Report on Foreign Bank and Financial Accounts: Compliance and Controversy

Editor: Stephen E. Aponte, CPA

The following is a brief discussion of various matters relating to T.D. F 90-22.1, Report on Foreign Bank and Financial Accounts (FBAR). In recent months, concern over who is required to file the FBAR has escalated among taxpayers and tax practitioners alike. Along with stepped-up enforcement by Treasury and the IRS, this has made for a very interesting and challenging period in the life of the FBAR reporting requirement.

Background

In 1970, Congress passed the Bank Secrecy Act (BSA), which is codified in title 31 of the U.S. Code (Sections 5311– 5330). The purpose of the BSA was to require the filing of certain reports and the retention of certain records where doing so would be helpful to the U.S. government in conducting criminal, tax, and regulatory investigations.

In April 2003, the IRS and FinCEN (the U.S. Treasury Department Financial Crimes Enforcement Network) signed a Memorandum of Agreement whereby FinCEN delegated its enforcement authority to the IRS. This agreement was reached primarily for three reasons: the IRS traditionally has had more enforcement resources, the enforcement was essentially geared toward tax evasion rather than money laundering or other financial crimes, and most FBARs were filed by individuals. (See IRS News Release IR-2003-48 (4/10/03)).

To achieve this goal, the BSA put into place two principal requirements: (1) each person subject to the jurisdiction of the United States (except a foreign subsidiary of a U.S. person) having a financial interest in, or signature authority over, a bank, securities, or other financial account in a foreign country must report that relationship in each year the relationship exists (31 C.F.R. §103.24 (2005)); and (2) records of accounts required to be reported shall be retained by each person having a financial interest in or signature authority over any such account (31 C.F.R. §103.32 (2005)).

The first requirement under the BSA forms the basis for FBAR reporting. As is described in the instructions to Form TD F 90-22.1, the FBAR filing requirement is as follows:

Each United States person who has a financial interest in, or signature authority over any foreign financial accounts, including bank, securities, or other types of financial accounts, in [a] foreign country, if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year, must report with the Department of the Treasury on or before June 30, of the succeeding year.

The second requirement under the BSA requires U.S. persons to retain (for five years) records supporting the name on the account, the name and address of the foreign person with whom the account is maintained, the account number, the type of account, and the maximum value of each such account during the accounting period.

Prior to the release of the current version of the FBAR in 2008, a “U.S. person” was generally defined in the instructions to the form as any entity or individual under the jurisdiction of the United States, meaning, broadly, a U.S. citizen, U.S. resident, domestic partnership, domestic corporation, domestic estate, or domestic trust. However, determining whether these entities in fact have a “financial interest” in, “signature authority” over, or “other authority over” an account will require a close examination of the definitions provided in the instructions to the form.

Penalties for failing to comply with the FBAR filing requirements can be severe. In the case of “non-willful” violations, the IRS may impose a maximum penalty of $10,000. A higher maximum penalty of $100,000 or 50% of the amount of the transaction or the balance of the account at the time of the violation (whichever is greater) can be asserted where the IRS finds a taxpayer’s willfulness in violating the requirement. Either of these penalties may be abated upon sufficient proof of reasonable cause.

Criminal violations may result in a fine of up to $250,000 and/or five years imprisonment. Criminal violations forming a pattern of criminal activity may result in a fine of up to $500,000 and/or 10 years imprisonment. The statute of limitation for assessment of civil violations is six years, and the statute of limitation for assessment of criminal violations is five years.

Stepped-up Enforcement

In Delegation Order 4-35 (Rev. 1), the IRS delegated to officials at several levels throughout the IRS the authority to:

• Investigate possible civil violations of the FBAR filing requirements;
• Prepare and file proofs of claims for FBAR penalties and take any appropriate action necessary in bankruptcies, receiverships, and insolvencies to protect the government’s interests;
• Make referrals to the Department of Justice;
• Issue administrative rulings;
• Provide preassessment hearings; and
• Enter into and approve a written agreement relating to civil liability for an FBAR penalty.

This order put IRS officials and taxpayers alike on notice that penalties for violations relating to the FBAR were now going to be enforced with a new vigor. Though the FBAR compliance requirements have existed for decades, the issuance of this order injected a new sense of urgency with regard to the FBAR for the calendar 2008 filing season.

Expanded Filer Category

With the issuance of a new version of the FBAR form (revised October 2008), the instructions contained an expanded definition of U.S. person (which refers to the definition of “person” from 31 C.F.R. §103.11(z)). This definition now includes foreign business entities, foreign trusts, and nonresident aliens doing business in the United States. As one might imagine, taxpayers and tax practitioners viewed this expanded definition as imposing a wholly new filing requirement. They struggled to determine whether they or their clients who were “foreign persons” would now be required to file the FBAR form. The IRS eventually provided relief for taxpayers.

