Your Best Defense to Foreign Account Penalties

A Defense Against Foreign Account Penalties

Your Best Defense Against Foreign Account Penalties 

In the past few years, the Internal Revenue Service and Department of Justice have significantly increased the assessment and enforcement of foreign account penalties. These penalties are issued for noncompliance with international information reporting forms such as the FBAR (FinCEN Form 114) and Form 8938 (Foreign Account Tax Compliance Act). While it may be difficult for taxpayers to challenge the IRS on matters involving foreign account penalties, it is not impossible. There are various options available to taxpayers seeking to avoid, abate, or reduce their foreign account penalties. In general, the best defense against foreign account penalties is to prove that the taxpayer acted with a reasonable cause and not willful neglect. Let’s take a look at the basics of developing a reasonable cause argument to avoid penalties.

Two Most Common Foreign Account Reporting Forms

When it comes to foreign account penalties, the two main forms are the FBAR and Form 8938 (FATCA).

Civil FBAR Statute

    • (5) Foreign financial agency transaction violation.—

      • (A) Penalty authorized.—

        • The Secretary of the Treasury may impose a civil money penalty on any person who violates, or causes any violation of, any provision of section 5314.

      • (B) Amount of penalty.—

        • (i) In general.

          • Except as provided in subparagraph (C), the amount of any civil penalty imposed under subparagraph (A) shall not exceed $10,000.

    • (ii) Reasonable cause exception.—

      • No penalty shall be imposed under subparagraph (A) with respect to any violation if— (I)such violation was due to reasonable cause, and (II)the amount of the transaction or the balance in the account at the time of the transaction was properly reported.

26 U.S. Code § 6038D – Information with respect to foreign financial assets

  • (g) Reasonable cause exception

    • No penalty shall be imposed by this section on any failure which is shown to be due to reasonable cause and not due to willful neglect. The fact that a foreign jurisdiction would impose a civil or criminal penalty on the taxpayer (or any other person) for disclosing the required information is not reasonable cause.

Reasonable Cause and Not Willful Neglect

The key phraseology in this code section is for the taxpayer to be able to show that any violation or failure was due to cause and not willful neglect. Depending on whether the taxpayer has already been penalized or not will determine whether they should submit the reasonable cause letter upfront along with the late-filed form or if they have already been penalized and it will serve as the crux of the protest letter that the taxpayer must file (usually) within 30 days of receiving a notice of the FBAR or FATCA violation — and/or a CP-15 Notice — depending on the type of notice of penalty the taxpayer receives.

How to Prove Reasonable Cause

There is no one-size-fits-all argument when it comes to reasonable cause. It is based on a totality of the circumstance test and while two different taxpayers may have similar circumstances, they will not have an identical set of facts.

The letter should be detailed and focus on the facts that illustrate reasonable cause.

For example:

      • Was it the first time the taxpayer was required to report the foreign corporation?

      • Did the taxpayer use a CPA or other tax professional when filing?

      • Did the taxpayer conduct their own due diligence?

      • Has the taxpayer been penalized on this type of issue previously?

      • Has the taxpayer been filing timely tax returns for the past years?

      • Has the taxpayer filed their other international information returns timely?

The Foreign Account Dispute Process is Long (and Winding)

There are many steps a taxpayer may have to take to resolve a foreign account reporting issue, from filing the form to reaching a resolution with the IRS. While Form 8938 may be litigated in tax court, the FBAR is not technically an IRS form, so Tax Courts do not usually hear FBAR cases. Likewise, many times these penalties are issued without prior notice, audit, or examination and are referred to as assessable penalties. This puts the taxpayer at an immediate disadvantage because they do not have a chance to dispute the penalty before it is issued to them by the IRS. If the initial protest/dispute letter is successful, then that is great –– but when it is not successful then the taxpayer must continue onto another alternative such as an appeal, collection due process hearing, tax court, or federal court (each with their own sets of pros and cons).

Hire Experienced Foreign Account Counsel

You should be working with a Board-Certified Tax Law Specialist that specializes exclusively in offshore tax matters. The firm should offer a flat-fee, and full-service representation. Realizing, that the IRS is very disorganized and understaffed and it can take many, many hours to even resolve the simplest issues with the IRS, and if you are being charged hourly, those hours can quickly add up and far surpass what you would have paid in a flat-fee situation.

About Our International Tax Law Firm: Golding & Golding

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.

Contact our firm today for assistance with getting compliant.