FBAR Non-Willful Update – When is it Reasonable to Rely on a CPA?
FBAR Non-Willful Update – When is it Reasonable to Rely on a CPA?
The short answer is when a CPA is well-versed in International Tax.
Every so often, the Internal Revenue Service pursues a non-willful individual for what appears to be intense fines and penalties for failing to properly file a form 8938 or FBAR.
Recently, there has been a case in which the IRS determined that certain individuals should be subject to relatively high non-willful FBAR penalties.
And, even though in that case, the court upheld multiple $10,000 FBAR penalties being issued across several years, that case must be taken in context of the specific facts of that case.
Be Careful of Fear-Mongering
Over the last few months, we have received numerous calls about other Attorneys scaring clients about how the courts are holding that the IRS is going “full-force” against individuals who pursue Reasonable Cause; this is false.
While Reasonable Cause is always a risk, the recent holding in Jarnagin does not necessarily increase that risk.
The Jarnagin Case – What Does it Mean?
It is important to understand that in this particular situation, the court and the IRS are not saying that it is unreasonable to rely upon a CPA. Rather, with the court was saying in this particular scenario is that based on the specific facts and circumstances it was not reasonable for the the Jarnagins to rely on a CPA who was not knowledgeable about Foreign Account Reporting, and was not knowledgeable about offshore disclosure requirements.
Three Main Takeaways from This Case
From reviewing the court documents, it is safe to say the three sticking points are as follows:
– If you are an astute business person with significant wealth from offshore investments and bank accounts, you cannot hire a CPA inexperienced in international tax and reporting rules and then rely on their inexperience as a reasonable basis for not filing the proper forms or reporting the income from abroad.
– If you want to try to prove reasonable cause for not timely filing your FBAR, then at some point you have to at least belatedly file your FBAR.
– The defense that you never read the tax return before signing it is a very poor defense.
Jarnagin Court Holding Summary
In case you’re in a rush and don’t want to read our entire blog post (we’re not offended, being busy is a good thing), what the court specifically stated in Jarnagin is that it was not simply that the plaintiffs failed to report the income or file the FBAR that lead to the denial of the reasonable cause defense.
Rather, the court is very clear that: “The Jarnagins must prove both the reasonable cause element and reporting elements. Because the Jarnagins failed to report the income from the CIBC account and failed to timely or even belatedly file FBARs to report the CIBC Account their defense necessarily fails and the court need not consider whether the Jarnagins meet reasonable cause element.”
In other words, you cannot show reasonable cause for not timely filing the FBAR if you do not at least at some point after learning the about the FBAR requirement that you filed FBARs.
Jarnagin – Background and Context
The Jarnagins were very successful business entrepreneurs. They were not the typical individual who relocates to the United States from a foreign country and may have a few foreign bank accounts. Rather, these were successful business persons. The husband was also a Canadian citizen even though he primarily resided in the United States.
Here are some key facts to consider before evaluating this case:
– Taxpayers had significant wealth, which was being stored in a foreign account, and they had businesses abroad.
– They amassed upwards of $30 million of net worth.
– The foreign account(s) was earning income.
– The income was not being reported on schedule B.
– Taxpayer said they never reviewed their own returns before submitting them (which is equivalent to a form of perjury because by submitting the return you are acknowledging that you have read it and reviewed it – even if you have a CPA).
– Taxpayers were working with a former bookkeeper/CPA who acknowledged that she literally had no background in international tax issues.
– Taxpayers marked NO for Schedule B question seven, which asks whether the individual has signature authority or other ownership over a foreign account (and they had a CPA)
**Even after these individuals learn that they were required to file the FBAR for previous years, they never did so. “The IRS only later uncovered the lack of FBARs in an audit of plaintiffs.”
Schedule B, Question 7
Too many inexperienced attorneys underestimate the value of this one little question on the tax return, especially when a person hired a CPA to prepare their original returns. We speak with thousands of individuals each year, with 95% of those conversations involving offshore disclosure.
And, many of our clients have legitimate reasons for not including yes on schedule B. but, when a person has their own CPA, and speaks English (especially their foreign accounts are in the millions of dollars USD), it is often-times hard-pressed to find a legitimate excuse for not marking Yes on schedule B.
**In recent months, we have had many clients come to us after working with other counsel, literally irate that they were goaded into going reasonable cause or streamlined when they knowingly understood that they had a foreign account but still marked no for question seven, because they were told that the chances of being caught were low. We are helping them fix their problem, and if you are in the same boat, please consider contacting our firm to discuss the issue.
Bookkeeper with no International Tax Experience?
This is another key point to consider: it would seem that the government is saying that because taxpayers knowingly used a CPA/bookkeeper who had no experience or background in international tax, this is a type of blindness (although the Jarnagins were not held willful).
