If you cannot come to an agreement to resolve your FBAR issue during the IRS examination stage, you may have a few options. The options available to you will depend on where you are in the penalty process, whether you were found to be in willful violation, and your history of compliance.
We will begin this article first with a discussion of FBAR penalty appeals. You have a right to take your case to Appeals. 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. We recommend discussing this option with a tax attorney.
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.
If you want to challenge the IRS decision in your FBAR case, then I advise you to contact me. This is a situation where you need the advice of an experienced tax attorney to look out for your best interests.
Pre-assessment vs. Post-assessment
There are two ways for a case to go forward from the examination stage to appeals — pre-assessment or post-assessment. There is no interest that accrues on the FBAR penalty until the penalty is assessed. This 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 to post-penalty assessment, there is an additional requirement that the Department of Justice must approve any settlement agreement that may be reached.
This Department of Justice approval is not required at the examination 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.
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 to get back in compliance, the IRS has a number of programs and options available. There are two types of programs, Offshore Voluntary Disclosure Program (OVDP) which is for willful violations. For non-willful violations, there are the Streamlined Foreign Offshore Procedures (SFOP) for non-resident taxpayers and the Streamlined Domestic Offshore Procedures (SDOP) for resident taxpayers.
These Streamlined Filing Compliance Procedures were designed to provide options to help both U.S. taxpayers residing overseas AND in the U.S., comply with their U.S. tax obligations.
Taxpayers who failed to disclose foreign dealings, either knowingly or unintentionally, now have the opportunity to “face the music” and possibly avoid criminal prosecution. Compared to the Former 2012 Streamlined Program, the SDOP and the SFOP include a broader section of non compliant, but non willful, U.S. taxpayers.
For the first time, U.S. resident taxpayers who are out of compliance with reporting their foreign source income or, who have failed to file international information returns such as the FBAR, could now participate. This chapter will first begin with a discussion of the revised Offshore Voluntary Disclosure Program.
Revised Offshore Voluntary Disclosure Program
Previously, the IRS had two programs, Offshore Voluntary Disclosure Program (2009) and Offshore Voluntary Disclosure Initiative (2011), which have been discontinued. In their place, the IRS has implemented a new program “affectionately” known as “Son of OVDP”, but is still often called OVDP. The main difference to the new OVDP is that there is no deadline. The stipulation is that the IRS demands full cooperation, because if you get caught concealing foreign assets while you are in the program, all bets are off. Also, you need to act quickly, as the IRS has the option to end or adjust OVDP at its discretion, which could mean a change in guidelines or an increase in penalties.
There are three steps to OVDP:
Step 1: The taxpayer must submit a pre-clearance request to Criminal Investigations on Form 14457. The latest version of the form was released in March 2019.
- Eligibility is still determined under IRM 18.104.22.168.
- To determine your eligibility for the program, the IRS inquires into the following:
- Whether the taxpayer, their spouse or related entities were informed that the IRS intends to initiate an examination or criminal investigation for the income in question
- Whether the taxpayer, their spouse, or related entities are currently being criminally investigated
- Whether the taxpayer, their spouse or related entities are currently under investigation by law enforcement authorities
- Whether the income is derived from legal sources. Illegal sources of income will be deemed ineligible. (e.g., a client who is a medical marijuana dispensary in a state where it is legal, but illegal under federal law cannot qualify for the OVPD program.) See IRM 22.214.171.124.4 (09-17-2020) Disqualifying Factors.
- Timely disclosure. Get pre-clearance before the IRS notices that there is a problem. Your attorney should consult the IRS manual to see if you can still be part of this program.
Step 2: After pre-clearance, the taxpayer is subject to a six-year voluntary disclosure program.
- There will definitely be an audit and the taxpayer must be able to substantiate any returns being filed.
Step 3: Penalty framework. The taxpayer will pay a 75 percent fraud penalty for the highest tax deficiency
- A wilful FBAR penalty will be 50 percent of the highest balance
- Informational return penalties will not be automatically imposed, but the examiner has discretion as to whether or not to impose those. The examiner is supposed to take into account the imposition of other penalties.
