April 15th is a date on the minds of many taxpayers this time of year. For some, however, June 30th marks another important deadline. This is the date the Report of Foreign Bank and Financial Accounts (the FBAR) is due, and there are no extensions.[i] The FBAR is not a tax return, but an information return used by taxpayers to disclose certain foreign accounts. Specifically, the FBAR is required to be filed by a taxpayer if (i) the taxpayer has a financial interest in or signature authority over any reportable financial account located in a foreign country and (ii) the aggregate value of all such accounts exceeded $10,000 at any time during the previous calendar year.[ii] The FBAR must now be filed electronically using FinCEN Form 114. Failure to timely file the FBAR can result in shockingly severe civil penalties and potential criminal prosecution.
With the implementation of the Foreign Account Tax Compliance Act (FATCA), it is more important than ever to ensure compliance with FBAR reporting requirements. Under FATCA, and beginning this year, foreign financial institutions (FFIs) must, as either a participating FFI or pursuant to an intergovernmental agreement (IGA), (i) disclose annually to the Internal Revenue Service (IRS) certain identifying information regarding U.S. account holders with aggregate account balances in excess of $50,000 as of December 31st of the prior year or (ii) be subject to a 30% withholding tax on U.S. source income.[iii] To avoid this withholding tax, FFIs in jurisdictions that have adopted the Model 1 IGA must provide this identifying information by September 30, 2015.[iv] Those FFIs not in such jurisdictions must provide this information by March 31, 2015.[v] Once the IRS has received this information and has initiated a civil examination of a taxpayer as a result, such taxpayer is no longer eligible to participate in the voluntary disclose programs discussed below. Accordingly, those taxpayers at risk of being disclosed to the IRS under FATCA must act quickly to take advantage of such programs and the reduced penalties they offer.
Reportable financial accounts for purposes of FBAR reporting requirements include checking, savings, demand deposit and time deposit accounts, securities and brokerage accounts, and some retirement or tax deferred accounts.[vi] Taxpayers need not consider the value of real and personal property or foreign stocks and other securities not held in a financial account when determining FBAR reporting requirements. As discussed below, foreign stocks and other securities not held in a financial account must be considered when determining other reporting requirements.
The maximum civil penalty for willful failure to comply with FBAR reporting requirements is the greater of $100,000 per violation or 50% of the highest balance of each reportable account during the year at issue.[vii] For non-willful violations, the penalty for failing to comply with FBAR reporting requirements is not to exceed $10,000 per violation. Note that the statutory maximum provides that a separate penalty may be assessed for each reportable account and for each year of non-compliance.[viii] If a taxpayer, however, can establish reasonable cause for failing to comply with reporting obligations, which must be more than ignorance of reporting requirements alone, the taxpayer may avoid penalties all together.[ix] The statute of limitations for assessing FBAR related penalties is 6 years from the due date of the applicable FBAR.[x]
The distinction between a willful and non-willful violation clearly is important in the context of FBAR reporting requirements. Establishing willfulness generally requires that the IRS demonstrate a voluntary, intentional violation of a known legal duty.[xi] Under the doctrine of “willful blindness” and in the context of FBAR reporting requirements, willfulness may be attributed to a person who has made a conscious effort to avoid learning about such requirements.[xii] The IRS has had success applying the doctrine of willful blindness broadly in the context of FBAR reporting requirements. The two cases interpreting willfulness in this context suggest the mere presence of certain questions on Schedule B of Form 1040, which inquire about foreign accounts and direct taxpayers to FBAR guidance, may be enough to establish willfulness under this doctrine.[xiii] This would essentially impute willfulness onto all non-compliant taxpayers who attach Schedule B (the schedule required to report interest income and dividend income above a certain threshold) to their tax return. Such an application of the doctrine would be grossly over inclusive. Fortunately, the precedent set by these cases does not require such an over inclusive application. The courts in each case cited additional factors (aside from the content of Schedule B) to support a finding of willfulness. Moreover, 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.”[xiv] In any event, determining whether a particular failure to comply with FBAR reporting requirements should be classified as willful requires a close examination of all relevant facts and is often quite difficult.
