Calculating FBAR (FinCEN 114) Penalties – IRS Legal Standards
- 1 FBAR Penalty Calculations
- 2 Understanding How FBAR Penalties Work
- 3 What does that all Mean?
- 4 FBAR Penalty Mitigation
- 5 FBAR – A Brief History
- 6 Filing an FBAR
- 7 What Are FBAR Penalties?
- 8 What is the Legal Standard for Willful and Non-Willful?
- 9 Why Are FBAR Penalties So High?
- 10 Turning Non-Willful Violations into Willful Violations
- 11 Can I be Criminally Prosecuted for FBAR?
- 12 IRS Offshore Voluntary Disclosure
FBAR Penalty Calculations
Trying to calculate FBAR penalties is a crapshoot, and the IRS Guidance on Legal Standards for the FBAR Penalty is burdensome at best.
The FBAR is the Report of Foreign Bank and Financial Account form. It is a form required to be filed annually by U.S. Persons who have more than $10,000 in foreign accounts on any given day of the year.
While there are some exceptions, along with some exclusions, there is not much wiggle room when it comes to the filing requirements.
Moreover, the IRS does not provide nearly enough information to individuals for them to even know they ever had a reporting requirement.
Rather, the IRS basically leaves it up to each individual and his or her tax representative (if they have one) to stay current and up-to-date to the reporting requirements.
Understanding How FBAR Penalties Work
When a person fails to file a FBAR, the penalties can range from the benign (a warning letter in lieu of penalty) to a catastrophic (100% penalty in a multi-year audit in which the IRS finds the individual was willful). Thanks to the IRS, there is no concrete definition of the term willful – it is essentially a totality of the circumstances test.
Compounding the confusion, is the fact that the IRS does not need to prove willful in the common sense “sense” of the word. Rather, the IRS can show a lower level of intent which is called reckless disregard.
Finally, it is also important to note the government does not need to establish the level of proof otherwise required for a criminal case, since the courts recently upheld that since it is a civil arena, the government does not need to meet a criminal burden.
What does that all Mean?
It means essentially you are at the mercy of the IRS. The IRS has the right, based on the totality of the circumstances, to find you were willful even if they cannot show intent. Moreover, they can issue criminal-like penalties even though you have not been charged with a “crime,” because the IRS is not required o meet the burden that they would otherwise need to meet in a criminal case to issue criminal penalties against you.
Here is a summary of the different burdens along with how penalty works.
FBAR Penalty Mitigation
FBAR Penalties represent a major part of our IRS Offshore Voluntary Disclosure practice. FBAR Penalties, including various threshold requirements, including Intent, Willfulness, Willful Blindness, or Reckless Disregard.
While we have authored several articles and blog postings on issues involving FBAR penalties, FBAR Filings, and FBAR Frequently Asked Questions (FAQ), we feel that by providing you a Summary Review Guide to FBAR Penalties in general — it may assist you better answer the following questions:
- What is an FBAR?
- What is the purpose of and FBAR?
- What are FBAR penalties?
- Which FBAR penalties will I be subject to?
- Most importantly — How can I avoid, limit or reduce FBAR Penalties?
FBAR – A Brief History
An FBAR is a Report of Foreign Bank and financial Form aka FinCEN 114. Unlike FATCA (Foreign Account Tax Compliance Act), which is a relatively new law, the FBAR rules and regulations has been around since the 1970s. It was only recently, with the development (2010) and enforcement (2014) of FATCA that FBAR filing has become such a big deal. While the FBAR was initially developed and enforced through FINCEN, the IRS has the power to enforce FBAR penalties against individuals and businesses.
Filing an FBAR
Once you understand the purpose of an FBAR, you will realize that it is not a difficult form to prepare and file. While the 5471 form is lengthy, and the 8621 Excess Distribution calculation is hard, the FBAR is more of an annoyance and invasion of financial privacy than it is a “hard” form to prepare.
Essentially, The FBAR must be filed annually, by any individual who has ownership, joint ownership or signature authority over either one account (or several) accounts, investments, life insurance policies — when the annual aggregate total value of all the accounts combined exceed $10,000 on any day of the year.
In reality, pretty much any type of foreign account must be included on the FBAR. While there may be some exceptions, the majority of the accounts must be reported. Therefore, whether it is a foreign bank account, foreign investment account, foreign savings account, foreign life insurance policy, foreign mutual fund, foreign pension (Superannuation, CPF, EPF, PPF) or any other foreign account that has an account number, it should be filed.
