Taxpayers who are now separated or divorced and had undisclosed foreign bank accounts may wonder if “innocent spouse relief” is available under the Bank Secrecy Act for FBAR penalties. The answer is likely no but could be maybe. The obligation to file a Report of Foreign Bank Account (FBAR) is set forth in Tile 31 of the United States Code (U.S.C.) whereas income tax liability and innocent spouse relief are set forth in Tile 26 of the U.S.C. , the Internal Revenue Code (IRC). Innocent spouse relief is provided in IRC § 6015, including 6015(f), which provided in pertinent part as follows:
“1) on the date of the request for relief the requesting spouse is no longer married to, or is legally separated from, the nonrequesting spouse, or has not been a member of the same household as the nonrequesting spouse at any time during the 12-month period ending on the date of the request for relief; (2) on the date the requesting spouse signed the return he had no knowledge or reason to know that the nonrequesting spouse would not pay the income tax liability; and (3) the requesting spouse will suffer economic hardship if relief is not granted.”
There is no similar provision in Title 31. The penalties for failure to time file an FBAR are listed in 31 U.S.C. §5321(a)(5). The distinguishing features between the three categories of civil penalties are (1) whether there was “reasonable cause” for failure to file. Reasonable cause meaning reliance on the advice of a third party professionals advice;(2) whether the failure to file was “non-willful” , such as inadvertence based upon lack of awareness of the filing obligation;or (3) whether the action was willful such as a deliberate act of non-compliance. None of these penalties address the issue of innocent spouse relief which is a purely eguitable concept of the IRC. The Internal Revenue Service administers the FBAR statute and therefore the same Revenue Agent may ultimately face the challenge of determining whether Innocent Spouse Relief should be granted for unreported income such as interest and dividends earned on the undisclosed foreign account(s) and at the same time determine which FBAR penalty level applies. There is one opportunity, however, under the Internal Revenue Manual for the Revenue Agent to issue a Penalty Warning Letter, (Form 3800) in lieu of imposing penalties. Whether a warning letter is appropriate is in the discretion of the agent. What make this very hard to sort out is the complex circumstances under which FBAR penalty liability can arise.
Example 1: One spouse can be the sole signatory on a foreign account or both can be signatories, One or both of the spouses can have signatory authority but not ownership of the account funds (as in the case of family assets under management). One or both of the separated spouses may be under audit or one or both may be participant in the voluntary disclosure program (OVDP). Each case requires analysis and no single answer will apply as each will turn on its own facts and circumstances.
Example 2: If both ex-spouses enter the voluntary disclosure program is may be best for the “innocent spouse” to consider “opting out” of the program and then arguing the “innocent spouse” claim/equitable relief request outside the program once the issue of potential criminal exposure is resolved.
These are highly complex fact driven issues complicated by two statutory schemes which were not drafted to accomplish the same purposes. The risks are high if the wrong approach is taken and therefore it may be a good insurance policy to consider making a voluntary disclosure if there is reasonable basis for “innocent spouse” relief and the income taxes have or will be paid by the other spouse. Payment of the income tax, interest and a 20% accuracy related penalty on the under reported income is a key component on submission of the OVDP. If the income tax has not been paid, then other approaches may need to be considered.