FBAR Penalties and the Reasonable Cause Defense

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Some taxpayer’s who think that they have properly relied on the advice of professionals and should therefore be able to avoid FBAR penalties need to consider what constitutes “reasonable cause”. First, the reasonable cause cases generally arise under the income tax laws and regulations, established under the Internal Revenue Code. FBAR penalties are assessed under the Bank Secrecy Act, which is part of the USA Patriot Act. The precedent set forth in the tax cases, may not, therefor, strictly apply in both contexts. Second, a “reasonable cause defense requires several elements. These elements are described as follows:

“A taxpayer may demonstrate reasonable cause through good-faith reliance on the advice of an independent professional, such as a tax adviser, a lawyer, or an accountant, as to the item’s tax treatment. sec. 1.6664-4(b), Income Tax Regs. To prevail in this effort, the taxpayer must show that he or she: (1) selected a competent adviser with sufficient expertise to justify reliance; (2) supplied the adviser with necessary and accurate information; and (3) actually relied in good faith on the adviser’s judgment”

It is important to note that each of the elements must must be met. If the elements are all met then the taxpayer may have a reason to either not enter the Offshore Voluntary Disclosure Program, (“OVDP”) or “opt out” of the program. The decision to either not enter the OVDP or “opt out” require a very careful analysis of the underlying facts and circumstances of the failure to file FBAR’s. For those taxpayer’s who have otherwise reported all taxable income earned on a worldwide basis and have no substantial risk on audit then an “opt out” or reasonable cause late filing can be considered. What is essential to the analysis is a careful review of the information proved to the taxpayer’s professionals and when it was provided.

Example:
FBAR filings must be received by June 30 in the Detroit Service Center. New filings are can be made on-line by the e-file system. The FBAR penalty is assessable based upon late filing, even if the late filing is just a day late. Suppose the professional filed the FBAR with the income tax returns, therefore, mailing late and to the wrong address, the FBAR penalty is assessable but may be subject to abatement for reasonable cause. Whether a reasonable professional should have known the correct filing address and method, and the due date of the FBAR, will be a matter to be considered in the reasonable cause argument. There is no guaranty that under these circumstances the taxpayer can establish “reasonable cause” defense to FBAR or tax related penalties.

Other factors to consider in deciding to enter or “Opt Out” of the OVDP include risk of other issues arising under examination. Such issues include other unfilled information returns, like Form 3520 (Report of Foreign Gift or Bequest) which has a 25%-35% failure to file penalty based upon the Value of the unreported gift or bequest. Here again a “reasonable cause” defense many apply, but the same standards or reasonable reliance must be met.

The ultimate issue to consider is whether the professional will admit in writing his/her error or resist the admission. In most cases if the taxpayer asserts reasonable reliance, and privileges that may exist will be waived. Careful consideration of privilege waiver is essential as the IRS will surely seek to interview the professional and review his/her files before abating penalties. In some cases what the taxpayer will find is that rather than having obtained reasoned advice, the taxpayer received advice below the standard of care. While failing the standard of care may vest claims against the professional, it does not constitute “reasonable cause” in most cases.

The lesson is that with 2012 FBAR’s and other information returns due or coming due, taxpayers must take care to fully and accurately disclose information about foreign assets to competent professionals, skilled in the offshore area, and get written advice where needed.