Experienced · Local · Affordable
Every year, millions of Americans file their taxes using TurboTax or another commercial tax prep software. The hope is that these programs will make sure their taxes are done correctly and avoid penalties or even an IRS audit. However, one recent case out of California shows that using tax prep software won’t automatically prevent willful FBAR penalties.
Timberly Hughes was a freelance bookkeeper and informal accountant whose primary role was assisting a family trust in managing their accounts. When her work for that trust became lucrative, she invested that money into a New Zealand winery, Takamatua Valley Vineyards Limited (TVV). In 2013, she also opened the Cuba Uncorked Limited wine bar in Wellington, New Zealand. Between the years 2010 and 2013, Hughes was the sole owner of several business accounts related to the winery and wine bar at the ANZ Bank in New Zealand, each with a balance of more than $10,000 USD.
Even though Ms. Hughes worked with a CPA in preparing her clients’ tax returns every year, she chose not to hire a professional to prepare her own. Instead, she used Turbo Tax, a tax prep software to prepare, print, and turn in her tax returns. Beginning in 2012, that included a Schedule B form. That form asks if the filer has “a financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign country? See instructions.” It then asks whether the taxpayer is “required to file Form TD F 90-221. To report financial interest or signature authority?” This is what is commonly referred to as the FBAR. In 2012, Ms. Hughes answered “Yes” to controlling foreign financial accounts, and that she was required to file an FBAR. The next year she answered “Yes” to controlling the accounts, but “No” to the FBAR question.
Ultimately, the IRS performed an audit which began with Hughe’s 2011 income tax return and later expanded to include 2007 through 2013. The IRS eventually assessed penalties for failure to file Form 927, failure to file Form 5471 (regarding ownership of foreign corporations), and failing to file FBARs from 2010 to 2013.
The tax prep software Ms. Hughes used was equipped with two modes: “interview mode” and “forms mode.” “Interview mode” helps taxpayers by asking them questions to guide them in preparing the right documents. “Forms mode” allows the taxpayer to fill in each form directly. It is not recommended because it does not offer the same error-checking functionality as “interview mode.” Ms. Hughes used “form mode,” completing, printing and mailing her return each year by copying over information from her last year’s tax returns. This meant the tax prep software could not detect errors like a missing Schedule B form or FBAR.
The details of when and how the tax prep software provided notice about these forms became relevant after the IRS imposed willful FBAR penalties against Ms. Hughes for the years 2010 through 2013. In “form mode,” the software did not prompt her to complete a Schedule B. However, when she opened Schedule B the form did provide notice that people who control foreign financial accounts must prepare FBAR forms unless they are exempt. Still, the instructions referenced on Schedule B appear on the back of the paper form, but were buried in a help menu in the program.
That difference proved to be important to the judge. Ms. Hughes had argued that because the program didn’t provide those instructions, she did not have notice that she was not exempt from the FBAR filings. She also said her New Zealand attorneys and accountants had told her that an exemption applied, so she did not think she needed to file the forms.
Judge Joseph Spero, from the United States District Court, Northern District of California was only partially convinced. He found many of Ms. Hughes’s excuses “not credible.” He upheld the willful FBAR penalties for 2012 and 2013 -- the years Ms. Hughes included Schedule B in her printed and mailed tax returns. The judge said that the “General Instructions” included on Schedule B itself were enough to put Ms. Hughes on notice. He noted that Ms. Hughes even testified that if she “had read the instructions, and taken the time to understand, [she] would have filed the FBARs.” Not doing so was “willful blindness” and proper basis for willful FBAR penalties.
However, the judge overturned the willful FBAR penalties imposed for 2010 and 2011, when the tax prep software didn’t include a Schedule B form. Since the instructions were only on the excluded form, and there was no evidence that Ms. Hughes had seen a Schedule B before filing those tax returns, the IRS hadn’t shown she had the necessary notice. The judge said the taxpayer’s signature on her tax return wasn’t enough to establish willful blindness when the tax return as filed did not include Schedule B or its notice.
US v Hughes shows that you can’t always depend on tax prep software to avoid willful FBAR penalties. If you have foreign financial accounts overseas you should work with an accountant or tax attorney with experience in the IRS’s reporting requirements, including FBARs. Otherwise even instructions hidden in the help menu could be enough to put you on notice that you must file.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you are facing FBAR penalties after using tax prep software to file your returns, contact Joe Viola to schedule a free consultation.