Since 1970, the Bank Secrecy Act has required U.S. persons who have in aggregate more than $10,000 in foreign financial accounts to report certain information about those accounts to the Department of the Treasury using Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). The FBAR is an informational return that is filed separately from a tax return. It must be received by the IRS by June 30. Failure to file an FBAR can result in significant civil and criminal penalties. Although the reporting requirements have existed more than 40 years, many people with foreign accounts have never heard of the FBAR.
Some taxpayers became aware of the FBAR requirement when the IRS announced its first Offshore Voluntary Compliance Initiative (2009 OVCI), which generally eliminated the risk of criminal prosecution and provided reduced penalties. The 2009 OVCI began on March 23, 2009, and ended on October 15, 2009. The IRS received close to 15,000 disclosures under this program. On February 8, 2011, the IRS announced a second Voluntary Compliance Initiative (2011 OVCI) to provide a mechanism for those who did not participate in the 2009 OVCI to cure past FBAR noncompliance issues. To participate, taxpayers must file their disclosure on or before August 31, 2011.
With the 2010 tax season upon us and with the details of the 2011 OVCI released, taxpayers have several methods to cure their past noncompliance. This article first summarizes the FBAR reporting and recordkeeping requirements and the civil and criminal penalties associated with noncompliance with those requirements. It then outlines the currently available options, including participation in the 2011 OVCI. Because the proper course of action depends on the particular facts and circumstances of each case, taxpayers should discuss their options with a knowledgeable tax attorney.
FBAR Reporting and Recordkeeping Requirements
The Bank Secrecy Act and the regulations thereunder require “U.S. persons” having a “financial interest” in, or “signature or other authority” over, a bank, securities, or other financial account in a “foreign country” to report such relationships to the IRS on Form TD F 90-22.1 if the maximum aggregate value of these accounts exceeds $10,000 at any time during the calendar year. The Bank Secrecy Act also contains a recordkeeping requirement, which states that if a person is obligated to file an FBAR, then that person must keep records for five years from the due date of that FBAR.
To clarify when the Bank Secrecy Act triggers an FBAR obligation, the IRS has published guidance regarding the meaning of each of the important components of the requirement. The IRS’s guidance can be summarized as follows:
“U.S. person” means a U.S. citizen or resident or a domestic entity (including a single member LLC).
A U.S. person has a “financial interest” in an account if: (1) the person is the owner of record of the account (even if the account is maintained for someone else’s benefit); (2) someone else is the owner of record of the account on behalf of the U.S. person; (3) the U.S. person owns more than 50% of an entity (corporation, partnership, trust) that is the owner of record of the account; or (4) the owner of record of the account is a trust (or a person acting on behalf of a trust) that was established by the U.S. person and for which a trust protector has been appointed.
A U.S. person has “signature or other authority” over an account if the U.S. person can control the disposition of money in the account by delivery of a document containing his signature or has comparable power over the account.
A “foreign country” includes all geographical areas outside the United States, the commonwealth of Puerto Rico, the commonwealth of the Northern Mariana Islands, and the territories and possessions of the United States (including Guam, American Samoa, and the U.S. Virgin Islands). Significantly, whether an account is “foreign” depends on the location of the account, not the nationality of the financial institution.
A “financial account” includes a bank, securities, or other financial account—such as a mutual fund or a cash value insurance or annuity policy—but not individual bonds, notes, or stocks. (Foreign mutual funds are subject to additional rules and a punitive tax structure if the taxpayer does not or cannot make a timely election because foreign mutual funds are treated as Passive Foreign Investment Companies.)
Noncompliance with the FBAR Requirements May Result in Significant Penalties
Those who have not been complying with the FBAR requirement may be subject to steep civil and criminal penalties if caught by the IRS. There are penalties for negligent violations (for businesses only), non-willful violations (which apply even if a taxpayer had never heard of the FBAR), and civil and criminal willful violations (which apply if a person knew about the FBAR requirement but willfully and/or intentionally did not file an FBAR). The following is a breakdown of those penalties:
Negligent (Businesses Only)
$500 per violation
Up to $50,000 for pattern of violations
Up to $10,000 per violation
(which the IRS interprets to mean “per account”)
Willful (Civil Penalties)
The greater of $100,000 or 50% of the account balance
Willful (Criminal Penalties)
Up to $250,000 and/or 5 years in prison for a single violation
Up to $500,000 and/or 10 years in prison for a pattern of violations
If multiple years and multiple foreign accounts are involved, the penalties can easily exceed the balance of the foreign accounts. The following example illustrates the potential magnitude of the penalties.
Assume that a U.S. person has five foreign accounts and that the maximum balance of each account is $100,000. If the U.S. person does not file an FBAR, the IRS could determine that the violation was either non-willful or willful.
If the IRS determines that the U.S. person’s noncompliance was “non-willful,” meaning that the person didn’t file the FBAR because he did not know about the FBAR, the IRS could assess penalties of up to $10,000 per account per year and could assess a similar penalty for the recordkeeping violation. In our example, a non-willful violation could potentially result in penalties of up to $100,000 per year.
If the IRS determines that the U.S. person’s noncompliance was “willful,” meaning the person knew that there was an FBAR requirement but willfully and/or intentionally did not comply with it, the IRS could assess civil penalties and could recommend criminal prosecution. The civil penalties would be the greater of $100,000 or 50% of the aggregate balance each year. In our example, 50% of the aggregate balance is $250,000. So the civil penalty would be $250,000 for each year that there was an FBAR violation plus the IRS could assess a similar penalty if there was a recordkeeping violation. The criminal penalties that could be imposed would be up to 5 years in prison (10 for pattern of illegal activity) for each year and a fine of $250,000 (or $500,000 for pattern of illegal activity) for each year.
