For a wide variety of reasons, many Americans have assets in foreign countries. Some have left established businesses and homes, fleeing persecution in their country of origin. There are those who have fled war-torn regions of the world and left their assets in tax havens; or maintain foreign financial accounts to support family abroad. Other individuals with immigrant roots may have inherited from a relative in the old country who passed away and left them a sum of money abroad.
Of course, American business interest have also grown far and wide across the globe. Multi-national corporations and individuals maintain accounts abroad to fund their various business operations and provide for their living expenses.
Since 2002, when the FBAR was first implemented, the methods and means of seeking out these individuals and enforcing reporting obligations has grown tremendously. Due to pressure placed on international banks by the US government, many foreign banks volunteer to disclose information relating to accounts held by US persons. Although it may not be apparent from the start that an individual has been audited for their foreign account holdings, this motivating factor will often surface at some point over the course of an audit.
A Report of Foreign Bank and Financial Accounts (FBAR) refers to a disclosure form that must be filled out by certain taxpayers with respect to financial accounts maintained abroad. Although this is often a concern for the millions of expatriates living and working in foreign countries, the FBAR applies to an even broader demographic of taxpayers. If you are a U.S. person with a foreign financial account in your name, authority to act on another’s behalf for a foreign account, or a financial interest in a foreign account held in someone else’s name; you may have certain reporting obligations to fulfill in compliance with Federal tax law. Although the FBAR is important, there are also separate information forms that individuals with an international presence should also be aware of for Federal Income tax purposes.
If you have already received a notice, it is best to seek experienced counsel to guide you in your efforts to be forthcoming. If you have not yet been audited but are concerned that you may have failed to make required disclosures for previous years, it is best to be proactive in order to take advantage of the full range of options available to help taxpayers resolve their delinquent foreign account reporting obligations. The full range of approaches may no longer exist once an audit is opened, and the path to a resolution may become considerably more difficult. Criminal sanctions, penalties, and relief available may also depend on the factual circumstances involved in the taxpayer’s failure to complete the required disclosure.
The objective of this guide is to inform taxpayers with foreign accounts on whether they may have an obligation to disclose a foreign financial account or other required information returns; how to make those disclosures; and what to do if they have previously failed to meet those reporting requirements. This guide will also discuss the penalties involved, and the programs available to help non-compliant taxpayers fulfill their disclosure obligations and return to a position of good standing.
Let us start with an explanation of who has an obligation to make financial disclosures under the FBAR.
Who is Required to File
As mentioned above, there are a variety of reasons why American citizens and residents have ties to foreign financial accounts. Under the FBAR reporting requirements, A United States person must file an FBAR if that person has:
- A financial interest in;
- Signature authority over; or
- Any other authority over any financial account(s) outside the U.S. and the aggregate maximum value of the account(s) exceeds $10,000 at any time during the calendar year.
Understanding the Statute
United States Person
A United States person refers to both citizens and residents. However, it also includes entities such as corporations, partnerships and limited liability companies; and even trusts or estates that are organized under U.S. law. In fact, even entities that are disregarded for federal tax purposes might still have an obligation to file an FBAR disclosure because FBARs are required under a Bank Secrecy Act provision of Title 31; and not under any provisions of the Internal Revenue Code.
Financial accounts include the following types of accounts:
- Bank accounts such as savings accounts, checking accounts, and time deposits,
- Securities accounts such as brokerage accounts and securities derivatives or other financial instruments accounts,
- Commodity futures or options accounts,
- Insurance policies with a cash value (such as a whole life insurance policy),
- Mutual funds or similar pooled funds (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions),
- Any other accounts maintained in a foreign financial institution or with a person performing the services of a financial institution.
Financial interest includes being the owner of record or holder of legal title. You are also considered to have a financial interest if the account is in your name, but you are acting on behalf of a United States Person. In that case, you both likely would have an obligation to make an FBAR filing.
A corporation is considered to have a financial interest if a U.S person owns either 50% of the total value of shares of stock, or more than 50% of the voting power of all shares of stock.
A partnership in which a United States person (see above) owns an interest in more than 50% of partnership profits or an interest in more than 50% of the partnership capital, has a financial interest.
If a United States person has greater than 50% present beneficial interest in the assets or income of the trust for the calendar year, they are also considered to have an economic interest. Additionally, a trust grantor is considered to have a financial interest if they have an ownership interest in the trust for federal tax purposes.
Financial interest also exists for any other entity in which a United States person owns more than 50% of the voting power, total value of equity interest or assets, or interest in profits.
In all of the above cases, financial interest exists whether the ownership exists both directly or indirectly.
