U.S. TAX ALERT – May 16, 2007


FBAR—foreign bank account reporting obligations: a primer for the practitioner

While it is generally understood that U.S. persons are obligated to file income tax returns with IRS on an annual basis, it is not as well understood that such persons may have additional reporting requirements if they have an interest in a foreign financial account. Form TD F 90-22.1, the “Report of Foreign Bank and Financial Accounts” and more commonly known as the FBAR, must be filed by U.S. persons on an annual basis if at any point during the calendar year they have an ownership interest in or signature authority over a financial account (or several such accounts) in a foreign country, with an aggregate value in excess of $10,000 (the “FBAR requirements”). Failure to file the report is punishable by both civil and criminal penalties.

Even though many professionals may be aware of the need to file the FBAR, there is much confusion surrounding the breadth of the reporting requirement. For example, multiple persons may be responsible for filing a FBAR to report the existence of the same financial account. Additionally, there are questions regarding who qualifies as a U.S. person, what constitutes signature authority over a financial account, and what is classified as a foreign account.

Notwithstanding any ambiguity regarding the FBAR requirements, the responsibility to file a FBAR currently falls on the taxpayer. If, however, Section E of the report by the Joint Committee on Taxation entitled “Additional Options to Improve Tax Compliance” (the “JCT Report”) should be enacted, tax practitioners will be placed squarely on the front line. The JCT Report proposals would put the responsibility for determining whether a taxpayer has a FBAR filing requirement on tax preparers, by extending to the FBAR the Code Sec. 6695(g) due diligence requirement, which currently imposes the responsibility on preparers to determine a taxpayer’s eligibility for the earned income tax credit as well as the amount of the credit permitted. Consequently, preparers would have to become intimately familiar with the FBAR requirements. Practitioners would be liable for (1) discussing with taxpayers the FBAR filing requirement as well as the civil and criminal penalties for failure to file the FBAR, and (2) documenting taxpayers’ responses to such discussions as well as retaining such documentation for IRS’s possible use in an audit.

Origin of the FBAR requirements. The FBAR is a by-product of the Bank Secrecy Act (BSA), which was first enacted in ’70. Congress created the BSA because of concern that financial institutions in tax haven jurisdictions were being used by U.S. persons to hide the proceeds of their illegal activities, evade tax, and for other criminal purposes. BSA § 5314 required Treasury to create forms that financial institutions and individuals would have to file that ultimately could be used by the government to track the movement in cash in the economy and crack down on nonfilers. The BSA specifically imposed responsibility on Treasury to promulgate regulations that would promote compliance and be useful in criminal, tax, regulatory, intelligence, and counter-terrorism matters, as well as to counter money laundering. 31 C.F.R. § 103.24 contains the requirement for a FBAR to be filed:

“(a) Each person subject to the jurisdiction of the United States (except a foreign subsidiary of a U.S. person) 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….”

The FBAR is filed with IRS’s Detroit Service Center, and the information on the return is entered into a FBAR database that is administered by both IRS and Financial Crimes Enforcement Network (“FinCEN”). Once entered, the information can be accessed by multiple governmental authorities for purposes of tracking the flow of money.

Early in 2003, FinCEN delegated its enforcement authority for FBARs to IRS. The delegation was the culmination of a study imposed on Treasury by the USA Patriot Act to find ways to improve compliance with reporting requirements. IRS now has the ability to investigate noncompliance with the FBAR, assess and collect civil penalties associated with such noncompliance, and use the full investigative arsenal available to it.

Who is subject to the FBAR requirements? The FBAR requirements apply to any “ U.S. person,” which includes all U.S. citizens and resident aliens. Nonresident aliens are not required to file a FBAR. Consequently, an individual who otherwise would qualify as a nonresident alien must be careful to avoid being classified as a resident alien under the substantial presence test of Code Sec. 7701(b)(3) and thus subjected to the FBAR requirements (and related penalties for failure to comply).

The substantial presence test provides that an individual becomes a resident if he or she is physically present in the U.S. for 183 or more days during the current tax year. An individual not physically present in the U.S. for 183 days or more during the current tax year, still may satisfy the substantial presence test under a three-year look-back. The rule requires the individual to be physically present in the U.S. during the current tax year for at least 31 days, and for a total of 183 days over a three-year period that includes the two preceding calendar years.

