By Dennis Brager
Earlier this month the IRS announced a new “Offshore Voluntary Disclosure Initiative” (OVDI) for those who failed to file foreign bank account reports (FBAR). It is the successor to the IRS’ previous offshore disclosure program which ended on October 15, 2009, and is intended to be less favorable than the earlier program.
Any U.S. citizen or resident who has signatory authority over, or a financial interest in, a financial account located in another country is required to file a report with the Treasury Department on Form TD F 90-22.1 (Report of Foreign Bank and Financial Account) aka FBAR if the balance was more than $10k at any time during the calendar year. The willful failure to do so is a felony. There are also civil penalties equal to the greater of $100,000 or 50% of the account balance imposed on the willful failure to file an FBAR; and the penalty can be imposed on an annual basis. Thus the penalties can easily exceed the amount in the account. The penalties are imposed pursuant to the Bank Secrecy Act codified as part of Title 31 of the US Code, and not in Title 26 which contains the tax laws. Initially the Treasury Department was tasked with the job of enforcing the FBAR rules; however that authority was delegated to the IRS.
Under the new voluntary disclosure initiative the IRS has given taxpayers until Aug. 31st to come clean. Those who come in from the cold will pay a reduced one-time FBAR penalty of 25% of the highest account balance at any time from 2003 to 2010. In addition amended returns must be filed for 2003 to 2010 reporting any previously unreported income. Tax must be paid on this amount with interest. On top of that there will be an accuracy related penalty under 26 USC 6661 of 20% of the unpaid tax for the years 2003 to 2010. Late filing penalties and/or late payment penalties under 26 USC 6651(a)(1) and (2) will also be imposed where applicable. In return those who make a voluntary disclosure will generally be safe from criminal prosecution, and will avoid potential civil penalties which could completely wipe out the entire account, and more.
For those account holders whose combined offshore account balances never exceeded $75,000 at any time from 2003 to 2010 the 25% penalty is reduced to 12.5%, but all other terms remain the same. A 5% penalty is available in two very limited situations. The first category of taxpayer who will be eligible for the 5% penalty is one who meets all four of the following conditions: (a) did not open or cause the account to be opened (unless the bank required that a new account be opened, rather than allowing a change in ownership of an existing account, upon the death of the owner of the account); (b) have exercised minimal, infrequent contact with the account, for example, to request the account balance, or update accountholder information such as a change in address, contact person, or email address; (c) have, except for a withdrawal closing the account and transferring the funds to an account in the United States not withdrawn more than $1,000 from the account in any year covered by the voluntary disclosure; and (d) can establish that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. taxation). This category is intended to apply to persons who inherited the foreign bank accounts.
The other category is what some have called the “coma exception.” If a taxpayer was a foreign resident, but was unaware they were a U.S. citizen they will be entitled to the 5% penalty. Of course assuming someone were actually in this situation their failure to file an FBAR would not be willful, and instead due to reasonable cause. As such they would not be subject to the 50% penalty for willful failure to file an FBAR. This underlines the major criticism of the OVDI—It does not allow a taxpayer to argue that there should be no penalty because there is reasonable cause for the failure to file, or that the penalty should be limited to $10,000 per violation under 31 USC 5321(a)(5)(A) because the failure to file the FBAR was not willful, but merely negligent.
Because FBARs are filed with the IRS there is a good deal of confusion since tax practitioners assume that the procedures that are applicable under tax law will apply to FBAR violations; however, that is not necessarily the case. For example a "resident" of the United States is not defined in the FBAR instructions, regulations, or statute. The definition of "resident alien" found in 26 USC § 7701(b) is not applicable for FBAR purposes. According to the IRS the plain meaning of the term "resident" (in this context, someone who is living in the U.S. and not planning to permanently leave the U.S.) should be used for FBAR filing purposes.
Another important distinction is that FBARs are not filed with the tax return. They are filed separately in Detroit, and are due on June 30th. The extension for filing a tax return does not extend the time to file an FBAR, and there is no extension of time for filing the FBAR available under the statute.
Most people have never noticed but when they file their personal income tax return the Schedule B (where interest and dividends are reported) contains the following question:
At any time during 2008, did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account? See page B-2 for exceptions and filing requirements for Form TD F 90-22.1.
Checking the box that says "No", subjects a taxpayer to a possible criminal charge of filing a false income tax return which is a felony pursuant to 28 USC 7206(1) punishable by up to three years in jail and a $100,000 fine or both.
There is a general assumption that all of this is a problem only for rich tax cheats. In fact we have discovered it is a very big problem for immigrants who have come here, but have left money behind in the old country. Most of them haven’t the vaguest idea that they are supposed to be filing FBARs, checking the box on Schedule B, or for that matter reporting income on their foreign accounts on their U.S. tax returns. The almost universal belief is that if the money wasn’t earned here tax is not due until it is brought into the U.S. Unfortunately that is not the law—U.S. citizens and residents are generally taxed on their worldwide income when it is earned.
Public attention became focused on offshore bank accounts in June of 2008 when the IRS announced it had filed a "John Doe Summons" seeking an order from a federal court in Miami, Fla., permitting the Internal Revenue Service (IRS) to request information from Swiss banking giant UBS, AG about U.S. taxpayers who might be using Swiss bank accounts to commit tax evasion. Ultimately UBS turned over the names of about 4,500 account holders despite the vaunted Swiss bank secrecy. In March of 2009 the IRS announced a limited amnesty for FBAR non-filers which applied to those making voluntary disclosures by Oct. 15, 2009. Approximately 15,000 persons stepped forwarded with bank accounts in over 60 countries. Since then an additional 3,000 taxpayers have made voluntary disclosures.
Taxpayers who failed to file FBARs due to a lack of awareness are left with an unenviable dilemma. Either enter the program and pay steep penalties, or refuse to step forward, and if discovered risk being wiped out financially, and going to jail if the IRS can prove that the failure to file was willful. Unfortunately, a sophisticated analysis of the facts and circumstances of each individual’s situation is necessary to guide taxpayers in making this choice, and even then there are few clear answers. Lawyers representing clients who are in this situation should understand that the IRS has taken a very aggressive stance, and views a taxpayer’s failure to (a) report the offshore income, and (b) to check the yes box on the Schedule B, as strong indications of willfulness.
Dennis Brager is a former IRS trial attorney, a California State Bar Certified Tax Specialist, and founder of Brager Tax Law Group, A P.C. --- a boutique tax controversy firm in Los Angeles, California.
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