- There is a six year statute of limitation for FBAR issues. As the FBAR penalty is pretty low, the examiner probably will impose some of the informational return penalties so the taxpayer isn’t completely off the hook. Even with the statute of limitations in place, penalties can be imposed for every one of those years and for years beyond the six year period if the taxpayer does not cooperate or does not conclude the examination with an agreement.
- While the taxpayer may request a reduction in penalties, any such request must be accompanied by compelling evidence.
That is the low-down for taxpayers who were in willful violation of FBAR. Now, let us take a look at the programs for non-willful violations.
Programs for Non-willful Violations: SFOP and SDOP
If you are found to have been non-willful, you may be eligible to enter one of the IRS’ streamlined procedures. The IRS has two main programs: 1) SFOP (Streamlined Foreign Offshore Procedures, for non-resident taxpayers who have filed delinquent or amended returns and 2) SDOP (Streamlined Domestic Offshore Procedures)- for resident taxpayers who have filed delinquent or amended returns. Additionally, the IRS has recently instituted a new program that provides relief for certain former U.S. citizens. This section will begin with a discussion of the SFOP and SDOP Programs.
To be eligible for the SFOP or SDOP program, the taxpayer must certify under penalties of perjury that their conduct for the failure to report all income, pay all tax and file all information returns, including FBARs, was due to non-willful conduct. However, these options are not without their downsides.
First off, these programs could close at any time. Secondly, by putting a taxpayer into a streamlined procedure and the IRS receives/discovers evidence of willfulness, fraud, or criminal conduct, it could result in the IRS opening up examination/investigation and FBAR penalties, civil fraud penalties, information return penalties, or referral to criminal investigation.
If the taxpayer gets audited, then all bets are off. To hopefully circumvent an audit, it is important that the taxpayer files a certification that discloses all the facts. It is important to get out in front of an audit but if there is any doubt in the mind of your client (or you) that they were acting willfully, then they should participate in the new disclosure program that replaced the old OVDP (Offshore Voluntary Disclosure Program).
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.
The benefit of these programs is that you can walk away with only paying a 5 percent 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.
The requirements for this program are:
- 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
The Differences Between SFOP and SDOP
The main differences between SFOP and SDOP is that in SDOP, the taxpayer qualifies as a resident taxpayer; in SFOP, you are classified as a non-resident U.S. taxpayer. Secondly, for SFOP, all penalties are waived.
The taxpayer only needs to file original or amended returns, pay taxes and interest due over a three-year period, and file delinquent or amended FBARs for the most recent six years.
For SDOP, the taxpayer must have filed original returns, amended returns and paid taxes and interest due over a three-year period and a five percent miscellaneous penalty on the highest account balances of the taxpayer’s offshore assets (using a six-year look back period and the year-end balances).
Completing the Certification Forms
The first step that must be taken for both SFOP and SDOP is to file Forms 14654 (domestic) and 14653 (overseas). These are certification forms and are extremely complex. That is why we cannot stress strongly enough that you should have an expert in tax law help you complete this, and other resolution program forms. The following content must be included in these forms:
- A statement of facts describing specific reasons for your failure to report all income, pay all tax, and submit all required information returns, including FBARs You must include the whole story — both the good and the bad.
- Specific reasons, including your personal background, financial background, and any other relevant facts to support why you failed to report all income, pay all taxes and file all required information forms
- A description of where the funds came from, their legality, whether the account or asset(s) were inherited and the reason for opening an account in a foreign country (if applicable)
- If you answered “No” on Schedule B, you must include an explanation
- An explanation for why you failed to properly report ownership of a foreign entity you owned or controlled (if applicable)
- If you relied on a professional advisor, then include a summary of the advice you were given as well as the advisor’s contact information. You must also provide background information about the advisor, how you know them and how often you are in contact with them.
