According to the Internal Revenue Service (“IRS”), approximately $1,500,000,000 in assets was transferred by U.S. persons to foreign trusts in 2010. This wave of tax planning involving off-shore assets and bank accounts has attracted a flood of attention from the IRS. While some of the well-known attention involves locating those pesky, Swiss bank accounts, some lesser-known attention involves the efforts of the U.S. Department of Justice to impose civil penalties against individuals and entities that failed to properly disclose bank accounts and financial assets held in other foreign banks and countries.
In addition to enforcement action, many firstworld nations around the globe are actively considering legislative and treaty efforts to require non-domestic banks to report account holder information to government agencies. In fact, the official theme of the 39th G8 Summit, held in June 2013, was tax evasion and transparency. In this environment, foreign financial transactions and assets are a robust area for Internal Revenue Service enforcement efforts. Awareness of the foreign account and asset reporting requirements is crucial to helping the client avoid substantial civil penalties and potential criminal punishment.
What is an FBAR? FBAR is the common term used by the IRS and tax practitioners to describe Form TD F 90-22.1, also known as The Report of Foreign Bank and Financial Accounts. FBAR reporting is mandated under the Bank Secrecy Act, which requires a resident or citizen of the U.S., or a person doing business in the U.S., to report foreign financial assets and maintain records of transactions and relationships with foreign financial agencies for five years.2 Substantial civil penalties, discussed below, may be imposed for failing to comply with foreign financial account reporting and recordkeeping.3
Though filed with the IRS, the FBAR is a separate reporting and is not filed with the taxpayer’s income or other federal tax return. Instead, the FBAR must be received by the IRS in its Detroit, Michigan Computing Center by June 30th of the year following one in which a U.S. person has a financial interest in or signature authority over a financial account in a foreign country with an aggregate value of greater than $10,000.4 Unlike an income tax return, the June 30th due date for the FBAR filing cannot be extended. The provisions and procedures of the Internal Revenue Code (Title 26) also do not apply when administering FBAR compliance arising under the Bank Secrecy Act (Title 31). The FBAR form specifies the nature and categories of information that must be reported to the IRS.5 Generally, the FBAR requires disclosure of the account holder, the foreign account number or other designation, the foreign bank or financial institution where the account is maintained or held, the type of account, and the maximum account balance during the year.
Who Must File an FBAR? An FBAR must be filed by a U.S. person who has (a) a financial interest in a foreign financial account or (b) signature or other authority over a foreign financial account, where the aggregate amount in the foreign financial account valued in U.S. dollars exceeds $10,000 at any time during the calendar year. A U.S. person is defined broadly in the Bank Secrecy Act to include “a resident or citizen of the United States or a person in, and doing business in, the United States.”6 However, the statute delegates authority to Treasury to prescribe persons subject to and exempted from the definition of U.S. person. The instructions to the FBAR form limit the definition of U.S. person to a citizen or resident (living in and not planning to permanently leave) of the U.S., a domestic partnership, a domestic corporation or a domestic estate or trust. A U.S. resident for FBAR purposes includes a person holding a green-card, a person physically present in the U.S. for at least 183 days during the year, and a person making a first-year tax return election to be treated as a resident alien.7
A financial interest generally arises where the U.S. person is the owner of record or has legal title, even though the account may be maintained for the benefit of another. Where multiple persons have a foreign financial interest, each is responsible for filing the FBAR. For foreign financial accounts held in the name of entities, an FBAR must generally be filed where a U.S. person holds more than a fifty-percent interest in the entity.
Furthermore, even where a financial interest does not exist, an FBAR is required where the U.S. person has signature or other authority (generally viewed as control over the disposition of money or property in the account) over a foreign financial account. However, when it comes to reporting requirements for signature authority over an account, numerous exceptions exist as reflected in the instructions to the FBAR form.
A foreign financial account is broadly defined to include a bank account, insurance policy, securities or financial instrument account, a mutual fund account, or bonds or stock certificates held in a bank or financial institution in a geographical area outside of the U.S. and its territories and possessions. The reporting requirements are triggered by the location of the account, not the nationality of the bank or financial institution. For instance, a bank account held by a Swiss bank located in the U.S. is not subject to reporting, but one held by a U.S. bank located in Switzerland must be reported on the FBAR. However, an exception exists for accounts held at military banking facilities.
