Under the Bank Secrecy Act, 1 U.S. persons with certain interests in bank or other financial accounts located in foreign countries are subject to a reporting requirement if the value of the accounts exceeds $10,000. Where the rule applies, the taxpayer must file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR.”
Prior to 2004, these requirements often received limited attention from taxpayers and their advisers, for a variety of reasons. 2 All that has changed. Now, a U.S. person who ignores the FBAR requirements is exposed to a significant penalty regime, including civil and criminal sanctions; the civil penalties alone can generate a liability greater than the value of the foreign account. 3 These provisions are in addition to those that apply under the tax laws, such as the 75% civil fraud and the 20% or 40% accuracy-related penalties. 4
To encourage FBAR filings, the IRS offered a voluntary program in 2009, known as the Offshore Voluntary Disclosure Program (OVDP). The OVDP provided the opportunity for reduced reporting penalties for those who came forward under its terms. The IRS offered a second voluntary disclosure initiative last year, which gave taxpayers who had not previously met the reporting rules another opportunity to become compliant. Under the 2011 program, labeled the Offshore Voluntary Disclosure Initiative (OVDI), U.S. persons who chose to participate were subject to various requirements, including filing original or amended tax returns and FBAR forms for the years in question, and possibly paying a penalty equal to 25% of the highest aggregate balance in the foreign accounts for the period covered by the initiative. 5 The 2011 OVDI closed on Sept. 9, 2011.
In the wake of these two programs, tax practitioners with clients holding unreported foreign bank accounts find themselves in interesting circumstances. Those with clients who elected to participate in either the OVDI or OVDP are likely still embroiled in the complex examination regimes of those programs. 6 Those with clients who, for whatever reason, did not participate in either program, face the question “What do I do now?” The IRS anticipated this issue and addressed it on Jan. 9, 2012, announcing yet another voluntary disclosure initiative. This time, the program remains open indefinitely.
Under the 2012 rules, the 25% 2011 penalty, applicable in some cases to the highest aggregate balance in foreign accounts covered by the initiative, has been replaced by a higher penalty rate of 27.5%. Otherwise, the terms of the new voluntary disclosure program are substantially similar to the 2011 OVDI. With this new and potentially permanent program, the IRS has created a unique doorway to FBAR compliance that not-so-coincidentally dovetails with the new reporting requirements of the Foreign Account Tax Compliance Act (FATCA), which was enacted in March 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act. 7 For practitioners, this confluence of events reinforces the importance and pervasiveness of the FBAR rules, especially in light of the punitive nature of the sanctions that can apply when the rules are violated and the fact that many taxpayers appear to be unaware of the FBAR and now FATCA obligations that may apply. 8
This article examines the FBAR provisions and describes when reporting is required and what information must be provided. It also discusses the consequences of noncompliance, including the civil and criminal penalties that may apply under Title 31 and under the Internal Revenue Code. The article includes a discussion of how tax advisers should handle FBAR requirements and considers specifically what to do for clients who have failed to provide the mandated reports, including those who have made so-called quiet disclosures. 9 Finally, it suggests steps that should be adopted to minimize FBAR problems for both clients and advisers and describes what is required under the new FATCA provisions.
The FBAR rules apply to “United States persons” with offshore financial interests that exceed $10,000. The term “United States person” includes citizens, residents, and entities such as corporations, partnerships, limited liability companies, or similar organizations created under U.S. laws. 10 Estates are subject to the disclosure rules, as are trusts, including cases where trust income, deductions, or credits are reported by another taxpayer under income tax rules 11 (e.g., a grantor trust). In general, a “resident” refers to a noncitizen who is present within the United States a certain number of days in the current and preceding two years. 12
The disclosure requirements are triggered when the maximum aggregate value of the accounts held by the U.S. person exceeds $10,000 at any time during the calendar year. The maximum value is the largest amount of assets appearing on any quarterly or more frequent account statement issued for the applicable year. 13 Where the funds are held in foreign currency, the determination of maximum value is calculated by converting the account into U.S. dollars, using the Treasury Department’s Financial Management Service rate from the last day of the calendar year. 14
One of the most significant questions for practitioners is whether their client is even required to file. Although not everyone must file and not every type of account is reportable, the filing requirement applies to a broader range of assets than most advisers might think. For example, updated regulations expand the class of interests that must be reported to include gold and expand the individuals subject to disclosure to citizens living abroad, dual citizens, etc. 15 The possibility of future regulations further increasing FBAR obligations cannot be ruled out; practitioners must stay alert to changes in all disclosure rules affecting offshore assets. 16
Accounts Triggering Disclosure
“Foreign financial accounts” that are reportable under the FBAR rules include bank accounts; 17 accounts with persons engaged in the business of buying, selling, trading, or holding stock or other securities; and “other” financial accounts. This last term includes insurance and annuity policies with a cash value and also accounts with mutual funds or similar pooled investments. 18 An account with a broker or dealer for futures or options transactions in a commodity on a commodity exchange also qualifies. 19
Investments with foreign hedge funds and private equity funds apparently are not reportable. 20 Disclosure also is not required for individual bonds, notes, or stock certificates held by the taxpayer. 21 This means that a U.S. person who owns stock directly, for example, is not required to report, while the same shares held through a typical brokerage account at a foreign broker will trigger an FBAR requirement. 22
The disclosure rules apply only to “foreign” financial accounts. Foreign refers to the location of the account, not the institution. 23 In other words, an account with a branch of a Canadian bank that is located in Detroit would not trigger a filing requirement. 24 However, a deposit with the Toronto branch of a U.S. bank would be treated as foreign. 25
A U.S. person with a “financial interest” in a reportable account is subject to the FBAR rules. “Financial interests” include the obvious, such as ownership of record or legal title. 26 However, the term also encompasses more indirect stakes in an offshore investment. For example, a U.S. citizen who directly or indirectly owns more than 50% of the total value or voting power of the stock in a corporation has a financial interest in the foreign financial accounts the corporation owns. 27 Similar rules apply to partnerships and to trusts. 28 A U.S. person cannot avoid FBAR requirements by placing ownership of a reportable account in the name of an agent, nominee, or someone else acting on the U.S. person’s behalf. 29
