Why are Non-Willful FBAR Penalties so High?
One of the greatest mysteries of international tax law is why FBAR penalties are so absurdly high.
As you may or may not be aware, an FBAR (Report of Foreign Bank and Financial Accounts) is one of the most controversial forms required to be filed by the U.S. Government.
Why? Because while it is a relatively easy form with a small threshold requirement, the penalties for failing to file the form are exorbitantly high — and far exceed the “crime.”
An FBAR or FinCEN 114 is a form required by the Financial Crimes Enforcement Unit. Even by the name of the form alone, it is evident that when the form was first introduced, the purpose of it was to crackdown on international financial crime.
Under most circumstances, the FBAR form must be filed by any individual who has ownership, joint ownership, or signature authority over $10,000 in funds held in qualifying accounts of foreign banks. It is important to note that the total value of all of the accounts is an aggregate total that exceeds $10,000 — on any day of the year — and not $10,000 per account.
For example, if Michelle has three (3) accounts overseas, each of them that have $400,000 in it, she would file the FBAR and report all 3 accounts; conversely, Scott may have nine (9) accounts that all have less than $10,000, but when aggregated (totaled) the value exceeds $10,000 — Scott would also have to report all the accounts on the FBAR.
The penalties can be extreme. For example, even in this situation in which a person was non-willful and/or had literally no idea that they were supposed to report their Foreign Accounts, the person may be subject to fines and penalties as high as $10,000 per account, per year.
Moreover, if the accounts are generating income that exceeds $5,000 per year, then the IRS can audit the individual for six (6) years instead of three — without having to go through the same hurdles it would have to under the other six-year audit scenario — in which the IRS would have to prove that there is more than 25% of unreported income.
Thus, in an example where Michelle had three accounts that each generated $3000 worth of income, she could be audited for six years and possibly have to pay $30,000 a year, in FBAR penalties for six years (aka $180,000). It should be be noted that the IRS does not always penalize an individual the total amount that they could — but they do have the power to do so, and even the recommended penalty is high – $10,000 per year.
Even using the recommended penalty, that would mean just because Michelle was unaware of the requirement to report her foreign accounts, she will now have to pay upwards of $30,000-$60,000 in FBAR penalties alone (not to mention other penalties for forms she may not a filed such as a FATCA Form 8938, 3520, 3520-A 5471, 5472, 8621, 8854). Unfortunately, each of the aforementioned forms carries with it its own penalty.
The Purpose of the FBAR Penalties
The purpose of the penalty is to dissuade individuals from attempting to hide or shelter money overseas outside of the view of the U.S. government. And, if a person is going to keep money offshore (Even if the foreign account is actually in your country of citizenship), then they must report it annually and update the U.S. Government accordingly.
The U.S. government believes that by implementing these laws (The FBAR has been around since the 1970s but only recently became a main stay of enforcement following the introduction of FATCA – Foreign Account Tax Compliance Act) that it will force individuals to get into compliance. The problem is that many good people are unaware of the law and for them it is completely and utterly absurd that they a pay penalty — solely because they did not know about the law.
It is not as if the IRS goes door-to-door, inquires about your legal status, and then provides you a summary about what your reporting requirements are.
If you are out of compliance, then one of the most effective and safest methods for getting into compliance is through voluntary disclosure. The following is a summary of the different offshore disclosure alternatives:
IRS Voluntary Disclosure of Offshore Accounts
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
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.
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. Unlikes 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.
Contact us; We Can Help.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)