Foreign Account Holder Successfully Asserts Fifth Amendment on Schedule B

The Fifth Amendment protects an individual from being forced to incriminate himself or herself, often referred to as “pleading the fifth.” In the past, some have unsuccessfully attempted to assert the Fifth Amendment as a reason to avoid filing tax returns, or to file tax returns that don’t report any income. These arguments, usually asserted by tax protesters, are generally considered frivolous by the IRS and federal courts.

Recently, the Tax Court ruled in favor of a taxpayer who reported his income but refused to disclose the source by asserting his Fifth Amendment privilege. Youssef Youssefzadeh timely filed his 2011 tax return and reported all of his income. On his Schedule B, however, he refused to identify the source of some of the interest income that he earned, which turned out to be from foreign bank accounts. The IRS threatened to assess a “frivolous-return penalty” against Youssefzadeh if he did not provide the missing information. When he still refused, the IRS assessed the penalty against him, which he challenged at the Tax Court.

U.S. taxpayers who hold $10,000 or more in foreign accounts at any time during the tax year are required by law to file an FBAR. Failure to file an FBAR can subject the taxpayer to both civil and criminal penalties. Schedule B of the tax return is used to report interest income and dividends received during the year. While Youssefzadeh correctly reported the total amount of interest income that he earned, he refused to disclose the source of interest income that he earned from his foreign accounts.

At trial, the IRS argued that the missing information was necessary to determine whether the tax return was accurate. The Tax Court ruled, however, that the tax return was “substantially correct,” making the frivolous return penalty improper. While taxpayers cannot make blanket assertions of the Fifth Amendment and refuse to provide any information, the Supreme Court has previously held that taxpayers may assert the Fifth Amendment privilege on their tax returns if the answer to a question would require that the taxpayer expose himself to criminal liability.

The opinion does not mention which country Youssefzadeh’s foreign accounts are in. With the implementation of FATCA, banks in more than 100 countries are set to begin exchanging information with the IRS about U.S. accountholders. Taxpayers with undisclosed foreign accounts are strongly encouraged to come forward voluntarily and participate in one of the ongoing IRS voluntary disclosure initiatives.