SFOP (for Non-Residents) Eligibility Requirements and Enrollment Process
Forms needed: 14653 (certification form)
Additional Requirements: The taxpayer was outside of the U.S. for at least 330 full days for one of the streamline years. The IRS has defined “abode” to mean “one's home, habitation, residence, domicile, or place of dwelling” and not one’s principal place of business. See the IRS’ page on Foreign Earned Income Exclusion - Tax Home in Foreign Country.
Temporary presence of the taxpayer in the U.S, or the maintenance of a dwelling in the U.S., does not automatically make the U.S. the taxpayer’s “abode” (non-residency requirements). See 26 CFR § 1.911-2(b). Taxpayers who are green card holders or not U.S. citizens, meet the non-residency requirement if they did not meet the “substantial presence” test for any of the past three years for which the U.S. tax return date has passed.
In addition to completing and submitting the required forms and paying all taxes and penalties, the you must:
- Meet the applicable non-residency requirement. For joint filers, both spouses must meet the applicable non-residency requirement.
- Not have reported the income from a foreign financial asset and failed to pay tax on it.
- Not filed an informational return, such as an FBAR due to non-willful conduct.
Once you have met the eligibility for SFOP, the process is as follows:
- You must file delinquent or amended tax returns and all required information returns for each of the most recent three years and pay any tax and interest due;
- You must file delinquent or amended FBARs for each of the most recent six years; and
- You must file a certification where you certify under penalty of perjury that the failure to file tax returns, report all income, pay all taxes, and submit all information returns, including FBARs was due to non-willful conduct.
SDOP (for Residents) Eligibility Requirements and Enrollment Process
Forms needed: Form 14654 (certification form)
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 six years missing a filing.
In addition to completing and submitting the required forms and paying all taxes and penalties, then you must:
- Not meet the applicable non-residency requirement. For joint filers, one or both spouses must fail to meet the applicable non residency requirement
- Have previously filed a U.S. tax return for each of the most recent the years for which the U.S. tax return due date (or properly extended due date) has passed
- Have not reported gross income for a foreign financial asset and pay taxes on it and not filed information return, such as an FBAR, with respect to the foreign financial asset
- Certify that such failures resulted from non-willful conduct (Form 14654)
Once you are have met the eligibility for SDOP, the process is as follows:
- You must file amended tax returns, together with all required information returns for each of the most recent three years and pay any tax and interest due;
- You must file delinquent FBARs for each of the most recent six years; and
- You must file a certification here you certify under penalty of perjury that the failure to file tax returns, report all income, pay all tax, and submit all informational returns, including FBARs, was due to non willful conduct.
Assets Included in the SDOP Miscellaneous Penalty
As we have mentioned, one major difference between SFOP and SDOP is that SDOP incurs a 5 percent miscellaneous penalty on the highest aggregate balance or value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered FBAR period. The following are assets that are included in the penalty assessment.
- All foreign financial accounts (as defined in the instructions for FinCEN Form 114) in which the taxpayer has a personal financial interest that should have been, but were not reported on an FBAR for the six years covered in the FBAR period
- All foreign financial assets (as defined in the instructions for Form 8938) in which the taxpayer has a personal financial interest that should have been, but were not reported on Form 8938 for the three years covered in the tax return period,
- All foreign financial accounts/assets (as defined in the Instructions for FinCEN Form 114 or IRS Form for the three years covered in the tax return period,8938) for which gross income was not reported for that year.
- All of the assets that meet the definition of foreign financial assets in the instructions for Form 8938 and not reported on that form, unless the taxpayer reported them on Forms 3520 or 5471 that were filed on time. (If they are reported on Forms 3520 or 5471 on time, they do not have to be reported on Form 8938 for the same tax year.)
- The penalty base includes the stock in the corporation, but not the underlying financial accounts, unless the entity is a disregarded entity for federal tax purposes. If the corporation is a disregarded entity, then the taxpayer must report the underlying foreign financial accounts.
- The same principal would apply to assets that are held in a foreign partnership or trust.
Relief Procedures for Certain Former Citizens
On September 6, 2019, the IRS announced new procedures that will enable certain individuals who relinquished their U.S. citizenship to come back into compliance with their U.S. tax and filing obligations and receive relief for back taxes. The taxpayer’s non-compliance actions must be deemed non-willful.