Signature authority exists when an individual has control over assets held in a foreign account and can exercise that control by a direct communication (including but not limited to a communication in writing). Whether or not they have ever previously exercised the authority would not matter.
For example, a U.S. resident who has a power of attorney for his elderly father’s accounts in Mexico would be required to file an FBAR if the power of attorney gives him signature authority over his father’s financial accounts and the aggregate maximum value of the accounts exceeds $10,000.
Calculating the Aggregate Maximum Value of a Foreign Financial Account
The first step is to determine the maximum account value for each of your foreign accounts. The maximum account value is a reasonable approximation of the greatest value of currency or nonmonetary assets in the account during the calendar year. Once you have determined the maximum account value for each account, use the exchange rate on the last day of the calendar year to convert each value into U.S. dollars. This should be done using the Treasury Reporting Rates of Exchange. Lastly, you add up each of your converted maximum account balances. If the total amount of all your account maximum values exceeds $10,000, all the accounts must be reported on the FBAR.
For example, a U.S. person owns foreign financial accounts X, Y, and Z with maximum account balances of $200, $9,000 and $4000 respectively. This individual would be required to file an FBAR because the aggregate value of the accounts would be $13,200; which is greater than the $10,000 threshold in the statute. All three accounts would have to be reported on the FBAR, and it does not matter whether an account is individually less than the threshold.
Deadline to File/Postponed Filing
An FBAR must be filed by April 15 of every year. You must continue to file the form on a yearly basis, even if you have no new accounts to report. If needed, you may also get an extension to file until October 15.
Bear in mind that you must also likely file Form 8938. This form is one of a few different information reports that is an attachment that must be filed along with your Federal Income Tax return. Notice that this is different than the FBAR, which is submitted separately and has its own due date. Examples of other forms that pertain to international tax which you may be required to file along with your federal income tax return are: Form 5471; 5472; and 3520/3520A. We will discuss these briefly below.
As part of the Coronavirus pandemic relief effort, the IRS issued notice 2020-23 which has extended the federal income tax filing deadline to July 15, 2020 for the 2019 tax year. Because the forms discussed above must be filed attached to the tax return, the due date for these schedules has also been postponed to July 15, 2020.
If you have any doubt whether you are required to file, err on the side of precaution and make the filing. The amount of penalties can be severe if you fail file either a Form 8938 or FBAR when you were required to do so. If you believe that you have failed to meet your filing requirements for previous years, it is best to be proactive in taking measures to correct non-compliance for reasons that will be discussed below.
Other Important Forms
This is the Statement of Specified Foreign Assets Form that you likely will have to file along with your income tax return if you must also complete an FBAR. Here is a link to instructions provided by the IRS to guide you in completion of the form. To understand the differences between the FBAR and Form 8938, Here is a chart which illustrates the comparison of requirements under both.
In addition to having an interest in a foreign account, you may own an interest in a foreign entity. If so, you may have obligations to file Form 5471; Information Return of U.S. Persons With Respect to Certain Foreign Corporations. The rules for 5471 can be somewhat complicated, and you should determine whether or not you may fit in the category of individuals who have an obligation to file. One example that would trigger an obligation to file a Form 5471 is if a corporation has had more than a 10% change in ownership. However, there are categories which apply to officers of a corporation as well so you may want to look further to determine whether your particular circumstances require you to file. Remember, failing to file a required disclosure form that is attached to your 1040 form can mean that the statute of limitations will be open indefinitely; not just for the form, but for the entire tax return. This form carries a $10,000 fine per form per month with a continuation penalty maximum of $50,000.
This Form is required in cases of a 25% foreign ownership of a U.S. corporation; or a corporation engaged in a U.S. trade or business. The penalty under this form is $25,000 per year with a $25,000 continuation penalty per month.
Return that is required to be filed by a U.S. transferor of property to a foreign corporation.
If you have an interest in a foreign trust, you may be required to also complete these forms. 3520 is an Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. 3520A is an Annual Information Return of Foreign Trust with a U.S. owner. The penalty for failure 3520 is the greater of $10,000 or 35% of the gross value of any property transferred to a foreign trust; 35% of the gross value of the distributions received from a foreign trust by a U.S. person; and 5% of the gross value of all of a foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules or 5% of the amount of the foreign gift for each month, not to exceed 25%. The penalty for 3520A is the greater of $10,000 or 5%.
An area of difficulty that has arisen with regard to FBAR cases is the ambiguity of penalties potentially faced by an individual in violation of disclosure requirements. The statute tells us that there are two categories of penalties that may be imposed:
- Willful Penalty; and
- Non-willful Penalty.