For purposes of the FBAR requirements, a U.S. person also includes all U.S. estates, trusts, partnerships, and corporations. Thus, if any of these domestic entities has an interest in or authority over a financial account worth more than $10,000, the entity must file a FBAR. Similarly, it is possible that the authorized representative of any of these domestic entities will have a personal filing requirement as a result of the affiliation with the entity (discussed in greater detail, below).

LLCs are not specifically classified as U.S. persons under the FBAR requirements. Nevertheless, since these entities are taxed as corporations, partnerships, or to the entity owner (i.e., a single-member LLC treated as a disregarded entity), it would appear as though the members of such entities would have a reporting requirement based on the entity’s classification for income tax purposes. In the absence of specific IRS guidance, members of an LLC would be well advised to take the conservative approach and file a FBAR if the LLC otherwise meets the FBAR requirements.

U.S. jurisdictions. For purposes of proving residency in a U.S. possession, territory, or commonwealth (“U.S. jurisdictions”), Code Sec. 937 and the Regulations thereunder specify that time spent in a U.S. jurisdiction is deemed to be time spent outside of the U.S. Additionally, time spent in a U.S. jurisdiction will not qualify as time spent in the U.S. for purposes of the substantial presence test. By contrast, for FBAR purposes each U.S. jurisdiction is deemed to be part of the U.S. Consequently, contrary to what would be expected pursuant to Code Sec. 937 and Code Sec. 7701, financial accounts in U.S. jurisdictions are not deemed to be foreign accounts and thus are not subject to FBAR reporting.

What types of accounts have to be reported? Generally, any type of account that holds liquid assets or marketable securities will be a “financial account” for purposes of the FBAR requirements. Thus, everything from a cash account to a foreign mutual fund, such as an exchange traded fund, is classified as a financial account.

Signature or other authority. If an individual can order the distribution or disbursement of funds or other property from the institution where the funds or property are maintained, by signing a document providing such direction (or in conjunction with one other person signing the document), that individual has signature authority over the financial account. Similarly, if an individual can exercise the same control verbally or via other means of communication, the individual has other authority over a financial account.

These powers should not be confused with the power of investment. Individuals who can make investment decisions but who do not have the ability or discretion to make disbursements do not have a FBAR reporting requirement. Notwithstanding the foregoing, the JCT Report would treat a U.S. person as having signature or other authority over a foreign account if the U.S. person creates a trust with a foreign protector. Specifically, the JCT Report will attribute any duties and powers held by the foreign protector to the U.S. person.

In summary, an individual who holds a power of attorney or who is a custodian of an account for a minor would appear to have the ability to exercise sufficient powers that would cause the attorney-in-fact or custodian to have a FBAR reporting duty. Similarly, a trustee, personal representative, president of a corporation, president of a general partner or managing member of an LLC, to name but a few individuals by title, could be deemed to have signature authority or other authority over a financial account held by the entity and thus a reporting obligation.

Financial interest. The definition of what constitutes a financial interest for purposes of the FBAR is based on who owns the interest. For example, a foreign pension account satisfying the FBAR requirements and which is owned by an employer or a foreign government would not have to be reported by a U.S. person, since the U.S. person does not have any ownership over the pension account. If, however, the employer maintains individual accounts for each employee, similar to a Code Sec. 401(k) account, the employee would have a filing requirement.

Essentially, an individual has a financial interest in every account for which the individual is the owner of record or has legal title, whether the account is for the owner’s benefit or for the benefit of another. There can be many situations in which several persons have an obligation to file a report with respect to the same account. For example, if the account is owned by more than one person, such as a joint account or an account held by tenants in common, each person has a financial interest for purposes of the FBAR. Similarly, if a U.S. person who owns a foreign bank account gave a power of attorney to another U.S. person to sign over the account, both the owner of the account and the individual exercising the power of attorney would have a reporting requirement. Multiple filings also would be required from the trustees of a trust with several trustees if the trust has an interest in a foreign financial account.