FBAR reporting is required where the aggregate value of currency and non-monetary assets exceed $10,000 (U.S. dollar equivalent) at any time during the year calculated by reference to the official currency exchange rate at year-end. The FBAR requires disclosure of the maximum account value during the year, which is also used in calculating FBAR non-compliance penalties, discussed below. The determination of account value is made by reference to the account statements. However, the accounts must be analyzed on an aggregate basis. Therefore, simply dividing foreign bank accounts below the $10,000 reporting threshold will not avoid the disclosure requirements. Additionally, since the maximum account values must be reported for each account, the FBAR may reflect total account values far in excess of the actual foreign financial asset holdings of the U.S. person due to transfers between accounts during the calendar year. Unfortunately, FBAR penalties are based upon the maximum account balances, which may not necessarily be consistent with actual foreign financial holdings.
FBAR Penalty Structure. Generally, civil penalties are intended to promote compliance and should be imposed by the IRS only for that purpose. However, IRS agents have substantial discretion in what does and does not require the imposition of penalties, and the appropriate amount. Accordingly, the failure to disclose foreign bank and financial accounts may result in a range of civil consequences, including the issuance of a Warning Letter (Letter 3800), negligence and pattern of negligence penalties for businesses, nonwillful penalties for individuals, and significant willful violation penalties. In addition to civil penalties, failure to comply with FBAR requirements may also result in severe criminal penalties for the same willful violation, including imprisonment up to 10 years and up to $500,000 in criminal penalties.8
An FBAR violation actually occurs on June 30th of the year following the calendar year in which the foreign financial account must be reported. A six-year statute of limitations exists for the IRS to assess civil FBAR penalties. 9 FBAR penalties are determined on an account-by-account basis, not per unfiled FBAR, for each year. Thus, where multiple accounts should have been reported and no FBAR is filed, multiple FBAR violations have occurred for the calendar year. Additionally, each person with a financial interest in, or signature authority over, the foreign bank account can be held responsible for the full amount of the FBAR penalty.
Individuals may be subject to a non-willful penalty in an amount up to $10,000 per violation for violation of the FBAR filing and recordkeeping requirements.10 Accordingly, the non-willful failure to report three foreign financial accounts in a single year may result in a $30,000 penalty for that year. A willful FBAR penalty in the amount of the greater of $100,000 or 50 percent of the account balance per violation applies to any individual, business or financial institution that voluntarily and intentionally violated the FBAR reporting or recordkeeping requirements.11 This is a significant penalty that in the case of multiple violations may far exceed the actual balance in the foreign bank account. For example, if the taxpayer fails to report a $1,000,000 U.S. dollar equivalent account for each of the six years for which the civil statute of limitations remains open, the potential civil willful FBAR penalty may be up to $500,000 per year, for a total civil FBAR penalty of $3,000,000. The FBAR penalty is in addition to other penalties that may be assessed under the Internal Revenue Code for tax reporting violations, as discussed briefly below.
As it relates to the willful FBAR penalty, the IRS bears the burden of proving knowledge of the reporting requirements and the conscious choice not to comply. Generally, willful violations are based upon conduct intended to conceal income, control of a bank account, or financial information. The involvement of a promoter, or other “advisor,” in the selection, maintenance and reporting of a foreign financial account is also likely to attract IRS consideration of a willful violation penalty. Prior noncompliance with FBAR or tax reporting requirements is a strong factor in favor of a willful violation penalty. It is crucial that a reasonable explanation exist for the failure to file the FBAR, and that it is thoroughly explained to the IRS agent in writing. Conversely, where the foreign financial account income was properly reported on a U.S. tax return, but no FBAR was filed, it is less likely that the IRS will impose an FBAR penalty.
Penalty Mitigation and the Reasonable Cause Exception. Penalty mitigation is available where the following threshold conditions are satisfied: (1) the person has no history of past FBAR penalties and no history of criminal tax or Bank Secrecy Act convictions for the prior ten years, (2) no money passing through any of the foreign accounts associated with the person was from an illegal source or used to further a criminal purpose, (3) the person cooperates with the IRS in requests for information and files delinquent FBARs and tax returns, and (4) the IRS did not obtain a civil fraud penalty against the person for failure to report income from the undisclosed foreign accounts. Numerous penalty mitigation procedures exist to reduce the amount of various willful and non-willful violation fact patterns, primarily based upon the maximum account balance in the unreported foreign financial accounts.