The IRS is not saying that taxpayers acted willfully per se, but they are basically saying that they should have vetted out the CPAs better and/or should have hired CPAs with International Tax experience in (taxpayers had other investments in Canada/British Columbia). By not doing so, they were almost setting themselves up for failure and the inability to properly comply with offshore disclosure requirements. This led to the high non-willful penalties being issued against Taxpayers.
Unreported Income as Well
Another sticking point to remember is that these individuals had more than just unreported accounts, they had unreported income from the foreign accounts. It would be hard-pressed for a CPA who passed the CPA exam (a test in which is very difficult in its own right) to be able to say (with a straight face) that he or she was unaware that the United States taxes individuals on their worldwide income.
Never Filed the FBAR, Even Belatedly
This is also the other most important fact in this scenario: At some point, plaintiffs had the actual knowledge that they were supposed to report the foreign accounts. And, even armed with the knowledge that they needed to file delinquent FBARs for prior years, the individuals did not file prior FBARs.
In reality, this is a type of willfulness. Why? Because taxpayers were aware at this time that they should’ve gone back and filed FBARs but did not do so. Still, the IRS did not issue Willful penalties, which is another important take-away from this case.
Never Read Tax Return
Finally, whether or not the IRS believes them or not, taxpayers continually stated that whether they were dealing with their bookkeeper, their CPA, or any subsequent CPAs after the death of their regular CPA, that they never read the tax return before signing it.
This is another mistake: a person is required to read the tax return before signing it. This is true, even if they have a CPA or team of accountants working on their behalf — it does not negate the individual’s requirement to review and confirm the information within the taxes.
Reasonable Cause is Still an Option
The court is not saying that in a typical situation in which a person may have a few foreign accounts but reasonably relied upon their CPA or otherwise, that the IRS going to penalize them.
Rather, it seems that the IRS is saying the person has significant wealth/foreign accounts/foreign businesses than that person has to use a CPA or firm that they properly vetted out to ensure that they have knowledge regarding the tax return at issue.
In this particular situation, that would mean a CPA that had experience with the businesses that they operated international business and corporate law, foreign investments, foreign income, and related offshore disclosure matters.
Moreover, the individuals should have read the tax return before they signed it because that is a nondelegable duty and once you learn that you are out of FBAR compliance you need to get into FBAR compliance…at least if they may want to show at any time in the future they qualify for reasonable cause.
Learn More About Offshore Voluntary Disclosure
There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.
5 IRS Methods for Offshore Compliance
- Streamlined Domestic Offshore Procedures
- Streamlined Foreign Offshore Procedures
- Reasonable Cause
- Quiet Disclosure (Illegal)
We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlike the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.
After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.
If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.
Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.
OVDP is the Offshore Voluntary Disclosure Program — a program designed to facilitate taxpayer compliance with IRS, DOT, and DOJ International Tax Reporting and Compliance. It is generally reserved for individuals and businesses who were “Willful” (aka intentional) in their failure to comply with U.S. Government Laws and Regulations.
The Offshore Voluntary Disclosure Program is open to any US taxpayer who has offshore and foreign accounts and has not reported the financial information to the Internal Revenue Service (restrictions apply). There are some basic program requirements, with the main one being that the person/business who is applying under this amnesty program is not currently under IRS examination.
The reason is simple: OVDP is a voluntary program and if you are only entering because you are already under IRS examination, then technically, you are not voluntarily entering the program – rather, you are doing so under duress.
Any account that would have to be included on either the FBAR or 8938 form as well as additional income generating assets such as rental properties are accounts that qualify under OVDP. It should be noted that the requirements are different for the modified streamlined program, in which the taxpayer penalties are limited to only assets that are actually listed on either an FBAR or 8938 form; thus the value of a rental property would not be calculated into the penalty amount in a streamlined application, but it would be applicable in an OVDP submission.
An OVDP submission involves the failure of a taxpayer(s) to report foreign and overseas accounts such as: Foreign Bank Accounts, Foreign Financial Accounts, Foreign Retirement Accounts, Foreign Trading Accounts, Foreign Insurance, and Foreign Income, including 8938s, FBAR, Schedule B, 5741, 3520, and more.
What is Included in the Full OVDP Submission?
The full OVDP application includes:
- Eight (8) years of Amended Tax Return filings;
- Eight (8) Years of FBAR (Foreign Bank and Account Reporting Statements);
- Penalty Computation Worksheet; and
- Various OVDP specific documents in support of the application.
Under this program, the Internal Revenue Service wants to know all of the income that was generated under these accounts that were not properly reported previously. The way the taxpayer accomplishes this is by amending tax returns for eight years.
Generally, if the taxpayer has not previously reported his accounts, then there are common forms which were probably excluded from the prior year’s tax returns and include 8938 Forms, Schedule B forms, 3520 Forms, 5471 Forms, 8621 Forms, as well as proof of filing of FBARs (Foreign Bank and Financial Account Reports).