Eligible individuals must have:
- Relinquished their U.S. citizenship after March 18, 2010
- Not filed U.S. tax returns as U.S. citizens or residents
- An aggregate tax liability of $25,000 or less for the five years preceding expatriation and in the year of expatriation
- Net assets of less than $2 million (at the time of expatriation and at the time of making their submission under these procedures)
- Not exceed the threshold related to average annual net income for the period of five years ending before the date of expatriation ($168,000 for 2019)
- Agreed to complete and submit all required Federal tax returns for six tax years at issue.
A taxpayer meeting these requirements will not be “covered expatriates” under IRC 877A, and will not be liable for any unpaid taxes and penalties for these years or any previous years.
This relief is only available to individuals. Furthermore, taxpayers who previously filed Form 1040-NR (U.S. Nonresident Alien Income Tax Return) under the good faith belief that they were non-citizens/resident may still apply for this relief. Seeking this relief will not automatically subject the taxpayer to an IRS audit. Rather, documents filed under this program will be viewed under the same criteria applied to determine whether to audit any other tax return.
Determining whether you are a “covered expatriate” is important because taxpayers with that designation must pay an exit tax on their assets for the tax year in which they leave the country.
Expatriates who meet the following criteria will be deemed “covered expatriates”:
- Their average annual net income tax for the 5 tax years before the date they renounced expatriation is greater than $171,000 (for those expatriating in 2020)
- Their net worth on the date of expatriation is $2,000,000 or more OR
- They fail to certify under penalty of perjury on Form 8854, that they are compliant with all federal tax requirements for the 5 years preceding the tax year in which they expatriated.
See IRC 877(a)(2) for more detail.
In order to receive this relief, qualified taxpayers must submit the following documentation to the IRS:
- Certificate of Loss of Nationality (CLN) of the U.S., Form DS-4083, or a copy of court order cancelling a naturalized citizen’s certificate of naturalization
- A copy of either a valid passport or a birth certificate and a government issued ID
- “Dual-status” return including Form 1040NR with all required information returns for the year of expatriation including Form 8854, Form 1040 attached as an information return reporting worldwide income up to date of expatriation, and other information returns such as Form 8938
- Form 1040 with all information returns for the five tax years preceding the taxpayer’s expatriation
See Relief Procedure for Former Citizens, Relief Procedures FAQs, Q. 11 for more detail.
We always always stress the importance of good record keeping when it comes to any tax matter, and documenting relief procedures is no exception. Keep copies of everything. In particular, put together a file of evidence that will substantiate the value of your assets. This will help prove your net worth to the IRS.
Filing Delinquent Information Returns
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 informational 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.
There are some conditions that you must meet in order to file delinquent informational returns:
- You must not have any unreported income and have not filed one or more international information returns (e.g., Forms 8938, 5471, 3520, 3520A).
- You should have met the requirements for non-willful intent and have reasonable cause for not timely filing the information return.
- You must not be under a civil examination or a criminal investigation by the IRS.
- You must not already have been contacted by the IRS about the delinquent international information returns.
- You need to file the delinquent international information returns with a statement of facts establishing reasonable cause for the failure to file. This statement must be made under penalty of perjury.
- You must certify that any entity for which the information returns are being filed was not engaged in tax evasion.
While filing delinquent will not automatically throw you into the audit category, it does not guarantee that you will not be audited in the future.
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. Make sure that you do not send the return to Utah; send it to the Austin, Texas address.
For all other delinquent information 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.
Delinquent International Information Returns Submission Procedures
Taxpayers who do not need to use the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns could still have additional issues. If the taxpayer has
- not filed one or more required international information returns,
- had reasonable cause for not timely filing the information returns,
- is not under a civil examination or a criminal investigation by the IRS, and
- has not already been contacted by the IRS about the delinquent information returns,
they should file the delinquent information returns with a statement of all facts establishing reasonable cause for the failure to file in a timely manner.
