As if Halloween was not frightening enough. With certain foreign taxing authorities releasing financial account holder information to the Internal Revenue Service (IRS), US citizens and domestic residents with undisclosed foreign financial accounts (US account holders) may be running out of time to take advantage of voluntary disclosure programs. Earlier this month, the IRS announced it had in fact exchanged account holder information with certain foreign taxing authorities under the Foreign Account Tax Compliance Act (FATCA).[i] The notice declined to identify the specific countries with which this exchange occurred. For those US account holders caught up in this exchange, the time to come forward voluntarily may be limited, and the failure to do so could be very expensive.

FATCA was enacted in 2010 to aid in the detection of undisclosed foreign financial accounts held by US persons and to deter foreign financial institutions from enabling such US persons. Under FATCA, foreign financial institutions (FFIs) must either (i) investigate all account holders with aggregate account balances of $50,000[ii] or greater as of December 31 of the prior year for indicia of US status (e.g., a US address or telephone number, or instructions to transfer funds to US accounts) and report all suspected US account holders or (ii) be subject to a thirty percent (30%) withholding tax on certain US source income and face other restrictions to US financial markets.[iii] This leaves most FFIs with little choice but to comply with FATCA’s reporting requirements. Moreover, many countries have entered into intergovernmental agreements (IGAs) with the US in which such countries agree to put further local pressure on FFIs within their respective jurisdiction to comply with the FATCA reporting requirements. There are two basic types of IGAs: (i) the Model 1 IGA and (ii) the Model 2 IGA.

Under Model 1 IGAs, FFIs must report US account holder information from the previous year each year to their respective taxing authorities, and these foreign taxing authorities must then report this information annually to the IRS no later than September 30th.[iv] The first reporting deadline under the Model 1 IGA was to be September 30, 2015.[v] Recognizing that many countries were not prepared to meet this September 30, 2015 deadline, however, the IRS extended the deadline to September 30, 2016 for those Model 1 IGA countries requiring more time.[vi] Many Model 1 IGAs are reciprocal–meaning the IRS is also obligated to report certain foreign account holders of US institutions to the respective country’s taxing authority. As discussed above, despite the extended deadline, the IRS announced it was able to timely exchange account holder information with at least some Mode1 1 IGA countries. It is unclear how much information has been supplied to the IRS, but reporting under the Model 1 IGAs has begun.

Under Model 2 IGAs, FFIs must report directly to the IRS by March 31 of each year–with 2015 being the first year such foreign government bodies are required to make such a report.[vii] The IRS has offered extensions to FFIs that have applied for them. Again, it is unclear how much information has been supplied to the IRS under the Model 2 IGAs.

The reporting occurring under FATCA should concern US account holders with undisclosed foreign accounts as the IRS will undoubtedly use the data it receives to open new investigations. This is problematic because US account holders with aggregate foreign account balances exceeding $10,000 (US dollars) at any point during a year are required to file, among other potential offshore information returns, FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR) by June 30 of the following year.[viii] The FBAR is an information return that discloses foreign accounts and their respective balances to the IRS and failure to timely file a complete FBAR can result in draconian penalties.

For instance, if such failure is found to be willful, according to recent guidance provided by the IRS, the US account holder at issue could face a penalty of between fifty percent (50%) to one hundred percent (100%) of the highest aggregate balance of the unreported foreign accounts looking at each year of non-compliance and going back six (6) years.[ix] It iss worth noting that the statutory maximum penalties for willful failure to file a timely and complete FBAR is significantly higher than these self-imposed limits[x], and there is at least one instance where an FBAR penalty was imposed that exceeded the total value of the accounts at issue was upheld.[xi] For non-willful violations, the IRS has indicated that the penalty should be limited to $10,000 for each year of non-compliance going back six years.[xii] The IRS has indicated that no penalty will be assessed against US account holders for non-willfully failing to timely file FBARs if such US account holders file all delinquent FBARs and had properly reported all income from foreign financial accounts.[xiii] Note that outside of certain voluntary disclosure programs any FBAR penalty would be in addition to other penalties (e.g., accuracy or fraud penalties as well as other potential offshore return penalties).