A financial interest also exists if a U.S. person has signature authority over a foreign financial account. This means the U.S. person has authority to control the investment by direct communication with the bank, for example, that maintains the account. 30 This apparently extends to internet authorization of a transaction through the use of passwords. 31
If more than one individual has signature authority, each is treated as having a financial interest. 32 In some situations involving, for example, certain bank officers or employees, persons with signature authority but no financial interest in an account are not required to make an FBAR report. 33 A modified disclosure is required when a U.S. person with signature authority over his or her employer’s offshore account lives outside the United States and the employer also is located outside the country. 34
It is possible that multiple parties have a reportable interest in an investment and are subject to a disclosure requirement. This could occur, for example, because of who has signature authority over an account or because of co-ownership. If both persons use the same tax accountant, the adviser may be placed in a difficult position, as where one client chooses to satisfy the FBAR requirements but the other does not. In that case, the tax accountant should consider AICPA guidance when preparing returns. Under the AICPA’s Statements on Standards for Tax Services (SSTS), a CPA is required to take into account information actually known from another person’s return, to the extent it is relevant and its consideration is necessary to properly prepare the taxpayer’s return. 35 It is possible withdrawal from the engagement may be necessary. 36
Where an offshore investment is jointly owned by a husband and wife, special rules exist that may permit only one FBAR to be filed on the couple’s behalf. 37 This exception does not apply in other cases involving multiple persons for the same account. In other words, if a person has signature authority over an account owned by his or her cousin, both would be required to make separate FBAR disclosures.
What Disclosure Is Required?
Where the FBAR rules do apply, what must a taxpayer do to satisfy the disclosure requirements? Tax advisers are undoubtedly familiar with the information that must be provided on Part III of Form 1040, Schedule B, Interest and Ordinary Dividends . 38 The FBAR disclosure form requires information about the filer, such as name and address, and also information about the accounts held, including maximum value during the calendar year reported, the name of the financial institution where the investment is located, and the type of account involved. 39 Where the U.S. person is an entity that directly or indirectly owns a more-than-50% interest in other entities, a consolidated report may be submitted. 40
Caution: The “mailbox rule” familiar to tax practitioners does not apply to FBARs: Form TD F 90-22.1 must be received by Treasury on or before June 30 of the year after the calendar year being reported. This date is fixed, meaning it cannot be extended, and applies regardless of the U.S. person’s tax year end.
Consequences of Noncompliance
Failure to provide the required FBAR information creates the potential for significant civil and criminal sanctions. Under Title 31, a taxpayer who willfully fails to file an FBAR faces a penalty equal to the greater of $100,000 or 50% of the foreign financial account balance as of the June 30 FBAR due date. 41 This penalty applies to each year open under the statute of limitation, 42 meaning a taxpayer who is willfully noncompliant over a period of several years can quickly owe more than the entire account balance. 43
Example 1 : C is a U.S. person who maintained a financial interest in a reportable offshore account for three years. The initial balance in the account was $200,000, and it paid a return of 5%, compounded annually, which C did not withdraw. He willfully failed to file the required FBARs. The penalty calculations required under Title 31 are shown in the exhibit.
Note that the penalty calculations do not allow for reduction of the account by the penalties assessed for earlier years. In other words, the year 2 penalty is 50% of $210,000, not 50% of $110,000. Also, there is no reduction in cases where more than one person has a reportable financial interest. If C and D co-owned the account and each willfully failed to file, each would face the penalties calculated in the exhibit. 44
“Willful” is defined as the voluntary and intentional violation of a known legal duty, so willfulness cannot exist if a taxpayer had no knowledge of the FBAR requirement. 45 Unlike the general presumption of correctness given to tax assessments, the burden of proof is on the government to establish that a taxpayer acted willfully. 46 In FBAR cases, proof a defendant knew of the reporting requirement and consciously chose not to file is sufficient. 47
In Williams, the court held that the government failed to prove by a preponderance of the evidence that the defendant’s failure to disclose reportable accounts was willful. Williams involved a taxpayer who did not file FBARs for accounts that had already been frozen as a result of government enforcement action. 48 In general, the absence of a tax liability in connection with an offshore account indicates no willfulness existed. Where it is present, evidence of willfulness may trigger imposition of other penalties under the Code, including the 75% fraud penalty under Sec. 6663. 49
The maximum penalty under Title 31 for a nonwillful failure to file an FBAR is $10,000 per account per year. No penalty is owed where the violation was due to reasonable cause and the balance of the account was properly reported. 50 The IRS may mitigate the $10,000 penalty, assuming certain conditions are met. For example, if a taxpayer with $38,000 in offshore accounts qualifies under the mitigation guidelines, she would owe a penalty of $500 per violation, not to exceed $5,000 in total. 51 This would be in addition to any back taxes, interest, and penalties owed under the Code.
Under Title 31, willful violation of the FBAR requirements is a felony, punishable by five years in prison, a fine of $250,000, or both. If willful noncompliance occurs while violating another federal law or in the context of a pattern of illegal activity involving more than $100,000 over 12 months, the defendant faces a $500,000 fine, 10 years imprisonment, or both. 52 It is possible a taxpayer who failed to file an FBAR also would be prosecuted under the Internal Revenue Code or the federal criminal code in Title 18. In Simon, for example, the taxpayer was convicted of filing false returns (Sec. 7206(1)), willfully failing to file FBARs (31 U.S.C. §5322), and mail fraud (18 U.S.C. §1341). 53 Simon involved a complex scheme that included use of so-called loans to disguise income and failure to disclose reportable funds held in foreign bank accounts. 54
From a client’s perspective, filing a voluntary disclosure is a daunting prospect. The disclosure immediately subjects the taxpayer to IRS scrutiny and possible exposure to substantial civil and perhaps criminal penalties. Moreover, the IRS has dramatically expanded the assets subject to disclosure to include “all of the taxpayer’s offshore holdings that are related in any way to tax non-compliance, regardless of the form of the taxpayer’s ownership or the character of the asset.” 55 So, what was once a relatively objective analysis of specific bank accounts and balances becomes much more subjective. For instance, the IRS will now inquire into the facts and circumstances of custodial accounts, indirect ownership interests, nominees, and alter ego arrangements.
