In Fairbank v. Commissioner, T.C. Memo. 2023-19, Dkt. No. 13400-18 (February 23, 2023) the Internal Revenue Service (IRS) issued a notice of deficiency in April 2018 for taxable years 2003, 2004, 2005, 2006, 2007, 2008, 2009, and 2011. The taxpayers argued the IRS could not go back to these prior years, challenging the assessments on statute of limitations (SOL) grounds. They lost.
My blog post last week reviewed the various tax SOL rules that can apply in tax matters. Application depends on the particular facts of the case. For example, different SOL rules apply depending on the amount of gross income omitted, or whether the omitted income was from certain kinds of foreign assets, or if foreign information returns are missing. The Fairbanks lost because an expanded SOL rule was enacted as part of the “Foreign Account Tax Compliance Act” (FATCA) in 2010. Today’s post provides the details.
The Fairbank Case
This long and convoluted case involves Barbara and her husband, Leigh Fairbank. Concisely, as part of her divorce, Barbara’s former husband paid about US$600,000 to a Liechtenstein Anstalt called “Xavana Establishment.” The court determined Xavana to be a foreign trust for US tax purposes. Xavana’s sole asset was a UBS bank account with Barbara being the sole beneficiary. Later, in 2009 Barbara’s Swiss attorney formed a British Virgin Islands corporation, Xong Services, Inc. in which Barbara was the sole shareholder. The attorney opened a Swiss account for Xong Services at a different Swiss bank; Barbara was the beneficial owner of that account. UBS was instructed to transfer funds to a bank account in Dubai and the remaining balance to the new Swiss account. The banks were instructed not to send correspondence to the couple’s US address. For some years things went well, and many transactions were made among the various foreign accounts, all for Barbara’s benefit.
The IRS began investigating UBS clients in a broad sweep after Bradley Birkenfeld blew the whistle. For the Fairbanks, IRS issued a notice of deficiency that covered many years – 2003 through 2009 and the year 2011. For all of those years, the couple checked “No” to the question about foreign bank accounts and failed to file Form 3520, Annual Return To Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, or file Form 3520–A, Annual Information Return of Foreign Trust With a U.S. Owner, with respect to Xavana. My readers know that failing to file this form can result in penalties that are a veritable gold mine for the IRS. On advice of counsel, the couple later filed Form 5471 relating to ownership in foreign corporations. They answered “No” to the questions whether they had an interest in a financial account in a foreign country.
The couple challenged the IRS deficiency notice on grounds the SOL had expired. At the end of the day, the court determined the deficiency notice was timely because IRC Section 6501(c)(8) (copied below) kept the assessment limitation period open simply because the couple had not complied with the Section 6048 reporting requirements (e.g., filing the forms pertaining to transactions with foreign trusts) and lacked reasonable cause for the failure. This particular Code provision was enacted as part of FATCA and is found in IRC Section 6501(c)(8), copied below:
(c)(8) Failure to notify Secretary of certain foreign transfers
(A) In general
In the case of any information which is required to be reported to the Secretary pursuant to an election under section 1295(b) or under section 1298(f), 6038, 6038A, 6038B, 6038D, 6046, 6046A, or 6048, the time for assessment of any tax imposed by this title with respect to any tax return, event, or period to which such information relates shall not expire before the date which is 3 years after the date on which the Secretary is furnished the information required to be reported under such section.
(B) Application to failures due to reasonable cause
If the failure to furnish the information referred to in subparagraph (A) is due to reasonable cause and not willful neglect, subparagraph (A) shall apply only to the item or items related to such failure.
This extended statute of limitations is applicable to (1) returns filed after the March 18, 2010, date of FATCA’s enactment and (2) returns filed on or before such date if the limitation period under IRC Section 6501 has yet to expire. Thus, the extended six-year statute and suspended three-year statute could apply to tax returns that were filed as early as 2004 if a six-year statute applies (evidently, as in Fairbank), or 2007 if the normal three-year statute applies.
I have shortened the description of the Fairbank facts. The opinion is over 30 pages and the facts are a tangled web – as is often case when dubious foreign structures are involved. Barbara’s ex-husband was a former CPA who turned into an oil broker and then, into a serious tax evader who eventually fled to New Zealand to avoid the IRS (yes, juicy facts). I have not delved into other issues such as the possible amount of penalties or the strength of the taxpayer’s argument (rejected by the court) that the SOL started to run when the IRS was “furnished” information during the audit.
The point Fairbank should drive home, at least for purposes of this post, is that the IRS has a very long arm that can reach very far back in the past if the proper forms are not filed. When it comes to foreign information returns, taxpayers must be on high alert and make sure they reveal all the information to their advisors so that proper filings can be made. They should make sure to use an advisor well versed in international US tax matters.
Posted March 30, 2023
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