Individuals serving as shareholders, partners, and trustees also may be deemed to hold a financial interest in an account if the account is owned by or the individual with legal title is any of the following:

(1) A person acting as an agent, nominee, attorney, or in some other capacity on behalf of the U.S. person.
(2) A corporation in which the U.S. person owns more than 50% of the total stock either directly or indirectly.
(3) A partnership in which the U.S. person owns an interest in more than 50% of the profits.
(4) A trust in which a U.S. person has either a present interest in more than 50% of the assets or from which the U.S. person receives more than 50% of the income.

Thus, while the domestic entity that has a financial interest that otherwise meets the FBAR requirements will have to file a FBAR, it also is possible that the shareholders, officers, or directors of foreign corporations, partners in foreign partnerships, grantors of foreign trusts, or beneficiaries of a foreign trust or estate also will have to file the FBAR.

Due dates for filing a FBAR. If a U.S. person has a foreign account that satisfies the FBAR requirements, the FBAR is due on June 30 of the following year (with no extensions). The form is filed with the Detroit Service Center. The duty to file the FBAR is independent of the obligation to file an income tax return even though the FBAR is cross referenced on Form 1040, Schedule B, Part III.

A foreign account that satisfies the FBAR requirements must be reported even if the account does not generate taxable income. Thus, a taxpayer who fails to file a FBAR because the account generates no taxable income will be subject to penalty. IRS has six years within which to assess a civil penalty related to a FBAR violation. It is unclear, however, whether the statute will toll if the FBAR is not filed.

Penalties for failure to file. A taxpayer who fails to file a FBAR may be subject to both civil and criminal penalties under Title 31 of the United States Code. The same violation may be punishable by both a civil and criminal penalty.

Civil penalties. Prior to the Americans Jobs Creation Act of 2004 (AJCA), civil penalties were imposed on willful violations of the reporting requirement. The minimum penalty was $25,000 and the maximum penalty was $100,000. After the AJCA, there is now a penalty of up to $10,000 for a non-willful failure to file the FBAR. If, however, the amount of the transaction or the balance of the foreign account is reported on the taxpayer’s Form 1040, the penalty may be eliminated as a result of the reasonable cause exception. Nevertheless, Form 1040, Schedule B, Part III instructs a taxpayer who indicates that he or she has a financial account in a foreign country to review the FBAR. To satisfy the reporting necessitated for the reasonable cause exception, the taxpayer must be certain to include on the Form 1040 any income generated by the foreign account and to the extent possible a detailed explanation of the transaction.

For a willful violation of the FBAR reporting requirement, the penalty is now a fine equal to the greater of $100,000 or 50% of the amount of the transaction or of the balance of the account at the time of the offense. Violations that are deemed to be willful are not subject to the reasonable cause exception. In the event the suggestions in the JCT Report are enacted in their present form, it would appear that the availability of the reasonable cause exception would be severely curtailed absent documentation of extenuating circumstances (such as the taxpayer’s tax preparer advising the taxpayer that the FBAR was not required).

Criminal penalties. While the AJCA did not change any aspect of the criminal penalties, such penalties are premised on the violation’s being willful. Thus, if the failure to file the FBAR is deemed to be a criminal violation, the penalty can include a fine of up to $250,000, imprisonment for up to five years, or both. If the failure to file is deemed to be part of a criminal activity (i.e., it occurs during the violation of another law or is part of an illegal activity involving more than $100,000 in a 12-month period), the maximum fine increases to $500,000 and the possibility of imprisonment increases to up to ten years. There is, of course, a possibility that both the $500,000 penalty and ten-year jail term will be applicable.

To establish willfulness, the government must prove that the taxpayer had knowledge of the reporting requirement and in spite of such knowledge chose to ignore the requirement. Some courts, however, have held that the government may prove willfulness by demonstrating that the taxpayer consciously or recklessly disregarded the law.

Conclusion. While the FBAR requirements include some ambiguities and could be clearer, the major issue for taxpayers and their advisors is the general level of ignorance with respect to both the filing requirement itself and the substantial and ongoing penalties that may follow noncompliance. It is not advisable to continue violating the statute in hopes that IRS will provide an additional amnesty program in the future.

Source: Federal Taxes Weekly Alert (preview) 05/17/2007, Volume 53, No. 20