Example 2 : G is a U.S. citizen who has been assigned by his employer to work at the company’s Toronto office on a long-term basis. The corporation for which G works has a generous stock ownership plan, and G ultimately receives shares worth $11,000, which are held in a Canadian brokerage account. G also contributes to his Canadian Tax Free Savings Account and Registered Retirement Savings Plan. G was asked by a good friend at the Toronto office to serve as custodian on a bank account for the colleague’s minor child. He also has in his Toronto apartment a valuable painting that was purchased with funds previously taxed in Canada.
If G decides to pursue voluntary disclosure, all of these assets will need to be reported. As part of either the OVDI or OVDP, or any subsequent voluntary disclosure outside of the programs, G will have to file U.S. income tax returns or amend previously filed returns accordingly to address each of the unreported assets.
As a result of these potential pitfalls and uncertainties, some United States citizens with interests in foreign assets, in the hopes of avoiding the voluntary disclosure penalty regimes, 56 have opted for so-called quiet disclosure. This option is quite simple. The taxpayer amends his or her tax return to identify foreign accounts, reports any income attributable to the account, pays any tax due, and hopes for the best. While tempting, especially since amended returns are appropriate under the law, the IRS made plain in 2009 and 2011 guidance that this strategy is not in a taxpayer’s best interest.
In its published Questions and Answers of May 6, 2009, the IRS clearly stated that quiet disclosures do not satisfy the reporting requirements. 57 More recently, on June 1, 2011, IRS representatives revealed that the Service is opening examinations against taxpayers who have submitted quiet disclosures. The government has developed a process by which to “filter” these submissions to facilitate proper processing either civilly or criminally. 58 The IRS cautioned that civil penalties and/or criminal prosecutions may apply with respect to quiet disclosures. In fact, Q&A 10 of the 2009 disclosure information and Q&A 15 of the 2011 disclosure program both encouraged taxpayers who made quiet disclosures to come forward and take advantage of the penalty framework of the respective programs. According to the IRS, “[T]hose taxpayers making ‘quiet’ disclosures should be aware of the risk of being examined and potentially criminally prosecuted for all applicable years … . The IRS has identified, and will continue to identify, amended tax returns reporting increases in income. The IRS will be closely reviewing these returns to determine whether enforcement action is appropriate.” 59
As noted previously, the civil and criminal penalties for FBAR violations depend primarily on the intent of the taxpayer. If a taxpayer is aware of the disclosure programs and the FBAR reporting requirements, and implements a quiet disclosure so as to play the “audit lottery” and avoid the penalty regimes, such a strategy might well be interpreted by a judge or jury as negligent, reckless, or perhaps willful. It is also important to note that quiet disclosures are inherently deficient in other respects. For example, disclosures made on amended income tax returns report income, taxes, and interest, but nothing else. Amended returns do not show accuracy-related penalties or relevant information required on the FBAR form (such as the highest balance of a foreign bank account in the subject tax year). For these and other reasons, tip-toeing past voluntary disclosure, or the FBAR rules in general, has been and continues to be a risky venture not for the faint of heart.
This point hit home on May 19, 2011, when the IRS made good on its warning with respect to quiet disclosures. The United States charged Michael Schiavo, a Boston bank director, with criminal failure to file an FBAR form disclosing his financial interest in a foreign bank account. Just before the deadline for the 2009 OVDP, Mr. Schiavo filed amended income tax returns for his 2003 through 2008 tax years that included interest from a foreign bank account with HSBC Bank. He did not file a voluntary disclosure under the OVDP.
The IRS investigated the amended returns and tried to interview him. Two days later, Mr. Schiavo filed another set of amended returns reporting income from a foreign partnership. He ultimately pleaded guilty to the charges brought against him and agreed to pay a civil penalty of $76,283 (one-half of the highest balance of his HSBC account). Mr. Schiavo also faces up to five years in prison and a $250,000 criminal fine. 60
Since Schiavo involves an incomplete quiet disclosure, whether the IRS will treat complete and accurate quiet disclosures similarly remains unclear. However, taxpayers and practitioners should read Schiavo in context with their circumstances and the uncertainties associated with the greatly expanded asset class subject to disclosure. Taxpayers and their representatives should also ask themselves the truly difficult question that the IRS will ask: Why do I want to do a quiet disclosure instead of a voluntary disclosure? Once the answer is fully formulated, envision providing a full explanation of that reasoning to the IRS. The Service’s mindset is critical here: For past and any future voluntary disclosure programs to succeed, the government must encourage participation and discourage use of a more surreptitious path. IRS enforcement and investigation will, therefore, focus on the taxpayer’s intent and reasoning in selecting his or her mode of disclosure.
On this point, it is important to note that the IRS will likely concentrate on communications between the taxpayer and his or her advisers. Consequently, practitioners should be mindful of the advice given to clients in this regard. Any discussions or communications about the decision to file a quiet disclosure would be fair game in an IRS investigation. While communications between an attorney and a client would likely be privileged, a taxpayer may not selectively assert the privilege in defending a determination.
