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Ten Top Mistakes Made With FBAR

 

Ines Zemelman, EAJul-05-2016

 

There are many options for US persons to correct their mistakes with Foreign Bank Account Reporting prior to the government discovering the violations.

Until 2017, the filing deadline for annual FBAR – Foreign Bank Account Reporting – is June 30th for the prior calendar year (starting in 2017, the due date will move to April 15, with the ability to extend until Oct 15). Ongoing and extensive lack of compliance by those who must file FBARs, both mistaken and intentional, has been recently brought into the public eye by enforcement actions taken by both the Department of Justice (DOJ) and the Internal Revenue Service (IRS). Both those with control over foreign accounts as well as those with an interest in them have been the subject of these enforcement actions. This article speaks to the most frequent misunderstandings about when filing is necessary, the information that is required to be disclosed, and the remarkably broad types of people and entities that are required to submit an FBAR. Non-compliance penalties can be quite severe. However, there are numerous options for correcting errors in reporting as well as omissions on a voluntary basis. The ability to make use of the alternatives, and severity of potential penalties, depends a great deal on the knowledge and intentions of the FBAR filer when the error was made. Deciphering these options and deciding which to employ often requires assistance from a qualified attorney.

The Basics of FBARs

US law requires "US persons" to file an FBAR annually to report their authority over, or ownership of, certain types of "foreign financial accounts." Generally speaking, a US person must file an FBAR if the total value of all of their foreign accounts exceeded USD 10,000, even at a single point during the year (calendar year basis). The Financial Crimes Enforcement Network (FinCEN) Form 114 is used for e filing of the FBAR, and must be submitted on or prior to& June 30th covering the previous calendar year. It is not possible to ask for an extension.

There are a wide range of civil penalties that can be brought for not filing a proper FBAR, ranging from a non-willful maximum of USD 10,000 for each account not reported, to half of the balance in the account per year or USD 100,000 – whichever is greater – for willful reporting failures. In general, willfulness is usually defined as an intentional neglect of known requirements. Non-willful violations are due to simple negligence, an inadvertent mistake, or otherwise due to a misunderstanding in good faith of what the law requires. It is important to note that ignoring legal obligations and/or information that reasonable people would determine requires further investigation into potential legal obligations could be taken to be an intentional, willful violation.

The Internal Revenue Service may waive civil penalties if what otherwise would have been a violation is determined to have been due to a reasonable cause. Conversely, willful violations of reporting requirements may also subject the filer to criminal charges, which can be imposed on top of the civil penalties and asset forfeiture.

There is an increasing risk that the Internal Revenue Service and the Department of Justice will find unreported foreign accounts because of the passage of the Foreign Account Tax Compliance Act (FATCA). This act, passed in 2010, was put into effect July 1, 2014. It requires all non-US financial institutions throughout the world to conduct detailed due diligence in order to identify owners of foreign financial assets, as well as US account holders of foreign assets, and then automatically disclose information about the accounts to the Internal Revenue Service on an annual basis.

The Ten Top Errors in FBAR Reporting

1. Failing to File

Without a doubt, the most commonly committed violation is the simple failure to submit the FBAR. Although some people do deliberately hide assets in covert foreign bank accounts to attempt to evade taxes in the United States, it is usually the case that Americans living abroad and working in foreign countries, foreign citizens living in the United States, recent immigrants, and children who have received bequests or gifts from their parents who are foreign nationals, are just not aware of the FBAR filing requirements. Even with many well publicized actions taken against individual account holders and financial institutions, along with amnesty programs corresponding to these actions, many people to whom the FBAR filing requirements apply simply remain ignorant of these requirements.

US persons who have ownership of, or authority over, any foreign accounts should request complete records of the accounts and become well educated in the obligations of FBAR reporting. They should also ask advice from tax professionals well ahead of the annual June 30th deadline for filing.

Harsh treatment can be expected from tax authorities for those who do not resolve past errors in reporting, not to mention continued exposure to significant penalties and the potential for criminal prosecution. In a similar way, uninformed account holders have found very little sympathy from US courts when they are found to have failed – whether willfully or not – to look into their obligations to report. The courts have, in a few cases, imposed a sanction of half of the largest account balance in each year the account was open within the statute of limitations. Prison terms have even been handed down for many of those who intentionally hid bank accounts offshore.

