take the streamlined procedures lightly. To the extent that your non-willful certification turns out to be a bad judgment call on your part, all that you will have succeeded in doing is making an already delicate situation – but otherwise, manageable situation – that much worse.

How so? If your non-willful certification is rejected, not only will you become ineligible for the streamlined procedures, but you could be subject to any one of the following “parade of horribles”:

(1) You will be ineligible for OVDP (once you make a streamlined submission, it is too late to apply to OVDP). Your only remaining option for coming into compliance with your U.S. tax obligations would be to file amended 1040s and delinquent foreign information returns in what is otherwise known as a “quiet disclosure.”

(2) You are but a heartbeat away from an examination that has the potential to be more painful than a root canal. Keep in mind that the IRS could assert multiple willful or non-willful FBAR penalties and that these penalties could be aggregated – one on top of the other – until they reach the stratosphere.

(3) Your case could be referred to the Criminal Investigation (CI) division of the IRS for investigation. CI, in turn, could refer your case to the Department of Justice – Tax, with a recommendation for prosecution;

(4) To the extent that the IRS obtains evidence that directly contradicts your certification of non-willfulness or that directly contradicts your representation that you satisfy the non-residency requirement of the streamlined foreign procedures, it could refer your case to the Department of Justice with a recommendation that you be prosecuted for perjury. Remember that the nonwillful certification –including all statements made in the streamlined submission (even those relating to the non-residency requirement for streamlined foreign) – must be signed under penalties of perjury.

This is why it is critical to consult with a tax attorney. A tax attorney will be able to provide practical and sound advice on what may be the most important decision of your life – whether your certification fully substantiates your claim of non-willfulness and whether it can be submitted in good faith. For example, he or she can check the consistency of your explanation and confirm that it is supported by ironclad evidence, such as tax and information returns. Having the “right” documents to prove your story will assuage even the most aggressive IRS agent.

At the same time, it is also important to be honest with yourself. To the extent that your conduct might be deemed to be, “less than non-willful” (to put it mildly), you must swallow your pride and make the obvious choice – apply to OVDP. To quote a cliché, “an ounce of prevention is worth a pound of cure.” Thinking that you can somehow “sneak” into the streamlined program in the “dark of the night” without being detected is as foolish as a man who robs a convenience store in a ski mask but forgets to remove his work uniform that prominently displays his name stitched across the front.