Example 3 : T is a United States person with a foreign financial account reportable under the FBAR rules. She failed to make the required disclosures and now is attempting to resolve this matter with the IRS. T will want to explain that she was unaware of her filing and reporting requirements for her foreign bank accounts until her lawyer advised her of the fact. Once so advised, T immediately took steps to comply. However, as part of those discussions, assume that T and her attorney also discussed the best way to submit the “disclosure” to the IRS so that it would go unnoticed and not subject her to even the reduced penalty regime of the disclosure programs. If T waives her privilege for the favorable aspects of her attorney-client communications, she may well open the door to disclosure of the other more unsavory and “willfulness-generating” communications.
Further, note that communications between CPAs or tax return preparers and their clients are not blessed with the same expansive privileges as those granted communications between attorneys and their clients. The federally authorized tax practitioner privilege found in Sec. 7525 is of limited scope and, most significantly, does not apply to criminal proceedings or to state court matters. Further, since the privilege applies to “tax advice,” the communications are privileged only to the extent that they are within the scope of the return preparer’s authority to practice. If, therefore, the discussions involve means of circumventing IRS detection, they might well fall outside of the protected communications and become fair game for revenue agent scrutiny.
A final point on Schiavo is that practitioners should carefully evaluate their role in a client’s decision to play the so-called audit lottery. SSTS No. 1, Tax Return Positions , requires that a practitioner “not take a questionable position based on the probabilities that the client’s return will not be chosen by the IRS for audit.” 61 Also relevant here are Code provisions imposing criminal 62 and a host of civil penalties for aiding in the filing of false tax returns. Given the risks these provisions create for tax advisers, careful analysis and discussion should go into any decision to venture down the path of quiet disclosure.
For taxpayers who made a submission under the 2009 or 2011 initiatives, the decision to participate does not lock them into the programs’ penalty structures. The IRS may deem penalties inapplicable under the circumstances, or a taxpayer may elect to “opt out” of the program and have his or her case resolved under the standard examination process.
The IRS acknowledges that, for certain taxpayers, the results under either program may be “too severe given the facts of the case” and opting out may be the preferred approach. 63 An opt-out, however, is irrevocable. In this regard, it is important for taxpayers and practitioners to note that IRS agents are charged with protecting “the best interests of the service” and the “integrity of the voluntary disclosure provisions.” 64 This means the agent is an advocate for the IRS and therefore should be viewed as an adversary in the process.
In “unclear” opt-out cases, it should be expected the IRS agent will likely pursue the path most advantageous to the government. When an opt-out is exercised, the case is transferred to another agent, who is expected to conduct a full-scope examination of the return. If this examination reveals undisclosed issues (like those in Schiavo), a referral may be made to the IRS Criminal Investigation Division. With that said, the IRS has warned agents that they should not treat taxpayers negatively because they elect out of the program. 65
The IRS has developed a protocol and standardized letters to use before and after a taxpayer opts out of either the OVDI or OVDP. It is important for the practitioner to understand that agents may be reluctant to document communications or draft letters that vary from these standard materials. The practitioner should, therefore, build and preserve a record memorializing all material submissions and communications with the agent through the audit. Some of the IRS form letters include tables listing documents requested and documents produced under the program.
It is imperative that the practitioner verify the accuracy of the information in the letters and tables and, if necessary, correct any misstatements or omissions in written correspondence to the IRS. Just as the protocol creates a record for the government, it establishes one for the taxpayer. Because telephone communications are common under the program, any material statements, scheduling, or agreements made over the phone should be memorialized in follow-up written communications.
Upon opt-out, the IRS will ask the taxpayer to submit a summary statement of facts of the case and a recommendation of what penalties, if any, should apply. A detailed record will assist the practitioner in this endeavor. Regardless of whether the client opts out of the program, the case is subject to review by the IRS Criminal Investigation Division, and criminal referral remains a possibility. 66 It is, therefore, advisable to consider the involvement of a criminal tax attorney in communications with IRS personnel under either the OVDI or OVDP or for any nonprogram disclosures. This will ensure proper disclosure while preserving the client’s rights. Indeed, the primary focus must be to keep the client out of the criminal process. Toward this end, the practitioner should emphasize with the client the need for regular and thorough communication and avoidance of misunderstandings about the assets that are reportable and the information that is necessary to provide full disclosure and the required cooperation with the IRS.
Program agents are instructed to gather evidence and conduct interviews of the taxpayers to build their case files. The IRS trains its agents to understand that the taxpayer interview is a valuable technique to obtain leads and secure evidence and information to be used in either civil or criminal proceedings. 67 This means that clients should under no circumstances meet or confer with any IRS personnel outside the practitioner’s presence.
On this point, it is important to bear in mind that the IRS copies the taxpayer on all correspondence it sends to the taxpayer’s authorized representative. Too often, clients receive a communication that requests information or a return phone call, and they feel the need to respond to the IRS without first contacting the representative. Practitioners should advise the client upfront, with periodic reminders, that any communications from the IRS (whether written or oral) should immediately be directed to the authorized representative.
Once the taxpayer submits the summary statement of facts, the IRS agent is charged with preparing his or her own summary recommendation in the case. The agent explains in the document whether he or she disagrees with the taxpayer’s version of the facts. If the agent disagrees, he or she will recite the operative facts and list recommendations as to the applicable penalties. The agent is also required to describe the scope of the audit to be conducted and the likelihood as to whether willful or nonwillful FBAR penalties should be asserted.
Once the agent prepares the summary, the case is forwarded to a centralized review committee composed of IRS managers. The committee will review the taxpayer’s and the agent’s submissions along with the documentation in the case file and determine the appropriate level of examination to be conducted. The committee may assign the case to an agent for normal exam, or to a Special Enforcement Program agent for criminal investigation, or recommend other treatment. The committee is charged with determining (1) whether the penalty under the program is too severe under the facts, and (2) the cooperation of the taxpayer and representative. Given the committee’s broad discretion and the scope of the documents that it may review, the state of the file and the persuasiveness of the taxpayer’s summary statement are crucial.