2. Not Understanding the Threshold for Filing

US persons are required to file an FBAR report if the total value of their foreign accounts surpasses, at any point, USD 10,000 during the year. People often misunderstand this filing threshold in one of three ways:

  • First Misunderstanding: The reporting threshold of USD 10,000 applies to each account separately.
    • The Truth: The USD 10,000 point is determined by totaling the greatest balance of each foreign account the person either owned or held signature authority over. As an example, holding power over a business account that had a maximum balance of USD 6,000 while also having USD 6,000 in a personal bank account requires FBAR filings for both accounts since the total value in aggregate exceeds the USD 10,000 threshold.
  • Second Misunderstanding: If an FBAR is filed, only accounts with balances over USD 10,000 require reporting
    • The Truth: Once the requirement to file an FBAR is triggered, a person is required to include all of their foreign accounts in the report, including those accounts under USD 10,000, like in the example above. Similarly, if the obligation to report is triggered due to only having signature authority on corporate accounts that have a total balance greater than USD 10,000, then all personal foreign accounts also must be reported, irrespective of their size.
  • Third Misunderstanding: The obligation to file is only triggered if the total of all balances is greater than USD 10,000 only at the end of the year.
    • The Truth: The requirement to report is triggered when the maximum total balance is greater than USD 10,000 on even a single point within the year (calendar basis). Account holders are allowed under the regulations to use the balance as it is reported on a periodic statement (e.g., monthly), on condition that it is a fair reflection of the greatest account balance held within the year. As an example, if a large amount was deposited and then later withdrawn within the same month, thereby causing the monthly statement to report a substantially reduced amount, then the account holder most likely will not be allowed to rely on that statement when calculating the maximum balance. If an account holds foreign currency, an account holder is required to convert the balance from the foreign currency into US dollars when calculating the balance using the Treasury’s Financial Management Service rate as published for the end of the year. This rate can be found at Reference & Guidance, Exchange Rates at www.fms.treas.gov.
    • It is important to note that the thresholds for filing an FBAR, as well as other foreign asset reporting requirements, are not the same as those for filing the IRS Form 8938, Statement of Specified Foreign Financial Assets. The Form 8938 must be filed yearly with the US Federal Income Tax Return (Form 1040). This form requires reporting on several “specified foreign financial assets”, which is defined in the instructions for the form. For example, any accounts held with a branch of any US institution in a foreign country are required to be reported for FBAR purposes, but are not required on a Form 8938 filing.

3. Failing to Understand Beneficial Ownership

Generally, a US person with “signature or other authority” over a foreign account, or who is on record as an owner of a foreign account, or who owns the account with legal title, must report using an FBAR, subject to the usual conditions of the accounts’ aggregate value exceeding USD 10,000 during the reporting year. According to the regulations, one tests for whether or not they have this authority over the account based on if the foreign institution is willing to “act upon a direct communication from that individual regarding the disposition of assets in the account.” If the authorization of more than a single person is required, each individual authorized to give direction to the bank in regards to the asset is a signatory. Simply put, if the account is registered to the person, or if they can make a withdrawal, sign checks, direct the investment of funds, give the bank instructions (either by themselves or alongside another person), then they are likely required to submit an FBAR.

It is not just legal account holders and signatories that are required to submit an FBAR. Anyone who is a US person and has “financial interest” with regards to a foreign account incurs the obligation to submit an FBAR. The definition of “financial interest” as stated in regulations is quite broad. It basically includes US persons who are beneficial owners of the account, regardless of whether or not they are the named account holder, or if they can communicate instructions directly to the institution. So, any US person must submit the FBAR if a legal title holder or owner of the foreign account acts for them as an attorney, agent, nominee, or in another way. An example is if a sister is living overseas and holds USD 20,000 of her brother’s money in her foreign account, he now has a “financial interest” regarding the foreign account and must submit an FBAR regardless of not having legal title to the account or being a signatory on the account. In the same way, US siblings who receive inheritance from their father and choose to let the funds stay in the foreign account of the estate each have reportable interest in their father’s foreign account and must both submit an FBAR. Even with the money comingled within a single account (assuming, of course, that each sibling’s aggregate portion is in excess of USD 10,000), this remains true. There are a few other circumstances in which the regulations require reporting, including when US persons conceal their beneficial interest by creating another entity to try to avoid the requirement to report. So, if someone (whether a US citizen or a foreign person) holds assets for any US persons, it is important for that US person to investigate their FBAR reporting obligations, and, if they have any doubts, file the FBAR to mitigate the threat of significant penalties.

