BY JOHN FREDERICK KARCH, TREVOR K. ROBERTS, insidecounsel.com
AUGUST 26, 2015
Do you have any bank or other financial accounts in foreign institutions? Did you know that if the aggregate value of those accounts exceeds just $10,000 at ANY TIME during the calendar year, you may have to file a report called an FBAR – a Report of Foreign Bank and Financial Accounts – with the U.S. Treasury? And did you know that under FATCA – the Foreign Account Tax Compliance Act – you may have to file a separate form with the IRS if the aggregate value of those foreign accounts exceeds $50,000 (or $200,000 if you are living abroad)?
These regulations are part of the United States’ growing efforts to crack down on tax evasion and abusive offshore transactions. And though most people are unaware that FBAR and FATCA even exist, millions of U.S. taxpayers are responsible for complying with these reporting requirements – including about 8.7 million expatriates living abroad. Ignorance of these disclosure laws is no excuse and, as the cases below demonstrate, the government is not bluffing when it comes to enforcement.
Michael Canale, a retired U.S. Army surgeon, pled guilty to willfully failing to report about $1.5 million he had in a Swiss bank account. Canale was penalized $766,423.50 for his intentional failure to report, forced to pay $216,407 in back taxes and fined $100,000. He was also hit with an additional $150,000 civil fraud penalty. Canale also faced jail time of up to 40 months, but his sentence was reduced to just six months in consideration of his military service and his service to the local community.
Mary Curran, a 79-year-old non-working widow, inherited $43 million held in an account in UBS, Switzerland’s largest bank, from her husband. Unfortunately, Curran’s financial adviser failed to inform her of the federal government’s reporting requirements. She was prosecuted and forced to pay $21.7 million in penalties and $700,000 in back taxes.
Ty Warner, the founder of Ty Inc. (the maker of Beanie Babies), went to great lengths to hide his foreign assets, going so far as to instruct a bank to destroy records. Warner was caught, nevertheless, and after a lengthy trial and appeal, he agreed to pay a civil penalty of $53 million (which is almost ten times the amount of taxes he originally owed), pay $27 million in back taxes, serve two years’ probation, and perform 500 hours of community service.
It should be noted that, while these penalties may seem harsh, they actually could have been much worse! FBAR violators, for example, can face fines of up to $500,000 and prison sentences of up to 10 years (see below). It is therefore vital that anyone with an interest in a foreign financial account knows their disclosure duties. And while this article will serve as a good starting point for understanding the FBAR and FATCA reporting requirements, readers should also visit the official IRS website for more detailed information.
Under the Bank Secrecy Act (197, as amended), FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), must be filed if the aggregate value of one’s foreign accounts exceeds $10,000 at any point during a calendar year. An FBAR must be filed electronically by June 30 of the year following the year being reported. The few, very limited exceptions to this FBAR filing requirement are listed in the FBAR Electronic Filing Instructions.
Who must file an FBAR?
The FBAR filing requirement applies to any “U.S. person” with an interest in, or signature or other authority over, an account held in a foreign bank or other financial institution. This includes, but is not limited to, offshore bank accounts, mutual funds, and variable annuities (Swiss annuities). A U.S. person can be an individual, such as a U.S. citizen or U.S. resident, or it can be an entity treated as a person for tax purposes, such as a corporation, a partnership, a limited liability company (LLC), or even a domestic estate or trust.
An FBAR is NOT filed with the IRS!
It is important to understand that the FBAR is not filed with your tax return. An FBAR is filed directly with the Financial Crimes Enforcement Network (FinCEN), a bureau of the Treasury Department. This form can only be completed through the BSA E-Filing System website and, unlike one’s tax returns, THERE IS NO PROVISION FOR REQUESTING AN EXTENSION FOR AN FBAR! However, space is provided on the FBAR itself if one wants to provide an explanation for a late filing.
NOTE: The timely filing of an FBAR does not cure the failure to file FBARs in previous years.
Penalties for non-compliance with the FBAR filing requirement
The maximum civil penalties for knowingly and willfully failing to file a complete and correct FBAR may be the greater of $100,000 or 50 percent of the balance in the account at the time of the violation FOR EACH VIOLATION, and the maximum criminal penalties include a fine of up to $500,000 and imprisonment of up to 10 years. See the IRS FBAR Reference Guide for a comprehensive list of the penalties that may be imposed.
The Foreign Account Tax Compliance Act of 2010 (FATCA) generally requires U.S. taxpayers with “specified foreign financial assets” worth an aggregate value of over $50,000 on the last day of the tax year (or a value of $75,000 at ANY POINT during the year) to report these assets to the IRS. This threshold is generally $200,000 for U.S. taxpayers living abroad. If no information regarding the fair market value of a reported asset is available from a reliable source, a reasonable estimate will be sufficient for reporting purposes.
NOTE: To qualify as “living abroad” must reside outside of the U.S. for 330 days out of a consecutive 12-month period.
Specified foreign financial assets
Specified foreign financial assets include foreign financial accounts and non-account assets that are held for investment (i.e., assets not for use in one’s own trade or business), including foreign stocks and securities, financial instruments, and interests in foreign entities. If you have such specified foreign financial assets that meet the applicable threshold, you must complete part III of Schedule B (Form 1040A or 1040) and Form 8938, which should be attached to your tax returns. Additional attached forms may be required for ownership in a foreign corporation (Form 5471), passive investment company (Form 8621), and partnership or LLC (Form 8865).