This protocol has caught some practitioners by surprise. The notion of an opt-out gives the impression of control over the situation. Many believed that opting out of the OVDI or OVDP allowed the practitioner to affirmatively opt for, say, the traditional IRS Voluntary Disclosure Program, under which the IRS may consider voluntary disclosure, among other factors, in deciding whether or not to recommend civil penalties, criminal prosecution, or no sanctions at all. 68
That is not the case. Upon opt-out, the IRS controls the manner of evaluation going forward. While this is not always detrimental, it does remove control from the taxpayers and shift it to the IRS. 69 What this means is that clients who hastily elected to participate in the 2009 or 2011 programs to meet the initiative filing deadlines and on the assumption they could later opt out if further consideration showed the traditional voluntary disclosure program to be the better choice may be in a difficult position if they did not fully cooperate with the program agent or if they did not take appropriate care to ensure that the IRS case file properly and thoroughly reflected all the facts and circumstances favorable to their position.
Just as a taxpayer has the right to opt out of either the OVDI or OVDP, the IRS has the right to remove a taxpayer from either program. The IRS will remove a taxpayer from the program
only in those cases where the taxpayer or the taxpayer’s representative has been demonstrably uncooperative, the lack of cooperation has been documented by the examiner, and the examiner has concluded that the case would not be resolved in an appropriate timeframe pursuant to the civil settlement structure of the 2009 OVDP or 2011 OVDI. 70
The form letters under the program are drafted to accommodate these determinations if circumstances require. Consequently, practitioners should ensure timely cooperation with the agent and also should memorialize all relevant communications and submissions. The IRS letters are designed to prompt responses and to stimulate cooperation. The agents are required to document all calls and responses to the communications. The practitioner, therefore, has a degree of control over an agent’s discretion in removing a case from the program through his or her communication and cooperation.
Cases forwarded for removal are reviewed by the centralized committee in the same manner as an opt-out. Upon removal of a case from the program, all open and relevant years and issues may be considered. 71 In this context, the practitioner should be mindful of the applicable statutes of limitation, which, for FBAR penalties, is six years from the date that any unfiled FBAR was due to be filed, 72 and, for substantive tax penalties, generally three years from the due date of the return or the date of filing, whichever is later. 73
To participate in the OVDI or OVDP, the IRS requires that the taxpayer extend the statutes of limitation to accommodate all tax, penalties, and interest assessed under the penalty regimes of the programs. If the taxpayer does not wish to accept the penalties proposed under the program, the case will be removed and all applicable statutes (and their exceptions) will control. 74 To protect statutes from expiring while a case is pending in either the OVDI or OVDP, the agent may request statute extensions before the IRS offers a resolution under the program. The practitioner should consider all facts and circumstances and consult with the taxpayer, before agreeing to extend the statute of limitation. 75
Agent Discretion at the OVDI/OVDP Level
Since the IRS views the OVDI 25% penalty as a “proxy” for more stringent FBAR sanctions and other available IRS penalties, agents do not have discretion to “settle” cases for compromised amounts due to the taxpayer’s circumstances. This does not, however, mean that a practitioner should not bother to supply all relevant material helpful to the client to the program agent handling the FBAR file. Material provided may establish the exclusion of a particular account, or the entire case, from the penalty regime.
Moreover, the information provided and reported in the agent’s and taxpayer’s summaries to the centralized committee will have a bearing on the committee’s directions and disposition of the matter. 76 While the agent may have limited discretion to resolve the case at the OVDI level, it is that agent who manages the file and drafts the summary recommendation that the committee and any subsequent IRS personnel use. The agent, therefore, controls the state of the record in the case going forward. Failure to take full advantage of the FBAR program agent’s requests for documents and information may result in the case’s taking a less advantageous route in the event of removal or opt-out.
While agent discretion is limited in the OVDI, practitioners should stay current on IRS pronouncements. For example, under the 2011 program, some taxpayers are eligible for a 5% penalty rather than the 25% sanction envisioned as applicable in most situations. The IRS recently expanded the cases to which the 5% penalty may apply and made the changes retroactive to the 2009 OVDP. So, agents are now offering 5% in lieu of 25% penalties under the programs to resolve simpler and less flagrant cases. The IRS does not characterize this as discretion but, rather, application of the rules. Regardless of what it is called, program agents are being given more options in resolving and developing cases under the program. The prudent practitioner should stay abreast of these updated rules and delegations of authority, and use them to his or her advantage.
Accepting an engagement with respect to a voluntary disclosure does not come without responsibilities. The IRS requires the practitioner representing a client in a voluntary disclosure to exercise due diligence to ensure the accuracy of any representations the practitioner makes to the client about the program and the implications for the client in choosing to participate. The practitioner must exercise that same due diligence about the accuracy of any statements made to the IRS on behalf of the client in the context of the disclosure. An adviser “must avoid giving, or participating in giving, false or misleading information to the Department of Treasury or giving a false or misleading opinion to the taxpayer.” 77 This is a heavy, but not unrealizable, burden. It is best practice to ensure at the outset of the engagement that the client understands both his or her responsibilities and the responsibilities of the representative. It is in this manner that the practitioner will gain comfort that the client is committed to full and complete disclosure under the program.
What, then, should the practitioner do if the client chooses not to participate? If the taxpayer decides not to make the required disclosure despite noncompliance with the tax laws, the practitioner must, under Circular 230, 78 advise the client that he or she is noncompliant with the law and advise the client of the consequences. Further, Circular 230 prohibits a practitioner who is aware of a client’s decision not to make full disclosure of a foreign financial account, or income from such account, from preparing that client’s tax return for the year in question. 79 The result under the SSTS is similar; a CPA must consider withdrawal where a current tax return cannot be prepared without perpetuating an earlier error. 80 Consequently, the practitioner may be required to terminate the engagement of that client.
