With remarkable consistency, the story I hear from clients starts something like this: “Just the other day, my husband and I were at this event, and I heard something that made me wonder if I should be concerned.”
What follows next is usually a description of bank accounts, real estate, or stocks held in another country, and a question: “Is there some special filing I should have been making with the IRS about these things?”
As is often the case with tax attorneys, my answer is: “It depends.”
[dropcap]W[/dropcap]hile the requirement for US taxpayers to make certain disclosures of their foreign assets is nothing new (the Financial Crimes Enforcement Network of the US Department of the Treasury first delegated its enforcement authority for the Report of Foreign Bank and Financial Accounts, or “FBAR”, to the Internal Revenue Service in 2003) many individuals are still unaware of their responsibilities and, as a result, have fallen behind. Although an individual’s particular foreign assets may necessitate other filings, such as the Statement of Specified Foreign Financial Assets (Form 8983) required under the Foreign Account Tax Compliance Act (FATCA), the FBAR is by far the most widely needed and commonly missed.
With certain exceptions and limitations, US taxpayers are required to electronically file an FBAR form (now identified as a FinCEN 114) by June 30th of each year to disclose their interest in, or signature power over, any financial accounts, including bank, securities, or other types of financial accounts in a foreign country which, in the aggregate, exceeded $10,000 at any time during the calendar year. The scope of the FBAR disclosure goes so far as to include accounts held at foreign branches of US banks, indirect interests in foreign financial assets held through an entity (if more than 50%-owned), foreign grantor trusts, and foreign-issued life insurance or annuity contracts with cash value.
Many clients, upon hearing this information, ask about that parcel of land they own in another country. Notably, the FBAR requirement does not include direct interests in foreign real estate. The typical FBAR case involves something like the Spanish bank account from the year they worked in Madrid or the German securities account they inherited from their grandfather several years back. The relatively low aggregate threshold to the reporting requirement means that the FBAR does not just apply to the wealthy—it can encompass a wide swath of US taxpayers because of its cumulative nature.
The most alarming parts of the FBAR filing requirement are the civil and criminal penalties available to the IRS in enforcing it. Willfully failing to file the FinCEN 114 carries with it the potential for significant jail time criminal penalties of up to $500,000. On the civil side, penalties for willfully failing to file are calculated to be the greater of $100,000 or 50% of the total balance of the foreign account per violation.
One important thing to keep in mind about these potential fines and penalties is that they are applied per violation, with each missed FinCEN 114 amounting to a new violation. Calculated in this manner, the penalties and potential fines can add up quickly. Clients are expectedly upset at the prospect of being tagged with such significant penalties, especially if they had been reporting any income associated with their foreign assets on their annual returns and paying any taxes due on time.
[quote float=”right”]Penalties for willfully failing to file are calculated to be the greater of $100,000 or 50% of the total balance of the foreign account per violation. [/quote]The lurking penalties cause clients to then ask the most important question: “Now that I know I should have been filing FinCEN 114s for the past few years, what can I do to minimize my risk?”
In a study conducted between 2006 and 2008, the IRS determined that many thousands of US taxpayers had fallen behind in making FBAR filings. The IRS correctly determined from this study that many taxpayers were not remedying their noncompliance for fear of subjecting themselves to the substantial civil penalties that were clearly designed to punish fraudulent and bad faith actors, not regular taxpayers failing to file from simple lack of awareness. As a result, in 2009 and again in 2011 and 2012, the IRS made the Offshore Voluntary Disclosure Program (OVDP) available to certain taxpayers in order to encourage them to come into compliance. The continuing success of the OVDP has led the IRS to continue the 2012 program indefinitely.
Upon application and acceptance into the OVDP, a taxpayer’s civil penalty liability is reduced. Instead of calculating the penalty as the greater of $100,000 or 50% of the highest aggregate foreign account balance per year, the OVDP penalty is calculated at 27.5% of the highest year’s aggregate value during the disclosure period (up to six years), so long as the taxpayer submits his or her request to be accepted into the OVDP prior to the IRS discovering their noncompliance through other avenues (such as through the FATCA disclosure requirements placed on foreign financial institutions).
In June of last year the IRS took another significant step toward encouraging additional voluntary disclosures by expanding the scope of their Streamlined Filing Compliance Procedures. Previously, the streamlined disclosure option had only been available to certain US taxpayers residing outside the US. With its recent expansion, taxpayers residing within the US can now qualify for streamlined disclosure, which carries with it the benefit of even further reduced civil penalties. The key qualification for the streamlined procedure is the taxpayer’s written certification to the IRS that previous failures to comply were unintentional. Under it, taxpayers residing outside of the US may have all penalties waived, while those residing inside the US can reduce their penalty exposure from 50% down to 5% of the foreign financial assets that gave rise to the compliance issue.
With the risk of sizable potential liability from noncompliance and the constantly changing landscape of voluntary disclosure options, a client’s initial questions about FBAR filing requirements is usually just the beginning of a much larger conversation about minimizing their exposure to penalties. However, with careful consideration and planning, the path to compliance can be completed without undue hardship.
Ryan Cofield is a member of The Van Winkle Law Firm’s Business and Tax Groups, working primarily out of their Asheville office.