It is not uncommon for individuals and businesses to hold foreign bank accounts. Although these activities are often portrayed in works of fiction as being shady and nefarious, there actually is nothing wrong with doing so.
Where people get into trouble is when they fail to disclose any involvement with overseas financial institutions to the IRS. The IRS takes a dim view of businesses or individuals who set up “tax shelters” outside the U.S. And even though conducting financial transactions overseas is not illegal, the IRS will wonder what you are trying to hide.
In this article, I am going to talk about FBAR, which stands Foreign Bank Account Report and refers to a disclosure form that must be filled out by certain taxpayers with respect to financial accounts maintained abroad (“foreign financial accounts”).
If you are unaware of or remiss in your responsibilities about FBAR, then you have come to the right place. Here you can learn everything you wanted to know (or really do not want to know!) about your FBAR obligations.
Let me make this very clear – the IRS is not messing around when it comes to U.S. citizens who have financial holdings overseas and they are cracking down big time. If you are concerned about FBAR and unsure of your next steps, give me a call.
Why You Need to Comply
For the purposes of FBAR, “foreign financial accounts” include those that are held by a U.S. bank in a foreign branch. Accounts held in foreign banks through a U.S. branch, on the other hand, do not count for the purposes of FBAR. Although this is often a concern for the millions of expatriates living and working in foreign countries, FBAR applies to an even broader demographic of taxpayers.
If you are a U.S. person with a foreign financial account in your name, have authority to act on another’s behalf for a foreign account, or have 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.
We cannot stress enough that when it comes to difficult financial situations involving the IRS, it is important to stay proactive. 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 available relief may also depend on the factual circumstances involved in the taxpayer’s failure to complete the required disclosure.
Our objective 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.
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. See 31 C.F.R. §1010.306(c), 31 C.F.R. §1010.350.
To make this disclosure you must determine the maximum value using periodic account statements. Then you must convert this figure to U.S. dollars using the end of the year exchange rates and report the figure in U.S. dollars. As of 2014, the report must be electronically filed through FinCEN’s website. Note that the FBAR is not filed with the federal income tax return.
There are some exemptions to the filing requirement. You do not have to report an account held in a U.S. branch of a foreign bank. Foreign stock or securities which are not held in a financial account do not have to be reported. Foreign partnership interests are not subject to reporting.
Domestic mutual funds that invest in foreign stocks or securities, foreign hedge funds and private equity funds are also exempt. If owned directly, personal property, such as jewelry and art, real estate, currency and precious metals held abroad are all exempt.
Additionally, for married couples who jointly own a foreign account, it is sufficient for only one spouse to file if that spouse filed the FBAR form in a timely manner and if Form 114a was signed by both spouses.
Foreign retirement accounts that are created by a foreign employer like foreign pensions plans will not require FBAR reporting. Additionally, most foreign social security programs as well as foreign government retirement plans will not require reporting. Foreign retirement accounts may be subject to FBAR reporting requirements.
However, foreign retirement accounts that are separated by employees do trigger FBAR reporting requirements. Look to see if your account has a separate account number and generates its own separate statements. Further, some foreign-government sponsored plans such as the Canadian and Mexican tax-free savings account will trigger FBAR reporting.
These are merely some of the exceptions that exist. For a complete list, review the IRS’ page Report of Foreign Bank and Financial Accounts (FBAR).
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 deposit
- 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 even if the account is not 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 percent of the total value of shares of stock, or more than 50 percent of the voting power of all shares of stock.
A partnership in which a United States person owns an interest in more than 50 percent of partnership profits or an interest in more than 50 percent of the partnership capital, has a financial interest.
If a United States person has greater than 50 percent 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 percent 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.
See IRS FBAR Reference Guide, pg. 4, for a list of specific scenarios in which the IRS will deem a person to have financial interest.
Signature authority exists when an individual has control over assets held in a foreign account and can exercise that control by 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.
It is important to have a clear understanding of these terms because you will need them when completing and filing the required forms and schedules to accompany your 1040/1040a.
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 $4,000 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 for FBAR
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 from 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 briefly touch on all of the required forms and hone in on specific questions 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 to 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.
The IRS Statute of Limitations: Is Time on Your Side?
A “statute of limitations” is a law which defines the time within which a legal action may be brought against a person or entity for an act or omission. Once that period of time has run out it is said that the statute of limitations has expired, which means you are exempt from having legal action, civil or criminal, filed against you.
With regard to tax matters, the statute of limitations is the time period that the government can come back against you criminally or civilly regarding issues concerning your tax returns.
The HIRE Act has made changes to the statute of limitations for informational 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 six years.
The statute of limitation for attachments such as Form 8938 or 5471 would be three years because this is the statute of limitations that is assigned to the income tax report. If you fail to file Form 8938 or fail to report a specified foreign financial asset that you are required to report, the statute of limitations for the tax year may remain open for all or a part of your income tax return until three years after the date on which you actually file Form 8938.
If a completed Form 3520 is not filed by the due date, including extensions, the time for assessment of any tax imposed with respect to any event or period to which the information required to be reported in Parts I through III of such Form 3520 relates, will not expire before the third anniversary of the date on which the required information is reported.
However unlike the FBAR, the HIRE Act made it so that the clock does not start running for the income tax and corresponding forms until the taxpayer files the appropriate informational return. So, if you never file the delinquent return, the statute of limitations does not start to run.
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 also never run out until you fill out the missing forms.
Simply put, if you never file the delinquent return, the statute of limitations never starts to run. This period can be extended if you do not include in your gross income an amount relating to one or more specified foreign financial assets. If the amount you omit is more than $5,000, any tax you owe for the tax year can be assessed at any time within six years after you filed your return.
This could lead to further liability, so it is important to fill out the appropriate disclosures as soon as possible so the three-year countdown 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 any 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. This is another situation where you would benefit from the advice of an experienced tax attorney.
If you have money in overseas banks you need to disclose it to the IRS. This is not to say that these practices are prohibited, but they are a definite trigger. Frankly, the IRS is fed-up with U.S. citizens trying to shirk their tax responsibilities by stashing money and other assets offshore.
In order to stay off the IRS’ radar screen, then you must file a FBAR. Failure to do so can result in major penalties and even criminal sanctions. It bears repeating, but I always tell my clients to stay one step ahead of the IRS.
That said, I encourage you to come talk to me if you have questions about FBAR and your tax obligations. International tax law is tricky and that is putting it mildly. Put your trust in the experience of Brotman Law to make sure you are in compliance and have nothing to stress over.