The taxpayer is required to pay the outstanding tax liability for the eight years within the disclosure period – as well as payment of interest along with another 20% penalty on that amount (for nonpayment of tax). To give you an example, let’s pick one tax year during the compliance period. If the taxpayer owed $20,000 in taxes for year 2014, then they would also have to include in the check the amount of $4,000 to cover the 20% penalty, as well as estimated interest (which is generally averaged at about 3% per year). This must be done for each year during the compliance period.
Then there is the “FBAR/8938” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank”) on the highest year’s “annual aggregate total” of unreported accounts (accounts which were previously reported are not calculated into the penalty amount).
For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all of their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.
Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe and remember that by entering the program, the applicant is seeking to avoid criminal prosecution!
2. Streamlined Domestic Offshore Disclosure
The Streamlined Domestic Offshore Disclosure Program is a highly cost-effective method of quickly getting you into IRS (Internal Revenue Service) or DOT (Department of Treasury) compliance.
What am I supposed to Report?
There are three main reporting aspects: (1) foreign account(s), (2) certain specified assets, and (3) foreign money. While the IRS or DOJ will most likely not be kicking in your door and arresting you on the spot for failing to report, there are significantly high penalties associated with failing to comply.
In fact, the US government has the right to penalize you upwards of $10,000 per unreported account, per year for a six-year period if you are non-willful. If you are determined to be willful, the penalties can reach 100% value of the foreign accounts, including many other fines and penalties… not the least being a criminal investigation.
Reporting Specified Foreign Assets – FATCA Form 8938
Not all foreign assets must be reported. With that said, a majority of assets do have to be reported on a form 8938. For example, if you have ownership of a foreign business interest or investment such as a limited liability share of a foreign corporation, it may not need to be reported on the FBAR but may need to be disclosed on an 8938.
The reason why you may get caught in the middle of whether it must be filed or not is due largely to the reporting thresholds of the 8938. For example, while the threshold requirements for the FBAR is when the foreign accounts exceed $10,000 in annual aggregate total – and is not impacted by marital status and country of residence – the same is not true of the 8938.
The threshold requirements for filing the 8938 will depend on whether you are married filing jointly or married filing separate/single, or whether you are considered a US resident or foreign resident.
Other Forms – Foreign Business
While the FBAR and Form 8938 are the two most common forms, please keep in mind that there are many other forms that may need to be filed based on your specific facts and circumstances. For example:
- If you are the Beneficiary of a foreign trust or receive a foreign gift, you may have to file Form 3520.
- If you are the Owner of a foreign trust, you will also have to file Form 3520-A.
- If you have certain Ownerships of a foreign corporation, you have to file Form 5471.
- And (regrettably) if you fall into the unfortunate category of owning foreign mutual funds or any other Passive Foreign Investment Companies then you will have to file Form 8621 and possibly be subject to significant tax liabilities in accordance with excess distributions.
Reporting Foreign Income
If you are considered a US tax resident (which normally means you are a US citizen, Legal Permanent Resident/Green-Card Holder or Foreign National subject to US tax under the substantial presence test), then you will be taxed on your worldwide Income.
It does not matter if you earned the money in a foreign country or if it is the type of income that is not taxed in the country of origin such as interest income in Asian countries. The fact of the matter is you are required to report this information on your US tax return and pay any differential in tax that might be due.
In other words, if you earn $100,000 USD in Japan and paid 25% tax ($25,000) in Japan, you would receive a $25,000 tax credit against your foreign earnings. Thus, if your US tax liability is less than $25,000, then you will receive a carryover to use in future years against foreign income (you do not get a refund and it cannot be used against US income). If you have to pay the exact same in the United States as you did in Japan, it would equal itself out. If you would owe more money in the United States than you paid in Japan on the earnings (a.k.a. you are in a higher tax bracket), then you have to pay the difference to the U.S. Government.
3. Streamlined Foreign Offshore Disclosure
What do you do if you reside outside of the United States and recently learned that you’re out of US tax compliance, have no idea what FATCA or FBAR means, and are under the misimpression that you are going to be arrested and hauled off to jail due to irresponsible blogging by inexperienced attorneys and accountants?
If you live overseas and qualify as a foreign resident (reside outside of the United States for at least 330 days in any one of the last three tax years or do not meet the Substantial Presence Test), you may be in for a pleasant surprise.
Even though you may be completely out of US tax and reporting compliance, you may qualify for a penalty waiver and ALL of your disclosure penalties would be waived. Thus, all you will have to do besides reporting and disclosing the information is pay any outstanding tax liability and interest, if any is due. (Your foreign tax credit may offset any US taxes and you may end up with zero penalty and zero tax liability.)
*Under the Streamlined Foreign, you also have to amend or file 3 years of tax returns (and 8938s if applicable) as well as 6 years of FBAR statements just as in the Streamlined Domestic program.
4. Reasonable Cause
Reasonable Cause is different than the above referenced programs. Reasonable Cause is not a “program.” Rather, it is an alternative to traditional Offshore Voluntary Disclosure, which should be considered on a case by case basis, taking the specific facts and circumstances into consideration.
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