4. Failing to Recognize Non-Traditional Foreign Assets Such As Retirement and Life Insurance

Many people consider a “financial account” to be the traditional bank held savings or checking account, but it actually includes, among other things, investment accounts, passbook accounts, CDs, mutual funds, futures and options accounts, and other similar accounts. It is notable that the definition clearly includes annuities and insurance policies that have cash value.

FBAR reporting requirements also apply to retirement accounts in most circumstances. There are limited exceptions for foreign accounts held in an Individual Retirement Account and for some retirement plans. Foreign retirement program benefits (analogous to Social Security) provided by foreign governments usually do not need to be reported. However, exceptions such as these are indeed exceptions and are not applicable to most retirement plans or retirement vehicles globally. US persons who are beneficiaries or owners of retirement assets in foreign countries, annuities and life insurance having cash value, or most other types of non-traditional assets are advised to investigate whether or not they are required to file FBAR reports for the type of account in question. If doubtful, it is best to report the account so as to limit the possibility of significant penalties.

The IRS’s internal guidance says that stock certificates, notes, and individual bonds held by a filer are not considered financial accounts for the purposes of FBAR reporting. According to IRS officials, US persons do not currently need to report virtual currency (such as Bitcoin) on FBARs; however, they have cautioned filers that they may reconsider this position going forward.

5. Failing To Recognize Reporting Requirements of Estates, Disregarded Entities, Partnerships, and US LLCs

Another Common Misunderstanding: Trusts considered disregarded entities and LLCs do not trigger the FBAR filing requirements.

The Truth: An entity’s federal tax considerations do not determine if there is an FBAR reporting requirement for the entity. Partnerships, LLCs, corporations, estates, and trusts organized under United States law are all considered US persons and are required to report on an FBAR. So, Delaware or Nevada LLCs considered disregarded entities must still submit an FBAR, assuming it has foreign accounts with total balances of over USD 10,000. Even if the U.S. LLC happens to be owned by a foreign person (i.e., is not a taxpayer in the US), this remains true.

6. Failure on the Part of Business Entity Majority Owners to File Individual Reports

US persons who directly, or even indirectly, own over half of the shares (based on value) or over half of the votes of the stock of either a foreign or US corporation are considered the corporation’s foreign account owner as far as FBAR reporting is concerned, and must submit an FBAR report on their own behalf which reports the foreign accounts of the corporation.

Similar rules apply to majority owners or majority partners of other entities. US persons who, directly or even indirectly, own interest in greater than half of the profits of the partnership (for example, their share of income from the partnership), or who own interest in greater than half of the capital of the partnership, are considered owners of the foreign accounts of the partnership as far as FBAR reporting is concerned, and must submit an FBAR report on their own behalf which reports the foreign accounts of the partnership. Other entities (even disregarded entities) must file an FBAR report for their foreign accounts if the US person, directly or even indirectly, owns greater than half the votes, total equity, total assets, or right to the profits.

It is important to note that these individual filing requirements are distinct from the filing obligations of the related business entity that the individual has majority interest in. So, if partnerships, corporations, or other types of entities are considered US persons, then those entities themselves could also be obligated to file FBARs. Even if the entity itself or its signatory complies with FBAR requirements, that filing will not eliminate the necessity of majority owners to file their own personal FBAR.

Note again that the threshold of USD 10,000 is determined in aggregate by totaling the greatest balance reported in each foreign account that a US person had financial interest in – or if they had signature or another type of authority (including accounts held by entities or nominees) – during the year (calendar year basis), and not on an individual account basis. As an example, the majority shareholder in a corporation holding corporate foreign accounts with a USD 6,000 maximum balance who also had personal foreign accounts exceeding USD 6,000 must report both of these accounts on an FBAR because the total value of these foreign accounts is greater than the USD 10,000 threshold.