Since filing the FBAR is merely a reporting requirement, it does not necessitate that any tax will be levied as a result of the filing, Thus, it is better to err on the side of caution and include all of your accounts on the FBAR.
*This is not a guide to understanding what accounts may be required on the FBAR, it is a summary for you to understand what happens when you did not file the FBAR and what penalties you may be subject to. For more information about FBARs in general, please refer to our Frequently Asked Questions page.
What Are FBAR Penalties?
When a person fails to properly file an annual FBAR statement, and the IRS discovers or uncovers the non-filing, the U.S. Government has the right to penalize the individual for failing to properly file the FBAR.
The law is found in the Internal Revenue Code (aka Tax code) Title 31 USC 5321. This is the code section that authorizes the U.S. government to enforce FBAR penalties against any individual that fails to properly comply with the filing an annual FBAR. As crazy as it sounds, the penalties for your failure to properly file this form are borderline obscene.
The IRS has the authority to penalize you upwards of $10,000 per violation, per account for violations that were non-willful. In other words, if you didn’t even know you were supposed to file the form and report your annual maximum balance on an FBAR statement, the IRS can still penalize you upwards of $10,000 per account, per year.
Sounds absurd, right?
Take this Example: David is a Legal Permanent Resident (Green Card recipient) who relocated to the United States for work when he was 42 years old. David was transferred by his company to the United States initially on an L-1 visa due to his proficiency in science and management. David earned several million dollars during the first 20 years of his career, which he staggered over seven different accounts. These accounts earn about $50,000 in year in passive income.
Under the current state of the law, David could be penalized upwards of $70,000 per year for the six years of unreported FBARs – that is a whopping $420,000 penalty solely because he was unaware of the rule. He will also have to pay taxes, fines and penalties on the unreported income — along with additional fines for unreported FATCA form 8938.
*The reason it is six (6) years instead of three (3) years is due to a nuance in the law statute of limitations which states that when a person has more than $5000 of unreported foreign income, the statute of limitations is expanded from three (3) years to six (6) years.
**The FBAR is only one of several forms David did not file which can lead to additional penalties, including FATCA 3520, 3520-A, 5471, 8621, and FATCA Form 8938.
If the IRS reserves the power to penalize you $10,000 per violation, per account, per year for a non-willful violation – would you like to take a guess at what the penalty would be if they think you were fraudulent?
Answer: The penalty can reach $100,000 or 50% of the account value – whichever is greater.
Therefore, in a multiyear audit, you could easily be penalized 100% value of the account balances. But, at least you can take some solace in the fact that the IRS has reduced the maximum penalty from 300% down to 100%. In other words, using the six-year statute of limitations explained above, in prior years, the IRS could penalize you 300% value (50% per year, for a total of six years). At least now, the penalty is limited to everything you have…and nothing more.
What is the Legal Standard for Willful and Non-Willful?
Despite the fact that the IRS can levy obscene-level penalties against you, it is also good to know that the IRS has not established a set, bright-line rule (clearly defined test) that you can use to determine whether you are willful or non-willful.
There are not as many cases as you would think that have referenced Willful, Non-Willful with respect to FBARs, but there are some guidelines to keep in mind:
Willful does NOT mean Intent or Knowledge
In other words, in order for the IRS to prove willfulness, the IRS does not need to show that you knew you were required to file the FBAR. That would make it too difficult for the IRS – therefore, the IRS has essentially lowered the threshold for themselves to prove Willfulness. This begs the question — what else qualifies as Willful?
Willfulness Can Mean Willful Blindness:
What does Willful Blindness even mean? It means that if you knew that you should have known you were required to file an FBAR, then you could be held to a willful standard.
Here is an example of Willful Blindness:
* Let’s say you were minding your own business and an individual walked up to you and told you they will give you $1 million if you drove their vehicle past a known DEA drug point. Without any question as to why they are offering to pay you this much money to essentially drive a car, you accept the offer and drive the vehicle up-to the checkpoint. Unfortunately, you are unlucky and the car is checked, and the cops discover 200 pounds of uncut cocaine was in the car. You could not argue that you did not know there were drugs in the car (no knowledge), because who pays another person $1,000,000 to drive their car past a drug checkpoint? In other words, you should’ve known there was something amidst… and by not asking, you are willfully blind.
Unlike willful blindness, reckless disregard appears to be an even lower standard of willfulness. At least with willful blindness, you should’ve known to ask, but you knowingly didn’t ask…because you didn’t want to know. With reckless disregard, according to the IRS, while you may have believed you didn’t have a filing requirement, your belief was so “stupid” that the IRS would never believe you are so stupid. Talk about a walking contradiction…
In a recent California District Court decision (Which could still go up on appeal — U.S. vs. Bohanecs) the court relied upon the reckless disregard standard in making its decision – which can be found here. It is important to note that in the Bohanecs, the facts reflected that the Bohanecs were pretty sophisticated…in addition to stupid.
