In recent years, the United States government has intensified its efforts to collect taxes on income generated by offshore bank accounts and financial holdings. A key tool in these enforcement efforts is a provision under the Bank Secrecy Act requiring United States persons (generally U.S. citizens, green card holders, or individuals spending a certain number of days in the United States within the last three years), or non-resident aliens located and doing business within the United States, to disclose annually to the Treasury Department a financial interest in, or signature authority over, a foreign financial account (including bank accounts, brokerage accounts, mutual funds, trusts, or other types of foreign financial accounts). The method of reporting these accounts to the IRS is by filing a Report of Foreign Bank and Financial Accounts (FBAR).
Until recently, FBAR filings could be made electronically or on paper. However, new rules effective July 1, 2013 require FBAR filings to be made electronically. These rules have raised concerns that taxpayers filing delinquent FBARs will not be able to adequately explain the reason for the delinquent filing and thus become subject to penalties.
General Qualifications of and Exemptions to Mandated FBAR Reporting
Generally, United States persons (which includes business entities and trusts created or formed in or under the laws of the United States), and non-U.S. persons located in and doing business within the United States, must file an annual FBAR disclosing the existence of all foreign financial accounts in which they hold a financial interest, or on which they hold signatory authority, if the aggregate value of the accounts exceeds $10,000 at any time during the calendar year.
Several exceptions apply to the FBAR filing requirement. Generally, parties that hold signatory power but no financial interest in a foreign account, holders of interests in accounts owned by foreign governments, IRA owners and beneficiaries, United States persons included in a consolidated FBAR, participants in, and beneficiaries of, tax-qualified retirement plans (e.g. a qualifying defined benefit plan), and trust beneficiaries (so long as the trust itself files the necessary report), are all generally exempt from the FBAR filing requirement.
If a taxpayer does not fit into one of the exemption categories and he or she holds an interest in or signatory authority over a foreign financial account the taxpayer must file an FBAR.
Mechanics of FBAR Filing and a New Electronic Filing Requirement
Parties subject to the FBAR filing requirement must file their FBAR (via TD F 90-22.1) by June 30 of the year following the year subject to reporting (for example, FBARs for 2012 must have been filed by June 30, 2013). It is important to note that the FBAR is filed with the Financial Crimes Enforcement Network (FinCEN), not the IRS.
As of July 1, 2013, all FBARs must be filed electronically on the prescribed form (TD F 90-22.1) unless an exemption from electronic filing is requested and granted. Amendments to previously filed FBARs must also be made electronically. Previously, FBARs could be filed electronically or on paper, even after the FinCEN announced its E-File program in 2011. Because FBARs for 2012 were required to be filed by June 30, 2013, the the new electronic filing requirement will primarily effect taxable year 2013 FBAR filers or delinquent 2012 filers.
FBAR Penalties and the Reasonable Cause Exception
The new electronic filing requirement has raised the concern among commentators that the required form in its current state does not contain a section to explain any delinquencies or past failures to file an FBAR.
An opportunity to explain past non-compliance with the FBAR requirements can be important for taxpayers seeking to avail themselves of the “reasonable cause” exception to the penalties imposed as a result of FBAR non-compliance. Specifically, failure to timely file or properly complete an FBAR can give rise to civil penalties of up to $10,000 per violation. Willful violations, for which there can be no reasonable cause exception, give rise to penalties up to the greater of $100,000 or half the balance of the subject account and may expose the violator to criminal liability.
Penalties for non-willful violations will not be imposed where the late filing or failure to file was the result of “reasonable cause,” and where all income from the subject account(s), and the account’s balance, were properly reported. Reasonable cause in this context is determined by examination of all of the facts and circumstances applicable to each taxpayer. IRS guidance indicates that factors that weigh in favor of a finding of reasonable cause include reliance on the advice of a professional tax advisor knowledgeable of all relevant facts, the fact that the subject account(s) were established for legitimate purposes, that no efforts were made to conceal income or assets, and there was no tax deficiency related to the unreported foreign account. No single factor is determinative.
Because circumstances constituting “reasonable cause” are often detailed and varied, and the opportunity to fully explain the circumstances would clearly benefit a taxpayer in his or her efforts to avail himself of the reasonable cause exception. However, until a new electronic form providing space to explain a delinquent filing becomes available at the end of September, FBAR filers appear to be without that opportunity. IRS guidance indicates that before the new form allowing for electronic submission of reasonable cause explanations becomes available, FBAR filers should create a statement but retain it for use if the IRS subsequently requests it rather than submit it with their FBAR filing.
To access FinCEN’s electronic filing system, a party must first register in the Bank Secrecy Act filing system. Third parties other than the subject taxpayer may complete the FBAR and its electronic filing and serve as the taxpayer’s liaison with the FinCEN provided that the third party representative registers with the Bank Secrecy Act filing system. A new form (FinCEN 114(a)) is used to document a taxpayer’s authorization of a third party representative.
Relationship between FBARs and the Offshore Voluntary Disclosure Program
In January 2012, the IRS reopened the Offshore Voluntary Disclosure Program (OVDP) to allow taxpayers with unresolved tax issues relating to assets held abroad to resolve those issues with reduced penalties by fully disclosing the existence of those assets to the IRS. The IRS reopened the program in response to continued interest in the program following its implementations in 2009 and 2011. Depending on a taxpayer’s circumstances, FBAR filing may also be part of a taxpayer’s OVDP reporting.
Taxpayers who failed to file FBARs in the past and failed to pay taxes on related income can take advantage of the OVDP by filing full and complete FBARs for the applicable years, paying any tax owed on the disclosed accounts, paying any applicable failure to pay penalties (IRC § 6651) or failure to file penalties (IRC § 6652), and paying a penalty equal to 27.5 % of the highest aggregate balance in the taxpayer’s foreign accounts over the period covered by the voluntary disclosure.
This flat penalty subsumes FBAR and other potentially applicable penalties (including willfulness penalties) and may therefore provide a significant reduction in overall tax liability, especially for those taxpayers with significant offshore holdings. Whereas a finding of willfulness could lead to a penalty equal to 50 % of the offshore account’s balance, under the OVDP that penalty is cut almost in half.
Taxpayers who reported, and paid tax on, all their taxable income from whatever source, but failed to file FBARs, cannot take advantage of the OVPD program. Instead they are required to file delinquent FBARs pursuant to the standard procedure (which now mandates electronic filing of FBARs, as described above). According to IRS guidance, FBAR penalties will not be imposed for failure to file timely FBARs if there are no underreported tax liabilities and the taxpayer has not been contacted regarding an income tax examination or a request for delinquent returns.
For taxpayers who failed to file FBARs and failed to report and pay tax on related income, and who choose to participate in the OVPD program, FBARs must be filed as part of the voluntary disclosure. Although there is no express requirement to file OVDP documents electronically, it appears that the electronic filing requirement applicable to FBARs extends to the OVDP context. See Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers at No. 44, found here.