The IRS launched a new initiative fairly recently called the “Offshore Voluntary Disclosure Initiative” (OVDI) for taxpayers who failed to file foreign bank account reports (FBAR). It’s predecessor was the IRS’ older offshore disclosure program that was in effect until October 15, 2009. The newer program is intended to be less favorable than the earlier one.
A U.S. Person (including citizens and residents) who holds signatory authority over, or a financial interest in, a foreign financial account is obligated to file a report with the Treasury Department on Form TD F 90-22.1 (Report of Foreign Bank and Financial Account), also referred to as the FBAR, as long as the balance was over $10,000 at any time during the calendar year. Willful non-filing is considered a felony offense. Civil penalties also apply, equal to the greater of $100,000 or 50% of the account balance, and this penalty can be assessed annually. Therefore, the penalties can easily surpass the the actual total account balance. These steep penalties are imposed pursuant to the Bank Secrecy Act codified as part of Title 31 of the US Code, and not in Title 26 which contains the tax laws. Historically, enforcement of the FBAR regulations was the job of the US Treasury Department, but more recently, enforcement was delegated to the IRS.
As part of the new voluntary disclosure initiative, the IRS gave taxpayers until August 31 of that year to fess up. Taxpayers who came clean were charged a one-time, reduced FBAR penalty of 25% of the highest account balance at any point between the years 2003 and 2010. Also, they were required to file amended returns for every year from 2003 to 2010 to retroactively report any previously unreported income. All applicable taxes were due immediately on those amounts plus interest. The IRS also added an accuracy-related penalty of 20% of the unpaid tax for the years 2003 to 2010 pursuant to 26 USC 6661 and late filing penalties and/or late payment penalties under 26 USC 6651(a)(1) and (2) where applicable. In exchange, anyone who made a voluntary disclosure found themselves much less likely to face criminal prosecution, were able to avoid altogether potentially lofty civil penalties that could have completely wiped out entire accounts, and more.
In cases of account holders whose combined offshore account balances never exceeded $75,000 at any point between 2003 and 2010 the 25% penalty was reduced to 12.5%, but all other terms applied as normal. A minimal penalty of 5% was made available in two very limited situations.
The first group of taxpayera who qualified the 5% penalty had to meet all four of the following conditions:
(a) never opened or never caused the account to be opened (unless the bank required that a new account be opened, instead of allowing a change in ownership of an existing account, upon the death of the owner of the account);
(b) only made minimal, infrequent inquiries or service requests on the account, such as checking the account balance, updating information such like address changes, contact persons, or email addresses;
(c) have, except for a final withdrawal to close out the account and having the funds transferred to a U.S. account, not made a withdrawal of more than $1,000 in any year covered by the voluntary disclosure; and
(d) are able to demonstrate that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have evaded U.S. taxation). This category is intended to apply to persons who inherited the foreign bank accounts.
The other category is what some refer to as the “coma exception.” If a foreign resident of the U.S. was residing here but was unaware they were a U.S. citizen they are entitled to the 5% penalty. Indeed, a person in this situation could not be accused of willful failure to file an FBAR. This non-filing would have been due to reasonable cause. This would excuse them from the 50% penalty for willful failure to file an FBAR. Herein lies the major criticism of the OVDI – there is no circumstance under its rules under which a taxpayer can argue that they should not be charged any penalties when they can exhibit reasonable cause for non-filing, or that their penalty should be limited to $10,000 per violation under 31 USC 5321(a)(5)(A) since their failure to file the FBAR was not willful, but simply negligent.
Because taxpayers file the FBAR with the IRS there is much confusion since tax practitioners assume that the same procedures that apply under tax law also apply to FBAR violations; however, that is not necessarily so. For instance, there is no definition of a “resident” of the United States listed in the FBAR instructions, regulations, or statute. The term “resident alien” as defined in 26 USC § 7701(b) is not applicable for FBAR purposes. The IRS stipulates that the plain meaning of the term “resident” (for these purposes, someone who is living in the U.S. and not planning to permanently leave the U.S.) should be used for FBAR filing purposes.
Some other significant distinctions are:
The majority of people missed this interesting detail: when filing your personal income tax return, the Schedule B (where you are asked to report interest and dividends) you are asked the following question:
At any time during 2008 (for example), did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account? See page B-2 for exceptions and filing requirements for Form TD F 90-22.1.
If you check the “No” box, you raise your chances of becoming subject to a criminal charge of filing a false income tax return which is a felony pursuant to 28 USC 7206(1) punishable by up to three years in jail and a $100,000 fine or both
It is convenient for most people to assume that these problems are reserved only for wealthy tax cheats. In reality, we have found that it can be a major problem for immigrants left some money back home and came to the U.S. Most of them don’t have the foggiest idea that they are required to file an FBAR, check the appropriate box on Schedule B, or even report income on their foreign accounts on their U.S. tax returns. Just about universally, immigrants believe that income that was earned in another country by them is not taxable by this country unless they bring the money here. On the contrary, the law stipulates that U.S. citizens and residents do pay tax on their worldwide earned income.
Offshore bank accounts came into the spotlight in June, 2008 upon filing of a “John Doe Summons” by the IRS seeking an order from a federal court in Miami that would allow the Internal Revenue Service (IRS) to request information from Swiss banking giant UBS, AG about U.S. taxpayers who may have be using Swiss bank accounts to commit tax evasion. In the end, UBS gave up the names of about 4,500 such account holders in spite of the lionized Swiss bank secrecy. In March of 2009 the IRS announced a limited amnesty for those who neglected to file FBARs if they made voluntary disclosures by Oct. 15, 2009. Roughly 15,000 persons cane forward with bank accounts in more than 60 foreign countries. Since then 3,000 more taxpayers have made voluntary disclosures.
Persons who neglected to file FBARs out of sheer ignorance remain in a troubling quandry. Their choices are to either enter the program and pay lofty penalties, or withhold their confession, and risk discovery. If they are found out, they could indeed face financial ruin and possibly time behind bars if the IRS can demonstrate that their failure to file was willful. Regrettably, it takes a comprehensive review of all the facts and circumstances of each individual’s case to steer clients in making this decision, and sometimes the choice is still a bit unclear. Lawyers representing clients who have these issues should be fully aware that the IRS has taken a very aggressive position, and views a taxpayer’s failure to (a) report all offshore income, and (b) to check the “yes” box on the Schedule B, as strong indications of willfulness.
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