The disclosure requirement is set forth in 31 Code of Federal Regulations Section 103.24, and requires that any person subject to the jurisdiction of the United States, “having a financial interest in, or signature or other authority over, a bank, securities or other financial account in a foreign country shall report such relationship to the Commissioner of the Internal Revenue for each year in which such relationship exists, and shall provide such information as shall be specified in a reporting form prescribed by the Secretary [of the Treasury] to be filed by such persons.” The disclosure requirement is limited to offshore accounts with more than $10,000 (on a cumulative basis).
Disclosure is required when a U.S. person owns the account or holds a beneficial interest in the account, or has signature authority over the account (ability to direct disbursements from the account). For example, Daughter opens an account with a Swiss bank, but asks Dad to sign under power of attorney. Both Daughter (as the owner) and Dad (as the signatory) must file the FBAR form with respect to the account. On his FBAR filing Dad must disclose Daughter’s identity as the owner of the account over which he can sign.
In October of 2008 the instructions to the FBAR form were revised to extend the disclosure requirement to U.S. settlors of foreign trusts with protectors. In this structure the account is owned and managed by a foreign trustee, and a protector is appointed to watch over the trustee. Although technically the U.S. settlor is neither the signatory nor the owner of the account, disclosure is required. No disclosure is required for a foreign trust that has not appointed a protector.
A “financial account” is defined by the IRS to include “any bank, securities, securities derivatives or other financial instruments accounts. The term includes any savings, demand, checking, deposit, or any other account maintained with a financial institution or other person engaged in the business of a financial institution. Individual bonds, notes, or stock certificates held by the filer are not a financial account nor is an unsecured loan to a foreign trade or business that is not a financial institution.” (From Instructions to Form 90-22.1). The IRS takes the position that both foreign mutual funds and life insurance policies (or possibly annuities) with cash surrender value are included within the meaning of the term “financial account.”
There are two required ways of reporting a foreign bank account. Checking the box on Schedule B of your 1040 and filing the Treasury Department Form 90-22.1, Report of Foreign Bank and Financial Accounts (the “FBAR” form). The FBAR isn’t an income tax return (it is an information return), and it shouldn’t be mailed with any income tax return. It must be mailed before July 1 of the following year to: U.S. Dept of the Treasury, P.O. Box 32621, Detroit, MI 48232-0621. No extension of time to file is granted.
Civil and criminal penalties for non-compliance with the FBAR filing requirements are severe. Civil penalties for a non-willful violation can range up to $10,000 per violation (31 U.S.C. Section 5321(a)(5)((i)). A finding of non willful violation is likely to be found only in those cases where the taxpayer marked the appropriate box on Schedule B and reported the income from the foreign account, had no prior FBAR filing violations and cooperated with the IRS in its investigation.
Civil penalties for a willful violation can range up to the greater of $100,000 or 50 percent of the amount in the account at the time of the violation. The IRS has six years to impose civil penalties on failure to file an FBAR.
Criminal penalties for violating the FBAR requirements can range from a $250,000 to a $500,000 fine or 5-10 years imprisonment or both (31 U.S.C. Section 5322(a)). The criminal penalties are increased when the FBAR violation is related to another crime. Civil and criminal penalties may be imposed together.
The IRS advises us that if a holder of a foreign account was required to file FBARs for earlier years, however, he or she should file the delinquent FBAR reports and attach a statement explaining why the reports are filed late. No penalty will be assessed if IRS determines that the late filings were due to reasonable cause.
The FBAR is a no-win proposition for taxpayers. Failure to file leads to confiscatory penalties (50% of account balance for each of the prior 6 years) if the taxpayer is caught with an unreported account. Voluntary disclosure program is somewhat less confiscatory on its face (20% penalty on the last year’s balance in the account, plus back taxes, interest and a negligence penalty). However, given that each individual taxpayer has a tiny chance of getting caught, mathematically voluntary disclosure makes little sense, if criminal penalties are not anticipated. If criminal penalties are anticipated, then most taxpayers will do whatever it takes to stay out of jail.
The government is zealously going after taxpayers with foreign bank accounts. IRS is allocating additional resources and employees to this “wonderful” new source of revenues. Navigating these troubled waters will be difficult, and we encourage all of our clients and all taxpayers with foreign accounts to have a serious discussion with their counsel and their CPA.