If you have a foreign bank account or other foreign financial asset, you may have a reporting obligation. Failure to report when required may result in significant penalties. The draconian penalties may be as much as 50% of the value of the assets at the time that the report was due.
Do you have a foreign bank account reporting obligation?
The Report of Foreign Bank and Financial Accounts (FBAR) is required when a U.S. person has a financial interest in, or signature authority over, one or more financial accounts with an aggregate value greater than $10,000 at any time during the reporting period (calendar year).
The following criteria must be met to trigger an FBAR filing requirement:
- The filer is a U.S. person.
- The U.S. person has a financial interest in a financial account OR signature authority over a financial account even if they have no financial interest in it.
- The financial account is in a foreign country.
- The aggregate amount(s) in the account(s) valued in U.S. dollars exceeds $10,000 at any time during the calendar year.
How will the IRS know if you have a foreign bank account?
For more than four decades, the IRS has sought to crack down on foreign bank accounts used for tax evasion. The FBAR reporting obligation was first devised as part of the Bank Secrecy Act of 1970 to prevent tax evasion, but the IRS was not empowered with enforcing FBAR penalties. In 2004, Congress amended the law to include penalties for non-willful FBAR violations, and tougher penalties for willful violations, and it delegated enforcement authority to the IRS.
Since 2004, there have been many news reports of whistleblowers turning over banking data to the IRS. In 2012, Bradley Birkenfeld received a $104 million whistleblower award for revealing the secrets of the Swiss banking system that led to many American citizens with accounts at UBS becoming subject to civil and criminal investigations.
The IRS no longer needs to rely on whistleblowers to obtain information about foreign bank accounts despite that it will likely continue to be a source of information. In 2010, Congress passed the Foreign Account Tax Compliance Act (FATCA), requiring foreign financial institutions and certain other non-financial foreign entities to report on the foreign financial assets held by their U.S. account holders or be subject to withholding on withholdable payments. As of February 2018, there were 100 countries that entered into Intergovernmental Agreements implementing FATCA.
It used to be a safe bet that the IRS would not learn of your foreign bank account unless you disclosed it or the IRS traced funds to it, but that is no longer the case. The question is no longer whether the IRS will learn of your foreign bank account, but when it will do so.
What are your filing requirements?
Generally, when dealing with foreign bank accounts, the following filing requirements must be met:
1. Schedule B on Form 1040
Part III of Schedule B of the Form 1040 asks about the existence of foreign accounts and usually requires U.S. citizens to report the country in which each account is located.
2. Form 8938, Statement of Foreign Financial Assets (starting after March 18, 2010)
Certain taxpayers may have to file Form 8938, Statement of Foreign Financial Assets, with their income tax return if the aggregate value of foreign assets exceeds certain thresholds that vary depending on filing status and whether the taxpayer lives abroad. Additional filing requirements apply to those with foreign trusts.
The aggregate value of specified foreign financial assets reporting thresholds for Form 8938 are as follows:
- Married taxpayers filing a joint income tax return and living in the US: The total value of your specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year
- Married taxpayers filing separate income tax returns and living in the US: The total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
- If you are a taxpayer living abroad you must file if:
- You are filing a return other than a joint return and the total value of your specified foreign assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year; or
- You are filing a joint return and the value of your specified foreign asset is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the year.
The penalty for failing to file Form 8938 may be up to $10,000 for failure to disclose and an additional $10,000 for each 30 days of non-filing after IRS notice of a failure to disclose, for a potential maximum penalty of $60,000; criminal penalties may also apply.
3. Report of Foreign Bank and Financial Accounts (FBAR)
In addition to Schedule B and Form 8938, taxpayers with foreign accounts whose aggregate value exceeds $10,000 any time during the year must file a Form 114, Report of Foreign Bank and Financial Accounts (FBAR).
