Cross-Border Bulletin – Winter 2016
FBAR Penalty Background
Foreign Bank and Financial Account Reports (FBARs) are information returns required to be filed by any U. S. citizen wherever located and by an individual, person, business, etc. that files U. S. income tax returns and has a financial interest in or signature authority over non-U. S. financial accounts (including bank accounts, brokerage accounts, mutual funds and trusts) where the aggregate value of the accounts exceeds $10,000 U. S. at any time during the calendar year.
FBARs are now filed electronically on FinCEN Report 114, and were historically filed on IRS Form TD F 90-22.1.
The once draconian Offshore Voluntary Disclosure Program has changed significantly for those who fail to timely file FBARs with the introduction of the New Streamlined Compliance Procedures. The potential penalty framework has also changed following publication of the IRS Interim Guidance for Report of Foreign Bank and Financial Accounts (IRS Interim Guide) of May 13, 2015. These programs offer dual status citizens or non-U. S. citizens engaged in a U. S. business several options to become compliant with U. S. income tax and reporting obligations before filing delinquent income tax returns and/or FBAR reports.
The statutory penalty for failure to file an FBAR is a maximum of $10,000 per account for a non-willful failure to file. For a willful violation the maximum statutory penalty is $100,000 or 50% of the balance in the undisclosed account at the time of the violation, whichever is greater. The burden of proving willfulness, however, is on the IRS. Taxpayers who prove they have “reasonable cause” for failure to disclose are entitled to seek a penalty reduction or full abatement of penalties which may be offered in the discretion of the IRS.
IRS Interim Guidance
The IRS Interim Guidance seeks to apply consistent and fair FBAR penalties notwithstanding a statutory framework that allows substantial and disproportionate penalties. IRS Agents are instructed to calculate FBAR penalties based on willfulness by identifying the year with the highest aggregate value of foreign accounts and imposing the 50% penalty on that value. That penalty is then spread across each tax year in question. Examiners have discretion to recommend higher or lower penalties if the facts and circumstances warrant. They are not permitted to recommend a total penalty based on willfulness for all the years under examination that exceeds 100% of the highest aggregate foreign account value in a single year.
IRS Examiners are instructed to apply the penalties for a non-willful failure to file in accordance with the statutory framework and mitigation guidelines in IRM 126.96.36.199.6.1 and are instructed to limit the penalty for any single year to the $10,000 statutory threshold.
New Streamlined Compliance Procedures (SCP)
The SCP, which was once only available to taxpayers having less than $1,500 in tax due to the IRS for the most recent 3 year period, is now available to all taxpayers regardless of the amount of additional tax due on unfiled or amended returns. Qualifying taxpayers wishing to participate in the program who pay taxes due plus interest, receive either full FBAR penalty abatement or are subject to the Title 26 ‘miscellaneous offshore’ penalty of 5% of the highest value of the foreign accounts during the 3 year time period.
Non-residents of the U. S. who have failed to file an FBAR may be entitled to full abatement of the failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, and FBAR penalties. Residents of the U. S. may avoid failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, and FBAR penalties, but will be subject to the 5% Title 26 miscellaneous offshore penalty.
The SCP is not available for persons who willfully failed to file tax returns or FBARs. Entry into the SCP program for qualified taxpayers is relatively straight forward. Taxpayers are required to file the last 3 years of tax returns, the last 6 years of FBARs, and several other disclosure related forms including a detailed statement, certified to be true under penalty of perjury, that noncompliance was non-willful. The preparation of these materials requires the assistance of an attorney to evaluate whether a taxpayer’s noncompliance is non-willful and to assist in preparing the requisite statement and certification of non-willfulness to avoid potential criminal implications.
Offshore Voluntary Disclosure Program (OVDP)
Introduced in 2009, and modified in 2014, the OVDP is now recommended only for Taxpayers who either do not qualify for the SCP; who seek absolute closure on prior noncompliance, or who may be at risk of criminal prosecution. The requirements for entry into this program are more onerous than the SCP and include a requirement that the taxpayer file the last 8 years of tax returns and FBARs.
The penalties under the OVDP after payment of tax and interest, include: (a) penalties relating to the inaccuracy of reported income (20% of tax on unreported income), (b) penalties for failure to file and failure to pay tax (25% of the resulting tax), as applicable, and (c) a Title 26 miscellaneous offshore penalty. Under the OVDP the miscellaneous offshore penalty is either 27.5% or 50% of the highest aggregate value of the taxpayers OVDP assets. OVDP assets are generally considered to be any assets in which the Taxpayer has a financial interest which is related to the tax/disclosure non-compliance. OVDP assets do not include assets in which the taxpayer only has signature authority and/or amounts transferred to another account as funds are only counted once in calculating the penalty).
At first blush the terms of the OVDP appear extraordinarily harsh, but at the conclusion of the process, the IRS will execute a formal Form 906 Closing Agreement and refrain from either assessing further penalties or pursuing criminal prosecution for matters disclosed under the OVDP. Finality could be well worthwhile for certain taxpayers.
Delinquent Information Return and FBAR Submission Procedures
Taxpayers who do not have unreported income or unfiled U.S. tax returns can, as a general rule, file delinquent FBARs (FIN Cen Form 114) without formally entering an IRS compliance program if the delinquent FBARs can be filed with a “reasonable cause” statement explaining the late filing. Under the delinquent information return procedures, IRS will consider, but will not guaranty penalty abatement. As a consequence, these procedures should only be used by taxpayers who have strong “reasonable cause” for not filing FBARs.
“Reasonable cause” is generally found to exist when a taxpayer exercises ordinary business care and prudence in meeting his or her tax obligations but nevertheless fails to meet those obligations. Ignorance of the law alone is not sufficient to establish reasonable cause unless a taxpayer made an effort to comply, such as by consulting a licensed tax professional. There are court decisions that provide some guidance on what “reasonable cause” is for failure to file FBARs.
Prompt Advice from a Tax Professional is Needed Now More than Ever
Given the complexities of the IRS compliance programs and the changing nature of the tax laws, there is no clear cut compliance plan for a taxpayer weighing delinquent FBAR issues. Only one thing is clear, the time within which a taxpayer has to file FBARs and bring his or her affairs into compliance is narrowing. The IRS programs are currently open indefinitely but they can be terminated at any time. Further, with the passage and roll out of the Foreign Account Tax Compliance Act and the subsequent intergovernmental agreements concluded between the U. S. and 113 countries to date, the IRS now has the tools it needs to identify non-compliant taxpayers. According to a press release issued by IRS on October 21, 2016, IRS has already raised nearly $10 Billion U. S. in revenue through its offshore compliance efforts.
Taxpayers who are contacted by the IRS prior to entering into a compliance program are prohibited from participating in the programs. Accordingly, dual status citizens and non-U. S. citizens who are engaged in business in the U. S. and are concerned that they may not be in compliance with U. S. tax and reporting obligations would be well advised to promptly evaluate their options with a U. S. tax professional and attorney at the earliest opportunity.