It is crucial for practitioners to understand that programs like the OVDP and OVDI are designed to (1) educate taxpayers on the filing requirements and (2) persuade people to “come out of the weeds” and disclose unreported accounts and assets. People will not respond to such a program unless they are sufficiently frightened by or concerned about the consequences of remaining in the weeds. As a result, the government must generate interest in voluntary foreign account disclosure through well-publicized prosecutions and penalties to establish to the public that the risk is clear and it is present.
Toward that end, the IRS and Department of Justice have recently publicized a number of criminal prosecutions of banking executives for aiding people in establishing and concealing foreign bank accounts. 81 In a similar vein, the Department of Justice reported a prosecution of an individual for establishing tax schemes involving foreign trusts. 82 Each announcement reminds the public of the voluntary disclosure initiatives and the need to voluntarily come forward in substantially similar circumstances. These stories often trigger clients’ awareness more effectively than broad, generalized admonitions using complex tax and statutory concepts. Advisers should expect inquiries when prosecutions are publicized and should consider using these government actions as examples when trying to inform clients about disclosure obligations.
The FBAR filing requirement must remain prominent on practitioners’ radar, as the focus on foreign accounts and assets is likely to grow in the near future. This prominence is no more clearly illustrated than by the IRS’s announcement of the new indefinite voluntary disclosure program, a move that places continued public pressure on United States citizens with foreign accounts to come into compliance through a specific, clearly marked door. As IRS Commissioner Douglas Shulman has stated, “[the IRS’s] offshore compliance effort is a multifaceted and multiyear effort.” 83 In its strategic plan for 2009–2013, the IRS specifically seeks to “enhance Bank Secrecy Act compliance.” 84 In fact, the plan specifically singles out FBAR violations as an operational priority. 85 With the new regulations governing FBARs going into effect on March 28, 2011, this priority status is unlikely to end. According to Shulman last year, the IRS has increased its workforce and international cooperation to confront foreign operations head-on. This includes the creation of a new high-wealth unit to examine the finances of very wealthy Americans, and foreign accounts and assets are fair game. 86
In fact, practitioners can count on more reporting obligations in the coming year as the new reporting requirements under FATCA become effective. Prior to its passage, Shulman referred to FATCA as “[p]robably the next big thing.” 87 The filing requirements under FATCA apply to tax years beginning after March 18, 2010. 88 Under new Sec. 6038D, taxpayers with any interests in specified foreign financial assets whose aggregate value exceeds $50,000 at any point during the tax year must file an information return with their income tax forms. 89 “Foreign financial assets” include both financial accounts maintained by foreign financial institutions and certain other foreign assets, for example, investments in a foreign hedge fund. 90
Taxpayers who fail to provide this information face a $10,000 penalty, subject to the usual reasonable cause exception. Once notified of their failure, taxpayers have 90 days to provide the information without additional penalty. After that 90-day grace period, the penalty increases by $10,000 for each additional 30-day period (or fraction thereof) that the failure to file continues, to a maximum of $50,000. 91 Lastly, a taxpayer faces an additional 40% accuracy-related penalty on any tax due from any “undisclosed foreign financial asset.” 92 The statute of limitation on the failure to file such a report is three years 93 but can run up to six years if the omitted income is substantial. 94
Depending on the value and type of assets a taxpayer possesses, both FATCA and FBAR requirements could apply. For example, a client with a $60,000 foreign hedge fund investment and $15,000 in an offshore bank account would need to make both disclosures. However, a taxpayer with $70,000 in a private equity fund and no other international investments would only be subject to FATCA, while a client with $20,000 in a foreign bank account would need to comply only with the FBAR rules. This means that determining what disclosure is necessary and when the disclosure must be made will be an additional concern for taxpayers and practitioners in the near future.
Taxpayers with unreported foreign bank accounts present themselves and their professional advisers with a host of important decisions. These decisions must be made based on careful review of all material information, an understanding of the potential tax penalties and interest involved, and the exposure to any other financial crimes or penalties. Regardless of how tempting, however, under no circumstances should advisers and clients ignore reporting requirements simply because the IRS has not yet raised the issue in the client’s specific case. To quote the timeless admonition of Neil Peart, “If you choose not to decide, you still have made a choice.” 95 And in the context of foreign asset disclosures, that choice could have substantial significance.
1 Bank Secrecy Act, P.L. 91-508.
2 Until 2004, no penalty even existed for negligent failure to file the required report. In addition, the reporting rules were formerly administered by the Financial Crimes Enforcement Network, which provided limited guidance and oversight (Blum, et al., BNA Tax Management Foreign Income Portfolios 947-1st: Reporting Requirements Under the Code for International Transactions XIII A (2009)).
3 See “Civil Sanctions” on p. 333.
5 2011 Initiative, FAQ 7.
6 See also the discussion on p. 336 regarding opting out of the 2011 Initiative. An opt-out would be appropriate, for example, where the penalties applicable to a U.S. person under the normal rules would be less than under the terms of the Initiative (2011 Initiative, June 2, 2011, update, FAQ 51.1).
7 Hiring Incentives to Restore Employment Act, P.L. 111-147, title V, subtitle A.
8 See Miller and Brody, “The 2011 OVDI: Is Voluntary Disclosure Really Better the Second Time Around?” 40 Tax Management International Journal 270 (May 2011).
9 A quiet disclosure occurs when a taxpayer files an amended return and pays any related tax and interest for previously unreported offshore income but does not otherwise notify the IRS. See 2011 Initiative, FAQ 15. See also “Quiet Disclosures” on p. 334.
10 31 C.F.R. §1010.350(b).
11 Form TD F 90-22.1 instructions (rev. Mar 2011).
12 31 C.F.R. §1010.350(b)(2) defines a resident as a resident alien under Sec. 7701(b), with an expanded definition of “United States.” See Blum, Portfolio 947-1st, supra n. 2, at XIII B 2. The Internal Revenue Manual (IRM) defines resident as someone “who is living in the U.S. and not planning to permanently leave” (IRM §126.96.36.199.1.1).