NOTE: An extended tax due date for expatriates is June 15, but you must attach a statement explaining that you live abroad to take advantage of this automatic extension. A request for an extension for one’s taxes will also serve to extend the Form 8938 due date.
There are a few exceptions to FATCA’s foreign asset reporting requirement. For example, if you do not have to file a U.S. income tax return for the year, then you do not have to file Form 8938 (regardless of the value of your foreign assets). Also, the asset value threshold is doubled for married taxpayers filing jointly to $100,000 for married couples living in the U.S. and $400,000 for married couples filing jointly living abroad. Other exceptions are listed on the Instructions for Form 8938.
Keep in mind that the Form 8938 filing requirement is in addition to, not in lieu of, any required FBAR filing. Similarly, Form 8938 in no way replaces or obviates the need to report worldwide income, including income from foreign trusts and foreign bank and securities accounts, on Schedule B. Part III of Schedule B asks about the existence of foreign accounts, such as bank and securities accounts, and U.S. citizens are generally required to report the country in which such accounts are located.
Penalties for non-compliance with FATCA filing requirements
If you fail to comply with a requirement to Form 8938, you may be subject to a $10,000 failure to file penalty per violation, an additional penalty of up to $50,000 for continued failure to file after IRS notification, and a 40 percent penalty for an understatement of tax attributable to non-disclosed assets. If you make a showing that your failure to disclose was due to reasonable cause and not willful neglect, a penalty may not be imposed. However, reasonable cause is determined on a case-by-case basis.
The Offshore Voluntary Disclosure Program (OVDP) has been set up as a limited amnesty for people with “willful” unreported taxable income from offshore financial accounts, or other foreign assets. Generally, OVDP gives taxpayers the opportunity to fulfill their FBAR and other reporting duties and grants them protection from criminal liability, including IRC §6663 fraud penalties of up to 75 percent of the unpaid tax, and it also provides more lenient terms for resolving other civil tax and penalty obligations.
There is no deadline for applying for OVDP, but taxpayers should be aware that OVDP can be expensive, and it can trigger state/local tax audits. Also, you must understand that OVDP requires that applicants do the following for the preceding 8-year period:
- Disclose previously unreported foreign assets and income;
- Disclose any persons who helped hide the foreign assets and income;
- File amended federal income tax returns and pay any unpaid tax plus (in general) a 20 percent penalty and interest; and
- Pay a separate OVDP penalty of up to 50 percent of the highest combined value of the taxpayer’s unreported foreign financial account and other assets for certain banks.
Special IRS procedures are also available for those living abroad who have recently become aware of their filing obligations and who now seek to come into compliance with the law. These new procedures are for non-residents including, but not limited to, dual citizens who have not filed U.S. income tax and information returns. In exchange for a waiver of charges that could result in jail time or a felony on your record, you must do the following:
- Certify that your failure to file was non-willful;
- File 3 years of back tax returns reflecting unreported foreign source income;
- File 6 years of back FBARS;
- Calculate interest on each year on unpaid tax; and
- Apply a 5 percent penalty of the highest balance of the account in the past six years (this requirement only applies if you reside in the U.S.).
Requirements imposed on foreign financial institutions
FATCA also requires that foreign financial institutions report to the IRS information about accounts held by U.S. taxpayers (including foreign entities in which a U.S. taxpayer holds a substantial interest). This regulation applies to foreign banks, brokerages, certain insurance companies, and even some non-financial entities. U.S. financial institutions and other withholding agents must withhold 30 percent on certain U.S. source payments made to foreign entities that do not document their FATCA status. They must also report to the IRS information about certain non-financial entities with substantial U.S. ownership. To avoid withholding requirements and potential denial of access to operations in U.S. markets, a foreign institution must register with the IRS, obtain a Global Intermediary Identification Number (GIIN) and report the required information pertaining to U.S. accounts to the IRS.
An interesting side note is that a lawsuit has been filed in federal court, Crawford v. U.S. Department of Treasury, by Rand Paul and six others that seeks to strike down many of FATCA’s provisions. This complaint alleges that FATCA is unconstitutional because the intergovernmental agreements (IGAs) the Treasury Department has reached with foreign countries violates Article II, Section 2 of the Constitution, requiring two-thirds of U.S. senators present and voting to approve a foreign treaty. The complaint also alleges:
- The Heightened Reporting Requirements for Foreign Financial Accounts Deny U.S. Citizens Living Abroad the Equal Protection of the Laws
- The FBAR Willfulness Penalty is Unconstitutional under the Excessive Fines Clause
- FATCA’s Information Reporting Requirements are Unconstitutional under the Fourth Amendment
If you have a foreign financial account and are unsure if the FBAR and FATCA reporting requirements apply to you, contact a tax attorney as soon as possible. Immediate action may be required because once the IRS commences an investigation, it may be too late for you to participate in the OVDP or other voluntary procedures in order to avoid the most severe civil and criminal penalties. An experienced lawyer will be able to analyze your case, answer your specific questions, and offer you options that will help you obtain the best results possible.