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Offshore Tax Evasion Lessons from the Paul Manafort Conviction – File Your FBARs People!!

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Offshore Tax Evasion Lessons from the Paul Manafort Conviction – File Your FBARs People!!

Today, in the U.S. v. Paul Manafort trial, the jury reached a partial verdict finding Paul Manafort guilty on five counts of tax fraud and one count of failing to file foreign bank account reports (“FBARs”).  A mistrial was declared as to 10 additional counts due to the jury being deadlocked.

The basic rule for filing FBARs is that a U.S. taxpayer must file an FBAR if they have a “financial interest” or “authority over” an account in a foreign country valued at more than $10,000.  31 U.S.C. § 5314.  In addition, U.S. taxpayers with over $200,000 ($400,000 if married) in foreign accounts must comply with the Foreign Account Tax Compliance Act (“FATCA”) and file Form 8938 with the IRS as well as the FBAR report.  26 U.S. Code § 6038D.

Between 2011 and 2014, Paul Manafort had 31 foreign accounts, 14 of which were in Cyprus and the Grenadines, which he controlled, which in aggregate held a total of $61 million at one time or another, with a staggering total of over $75 million flowing through the accounts. 

These accounts were not reported on a FinCEN Form 114 (formerly TD F 90-22.1) as required, in part because Manafort did not report the income these accounts generated or pay taxes allegedly due on that income. 

For this same reason, Manafort was convicted of tax evasion or tax fraud and/or aiding and abetting the production of false tax returns for each of these years.  So, what was the defense?  That these really were not Manafort’s accounts.  This was a defense-of-last-resort that has often come up short, but which the defense presented very effectively.

Most of the money that flowed through these accounts came from Manafort’s Ukranian political work.  The focal point of that work was Manafort’s connection to President Viktor Yanukovych, whom he helped to elect.  The real Paul Manafort case, scheduled to go to trial in Washington on September 17th, involves as one of its focuses alleged unregistered lobbying activities for Yanukovych and other Russian oligarchs. 

The goal of the Mueller team would now be to get Manafort, who faces more than 10 years in prison, to plea and flip over to a witness who could provide critical information on Russian activities under the Putin regime aimed at influencing the U.S. political process and to attempt to connect those Russian influences to any U.S. co-conspirators.

While that is obviously Mueller’s goal, it is unlikely that there is any evidence of “collusion” or any connection between any foreign activities aimed at influencing U.S. political elections and the Trump Campaign.  Since every world superpower attempts to influence every major U.S. election in some way, shape or form – the premise of the Mueller probe that there is some vast underlying conspiracy that actually could have moved the needle in one candidate’s favor seems somewhat fantastical.

Relevant to the conviction, Manafort failed to pay taxes on the political lobbying income received from these Russian oligarchs and the returns (interest, dividends, etc.) which these undisclosed foreign bank accounts generated.  Michael Welch, a revenue agent for the Internal Revenue Service, testified that Manafort did not report $16.5 million of business income on his tax returns between 2010 and 2014. 

Interestingly, the jury only found Paul Manafort guilty of failing to file the FBAR report for the 2012 tax year.  Paul Manafort’s lawyer, Kevin Downing, used to be a veteran Justice Department lawyer who specialized in offshore tax evasion cases and was hailed in 2012 by Reuters as “the U.S. prosecutor most responsible for piercing the veil of Swiss bank secrecy.”  Kevin Downing’s name is synonymous with FBARs. 

Through some subtle and effective legal work, Downing made points to the jury about the concept of “control” or “authority” over an account and raised a question in their minds about whether Manafort was the party responsible for filing the required reporting. 

Confused over the issue, jurors asked the Judge to clarify if an FBAR must be filed if someone had less than a 50% interest in an account and lacked signature authority, but still could direct disbursement of funds. 

What is this all about?  Manafort’s Cyprus lawyers, Cyprus lawyers being infamous for crafting creative tax structures U.S. tax authorities look at with contempt, set up entities like Global Highway Limited, Leviathan Advisers Limited, and Lucicle Consultants Limited that sliced and diced the various corporate ownership and responsibility among different entities and individuals and different general and limited partners. 

The defense tactic of raising doubt about Manafort’s “control” over and “responsibility for” these accounts was effective, and was exactly what his Cyprus lawyers envisioned when they set up these structures.  Nonetheless, Manafort ran afoul of the four cardinal rules of FBAR filing identified below, and the prosecution did enough to convince the jury that Manafort had enough control to be guilty of at least a single FBAR violation.

Morgan Magionos, an FBI forensic accountant, walked the jury through her tracing of the wire transfers from the overseas accounts, which she said showed the accounts were controlled by Manafort either directly or indirectly via his agents in Cyprus.

So, what is Paul Manafort facing?  The FBAR penalty carries a tripwire “non-willful” penalty of $10,000 per offense.  But, the penalty for “willful” violations like the kind Manafort was convicted of carry a penalty of $100,000 or 50% of the highest aggregate account balance for each violation!  We are talking potentially about multiple $30 million penalties.  On top of that, “criminal” FBAR violations carry an additional fine of $250,000 and 5 years of imprisonment.  31 U.S.C. § 5322. 