7. Failure on the Part of a Trust’s Beneficiary, Grantor, or Trustee to File

There is much confusion around the rules for foreign and US trusts. First, US trusts maintaining foreign accounts with aggregate balances exceeding USD 10,000 are required to submit an FBAR. Even trusts considered disregarded entities for US tax purposes (for example, US grantor trusts), have a reporting obligation. Second, a US person with signature or any other type of authority over the foreign accounts of a foreign or US trust (for example, a trustee) must also comply with FBAR filing obligations in their role as account signatory.

Along with the requirements already noted, US persons who are both the grantor of the trust and who have ownership for the purposes of federal US tax are considered to have ownership of the foreign accounts of the trust for the purposes of FBAR reporting, and as such are obligated to submit an FBAR which reports the foreign accounts of the trust. This filing obligation is personal, and separate from the filing obligations of the trust.

Trust beneficiary rules are a little different. US persons who are beneficiaries of either a US or foreign trust are considered to have ownership of the foreign accounts of the trust as far as FBAR reporting obligations are concerned, and must submit an FBAR which reports the foreign accounts of the trust if the beneficiary has more than half the interest in a trust’s income or assets for that year. However, current regulations allow the beneficiary to avoid FBAR requirements if a trust itself, its agent, or trustee discloses the foreign accounts in the trust using an FBAR. This exception is limited and is not applicable to trustees or grantors – only to beneficiaries. If in doubt, beneficiaries are advised to report the account(s) of the trust via an FBAR to avoid possible substantial penalties.

8. Spouses Filing Joint FBARs, Other Than in Certain Circumstances

Joint FBAR filings by spouses are only permitted in certain circumstances.

FBAR instructions allow a spouse to submit an FBAR for the other spouse only when all of these three conditions can be met:

  • (1) Every one of the foreign accounts the spouse who is not filing must report are joint accounts with the spouse who is filing;
  • (2) the spouse who is filing reports those joint accounts on an electronically signed FBAR submitted timely; and
  • (3) FinCEN Form 114a Record of Authorization to Electronically File FBARS is completed by the filers and signed. Stated differently, each spouse must file separately if the spouse not filing has ownership or authority over an account the spouse who is filing does not have a reporting obligation on.

The obligation to use Form 114a is not commonly understood. The instructions for the Form 114 and Form 114a are clear that a spouse filing joint FBARs must have the spouse who is not filing designate them formally as their preparer by both signing and keeping Form 114a (properly executed by each). It is best for each of the spouses to submit separate FBARs so as to avoid the possibility of the IRS later deciding that one or both of them did not meet FBAR requirements for joint filing.

9. Failure of Minor Children to File

Even minor children must submit FBARs if the minors are US residents or citizens who meet the requirements for filing. Each of the requirements for filing discussed above are equally applicable to minor children. The instructions for the FBAR explain: “Generally, a child is responsible for filing his or her own FBAR. If a child cannot file his or her own FBAR for any reason, such as age, the child’s parent, guardian or other legally responsible person must file it for the child.”

10. Failing to Observe the Record Retention Obligations of the Bank Secrecy Act (BSA)

Along with the obligation to file FBARs, US persons who must comply with FBAR submission requirements must also keep certain records and information in relation to the foreign accounts for a minimum of five years. The records that are required to be kept include: (1) the account holder’s name; (2) account numbers; (3) name of the institution, along with the address; (4) the account type; and (5) maximum values for each of the accounts during the associated reporting cycle. These recordkeeping requirements can be met simply by keeping an accurately completed FBAR (which includes this information). Still, it is better to keep the complete records, including bank statements, from each of the foreign accounts in support of the FBAR filing for a minimum of six years past the FBAR due date. Failure to keep adequate records of the foreign accounts submits one to the same potential penalties as failing to submit an accurate and timely FBAR.

Zemelman
Ines Zemelman, EA is the founder of Taxes for Expats
She may be reached at: +1-646-397-2887