United States v Hom
Online "pocket aces" may be detrimental to your pocket! A district court has found that a taxpayer's accounts at two online poker companies and an online financial company had to be reported on a Foreign Bank and Financial Accounts Report (“FBAR”). From 2006 to 2007, the taxpayer maintained accounts at PokerStars, PartyPoker, and FirePay that had aggregate values in excess of $10,000 during each year, which he did not report on a timely filed FBAR. The court found that all of these accounts were considered financial accounts located in a foreign country, and were therefore required to be reported. Accordingly, the Court agreed with the IRS’s imposition of non-willful failure to file penalties of $10,000 per account for each year the account was not reported.
During 2006, John Hom (“Hom”) gambled online through internet accounts with PokerStars.com and PartyPoker.com. He also used an online financial organization, FirePay.com, to transfer money from is domestic bank accounts to his two poker accounts. PokerStars, FirePay, and PartyPoker are all licensed and operated in foreign countries. During 2007, Hom only maintained an account at PokerStars.com. For both years at issue, the aggregate amount of funds in these accounts exceeded $10,000. The IRS assessed a $30,000 non-willful failure to file penalty for 2006, which included a $10,000 penalty for each of the three accounts, and a $10,000 penalty for 2007 based solely on his PokerStars account.
An individual must file an FBAR for a reporting year by June 30th of the following year if:
- He or she is a U.S. person;
- He or she has a financial interest in, or signature or other authority over, a bank, securities, or other financial account;
- The bank, securities, or other financial account is located outside of the U.S.; and
- The aggregate amount in the accounts exceeds $10,000 in U.S. currency at any time during the year.
Failure to file the FBAR is subject to penalty. No penalty is imposed, however, if the violation is due to reasonable cause and the amount of the transaction or the balance in the account at the time of the transaction is properly reported.
The issues in this case boiled down to main issues:
- Whether Hom's accounts with the poker companies were "a bank, securities or other financial account"; and
- Whether each of the three accounts were located outside of the U.S.
The District Court’s Decision
Ultimately, the Court concluded that Hom’s accounts were considered "bank, securities or other financial accounts" in foreign countries. As a result, the Court agreed with the IRS's assessment of the penalties.
The Court determined that PokerStars, PartyPoker and FirePay were all financial institutions because they functioned as commercial banks by holding funds for third parties and disbursing them at their discretion. This is in line with the generally broad definition given to the term “financial institution” by the appeals courts.
As to whether the accounts were located in foreign countries, IRS argued that "located in" refers to where the financial institution that created and managed the account is located, whereas Hom argued that "located in" refers to the geographic location of the funds. Hom even provided some evidence to suggest that PokerStars has several dozen bank accounts located in the U.S.
The court agreed with the IRS stating that it is irrelevant where PokerStars, FirePay, or PartyPoker opened their company bank accounts. Those accounts belong to them, not Hom. Rather, his accounts are digital constructs that these financial institutions, all located outside of the U.S., created and maintained on his behalf. These outside-the-U.S. places are the locations of his digital accounts, regardless of where the three companies place their own funds. The Court held that an account's location is determined by the location of its host institution, not where the physical money might be stored after it is sent to a financial institution, agreeing with Treasury’s interpretation.
The Tax Warrior Perspective
The Court’s finding that an account's location is determined by the location of its host institution, not where the physical money might be stored after it is sent to a financial institution, is a troubling conclusion. To begin, it is a contradiction of the IRS-issued instructions for the 2010 FBAR, which state:
“The geographical location of the account, not the nationality of the financial entity institution in which the account is found determines whether it is in an account in a foreign country.”
While it is common knowledge among tax professionals that IRS instructions do not carry the weight of law, they are nonetheless relied upon substantially by non-tax professionals and individuals as correct interpretations of the law.
Looking at the most current version of the FBAR instructions, which have been updated since 2010, the language regarding the determination of a foreign account is still ambiguous. The current instructions read:
“A foreign financial account is a financial account located outside of the United States. For example, an account maintained with a branch of a United States bank that is physically located outside of the United States is a foreign financial account. An account maintained with a branch of a foreign bank that is physically located in the United States is not a foreign financial account.” (emphasis added)
Had PokerStars, PartyPoker, and FirePay held Hom’s accounts in banks or branches physically located within the United States, could the accounts have been considered domestic? One would think so based on the second example in the IRS guidance above. However, Hom had no confirmation from the non-U.S. based companies that this was the case. This furthers the point that accounts held by non-U.S. based companies and institution will generally be deemed foreign accounts, unless there is clear evidence they are maintainted within the U.S.
In all, the case raises questions as to the types of accounts that are required to be reported on an FBAR. With only a few weeks left before the June 30th filing deadline for 2013 FBARs (recently renamed Form FinCEN 114), it is doubtful the IRS will be able to react to the court’s decision and issue guidance, nor will an appeal likely be heard before then. Additionally, the case brings prior-year FBAR filings into question for online gamblers and provokes whether voluntary disclosure programs should be considered.
The Tax Warriors® at Drucker & Scaccetti have extensive experience in representing individuals with foreign financial accounts and are experts in navigating the risks and rewards of the many offshore voluntary disclosure programs currently being offered by the IRS. While the Hom case raises some unanswered questions, our experts have the experience and knowledge to guide you through the maze of foreign asset reporting to reduce your criminal and civil penalty exposure. Contact us via the “Ask A Tax Warrior” button below if you have any questions about your specific situation. We are always prepared to help you with this or any other tax matter related to U.S. taxation of foreign assets and investments.