The Report of Foreign Bank and Financial Accounts, Form TD F 90-22.1 (also known as “FBAR”) for 2010 is due this June 30 (next Thursday). This form must be filed by all U.S. persons with a financial interest in or authority over a foreign financial account. Because this form is not part of one's tax return it is often overlooked, particularly by U.S. tax residents residing abroad where U.S. tax reporting expertise may be limited. Until recently, many taxpayers required to file this form were not even aware of their filing obligation.
This is an annual filing requirement, so failure to file this form in past years will expose one to substantial penalties that could be as high as 300% of the balance in one's foreign financial accounts.
It may not be simple to determine whether you are required to file this report. The form instructions do not address many questions that have arisen in particular situations. The requirement to file involves a set of decision points that may depend on specific definitions of key terms. The IRS recently issued final regulations clarifying some of the issues that have been raised by taxpayers. The deadline for filing the FBAR for 2010 is June 30, 2011. There are no extensions.
It is important to correct past years delinquencies in order to protect against the above penalty. Below are the options available for handling these delinquent FBAR filings. The variances between the options essentially revolve around the uncertainty of an IRS audit, along with other risk factors that should also be considered:
Option 1 – Do Nothing One could do nothing with regard to past years, and simply be in compliance going forward. This approach is not advisable. The statute of limitation on FBAR filings is six years. Accordingly, the exposure to potential penalties is huge. Upon audit, penalties and criminal charges would likely be imposed, and the taxpayer would have nothing to show the IRS to argue against such heavy penalties.
Option 2 – File Past FBARs from 2005 Forward A taxpayer could simply file past years' FBARs for 2005 through 2010 (six years). This option is simple, low cost, and should limit penalties to $10,000 per violation. The disadvantage to this option is the potential for assessment of FBAR penalties as high as 300% of your account balances. For example, if one left $100,000 in a foreign account, the IRS could impose penalties of 50% x $100,000 x 6 years = $300,000.
This is not a likely outcome as the IRS would need to prove taxpayer willfully violated the FBAR filing requirements to properly assess this penalty. It is the IRS's burden of proof to show a willful violation of the FBAR filing requirement. In this case, showing willfulness requires the IRS to show that the taxpayer knew of the requirement to file, and decided not to comply by filing the appropriate form. Also helpful would be for the taxpayer to obtain an advisory letter from a tax professional recommending this course of action. Whenever one is confronted with penalties, a key element of getting penalties waived is to indicate that one is following the advice of a qualified advisor.
Option 3 – File Past FBARs (6 Years) and Amended Returns (3 years) In addition to filing past years' FBARs, a taxpayer may also consider filing amended returns to report unreported income in the foreign accounts. This option is also relatively simple, but is slightly more costly than Option 2 above due to increased professional fees for preparing amended returns and the payment of additional tax. However, this approach provides greater arguments, in the event of an audit, to limit possible penalties.
The ability for the IRS to impose the 50% penalty still exists, but is significantly lowered as a result of one's good faith filing of the amended returns. This is particularly true if the unreported income is minimal.
Although the statute of limitations for FBAR filings is six years, the statute of limitations for assessment of additional tax is generally only three years. Accordingly, the IRS should not be able to reach back further than three years to assess additional tax. If, however, more than 25% of one's income is not properly reported in one's returns, the statute is six years. Filing these amended returns will reduce interest owing on additional taxes assessed, but more importantly filing shows a good faith effort to comply with the reporting rules. Showing good faith to the IRS may be valuable in the event of an audit to augment an argument for non-willful violations.
Such filings should be accompanied by a letter explaining the reasons for the amended returns and delinquent FBAR filings. It also may allow the taxpayer to argue reasonable cause for the failure to file FBARs, which might reduce the penalties further.
At the same time, however, it also brings greater attention to the taxpayer. These so called "noisy" filings are typically viewed by actual IRS personnel as are most amended returns. Additionally, such filings should be accompanied with a letter explaining the amended filing and delinquent FBAR filings. Together, the package may call attention to itself.
Regardless, this approach is likely the most professional treatment, and should result in the most efficient outcome.
Option 4 – Voluntary Disclosure The Offshore Voluntary Disclosure Initiative ("OVDI") of 2011 (offering a 25% penalty on the highest balance in one's foreign accounts in the past eight years in lieu of all other back year reporting penalties) is currently in process, and open to participation until August 31, 2011. There is a 90 day extension of that date in limited circumstances. Additionally, the voluntary disclosure program itself will still exist beyond that deadline. The penalties that may be assessed outside the 2011 OVDI program, however, are potentially much higher.
The principal advantage offered by the OVDI program is exemption from criminal prosecution. In a majority of the cases, however, criminal prosecution is not an issue as the unreported income is often insignificant. A second advantage of the OVDI program is certainty in the amount of penalties due (25% of highest balance in past eight years plus value of certain property; 12.5% for account balances below $75,000). The property to which the penalty applies includes property acquired with unreported income and/or property generating unreported income.
A disadvantage is that these penalties are non-negotiable. There is absolutely no ability within the program to argue a non-willful violation regardless of the taxpayer's circumstances. There is no ability to maneuver or even appeal these very punishing and inequitable penalty assessments.
Taking advantage of the OVDI program requires amending tax returns for the past eight years (2003-2010) to report all unreported income.
Additional tax, penalties and interest would be assessed on outstanding taxes. On top of that would be the 25% (or 12.5%) FBAR penalty. Despite the general six years statute of limitations on income tax filings, the IRS requires a waiver of that statute for taxpayers to enter the program.
Taxpayers that entered the 2009 program are being hit with significant penalties and are now considering withdrawing from the program and processing their amended returns and FBARs through the normal audit process where penalties can be reviewed and negotiated. This may be a good option for taxpayers that were not negligent, but were merely uniformed about the FBAR reporting.
There are many options to the taxpayer to manage one's delinquent FBARs. The IRS wants taxpayers to participate in the OVDI program. Participating in the OVDI program is definitely the answer if there is a real risk of criminal prosecution. Often times, however, the OVDI program may prove unwise and overly costly to the taxpayer. Indeed, numerous clients in the program desire to withdraw from the program, but fear the world "outside".
The better approach may be to simply file delinquent FBARs, and amend returns as necessary to report associated unreported income. If audited, the taxpayer will then be able to argue that their oversight was non-willful, which is not available in the program. The penalties issuing from a successful argument will likely be far below the 25% penalty being offered in the OVDI program by several magnitudes. The risks associated with staying out of the program are present, but according to the case law are not great. Outside the program, taxpayers enjoy the freedom to argue and negotiate reduced penalties.
Rowbotham International Presentation Rowbotham International participated in a panel discussion at the Indian Community Center in Silicon Valley on June 2, 2011. The discussion involved investing abroad and related U.S. tax reporting implications. Our presentation dealt with the very time sensitive issue of reporting foreign bank accounts (FBAR filings), which are due June 30.
You can view the slides for our presentation here.
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