Aside from criminal sanctions, a willful penalty that is the greater of $100,000 or 50% of all non-disclosed accounts, per year; and for year for every year for which the statute of limitations is open. This means that the statute allows the IRS to fine a taxpayer up to 300% of the amount of an account in violation of disclosure obligations. Of course, these large fines have had their critics; who have raised the issue of whether these excessive fines taken to their full extent under the statute, may violate a taxpayer’s rights under the 8th amendment. Perhaps as a recognition of this complaint, the IRS has generally adopted a policy of limiting actual implementation of these 50% penalties to once or twice over the collection period; which is still burdensome enough to drain your account entirely.
While cases of intentional concealment or fraud are generally distinguishable as Willful violations; often there are cases where the distinction between a willful and Non-willful violation can be difficult to assess without professional guidance. Depending on the circumstances surrounding the taxpayer’s failure to file, the courts may find that a taxpayer is “willfully-blind” to their filing obligations. This means that the taxpayer made a conscious effort to avoid learning about their FBAR reporting obligations. For example, if the taxpayer failed to inform his tax preparer about any foreign accounts he owns, a court may find that the taxpayer willfully avoided learning about their disclosure obligations.
On the other hand, if a taxpayer did inform their tax preparer, the court may look a bit deeper to the facts of the circumstances that led to the taxpayer’s failure to file. The court looks to determine whether or not the taxpayer had reasonable cause; does the taxpayer have a good reason that would allow the court to excuse the violation. For example, if the taxpayer told his tax return preparer about the foreign accounts and the preparer misinformed the taxpayer––was it reasonable for the taxpayer to rely on the tax preparer’s advice?
This can be a very fact specific inquiry. If the return preparer was unpaid or known to be inexperienced, or if you had filed an FBAR in a previous year; these facts will not likely weigh in your favor. The court’s rulings in FBAR cases has indicated that the reasonable cause defense that is usually available in other contexts is severely limited in FBAR cases. However, if you are able to give a valid and acceptable reason as to why you violated the FBAR filing requirement, you will qualify for a non-willful penalty.
A non-willful penalty carries a fine of $10,000 per year you are in violation. The non-willful penalty has been limited to a $10,000 penalty per open year, regardless of the number of accounts. Unfortunately, the government has taken the position that the fine can be applied to each non-disclosed account. As mentioned previously, the IRS has generally operated under a circumscribed policy limiting the application of the penalty to its full extent. However, depending on the facts and how egregious the violations are, the IRS may push the penalties further than they normally do. The IRS has had cases go in their favor in this area, but these FBAR penalty cases are still being litigated.
For now, this means that if you have three foreign bank accounts that fall under FBAR reporting obligations, you could potentially be fined $30,000 (3 accounts x $10,000 fine) for every year that you did not fulfill your filing requirements. This stacking of penalties under the non-willful penalty has imposed a pretty severe punishment on taxpayers who unintentionally failed to file. The IRS is serious about FBAR compliance; the possibility of being penalized to this extent provides enough incentive to file an FBAR, even in cases where you are not entirely convinced that your circumstances require doing so. It is better to make the filing beforehand, and square away the rest later.
How Long Does the IRS Have to Collect? (Statute of Limitations)
The HIRE Act has made changes to the statute of limitations for international form penalties. The changes only apply to the informational returns which are required to be submitted along with the federal income tax return; not the FBAR. The FBAR statute of limitations is 6 years.
The statute of limitation for attachments such as Form 8938 or 5471 would be 3 years; because this is the statute of limitations that is assigned to the income tax report. However unlike the FBAR, which has a statute of limitations of 6 years whether or not you file the form, the HIRE Act made it so that the clock does not start running for the income tax and corresponding forms the taxpayer files the appropriate informational return. In addition, the statute of limitations on the income tax return itself will not start to run until you complete the appropriate forms. This means that the statute of limitations on your income tax will never time out until you fill out the missing forms. This could lead to further liability, so it is important to fill out the appropriate disclosures as soon as possible so the three year count down can begin.
Whether you are in appeals or litigation, the government may request that the taxpayer agree to extend the statute of limitations. It may be in your favor to extend in FBAR cases. This is because both you and the government may need time to prepare your argument and evidence, and there is no interest on FBAR penalties until the actual penalty has been assessed. Refusing to grant the statute of limitations extension will result in the IRS making an assessment of the penalty. Because appeals and litigation may take years to get through the process, you do not want interest and other penalties to accumulate on the FBAR penalty during that time. For this reason it is best to work with the IRS agent assigned to your case, and sometimes that means signing the statute of limitations extension in order to avoid the penalty from being assessed.