Whether a violation is willful or non-willful it is clearly important in the context of FBAR violations. Unfortunately, determining willfulness in this context is difficult. Willfulness includes not only those instances where a US account holder consciously decides to avoid his or her FBAR filing requirements, but also includes those US account holders who have remained willfully blind to such requirements (i.e., consciously avoiding to learn about FBAR filing requirements).[xiv] The IRS has had success applying the doctrine of willful blindness broadly in the context of FBAR reporting requirements. The limited case law interpreting willfulness in the context of FBAR reporting requirements suggests the mere presence of certain questions on Schedule B of Form 1040, which inquire about foreign accounts and direct US account holders to FBAR guidance, may alone be enough to establish willfulness under this doctrine.[xv]However, such a broad application would be grossly overinclusive. IRS guidance itself provides that “[t]he mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness.”[xvi] Given the ambiguity that exists, it is imperative that US account holders work with a competent tax counsel to determine whether the violations at issue are likely to construed as willful or non-willful by the IRS.

If the IRS does open an investigation regarding a US account holder, he or she would be ineligible to enter one of the voluntary disclosure programs offered by the IRS. These programs include the Offshore Voluntary Disclosure Program (OVDP) for willful violators and the streamlined procedures for non-willful violators.

Under the OVDP, willful violators are required to pay a one-time offshore penalty of twenty-seven and one-half percent (27.5%) of the highest aggregate balance of all foreign accounts and property associated with the tax-noncompliance going back eight (8) years. This usually amounts to a significantly lower penalty than the potential fifty percent (50%) to one hundred percent (100%) penalty that those willful violators who fail to come forward outside the OVDP may face. However, this 27.5% could be applied against property other than foreign financial accounts (e.g., foreign rental property that generated unreported rental income), which can make the OVDP less attractive to those with such assets. Additionally, completing the OVDP requires, among other things, filing and paying taxes and penalties on eight (8) years of amended tax returns. Except in cases of fraud, the statute of limitations is normally limited to three (3) to six (6) years depending on the amount gross income that went unreported. The benefit of the OVDP is that the US account holder (i) enjoys greater certainty, (ii) pays a potentially far lower penalty (this may not be the case when the taxpayer has significant non-financial account assets associated with non-compliance), and (iii) is not referred to the US Department of Justice for possible criminal prosecution. For more information on the OVDP, please visit the following —https://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers-2012-Revised.

The streamlined procedures allow non-willful US account holders who resided outside the US at the time of the violations at issue to come forward without paying any penalty. Non-willful US account holders residing inside the US at the time of the violations at issue, must pay a one-time miscellaneous offshore penalty equal to five percent (5%) of the highest aggregate year-end balances of the foreign financial accounts at issue going back six (6) years (not including non-financial account assets). Significantly, this penalty is paid in lieu of any other accuracy related penalties or other potential offshore information return penalties. Additionally, as part of the streamlined procedures, US account holders are required to file only three (3) years of amended tax returns as opposed to eight (8) years. When a non-willful US account holder is facing significant penalties outside of the FBAR penalties, the streamlined procedures can offer significant savings. Note that if the IRS determines that a US account holder acted willfully, then such account holder will be ineligible for any of the benefits offered by the streamlined procedures. For more information on the streamlined procedures, please visit the following —https://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-Compliance-Procedures.

Reporting under FATCA has begun and will only increase significantly in the coming years unless the laws change. US account holders with undisclosed foreign accounts or unreported income must assume that they will be discovered. Accordingly, it is more important than ever to reach out to a qualified tax counsel to discuss options to come forward voluntarily before it is too late.

Lastly, it should be noted that in addition to imposing reporting requirements to FFIs, FATCA also imposes its own reporting requirements on US account holders. FATCA requires US account holders to file Form 8938, Statement of Specified Foreign Financial Assets, if such taxpayers have an interest in “specified foreign financial assets” above a certain threshold.[xvii] For single US account holders, this threshold may be reached if the aggregate value of all specified foreign financial assets exceeds either (i) $50,000 at the end of the tax year or (ii) $75,000 at any point during the tax year.[xviii] For married US account holders filing a joint tax return, this threshold may be reached if the aggregate value (aggregating assets of both spouses) of all specified foreign financial assets exceeds either (i) $100,000 at the end of the tax year or (ii) $150,000 at any point during the tax year.[xix] The penalty for failing to timely file Form 8938 is initially $10,000, but may be increased $10,000 for each additional 30 day period of non-compliance that continues 90 days after the taxpayer receives notice from the IRS regarding such non-compliance.[xx] The maximum penalty that may be assessed against a taxpayer in any given year, however, is $50,000.[xxi] Form 8938 must be filed by the due-date of the taxpayer’s Form 1040 (including extensions).[xxii] Form 8938 filing requirements apply only to taxable years beginning after 2010.

Additional offshore information returns may be required depending on each US account holder’s unique situation.