On June 6, 2009, the IRS issued an announcement (Announcement 2009- 51) stating that for the purpose of filing the FBAR for calendar year 2008, the IRS would temporarily suspend the reporting requirement for those persons who are not citizens, residents, or domestic entities. Though this announcement may have eased some taxpayer’s frustrations, the relief is merely temporary. Unless some additional relief is provided, foreign persons will be required to prepare the FBAR for calendar year 2009.

On August 7, 2009, the IRS announced in Notice 2009-62 that it was also providing relief for persons with signature authority over, but no financial interest in, a foreign financial account and persons with a financial interest in, or signature authority over, a foreign commingled fund. Persons in those groups have until June 30, 2010, to file an FBAR for the 2008 and earlier calendar years with respect to these foreign financial accounts.

Voluntary Disclosure Program

The IRS has established a program creating a six-month window (from March 23, 2009, to September 23, 2009) for a voluntary disclosure and settlement option for taxpayers with delinquent FBAR filings. The program allows taxpayers to avoid criminal prosecution if they voluntarily report their foreign accounts—for all relevant tax years—and pay the tax (including interest and penalties) on all unreported income generated from those accounts during that period. Various important issues relating to the voluntary disclosure program are as follows:

• Taxpayers who have properly reported and paid tax on all taxable income but merely failed to file the appropriate FBARs will not be penalized if they file them and attach a statement explaining why the reports are being filed late. They should not use the voluntary disclosure process.
• Taxpayers under civil examination are not eligible to make a voluntary disclosure under the program, regardless of whether the examination relates to undisclosed foreign accounts or entities. This preclusion also holds true for individuals and entities under criminal investigation.
• Taxpayers are firmly discouraged from making “quiet disclosures.” A quiet disclosure is a technique whereby the taxpayer merely amends the return for the relevant tax year, reporting the additional income from foreign accounts, and thereby circumvents the voluntary disclosure process completely. IRS officials have repeatedly stated that they are scrutinizing amended returns filed (especially those that result in increased taxable income) in order to determine whether the amendment qualifies as a quiet disclosure.

The IRS reminds taxpayers who may be considering making a quiet disclosure that the tax return amendment option deals adequately only with unpaid tax and interest. It does not deal adequately with applicable civil or criminal penalties. Once a return is flagged for examination as a quiet disclosure, the taxpayer cannot use the voluntary disclosure option. The benefits of voluntary disclosure as it relates to criminal penalties are also no longer available.

The Controversy Regarding Offshore Funds

During a June 12, 2009, teleconference sponsored by the AICPA and the American Bar Association, an IRS official made what many consider to be a somewhat controversial comment regarding how the Service would define the term “financial account.” He stated that the term would include interests in hedge funds “that function like mutual funds.”

Many believe this definition would expand the filing requirement to include taxpayers that formerly believed they were not required to file the FBAR. It implies that in addition to taxpayers who have “control” (a more than 50% interest) in a foreign entity and are deemed to have a “financial interest” in any foreign accounts owned by that entity, taxpayers owning any interest—no matter how small (as long as the taxpayer’s aggregate foreign account balances exceeded $10,000)—in an offshore fund or passive foreign investment company (PFIC) would be deemed to own a “financial account,” requiring an FBAR filing.

Investors in offshore private equity funds, hedge funds, and PFICs were understandably concerned. As stated above, the FBAR penalties are onerous; should an eligible U.S. person fail to file the FBAR, he or she could be subject to severe penalties. Most taxpayers settled on the position that regardless of what could be determined definitively regarding the status of an interest in an offshore account, filing the FBAR for ownership interests in all types of offshore funds was the advisable approach, especially in light of the potential penalties. That notwithstanding, it remains unclear—without meaningful guidance—which types of foreign fund interests would require the owner to file the FBAR and which types would not. Finally, the Service would be wise to clarify what information would be reportable for such interests because the form itself clearly contemplates capturing traditional bank or securities account information rather than information regarding interests in foreign funds.

The foregoing is a brief discussion of some current issues relating to the FBAR. There can be no doubt that the discussion will remain in the headlines in the near future.

EditorNotes

Stephen Aponte is a senior manager at Holtz Rubenstein Reminick LLP, DFK International/USA, in New York, NY.

Unless otherwise noted, contributors are members of or associated with DFK International/USA.

For additional information about these items, contact Mr. Aponte at (212) 792-4813 or saponte@hrrllp.com.