IRS Levying Massive FBAR Penalties?
by: Christopher Klug – Washington DC Tax Attorney
The Internal Revenue Service (“IRS”) has significant discretion to levy large (“FBAR”) penalties and as of recently has been using this discretion to impose or threaten large penalties in FBAR audits. This is causing US tax practitioners frustration with the IRS due to what practitioners see as the IRS being inflexible, heavy-handed with penalties, and presuming willful violations of reporting obligations in every case. This highlights the importance for clients who are not compliant with their US reporting obligations, to become compliant as soon as possible through either the Streamlined Filing Compliance Procedures (“SFCP”) or Offshore Voluntary Disclosure Program (“OVDP”) as the circumstances justify.
FBAR penalties can be significant and this is the reason it is important to review the IRS enforcement of FBAR penalties. The FBAR maximum penalty for non-willful violations is $10,000 per account per year for up to six years. The maximum FBAR penalty for willful violations is the greater of $100,000 or 50 percent of the aggregate balance of the unreported account per year for up to six years. While legally permissible to impose six years of willful penalties for a total of 300 percent of an account’s value, the IRS issued a memorandum in 2015 that capped the total penalty amount for all willful violations at 100 percent of the aggregate balance of the unreported account.
One practitioner reported that his client, originally from another country, is 75 years old and has resided in and worked in the United States for many years. She also suffered from multiple strokes and is legally blind. Several years earlier, her father, who still lived in the foreign country died. Following his death, the client sold her offshore real estate and deposited the proceeds into a local foreign bank. The client did not give the matter much more thought. Her old accountant died and when she hired a new accountant the accountant informed her of her FBAR filing obligation. The IRS audited the client and is insisting the willful penalties should be imposed. This would appear to be a clear case of a non-willful violation, nonetheless, the IRS is asserting willful penalties.
There is another example where the IRS is considering a multi-million-dollar penalty on an FBAR that was filed three months late, even though the related audit revealed a tax refund was due. This would clearly represent an excessive penalty given the circumstances and tax refund that is due. This situation also highlights the fact that it is important to timely file the FBAR.
Under a common-sense approach to willfulness, it’s clear that many individuals who face FBAR exams should be considered non-willful. However, the IRS is classifying nearly every taxpayer coming forward as willful.
The IRS is increasing FBAR audits and its use of information document requests to seek FBAR information. It appears the IRS strategy is that if the IRS can develop an FBAR compliance issue, then the taxpayer will be on their heels, hostage to a massive penalty, even though the FBAR penalty is unrelated to any tax issue.
Both the American Bar Association and American Institute of CPAs agree that in determining appropriateness of FBAR penalties that age, education, health, language barriers, mental capacity, communication with advisers, ties to country where the account is located, compliance history, source of funds, and involvement with the account should be considered in determining willfulness of the conduct. The IRS should develop similar standards as benchmarks so that there is sufficient guidance of how the IRS will determine willfulness.
Early FBAR Enforcement
An FBAR filing requirement has existed for US persons since 1971, the IRS more or less ignored it at least in terms of enforcement until relatively recently. For several decades, there were relatively few FBAR cases brought only where there was outright, unequivocal tax evasion. This started to change about a decade ago with the tax-evasion scandal involving Swiss Bank UBS, when more benign actors were caught up and the civil FBAR penalty became a go-to punishment for the IRS.
The IRS and Treasury Department reacted to the UBS scandal by enforcing the FBAR horrendous penalty regime to encourage those who were hiding assets overseas to avoid US taxation to come into compliance voluntarily or else face the stiff monetary and criminal penalties. As with most laws, the stiff penalties were aimed at tax evaders, who were knowingly using foreign bank accounts to evade US tax, also caught a significantly larger group of innocent, otherwise law-abiding taxpayers in its net, especially those who happened to be US citizens living outside the US.
In exchange for fixed penalties of 27.5 percent (50 percent when a financial institution has been publicly identified as under investigation) of an account’s value, the OVDP provides taxpayers with freedom from criminal prosecution for failure to file FBARs. It is important to think of this penalty structure in view of a US citizen living outside of the US with all of their financial accounts being located outside the US, this could be essentially requesting this individual to take a haircut of 27.5 percent to 50 percent of their net worth. Innocent non-filers in this position should file through the SFCP so that there is no imposition of penalties.
Increase in FBAR Filings
FBAR reporting has seen a meteoric rise in the last decade. According to the Taxpayer Advocate Service (“TAS”), there were about 322,000 FBARs filed in 2007. In 2015 that number increased to over 1.1 million. The TAS report attributes that increase to the enactment of the Foreign Account Tax Compliance Act and increased awareness of reporting obligations.
Foreign Account Tax Compliance Act
Although the FBAR enforcement initiative started around 2008, it has received a lot of press in recently as a result of the Foreign Account Tax Compliance Act (“FATCA”). FATCA requires foreign financial institutions to report accounts of US persons to the IRS either directly or through their governments. FATCA has dramatically changed the awareness of the FBAR filing requirement.
The government will argue that given the publicity of the voluntary disclosure programs, numerous criminal prosecutions, and increasing assessment and enforcement of large civil penalties, it strains credulity that foreign account holders might still be non-willful because a lack of awareness of the filing requirements.
With the foreign financial institutions reporting under FATCA and the IRS asserting willful penalties at every turn, it is important for US taxpayers who are not compliant with their obligations to get compliant before they find themselves in audit. The IRS enforcement efforts are extremely aggressive and it appears like the IRS is searching for revenue, not administering the tax laws fairly.
Who Must File the FBAR
US persons must disclose any financial interest in, signature authority over, or other authority over foreign financial accounts if the aggregate high value of all of their accounts exceeds the equivalent of USD 10,000 at any time during the calendar year. The information is reported on FinCEN Form 114, otherwise known as the FBAR. As of July 1, 2015, the Department of Treasury mandated that all FBARs be filed electronically through FinCEN’s BSA E-Filing System.
What is a Foreign Financial Account
A foreign financial account is an account located outside the US. Accounts maintained with a branch of a US bank physically located abroad are foreign accounts. The reportable accounts are bank accounts, such as savings and checking accounts, securities accounts, and insurance or annuity policies with a cash value. Financial accounts also include mutual funds or similar pooled funds if they issue shares available to the general public with a regular net asset value determination and regular redemptions.
A US person has a financial interest in an account if the person is the owner or titleholder of the account. It is important to note that a US person has an obligation to report a foreign account even if it does not generate any taxable income.
Who is a US Person
For purposes of the FBAR, a US person includes a US citizen, US resident, all forms of domestic business entities including US corporations and partnerships, and trusts and estates formed under the laws of the United States, US citizens or residents who reside outside the US are required to file FBARs if the reporting requirements are met.
It is not illegal for US persons to own foreign financial accounts, but it is important the US person correctly and timely report the accounts on an FBAR to avoid potentially significant penalties. With the passage of FATCA it is unlikely non-filers of the FBAR will stay under the IRS radar for much longer. For any US person with unreported foreign financial accounts, it is time to file under either the SFCP or the OVDP and avoid the imposition of massive penalties.
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