Civil penalties may be avoided in full by a showing that the failure to comply with FBAR reporting requirements was due to reasonable cause. The reasonable cause standard is not clearly explained in the FBAR regulatory regime. Thus, the IRS typically looks to reasonable cause factors under Treasury Regulation section 1.6664-4, though the regulation is not controlling authority with respect to FBAR reporting. Such factors include the taxpayer’s knowledge, sophistication, experience and efforts to determine correct reporting requirements, including consultation with professional advisors.12 In addition to reasonable cause, the foreign financial account must be reported on a delinquent FBAR to avoid imposition of penalties. A determination of reasonable cause, and the imposition of FBAR penalties, is based upon the particular facts and circumstances of each case.
Other Foreign Bank Account Disclosures. The Form 1040, U.S. Individual Income Tax Return, requests information concerning foreign financial accounts on Part III of Schedule B, Interest and Dividends. The IRS may attempt to prove a willful violation of the FBAR reporting requirements based upon a taxpayer’s responses, or lack thereof, to Part III of Schedule B. However, the mere fact alone that the taxpayer did not complete or completed incorrectly Part III of Schedule B does not establish a willful violation. Foreign financial account information is also requested on other U.S. tax returns, including Form 1041, Form 1120 at Schedule N, and Form 1065 on Schedule B.
The IRS has also required the disclosure of foreign financial assets on Form 8938, which is filed with the U.S. income tax return beginning with the 2011 taxable year. However, the filing of Form 8939 does not relieve the filing of the FBAR form for the same year.
Getting Right with the IRS and Voluntary Disclosure. In an effort to assist foreign account holders to come into FBAR compliance, the IRS has offered a series of three voluntary disclosure programs dating back to 2009. The voluntary disclosure program provides a civil settlement structure where an offshore penalty is paid in the amount of 27.5 percent of the maximum account balance during the eight-year voluntary disclosure period, and appropriate amended income tax return liabilities are paid along with a twenty-percent accuracy related penalty. The settlement provides protection from criminal prosecution and the aforementioned substantial willful violation penalties. Under certain circumstances, a taxpayer may elect to opt-out of the foregoing structure in favor of seeking penalty mitigation due to reasonable cause or other factors. However, once the IRS has initiated contact with the taxpayer regarding the unreported foreign financial accounts, the voluntary disclosure program is no longer available. While not appropriate for every taxpayer, the voluntary disclosure program must be considered where the unreported financial account balances are substantial and the facts and circumstances are peculiar.
The IRS is actively investigating foreign financial account noncompliance and has placed significant emphasis on achieving increased compliance through enforcement efforts. FBAR violations may be uncovered in a number of ways, including an income tax audit, disclosures by other account holders at a particular bank, the use of IRS summons authority, treaty requests with foreign jurisdictions, and legal action against foreign financial institutions for disclosure of account holders. Additionally, individuals in possession of solid information regarding tax underpayments may report it to the IRS and obtain a reward, of up to 30 percent of the amount collected by the IRS, for reporting foreign financial account and FBAR noncompliance.
IRS whistleblowers continue to be a solid source of tax noncompliance information. Given the pressures and potential civil and criminal penalties on account holders that have failed to report foreign financial accounts, the delinquent filing of FBARs and related income tax returns must be considered before the IRS is knocking on the door. However, with a little knowledge and appropriate due diligence, an attorney can properly counsel his or her clients to avoid enforcement action for foreign bank account reporting non-compliance.
2 31 U.S.C. § 5314; 31 CFR § 103.32
3 31 U.S.C. § 5321(a)(5).
4 31 CFR §§ 103.24, 103.27
5 31 CFR §§ 103.32, 103.56
6 31 U.S.C. § 5314
7 26 U.S.C. § 7701(b)
8 31 U.S.C. § 5322, 31 U.S.C. § 5321(d); 31 CFR §§ 103.59,103.56(c)(2).
9 31 U.S.C. § 5321(b)(1); see also 31 U.S.C. § 5321(b)(2) (two-year statute of limitations on collection of FBAR penalty) and 18
U.S.C. § 3282 (five-year statute of limitations on FBAR criminal penalties).
10 31 U.S.C. § 5321(a)(5)(A)
11 31 U.S.C. § 5321(a)(5)(A)
12 I.R.C. § 6664(c); Treas. Reg. § 1.6664-4
Justin D. Scheid is an attorney and certified public accountant with The Law Offices of Debra A. Buettner, P.C. in South Barrington, focusing on assisting individuals and entities in tax planning and tax controversy and litigation. He is a former senior tax attorney and a former FBAR Coordinator with the Internal Revenue Service, Office of Chief Counsel in Chicago. He received his L.L.M. in taxation, with honors, from Northwestern University School of Law in 2006, his J.D. from Chicago-Kent College of Law in 2004, and his B.S. in economics from the University of Illinois at Urbana-Champaign in 2001.