Many taxpayers have not taken advantage of the Offshore Voluntary Disclosure Program (OVDP) and are therefore exposed to civil and criminal penalties for not filing a timely Report of Foreign Bank Account (FBAR). Among the most common reasons for not coming forward is the cost, now 27.5% of the highest single year account balance during the years 2003-2011. There are two reduced penalties, however. There is a 13.75 % penalty when the highest single year account balance does not exceed $75,000 and there is a 5% penalty. The 5% penalty has the following requirements.
(1) Taxpayers who met all four of the following conditions: (a) didn’t open or cause the account to be opened (unless the bank required that a new account be opened, rather than allowing a change in ownership of an existing account, on the death of the account owner); (b) had exercised minimal, infrequent contact with the account, for example, to request the account balance, or update account holder information such as a change in address, contact person, or email address; (c) had, except for a withdrawal closing the account and transferring the funds to an account in the U.S., not withdrawn more than $1,000 from the account in any year for which the taxpayer was non-compliant; and (d) could establish that all applicable U.S. taxes had been paid on funds deposited to the account. For funds deposited before Jan. 1, ’91, if no information was available to establish whether such funds were appropriately taxed, it was presumed that they were.
There is a potential trap in the 5% penalty qualification, however, If the taxpayer who claims to have inherited the funds in the offshore account was a U.S. taxpayer at the time of the inheritance, then a Report of Foreign Gift or Bequest (Form 3520) may have been due. The penalty for not timely filing the Form 3520 ranges from 25% -35% of the gift or bequest, absent reasonable cause.
The issue that comes up is will the IRS assert that the a Form 3520 was necessary and without it there is no valid gift or inheritance claim. The best approach, therefore, is to include a late Form 3520 with the OVDP filing. Taxpayer’s should not risk the possible denial of the reduced 5% penalty. The consequences of waiting to be discovered include potential civil willfulness penalties of 50% of the account balance per year or $100,000 whichever is greater, and prosecution.