If you cannot come to an agreement in resolving the issue in the IRS examination stage, you still have a right to take your case to Appeals. As mentioned above however, it may currently be in your best interest to work with the IRS agent and not depend on the case to go your way in Appeals. The restructuring of IRS Appeals paired with budget cuts have undercut the traditional functionality of the Appeals division. Additionally, IRS agents have a surprising amount of discretion in this area; discretion that the Appeals division has been reluctant to wield.
Pre-assessment v. Post-assessment
There are two ways for a case to go forward from the examination stage to appeals: pre-assessment or post-assessment. As mentioned previously, there is no interest that accrues on the FBAR penalty until the penalty is assessed. Which means you are incentivized to work closely with the agent assigned your case in the examination stage to ensure that if your case does need to continue on to appeals, it gets there pre-assessed. It is better for the case to go forward in pre-assessment. However if it does go forward post penalty assessment, there is an additional requirement that the Department of Justice approve of any settlement agreement that may be reached. This Department of Justice approval is not required at the examinations stage, which provides another reason to try and work to resolve the issue with the IRS agent.
If appeals does not resolve the dispute, you still have the option to pursue litigation. There is currently much litigation for ongoing FBAR cases. Depending on how these cases turn out, you may or may not need to pursue the litigation option.
Resolution Programs Available
You have options available to help you resolve your tax and foreign account reporting obligations if you voluntarily come into compliance before the IRS is aware. Once a civil investigation is started, it may be too late to get a favorable deal and avoid heavy penalties. To allow taxpayers with international tax issues get back in compliance, the IRS has a number of programs and options available.
One option to consider is the Streamlined Programs. These programs allow you to come in to the program if you have made a non-willful violation. Remember, this is a vey fact sensitive determination, and you likely should seek tax council’s advice on whether your circumstances would allow you to qualify. The benefit of these programs is that you can walk away with only paying a 5% penalty after making full disclosures. However, you should really approach this with caution because there are no guarantees and an audit may accompany to verify that the disclosures are full and complete. Here are the requirements for this program:
- Available to U.S. persons and estates only
- There has been a failure to report foreign financial assets or pay all tax due in respect of those assets
- The taxpayer is able to certify that the failures to comply were non-willful violations
- The taxpayer is not currently under IRS examination or criminal investigation
- The taxpayer has a valid Social Security of Taxpayer Identification Number
Streamlined Domestic Offshore Procedures (For Residents
Forms needed: Form 14654
Additional Steps: You must file amended tax returns and file all required information returns (for example: 3520, 3520-A, 5471, 5472, 8938, 926, and 8621)
You must also file any delinquent FBARs for any of the last 6 years missing a filing.
Streamlined Foreign Offshore Procedures (For Non-Residents)
Forms needed: 14653
Additional Requirements: The taxpayer was outside of the U.S. for at least 330 full days for one of the Streamline years
If you pay the full amount of tax and interest at the time you submit these missing or corrected returns, you can also avoid the 5% penalty.
Because you are required to make a certification that the failure to complete the appropriate disclosures or tax obligations, be sure that this is the appropriate resolution for your circumstances.
The IRS has already ended the OVPD program, and has stated that they may end the Streamlined programs. If you think this may be a viable option for you, do your best to take advantage of the program soon. The IRS has stated that they may terminate these programs in the near future.
Delinquent Filing Procedure Option
Informational Return Delinquent Filings
If you are not in need of the Streamlined Procedures because you do not owe additional tax, and you have reasonable cause for not filing an information return; you may file the delinquent information returns along with an explanation of the facts that support your claim of having reasonable cause for failing to file on time. You must do this before a civil examination or criminal investigation has been opened.
If you must file a delinquent form 3520 and 3520-A, you will file it according to the instructions on the form which can be found Here.
For all other delinquent informational returns (e.g. 5471, 5472, 8938, 926, and 8621): attach the completed forms and reasonable cause supporting fact statement to an amended tax return and file according to the instructions for an amended return; which can be found Here.
FBAR Delinquent Filings
Similar to Informational Return Delinquent Filings, you must include a statement that explains why you have reasonable cause; and you must take action before being contacted by the IRS about the delinquent FBAR(s).
Keep in mind that any of these filings can be selected for audited, so be sure your reasonable cause has sufficient support and your disclosures are complete! If you should find yourself in need of further assistance, please feel free to reach out and set up a consultation with our experienced Senior Counsel at Brotman Law.