As part of the reasonable cause statement, taxpayers must also certify that any entity for which the information returns are being filed was not engaged in tax evasion. If a reasonable cause statement is not attached to each delinquent information return filed, penalties may be assessed in accordance with existing procedures.
Required Attachments for Amended U.S. Tax Returns
All delinquent international information returns other than Forms 3520 and 3520-A should be attached to an amended U.S. tax return and filed according to the applicable instructions for the amended return. All delinquent Forms 3520 and 3520-A should be filed according to the applicable instructions for those forms.
A reasonable cause statement may be attached to each delinquent information return filed for which reasonable cause is being requested. However, the IRS states that penalties still may be assessed without regard to the reasonable cause statement. Information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for normal tax or information returns.
Similar to information 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).
Delinquent FBAR disclosures are made electronically. This must be done on the FinCEN BSA e-filing system. You may find additional instructions from the IRS here.
Keep in mind that any of these filings can be selected for audit, 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.
What Is Reasonable Cause?
For starters, a lack of funds is not reasonable cause for failure to file or pay taxes on time. However, the reasons for the lack of funds may meet reasonable cause criteria for the reducing failure to pay penalty. The IRS will consider any reason which establishes that the taxpayer used all ordinary business care and prudence to meet filing obligation but was nevertheless unable to do so.
The IRS will consider the following circumstances as “reasonable”:
- Fire, casualty, natural disaster or other disturbances;
- Inability to obtain records
- Death, serious illness, incapacitation or unavoidable absence of the taxpayer or a member of the taxpayer’s immediate family
- Insufficient funds, alone, will not suffice but the reason for the insufficient funds may serve as reasonable cause
- Any other reason which establishes ordinary business care and prudence
FBAR Delinquent Filings
Some taxpayers may not need to use the Streamlined Filing Compliance Procedure options, but still may have a delinquent FBAR. FinCEN has established a procedure to address this problem.
The solution is available to those who:
- Have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN) (Form 114, previously Form TD F 90-22.1)
- Are not under a civil examination or a criminal investigation by the IRS, and
- Have not already been contacted by the IRS about the delinquent FBARs.
Filing a FinCEN 114 or FBAR
Time is of the essence when dealing with a delinquent FBAR.
A taxpayer who has not already been contacted should immediately file the delinquent FBARs electronically according to the instructions on the FinCEN website.The filing must include a statement explaining why the FBARs were filed late. Legal counsel should be retained to assist in the preparation of this letter.
On the cover page of the electronic filing, you will be required to select from a list of options as to the reason for the late filing. If you are absolutely unable to file electronically, you should contact FinCEN’s Regulatory Hotline for guidance concerning alternatives.
Keep in mind FinCEN form 114 (the FBAR) is not an IRS filing.
The IRS will not impose a penalty for the failure to file the delinquent FBARs as long as you properly reported the income on your U.S. tax return and paid the tax on the income from the foreign financial account.
You will also be exempt from a failure to file penalty as long as you have not otherwise been contacted regarding an income tax examination or received a request for delinquent returns for the years in which the delinquent FBARs are submitted.
The audit process with regard to FBARs is similar to the selection process in place for tax returns. The key to curing the delinquency is to get the FBAR filed before FinCEN or the IRS comes looking for it.
First Time Abatement (FTA)
Where a taxpayer cannot establish reasonable cause for their failure to file and it is the first time they are being subject to the penalty in question, there is still the option of applying for penalty relief under the First Time Abatement (FTA) waiver. The FTA waiver is available for those who have filed a return or an extension for any returns due AND have paid or arranged to pay any taxes currently due. See IRS Part 20. Chapter 1. Section 1. 126.96.36.199
Consistent with the statute of limitations, the IRS will expect the taxpayer to be up to date, or on a path towards being up to date, on the past six years of returns.
The FTA may only be applied to the first instance in which the specific penalty in question is being imposed. However, because failure to pay penalties accrue until the taxpayer has remitted all of the proper tax amount (even after the first FTA relief is granted), the taxpayer may request the waiver a second time when the balance has been paid in its entirety.