The reporting requirements of the Form 8938 and FBAR differ. Form 8938 is attached to the taxpayer's income tax return. The FBAR is not filed with a federal tax return. It is filed electronically through FinCEN's BSA E-Filing System by April 15, with a maximum extension of six months ending on October 15.
The penalty for failing to file the FBAR may be up to $10,000, if the failure to file is non-willful; if willful, however, the penalty is up to the greater of $100,000 or 50 percent of account balances; criminal penalties may also apply.
What are your options for becoming compliant?
There are generally five approaches. The best option will depend on the facts and circumstances of your particular case, and the risk that you are willing to take versus your desire for certainty and your willingness to pay for it through reduced penalties.
1. No disclosure
You may choose not to disclose your foreign financial accounts. This option is not recommended, and you may be subject to civil and criminal penalties.
2. Quiet disclosure
You may choose to simply file original or amended returns, Forms 8938, and FBARs and pay the related tax and interest without otherwise notifying the IRS. I do not recommend this option if you have exposure for criminal or civil willfulness penalties. If you do not have exposure for criminal or civil willfulness penalties, I recommend that you choose the streamlined filing compliance procedures because it reduces your overall exposure to penalties.
3. Offshore Voluntary Disclosure Program (OVDP)
OVDP is a voluntary disclosure program specifically designed for taxpayers with exposure to potential criminal liability and/or substantial civil penalties due to a willful failure to report foreign financial assets and pay all tax due in respect of those assets. OVDP is designed to provide to taxpayers with such exposure (1) protection from criminal liability and (2) terms for resolving their civil tax and penalty obligations. The program has extensive requirements. The most significant requirement is the payment of a penalty of the account balance equal to 27.5%. The penalty increases to 50% if either a foreign financial institution at which the taxpayer has or had an account or a facilitator who helped the taxpayer establish or maintain an offshore arrangement has been publicly identified as being under investigation or as cooperating with a government investigation.
4. Streamlined Filing Compliance Procedures
The streamlined filing compliance procedures are available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part. Returns submitted under either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures will not be subject to IRS audit automatically, but they may be selected for audit under the existing audit selection processes applicable to any U. S. tax return and may also be subject to verification procedures in that the accuracy and completeness of submissions may be checked against information received from banks, financial advisors, and other sources. Thus, returns submitted under the streamlined procedures may be subject to IRS examination, additional civil penalties, and even criminal liability, if appropriate. If the taxpayer resides in the United States, the taxpayer must pay a 5% miscellaneous offshore penalty. If the taxpayer resides outside the United States, there is no penalty.
5. Delinquent International Information Return Submission Procedure
The delinquent international information return submission procedure is available where a taxpayer has reasonable cause for not filing international information returns. Taxpayers who have unreported income or unpaid tax are not precluded from filing delinquent international information returns. If the IRS does not accept the reasonable cause explanation, the IRS may assess penalties against the taxpayer. Unless a taxpayer has a strong reasonable cause argument, the streamlined filing compliance procedures are preferred because the IRS is more likely to accept that a taxpayer was not willful than it is to accept that a taxpayer has reasonable cause.
Why do you need a tax controversy to help you through the process?
Many taxpayers attempt to handle their foreign reporting obligations on their own or use their tax preparer to help them guide them through the process. A tax controversy attorney—a tax attorney that specializes in disputes with the IRS—is recommended for the following reasons:
- If a taxpayer is determined by the IRS to be willful, it may cost the taxpayer significant penalties, possibly the entire foreign account balances or more. An attorney can help analyze the facts and circumstances, determine the best route for compliance, and present the facts in the most favorable manner to minimize a determination by the IRS that the taxpayer was willful.
- The attorney-client privilege is important when a taxpayer discloses all the facts to his or her attorney. The privilege is only available with attorneys. The accountant privilege does not apply in criminal proceedings.
- Tax controversy attorneys frequently deal with foreign reporting obligation issues, and leveraging that experience is the best way for a taxpayer to protect themselves from civil and criminal exposure.