13 IRM §188.8.131.52.6. If periodic statements are not provided, use the largest amount of currency and nonmonetary assets in the account at any time during the year (id.).
14 Form TD F 90-22.1 instructions.
15 31 C.F.R. §1010.100(v).
16 This caution also applies to FATCA, discussed under “Future Outlook” on p. 339.
17 Included within this term are savings deposits, demand deposits, checking, or other accounts maintained with a person in the banking business (31 C.F.R. §1010.350(c)(1)).
18 A mutual fund or similar investment is treated as a reportable account if it issues shares to the general public that have a regular net asset value determination and regular redemptions ((31 C.F.R. §1010.350(c)(3)). Foreign mutual funds raise passive foreign investment company issues (2011 Initiative, FAQ 10; see Secs. 1291–1298 for applicable tax rules).
19 See 31 C.F.R. §1010.350(c)(3)(iii) for more details.
20 Blum, Portfolio 947-1st, supra n. 2, at XIII B 3.
21 IRM §184.108.40.206.2.
22 Blum, Portfolio 947-1st, supra n. 2, at XIII B 3. Apparently the standard for determining if noncash assets held in foreign accounts are reportable is whether the taxpayer can direct someone else to move or sell the asset, or otherwise accomplish transactions with respect to the account or assets in the account. In other words, if the taxpayer is the only person with authority to move or dispose of an item, then no reporting is required. This means a safe-deposit box held at a Mexican bank, with no authorization given to the bank to move or sell the assets, would be outside the reporting obligations (authors’ discussion with IRS FBAR Hotline personnel).
23 Form TD F 90-22.1.
26 31 C.F.R. §1010.350(e). This rule applies even if the account actually is maintained for the benefit of another person (id.).
27 31 C.F.R. §1010.350(e).
28 Id. A U.S. person who is the grantor of a trust and who has an ownership interest in the trust for tax purposes holds a financial interest in the foreign financial accounts the trust owns (id.). Under the regulations, the offshore holdings of “any other entity” in which a U.S. person directly or indirectly holds more than 50% of the voting power, total value of equity interests or assets, or profit interest will be attributed to the U.S. person (id.).
30 31 C.F.R. §1010.350(f)(1).
31 Blum, Portfolio 947-1st, supra n. 2, at XIII B 6. A reportable interest exists where a U.S. person has “signature or other authority” (IRM §220.127.116.11.5). “A person has other authority if the person can exercise power comparable to signature authority over an account by communication to the financial institution where the account is maintained, either orally or by some other means” (id.).
32 31 C.F.R. §1010.350(f)(1).
33 31 C.F.R. §1010.350(f)(2).
34 Form TD F 90-22.1.
36 2011 Initiative, FAQ 47. See discussion under “Practitioner Responsibilities” on p. 338.
37 Specifically, the requirements are that all accounts the nonfiling spouse is required to report are jointly owned with the filing spouse; the filing spouse timely reports the joint accounts on an FBAR; and both spouses sign the report (Form TD F 90-22.1 instructions).
38 For C corporations, the information is reported on Form 1120, Schedule N, Foreign Operations of U.S. Corporations.
39 Form TD F 90-22.1 instructions.
40 Form TD F 90-22.1 instructions. Note that the definition of affiliated group for purposes of consolidated tax returns is different. See Blum, Portfolio 947-1st, supra n. 2, at XIII C. See also IRM §18.104.22.168.1.1.
41 31 U.S.C. §5321(a)(5)(C). See IRM §22.214.171.124.5.5 (“The amount [balance] in the account at the close of June 30th is the amount to use in calculating the filing violation.”).
42 Miller and Brody, supra n. 8. The statute of limitation for FBAR penalties is six years from the date an unfiled FBAR should have been filed (2011 Initiative, FAQ 42).
43 See, e.g., 2011 Initiative, FAQ 8.
44 IRM §126.96.36.199.5.5. See also IRM §188.8.131.52 (“Thus there may be multiple penalty assessments if there is more than one account owner or if a person other than the account owner has signature or other authority over the foreign account. Each person can be liable for the full amount of the penalty.”).
45 Chief Counsel Advice 200603026 (1/20/06).
46 IRM §184.108.40.206.5.3.
48 Williams, No. 1:09-cv-437 (E.D. Va. 9/1/10). In Williams, the defendant failed to file FBARs by the due date of June 30, 2001. The accounts in question had been frozen at the request of the U.S. government on Nov. 14, 2000, after a meeting involving Williams and Swiss authorities. Williams claimed that he did not realize FBARs were required for accounts the government obviously knew about. The court concluded his failure was not willful.
49 2011 Initiative, FAQ 8. For a more complete discussion of tax fraud, see Hibschweiler and Salzman, “Tread Carefully: What CPAs Should Know About Tax Fraud,” 40 The Tax Adviser 20 (January 2009).
50 31 U.S.C. §5321(a)(5)(B). The latter requirement means the IRS examiner receives the delinquent FBARs from the nonfiler (IRM §220.127.116.11.4).
51 IRM §18.104.22.168.6.2. Mitigation rules also apply to willful FBAR violations. In a case involving an aggregate balance in offshore accounts of less than $50,000, for example, the mitigation guidelines provide for a penalty equal to the greater of $1,000 per violation or 5% of the maximum account balance during the calendar year (IRM §22.214.171.124.6.3). Conditions for mitigation in general include no history of criminal tax or Bank Secrecy Act convictions for the preceding 10 years; no history of past FBAR penalty assessments; and taxpayer cooperation (IRM §126.96.36.199.6.1). Other conditions relate to whether the funds involved were from an illegal source or were used to further a criminal purpose and also whether the civil fraud penalty was sustained against the taxpayer.
52 31 U.S.C. §5322.
53 Simon, No. 3:10-CR-56 RLM (N.D. Ind. 11/9/10). The defendant also was convicted of fraud involving federal financial aid (20 U.S.C. §1097).