Taxpayers who have been non-compliant and who have not already been the subject of a civil examination regarding such non-compliance may consider coming forward under one of the voluntary disclosure programs provided by the IRS. If after consultation with a qualified tax professional a taxpayer believes his or her failure qualifies as willful, he or she may consider entering the Offshore Voluntary Disclosure Program (OVDP). The OVDP requires, among other things, (i) properly completing and filing FBARs and all other required offshore-related information returns not correctly filed within the last 8 years, (ii) filing amended tax returns to report all previously unreported foreign income for the last 8 years and paying any associated tax, (iii) paying interest and a 20% accuracy penalty on all previously unreported amounts, (iv) paying a one-time penalty of 27.5% of the highest aggregate balance of the unreported foreign accounts and any other foreign property associated with tax non-compliance looking back 8 years, and (v) not having been already contacted by the IRS regarding non-compliance for failure to file the FBAR or other offshore-related information returns.[xv] Once a taxpayer completes the OVDP, such taxpayer will not be subject to additional penalties regarding any offshore-related information returns filed as part of the program.[xvi] Note that a 50% penalty (as opposed to a 27.5% penalty) will apply if the financial institution at which the foreign account is held is under investigation by the IRS or U.S. Department of Justice.[xvii]
The benefit of the OVDP is that the taxpayer (i) enjoys greater certainty, (ii) pays a far lower penalty than the statutory maximum for willful violations, and (iii) is not referred to the U.S. Department of Justice for possible criminal prosecution. The costs, however, are still high. Accordingly, for non-willful violators, the OVDP does not make financial sense.
Recognizing this, in June of 2014, the IRS announced a new streamlined voluntary disclosure program for non-willful violators. This program allows eligible taxpayers to come into compliance at far lower costs. For taxpayers who resided within the U.S. during the applicable disclosure periods, the Streamlined Domestic Offshore procedures (SDO procedures) allow eligible taxpayers to come into compliance by, among other things, (i) properly completing and filing all FBARs not correctly filed within the last 6 years, (ii) filing all other offshore-related information returns (excluding the FBAR) not correctly filed within the last 3 years, (iii) filing amended tax returns to report all previously unreported income for the last 3 years and paying any associated tax, (iv) paying a one-time miscellaneous offshore penalty calculated as 5% of the highest aggregate year-end balance of all unreported foreign accounts going back 6 years, and (v) certifying that the violations at issue were non-willful.[xviii] Unlike those taxpayers who complete the OVDP, the SDO procedures do not protect taxpayers from additional penalties or potential criminal prosecution if such taxpayers are later found to have acted willfully. Moreover, if taxpayers attempt to come into compliance under the SDO procedures and are later found to have acted willfully, such taxpayers are prohibited from entering the OVDP. Accordingly, taxpayers must carefully examine their particular factual situation with a qualified tax professional before moving forward under the SDO procedures. Note that certain taxpayers who resided outside the U.S. during the applicable disclosure periods may be eligible for the Streamlined Foreign Offshore procedures, which do not require payment of a miscellaneous offshore penalty.[xix]
In addition to the FBAR, certain taxpayers may have additional reporting requirements. For instance, taxpayers must also file Form 8938, Statement of Specified Foreign Financial Assets, if such taxpayers have an interest in “specified foreign financial assets” above a certain threshold.[xx] For single taxpayers, 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.[xxi] For married taxpayers 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. Specified foreign financial assets include (i) any financial account maintained by a foreign financial institution, (ii) stock or securities issued by entities not organized in the U.S., and (iii) financial instruments or contracts that have an issuer or counterparty other than a U.S. person (including life insurance with cash value). Penalties for failing to file Form 8938 are significant, but not as severe as those for failure to file the FBAR. 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. [xxii] The maximum penalty that may be assessed against a taxpayer in any given year, however, is $50,000.[xxiii] Form 8938 must be filed by the due-date of the taxpayer’s Form 1040 (including extensions).[xxiv] Form 8938 filing requirements apply only to taxable years beginning after 2010.
Additional offshore-related information returns include (i) Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, which must be filed by taxpayers who contribute to or receive distributions from a foreign trust or receive gifts above a certain threshold from foreign individuals or entities, (ii) Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, which must be filed when U.S. persons are treated as an owner of a foreign trust, and (iii) Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, which must be filed by taxpayers who are treated as owning 10% percent or more of the stock of a foreign corporation or who meet other filing criteria. Forms 3520 and 5471 must be filed by the due-date of the taxpayer’s Form 1040 (including extensions), while Form 3520-A must be filed by the 15th day of the 3rd month after the end of the applicable trust's tax year. Note that the above is not an exhaustive list of other offshore-related information returns.
In sum, determining a taxpayer’s disclosure obligations regarding foreign accounts or other foreign interests as well as the best courses of action to address previous non-compliance is often challenging and requires a careful examination of all relevant facts. Given the implementation of FATCA and the IRS’s ever increasing focus on offshore-related disclosure compliance, any taxpayer concerned with his or her disclosure obligations is strongly encouraged to consult a qualified tax professional as soon as possible.