My last blog post analyzed various tax issues involved when someone dies owning an unreported foreign financial account leaving the heirs and executors of the estate with a dilemma as to how to rectify the problem. On possible avenue to address the problem is use of the IRS Streamlined Procedures. These streamlined filing compliance procedures are designed not only for individual taxpayers, but for estates of individual taxpayers as well. My previous post raised the question how to deal with the certification of “nonwillfulness” when entering the procedure as the executor of an estate.
Whose Nonwillfulness is it Anway?
Significantly, taxpayers using the Streamlined procedure must certify that the tax noncompliance was “nonwillful”. According to the IRS, “Taxpayers using either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures, will be required to certify, in accordance with the specific instructions, that the failure to report all income, pay all tax and submit all required information returns, including FBARs (FinCEN Form 114, previously Form TD F 90-22,1) was due to non-willful conduct.”
According to the IRS, “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.”
What is very unclear is whether the nonwillfulness applies to the conduct of the decedent or to that of the executor who is now filing the returns and reporting the overseas account on behalf of the decedent’s estate. It would seem on the one hand, that the “nonwillfulness” relate to the conduct of the decedent in not properly reporting the foreign account while he was alive. However, it is obvious that the decedent can no longer certify to the fact that his conduct was nonwillful since he is now dead. In addition, it would seem that the executor cannot certify anything about whether the decedent himself was or was not “willful”. How would the executor be in a position to know this and certify it under penalty of perjury? In many instances the executor is an attorney, law firm or other institution without any real knowledge of the decedent as an individual. Even in cases when the executor is a party who may have personally known the decedent, it still remains open to question whether the executor can certify for purposes of the Streamlined Procedure that the decedent’s failure to report all income, pay tax and submit required information returns, was due to non-willful conduct.
In determining how an executor might use the Streamlined procedures I sought input from my colleague, prominent attorney John Richardson of Toronto, Canada John and I considered the matter and our thoughts are reflected in this post. Here is our view on how the Streamlined Procedure might work in situations involving a decedent, his estate and its executor:
Determine Which Party Failed to File or Pay Tax
With an unreported foreign account, the executor might have to rectify filing duties for the decedent as an individual, or the estate, as an entity. In some cases the executor might have to fix the problem for both the decedent and the estate. John and I believe that the first step would be to determine who or what party failed to report the income, file the returns and so on. Is it the decedent or the estate, or both? The second step would be to provide the certification of non-willfulness on behalf of that particular party.
Decedent Failed to File
In many cases, the decedent will have been the person with the filing obligation. This can happen, for example, when the decedent should have filed FBARs, reported income from foreign financial accounts and so on, while he was alive. After his death, the estate is often in the position of cleaning up the problem regarding the decedent individual’s US tax filing obligations that were unmet at the time of death. The executor essentially stands in the shoes of the decedent, since the executor represents the estate and the estate, in turn, is comprised of all of the assets and liabilities of the decedent. Unpaid taxes, for example, are a liability of the deceased individual which then become a part of his estate.
While we are not certain, John and I think that the Streamlined Procedure can be used by the estate on behalf of the decedent in this instance. John and I struggled with how the certification might be prepared in this type of case. We think that a possible approach is to view the case logically: the executor can be viewed as acting on behalf of the estate, which in turn, can be viewed as indirectly making the certification for the decedent. Following this rationale, the executor can provide a narrative (supported by affidavit from a third party, if necessary) signed under penalty of perjury that:
1. To the best of the knowledge and belief of the executor, there is no evidence of willfulness on the part of the decedent (i.e., no evidence of the decedent’s intentional disregard of a known legal duty); and
2. To the best of the knowledge and belief of the executor, there is evidence that the failure to file/pay is based on the decedent’s “negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”
These assertions of the executor would be supported by a factual narrative, which would likely be set out in an affidavit sworn by a third party (e.g., the decedent’s spouse or other person) who would be able to provide facts indicating the elements (numbers 1 and 2, above) necessary for entry into the Streamlined procedure.
Executor Failed to File
In other instances, the party that may have had the obligation to file or pay tax is the estate, as an entity. The person responsible for the estate’s tax filings and tax payments is its executor. This type of problem can arise, for example, when the estate, as an entity, should have paid US tax on income earned in the estate, but failed to do so; or it can happen when the estate should have filed an FBAR, but did not. Yes! Estates are required to file FBARs (as are minor children and your pet dog if he was granted a human license on or after May 31, 2012). See the FBAR instructions at page 5 definition of “person” — “Person. A person means an individual (including a minor child) and legal entities including, but not limited to, a limited liability company, corporation, partnership, trust, and estate.” On the other hand, the estate is not required to file Form 8938. The executor’s omission to file or to include the income on the estate’s income tax returns must be “nonwillful” in order to use the Streamlined procedure.
Preparation of the certification of nonwillfulness is more straightforward in this type of case. The certification would be prepared by the executor setting out his/her or its reasons for the failure to file the proper forms or to include the income. Perhaps, for example, the executor was unaware of the duty to file an FBAR for the foreign accounts held by the estate.
With an unreported foreign account, it is important to make the distinction between the decedent and his estate. While decedent was alive, the income earned on the unreported foreign account is taxed to him as an individual. Once the individual has died, however, the estate generally earns the income and becomes responsible for filings. See IRS Publication 559 for more information.
The executor might not learn about the foreign account for some time period and can then become delinquent in the estate’s income tax and FBAR filing obligations. In this type of situation, given the right facts, the executor can enter the decedent into the Streamlined procedure with regard to the deceased individual’s income tax returns, Form 1040, FBARs and information returns, and can also enter the estate into the procedure for the Estate’s income tax returns, Form 1041 and FBAR filings. Please note, however, you really do need the right facts to use the Streamlined procedures. A failure to do the right thing can have serious consequences, including the possibility of criminal charges.
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