54 Simon, No. 3:10-CR-56 RLM (N.D. Ind., 10/8/10).
55 2011 Initiative, FAQ 35.
56 The 2009 OVDP generally required, with some exceptions, (1) payment of any taxes due for 2003 through 2008, plus interest and accuracy-related or delinquency penalties, and (2) a 20% “FBAR-related” penalty equal to the highest aggregate value of the taxpayer’s foreign financial account balance for any year between 2003 and 2008. In some circumstances, the FBAR-related penalty could be eliminated or reduced to 5% of the account value or $10,000 per tax year.
58 John McDougal, special trial attorney and division counsel in the IRS Small Business/Self-Employed Division, speaking at the third annual Tax Controversy Forum sponsored by the New York University School of Continuing and Professional Studies (Coder, “No Traditional Disclosure Practice Allowed for Offshore Cases, IRS Officials Say,” 2011 TNT 113-3 (June 13, 2011)).
59 IRS, “Voluntary Disclosure: Questions and Answers,” Q&A-10 (May 6, 2009). See also Q&A-15 (Feb. 9, 2011).
60 Schiavo, No. 1:11-cr-10192-RGS (D. Mass.); Justice Dep’t press release, “Bank Director Charged with Hiding Foreign Assets” (5/19/11).
61 Hoffman, Raabe, Smith, and Maloney, West Federal Taxation 2008: Corporations, Partnerships, Estates and Trusts, 16-26 (Thomson South-Western 2008). For more on SSTS No. 1, see Gardner, Eide, May, and May, “Interpretations of SSTS No. 1, Tax Return Positions.”
62 Sec. 7206(2).
63 IRS, Opt Out and Removal Guide for 2009 OVDP and 2011 OVDI (June 1, 2011) . Presumably, this also applies to the 2012 program, but practitioners should stay alert for further IRS guidance.
64 2011 Initiative, FAQ 51.
65 IRS, Opt Out and Removal Guide for 2009 OVDP and 2011 OVDI, supra n. 63.
66 2011 Initiative, FAQ 51.
67 IRM §188.8.131.52.
68 Under Section 184.108.40.206.1 of the Internal Revenue Manual, the disclosure must be truthful, timely, and complete. Other requirements include good faith and a willingness to cooperate. See IRM §220.127.116.11.1 for more information.
69 See Coder, “No Traditional Disclosure Practice Allowed for Offshore Cases,” supra n. 58.
70 Opt Out and Removal Guide for 2009 OVDP and 2011 OVDI, supra n. 63. Again, this also presumably applies to the 2012 program, but practitioners must watch for guidance.
71 2011 Initiative, FAQ 51.
72 31 U.S.C. §5321(b)(1).
73 Sec. 6501. However, the three-year period extends to six in the event of a substantial omission of gross income (Sec. 6501(e)), and there is no statute of limitation in the case of a failure to file returns (Sec. 6501(c)(3)), or in the case of the filing of a false or fraudulent return (Sec. 6501(c)(1)).
74 2011 Initiative, FAQ 42. This discussion also likely applies to the 2012 initiative.
75 Of particular significance here is that the IRS has begun soliciting statute extensions not only for the Title 26 (Internal Revenue Code) tax and penalties, but also for the Title 31 FBAR penalties. Since the latter’s Section 5321(b)(1) does not contain the same provisions for extension by consent of the parties as does Code Sec. 6501, the IRS does not use the standard Form 872, Consent to Extend the Time to Assess Tax , typical in tax cases, but has developed an entirely different form. The practitioner must be mindful of all of these differences and must understand which limitation periods have expired, which are near expiring, and whether the facts and circumstances of the client’s case may result in an extension of the normal three-year statute under Sec. 6501.
76 For example, the practitioner should consider submitting information substantiating the fact that the taxpayer only recently became aware of the FBAR requirement. Also, if the funds in the account at issue are attributable to or taxable to some other individual, that information is relevant to a determination of willfulness or reasonable cause. Tax returns filed with a foreign country of residence reporting the income at issue are also important. The practitioner should partake in meaningful dialogue with the program agent about the items at issue, as the agent can provide insight into what substantiating documentation would satisfy the agent for the IRS inquiry. As with any audit, one never knows what information will prove significant to case resolution, and a productive means to explore that area is through dialogue with the agent.
77 2011 Initiative, FAQ 47.
78 Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10).
79 2011 Initiative, FAQ 47.
81 See, e.g., Justice Dep’t press release, “Former UBS Banker Charged with Helping U.S. Taxpayers Use Secret Swiss Bank Accounts to Evade U.S. Taxes” (8/2/11).
82 Trivedi, “Offshore Multiple Employer Plan Participants May Have FBAR Obligations,” 2011 TNT 148-2 (Aug. 2, 2011).
83 Bonner, “Tax From the Top: Q&A With IRS Commissioner Doug Shulman,” 209 Journal of Accountancy 16 (April 2010).
86 Bonner, “Tax From the Top,” supra n. 83.
88 Hiring Incentives to Restore Employment Act, §511(c).
89 Sec. 6038D(a).
90 Sec. 6038D(b).
91 Sec. 6038D(d).
92 Secs. 6662(b)(7) and (j).
93 Sec. 6501(c)(8)(A).
94 Sec. 6501(e).
95 Rush, “Freewill,” on Permanent Waves (Mercury Records 1980).
Randall Andreozzi is a partner with the law firm Andreozzi, Bluestein, Fickess, Muhlbauer Weber, Brown LLP in Clarence, N.Y. Arlene Hibschweiler is a full-time adjunct associate professor in the School of Management’s Department of Accounting and Law at the State University of New York at Buffalo in Buffalo, N.Y., where Mr. Andreozzi is also a part-time adjunct professor. For more information about this article, contact Mr. Andreozzi at firstname.lastname@example.org or Prof. Hibschweiler at email@example.com.