**One very important thing to takeaway from the Bohanecs case, is not just that the threshold to prove willfulness does not require “actual knowledge,” but just as important is that even though willful FBAR penalties are essentially criminal nature, since they are not being enforced in a criminal setting, the government was not required to meet the criminal standard of beyond reasonable doubt.
In other words, if the IRS wants to issue you criminal level penalties in a civil setting, they do not have to reach the level or burden of proof required in a criminal setting — and the standard essentially boils down to someone being…stupid.
Put it this way: With the way the IRS is always increasing enforcement of international tax related matters, is it safe to say that if the IRS believes in any way shape or form that you knew, should’ve known, intentionally blind-to-the-fact, or were just stupid to the fact that you should have been reporting the FBAR, you are probably in for a dogfight with the IRS — because they will presumably try to enforce willful penalties against you.
Why Are FBAR Penalties So High?
This is a good question, to which there is no real proven substantive answer.
Sure, the IRS will argue that is to reduce financial crimes, minimize offshore monies being diverted to illegal operations such as drugs and terrorism, and eliminate offshore tax havens – but these facts have yet to be proven. While the IRS touts that it has recovered more than $10 billion in the offshore disclosure program, it has not indicated that it has achieved any reduction in the above-referenced illegal activities as a direct result of the heightened penalties. In reality, many of these people were just scared individuals who probably did not meet the threshold for Willful, and either did not want to “Chance it” with the Streamlined Program, or too nervous (understandably so) to Opt-Out.
In reality, the IRS knows that this is a money grab. In other words, the IRS is aware that yes, there are some major players in the offshore tax world who were caught with hundreds of millions of dollars offshore, and will now be forced to pay very stiff penalties in order to avoid Jail – but that is not the majority of people the IRS catches.
The IRS must be aware that the majority of individuals who have “offshore” accounts did not create these accounts for any illegitimate purpose. Rather, the majority of these individuals either worked overseas, were originally from overseas before relocating the United States and/or have family overseas. Thus, it would make perfect sense that these individuals would maintain offshore or foreign accounts.
For these individuals it is a very scary ordeal.
Turning Non-Willful Violations into Willful Violations
When the IRS can simply bootstrap a non-willful violation into a willful violation, just by showing that a person should’ve known they should have been reporting their foreign accounts (or the IRS believes they were too “stupid” not to know) – what protection do individuals really have against the willful penalties? Since the IRS refuses to provide a specific bright-line test for taxpayers to determine if they were willful or not — the IRS is intentionally keeping the U.S. taxpayers in the dark.
While there are some situations in which it will be obvious that the person was reckless or willfully blind, there will be many more scenarios/situations in which the person may not have been willfully blind or reckless – but the IRS disagrees and wants to push forward with willful penalties.
Our conclusion is simple: the penalties are so high, in order to catch the big Whales. And, while many small fish may also get caught in the Offshore Disclosure net, the IRS does not a believe in “Catch and Release.”
Can I be Criminally Prosecuted for FBAR?
The IRS has the absolute right to initiate a criminal investigation by assigning your matter one of the IRS special agents to pursue a full-fledged criminal investigation to determine whether you were willful in your failure to report your foreign accounts on an FBAR.
The reality is, the IRS does not always initiate a criminal prosecutions – in fact the chances of them doing so are relatively low. Out of the millions upon millions of violations each year, coupled by the millions of civil audits the IRS launches each year that may uncover an FBAR non-filing, the IRS only prosecutes anywhere from 3000 to 7000 criminal prosecutions each year.
That is not to say that the IRS does not pursue many more criminal investigations, but less than 10,000 each year will reach the point in which the IRS wants to prosecute an individual and place him or her in prison. Usually because the individual is forced to succumb to a pre-indictment resolution – even when they believe they were non-willful.
Offshore tax evasion enforcement is a major priority for the IRS. Each year, the IRS publishes a dirty dozen tax scam list for individuals to be cautious of, and offshore tax evasion is always in the top three spots on the list.
In fact, the U.S. Government has developed specific programs that are specifically designed to combat offshore tax evasion and tax fraud.
IRS Offshore Voluntary Disclosure
Before making any affirmative representation, or past filing to the IRS it is important to speak with an experienced offshore disclosure where to learn the pros and cons of each different approach.