What is the difference between willful and non-willful violations?

4 min

Not fulfilling your US tax obligation when you knew about the obligation but chose (for whatever reason) not to file is considered to be a willful violation. Not fulfilling your US tax obligation when you did not know about the obligation is considered to be non-willful and usually leads to lower or no penalties.

If a taxpayer entering the Streamlined procedure has tax noncompliance that was the result of  “willful” conduct – what happens? The answer here depends on whether the “willfulness” fits within the meaning of the civil penalty definition, or the criminal penalty definition. Taxpayers with criminal issues lurking in their facts risk serious criminal penalties, including jail time. They should not be entering the Streamlined Procedure, which does not provide protection from criminal prosecution, but instead should be entering the “Offshore Voluntary Disclosure Program”. If the taxpayer’s conduct does not involve criminal issues, then the “willfulness” inquiry may involve exposure to possible civil penalties.

Background – IRS Streamlined Programs

On June 18th, the IRS announced new “Streamlined” procedures implementing practical methods of achieving tax compliance for US persons about offshore accounts or assets that have not been reported properly.  While the new “Streamlined” procedures may sound somewhat simple, I have cautioned readers to be very careful and to obtain sound advice about using these new “Streamlined” procedures.

“Non-Willful” Behavior

To use the procedures, tax compliance must be the result of “non-willful” conduct. A Statement of Facts must be provided to the IRS explaining the reasons for any compliance failures.

According to the Streamlined Procedures, the IRS states 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.”  The IRS does not tell us in any detail what is meant by these terms or what they entail.  Many factors can influence whether a finding of “non-willfulness” is the right label, and a single slip could change the result to “willful”.

While some cases may be black or white, and neatly fit the tax noncompliance into one category or the other, there are numerous cases with many shades of gray. For example, even the IRS concedes that if you had a foreign account but checked “NO” in the box on Part III of Schedule B asking if you had such a foreign account, this is not enough to say the conduct was “willful.” See, Internal Revenue Manual FBAR Willfulness Penalty – Willfulness.

Pre-empt IRS questions

A carefully prepared Statement of Non-Willfulness might explain this and pre-empt any further IRS questions.  Other factors should be scrupulously examined – Did the taxpayer seek professional tax advice?   Did he reveal the foreign assets to his advisor?  What did he write in any tax organizers?  What is the taxpayer’s profession and educational background, and so on.

We do know that as used in the civil penalty provisions, the term “willful” can mean that the act was the result of gross negligence, reckless disregard, or willful neglect. Whether a failure was “willful” is determined based on the facts and circumstances. It makes sense then, that for purposes of the Streamlined Procedures, “non-willful” behavior cannot be the result of gross negligence, reckless disregard, or willful neglect.

Guidance From the Section 367 Regulations?

The Section 367 Regulations provide relief for certain failures to file the aforementioned GRA, so long at the failure was not “willful”. The Regulations provide that for this purpose, “willful” is to be “interpreted consistent with the meaning of that term in the context of other civil penalties, which would include a failure due to gross negligence, reckless disregard, or willful neglect.”

Examples are found on page 28 and from the examples we can glean some significant information:

  • Isolated, accidental oversights are not “willful”.
  • Intentionally failing to file when one knows the requirement is “willful”, apparently even if a taxpayer has a somewhat plausible reason for the failure to file.  In the failure to file situation described in the Section 367 Regulations, the taxpayer anticipated selling a business in the following tax year which was expected to produce a capital loss that could be carried back to fully offset the gain recognized on a particular transfer that would require the filing of a GRA. The taxpayer reasoned this would obviate any gain and the taxpayer intentionally chose not to file a GRA. At the end of the following year, a large class action lawsuit was filed against the business preventing the taxpayer from selling it, with the result that the expected capital loss did not materialize. The taxpayer was not able to offset the gain as anticipated and sought to file the GRA late. Based on all the facts and circumstances, IRS determined the failure to file the GRA was “willful”.
  •  Very significantly, the examples illustrate that IRS looks to the taxpayer’s course of conduct and compliance “history” in determining whether the current non-compliance was “willful”.  In a poignant example, when a taxpayer had not consistently and in a timely manner filed GRAs in the past, and also had an established history of failing to timely file other tax and information returns for which it was subject to penalties, and did not implement any safeguards to prevent the noncompliance from recurring, the conduct was determined to be “willful”.
  • Many taxpayers faced with tax noncompliance issues have been delinquent filers for a number of years, and then, later catch up with their tax filings, only to fall off the wagon once again. Can such a taxpayer use the Streamlined program for his latest fall from grace on grounds that the recent tax compliance was “non-willful”?  If the examples in the Section 367 Regulations are a guide, it appears that will be a tough argument to make even with professional assistance (which should be a “must” in such difficult cases).
  • Other taxpayers submit tax returns that have omissions of one sort or another — from failing to report income to failures to attach schedules. Another example in the Section 367 Regulations illustrates that “knowingly” not completing a tax document (in the example, a GRA) in all material respects, can result in a finding that the tax noncompliance was “willful”.

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Source: Forbes, Robert Wood