Correction of Past FBAR Noncompliance and the New Voluntary Disclosure Program
Taxpayers currently have several options on how to mitigate the possibility of steep civil and criminal penalties for noncompliance with the FBAR requirements.
Some taxpayers may be tempted to ignore past noncompliance and simply file correct returns and FBARs going forward. Unfortunately, this option does not offer any comfort regarding potential exposure to willful civil and criminal FBAR penalties that the IRS could impose for past noncompliance.
Another option is to file past FBAR returns with the Detroit office and to file amended income tax returns with the IRS Service Center reporting any underreported income. Once again, this option, called a “quiet disclosure,” does not give the taxpayer any certainty regarding penalties. In fact, the IRS has publicly stated that it will be examining and potentially criminally prosecuting taxpayers that make “quiet” disclosures.
A third option is to participate in the IRS’s new 2011 Offshore Voluntary Compliance Initiative. Under the new program, taxpayers submit past due FBARs and amended tax returns for 2003 through 2010. Taxpayers would therefore pay eight years of taxes owed plus interest and a 20% accuracy-related penalty on the full amount of underpayments of tax for all years. Participants would also agree to a one time 25% penalty that will be levied on the highest aggregate amount in the participant’s foreign account between 2003 and 2010. This penalty is a 5% increase over the one offered in the 2009 Offshore Voluntary Compliance Initiative. The 25% penalty would be in lieu of the standard potentially applicable FBAR penalties. Unlike the 2009 OVCI, the 2011 OVCI will recognize that some taxpayers are less culpable than others. The 2011 OVCI will allow a reduced penalty of 12.5% for taxpayers who own accounts with aggregate values of $75,000 or less. It will also allow a reduced penalty of 5% for taxpayers who either (1) did not know they were U.S. Citizens or (2) did not open the account, had minimal contact with the account, did not withdraw more than $1,000 in any year covered by the program, and can establish that taxes were paid on the funds deposited in the account. Additionally, taxpayers who have no unreported income related to their foreign accounts will be able to submit past due FBARs without incurring any of the FBAR penalties.
The IRS has once again stated that participation in the 2011 OVCI will “generally eliminate the risk of criminal prosecution.” To participate in the 2011 OVCI, taxpayers must submit amended tax returns, FBARs, and a check to the U.S. Treasury by August 31, 2011. Taxpayers who are interested in this program are advised by the IRS to begin gathering information now, rather than waiting until August. The IRS is calling the 2011 OVCI the “last, best chance for people to get back into the system.”
All of the options have pros and cons and each should be discussed fully with a tax attorney. The best option highly depends on the facts and circumstances, including the source of the funds used to establish the account, the reporting or non-reporting of the income from the account on the taxpayer’s tax returns, the balances of the accounts, the amount of income from the accounts, and the taxpayer’s knowledge.
Signature Authority and the FBAR’s Impact on Multinational Companies
Although the FBAR requirement is intended to catch terrorists, tax evaders, money-launderers, and drug dealers, it also impacts individuals who merely have signature authority over their companies’ foreign financial accounts. For example, if an officer of a multinational company is a U.S. person who has signature authority over one or more of that company’s (or of its foreign affiliates’ or related entities’) financial accounts, then the officer needs to file an FBAR even though he or she does not have a financial interest in that account.
There is an exception from the FBAR requirement for officers or employees of a domestic corporation whose equity securities are listed on any U.S. national securities exchange or which has assets exceeding $10 million and has 500 or more shareholders of record, but only if the officer/employee has no personal financial interest in the account and he has been advised in writing by the CFO or similar responsible officer of the corporation that the corporation has filed an FBAR that includes that account.
For those officers/employees that do need to file FBARs because they don’t fit into the exception discussed above, the good news is that the IRS has extended the deadline until June 30, 2011, for persons who only have signature authority, but no financial interest, in a foreign account. Thus, the officer in our example above could file FBARs for the past six years for his or her signature authority accounts by June 30, 2011, without triggering any penalties from the IRS. Surprisingly, however, one district court recently held that the extended deadline announced by the IRS does not guarantee immunity from criminal prosecution if the officer willfully or intentionally did not file FBARs. Additionally, as part of the 2011 OVCI, the IRS has stated that in most cases, if a taxpayer has mere signature authority over an account (e.g. an owned by his employer), then the taxpayer may cure the FBAR delinquency by filing past due FBARs with an explanatory statement by August 31, 2011, without incurring any penalties.
The IRS has stated that it plans to continue aggressively pursuing noncompliant taxpayers through audits, additional agreements with banks located in foreign countries, and through new reporting requirements that will be effective for tax years beginning after March 18, 2010. (For tax years beginning after March 18, 2010, Congress has enacted additional reporting obligations for those with “specified foreign financial assets” the aggregate value of which exceeds $50,000. The rules for when a person will have to comply with the new HIRE Act obligation differ from the FBAR requirements; penalties for noncompliance can amount to up to $50,000.)
The new 2011 Offshore Voluntary Compliance Initiative is an excellent opportunity for taxpayers to come forward voluntarily and cure past noncompliance. So, as this year’s tax season approaches, taxpayers should discuss with their tax attorneys whether they are subject to the FBAR requirements and what their options are if they have past noncompliance issues, including the possibility of participating in the new IRS voluntary disclosure program.