When the FBAR violation is coupled with a pattern of any criminal activity involving more than $100,000 in a 12-month period or involves a violation of another law (such as money laundering, tax fraud, bank fraud, etc.), the fines are increased to $500,000 and 10 years of imprisonment.  31 U.S.C. § 5322(b). 

Under Federal Sentencing Guidelines, Paul Manafort would likely receive a sentence of between 7 and 12 years of imprisonment on these convictions if he does not cut a plea deal for a favorable sentencing recommendation.

There are a number of “badges of fraud” that draw the IRS’s attention and raise red flags which despite their allure for tax savings to some who are particularly keen to walk the razor’s edge, should truly be avoided at all costs: (1) illegal source income; (2) use of nominees; (3) location of offshore accounts in foreign tax havens; and (4) living large while taking questionable tax positions and/or failing to report income.

Illegal Income

It was not proven here that any of the income in the Manafort case was from an illegal source.  But, this is always something the IRS looks to prove when they are dealing with undisclosed accounts and money that has been hidden away from prying eyes.

Nonetheless, even the appearance of impropriety can be used against you.  Manafort’s history from his “Torturers’ Lobby” days combined with the association with Russian oligarchs clearly did not paint Manafort in the most flattering light before the jury. 

The old adage goes that “birds of a feather flock together,” and while guilt by association may not be an indictable offense, it certainly can lead to a conviction in the event of a trial on other charges.

Use of Nominees

Utilizing a classic tax evasion technique, money earned from foreign lobbying was allegedly funneled into various offshore entities, which then loaned Manafort the funds to spend on various, and often lavish, personal expenditures.  As is often the case with those who are receiving a “bonus” by not paying taxes, the money has a tendency to “burn a hole in one’s pocket” since stockpiling large piles of untaxed cash is something even the most brazen generally steer clear of. 

Since taking out a loan is not taxable, this strategy might initially look good on paper, and be hard to unravel, but ultimately breaks down when one considers the nominal ownership and control of the companies. 

In a less sophisticated fashion, many “tax avoiders” try to insulate themselves from liability by creating “successor companies” or placing assets in the name of a relative or someone they are otherwise close to.  And there may be an appropriate reason to invoke these strategies.  For example, if you are changing your business and want to transition to a new business model, it makes sense to start a new company.  As another example, if a goal of estate and/or succession planning is to reduce one’s taxable estate and transition control of business interests to a relative, then the use of a nominee entity or a Family Limited Partnership may be advisable in certain circumstances.

What is the upshot of Manafort’s use of nominees and nominee entities?  It put a target on his back with IRS.  The gut reflex by high-earners to use nominees to protect some income or a particular asset from IRS detection or from government tax collection efforts by “adding a layer” is so predictable that the IRS actually presumes wrongdoing when it sees these steps being taken.  And, more often than not, they will see it.

A much more sophisticated strategy is needed and it is important to use nominees sparingly unless there is a very good reason for doing so.

Placing Money Earned in Ukraine in Cyprus

Cyprus, the Seychelles, Saint Vincent, Monaco, the Caymans, the Isle of Man, and the Grenadines are beautiful places and favorite haunts of the ultra-wealthy.  The International Consortium of Investigative Journalists (ICIJ) Panama Papers and Paradise Papers databases are an effort to marshal investigative resources to identify banks, bad actors and the like and to provide transparency to those who lurk in these dark corners.

Despite the beauty of these islands and other international tax havens, anyone that does not live on one should think long and hard and act with great caution before opening a foreign bank account in these locales, as that act alone is considered evidence of a fraud.  Moreover, in the current environment where Swiss and Cyprus banks are widely known as being covers for shady dealings, they are no longer the “safe haven” that they once were.

The best way to avoid the appearance of impropriety is to bank local and have nothing to hide.

Lavish Spending on the Government’s Dime

Living large or the “lifestyle audit” is the uncodified crime that the IRS prosecutes more than any other and which is often used by prosecutors and other federal investigators to prove wrongdoing.

Witnesses said Manafort spent lavishly while cheating the IRS and failing to pay his taxes — he spent more than $1 million on clothes, including a $15,000 ostrich leather jacket, more than $2 million on home entertainment systems, and millions of dollars on homes for himself and his family. One witness said Manafort spent hundreds of thousands of dollars on landscaping, including a bed of red flowers in the shape of an “M” in the backyard of his Hamptons home. 

Other expensive and over-the-top purchases made with the foreign lobbying money included $132,000 paid to a yacht broker, International Yacht Collection, $45,000 paid for a cosmetic dentist in Palm Beach, payments to rent an Italian villa, and ongoing horseback riding lessons that were paid for at a prestigious horseback riding academy in northern New Jersey.

Manafort had 14 separate bank accounts in Cyprus and the Grenadines.  But for these accounts, and but for failing to file an FBAR, it is highly unlikely that Manafort would have been convicted of anything.  It is this use of FBARs to root out other potential tax avoidance that makes it a powerful government tool, and which should cause everyone with foreign ties to take great care not to make any mistakes that would give rise to FBAR liability.

Are you a U.S. taxpayer?  If you file a tax return, then you are.  This includes citizens, dual citizens, and Green Card holders (even if they are living abroad).











Category: Tax

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