Do you have a financial interest in or signature authority over a foreign nest egg that is worth over $10,000 on any day of the year? Then you cannot afford to hide your head in the sand and ignore the annual Report of Foreign Bank and Financial Accounts (FBAR) filing and recordkeeping requirements. In addition to negligence or fraud penalties, steep civil and/or criminal penalties may apply if you fail to file the FBAR. What can happen, you ask? Consider the creator of Beanie Babies, H. Ty Warner, as an example. In 2008, he paid $53.6 million (i.e., 50 percent of the maximum balance of his foreign account), one of the largest FBAR penalties the United States has collected to date. United States v. Warner, 792 F.3d 847 (2015). Enough to make anyone’s feathers ruffle!
The United States requires its citizens, residents, and domestic entities to file FBARs because foreign financial institutions (unlike domestic ones) are not under U.S. jurisdiction and, therefore, are not subject to U.S. reporting obligations and to the power of the U.S. district courts to enforce the Internal Revenue Service’s (IRS) summons authority. The United States has several foreign asset filing requirements (see Chart 1). However, the FBAR is unique in that, unlike the IRS forms and schedules depicted in Chart 1, the FBAR is not a tax return protected under the taxpayer confidentiality rule, found in IRC (Internal Revenue Code) section 6103. Rather, it is a required yearly report, regardless of whether income is earned. It assists the United States with ferreting out secret foreign accounts used to fund international terrorist activities, launder money, hide income, and other illegal acts. Accordingly, it is freely shared among a network of law enforcement agencies.
Additionally, the FBAR, or the Financial Crimes Enforcement Network (FinCEN) Form 114 (formerly TD F 90-22.1), is not filed with the IRS but electronically through the FinCEN BSA E-filing system (no paper filing as of July 2013). Beginning in 2017, the FBAR due date will be moved from June 30 to April 15, and a maximum six-month extension to October 15 will be allowed (as a result of the enactment of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015). Thus, this new due date will coincide with that of tax return filings.
Since the Bank Secrecy Act’s (BSA) enactment, the FBAR has been around for over forty-five years, and is codified in Title 31 of the U.S. Code. Then why all the recent attention? Because the United States has stepped up FBAR enforcement efforts.
During the late 1990s, there were few FBAR indictments. In response to the tragic events of September 11, 2001, however, the United States made several efforts to improve the tracking of foreign funds. In April 2003, through a Memorandum of Agreement, FinCEN delegated full civil investigatory and enforcement authority to the IRS, giving the IRS power to assess and collect penalties, investigate civil violations, employ the summons power, issue administrative rulings, and take any reasonably necessary enforcement actions. The advent of the American Jobs Creation Act of 2004 (Jobs Act) created more stringent civil penalties for noncompliance. In 2008, the Department of Justice launched a crackdown into secret overseas assets, starting with Swiss Bank UBS, one of Europe’s largest financial institutions. In February 2009, UBS entered into a deferred prosecution agreement, agreeing to pay a settlement of $780 million to the United States as well as to identify over 4,000 U.S. taxpayers with hidden Swiss accounts. Finally, in March 2010 came a momentous change in the detection of offshore tax evasion: Congress passed the Foreign Account Tax Compliance Act (FATCA). FATCA enhanced the enforcement of the FBAR through mandatory disclosures by both foreign financial institutions (FFIs) and U.S. taxpayers. As IRS Commissioner John Koskinen commented in a March 15, 2016 IRS News Release, “Taxpayers here and abroad need to take their offshore tax and filing obligations seriously.”
This article focuses on the elements triggering a mandatory FBAR filing (with a skeletal flowchart) and concludes with a short overview of the possible outcomes for noncompliance.
Do You Need to File an FBAR?
To make the determination whether you are obligated to file an FBAR, ask yourself the four questions presented in Flowchart 1. Certain IRS forms and schedules also direct you to a possible FBAR filing requirement, if you check the box “Yes” as to having a financial interest or signature authority over a foreign financial account (see Item 5 of Chart 1).
Question 1: Is the Filer a U.S. Person?
Under the BSA, U.S. persons include: (1) U.S. citizens; (2) U.S. residents; and (3) entities formed within the United States. For FBAR purposes, the United States includes the 50 states, the District of Columbia, the territories and insular U.S. possessions (i.e., American Samoa, the Commonwealth of the Northern Mariana Islands, the Commonwealth of Puerto Rico, Guam, and the U.S. Virgin Islands), and the Indian lands as defined in the Indian Gaming Regulatory Act. Children are also included in the definition of U.S. persons, although their parents or guardians may file on their behalf. Let us look at these terms in more detail:
(1) Citizens. U.S. citizens are those with a U.S. birth certificate or naturalization papers.
(2) Residents. Residents are individuals who meet one of the following tests: (1) the green card test (i.e., a green-card holder who has entered the United States); (2) the substantial presence test (i.e., physically present in the United States for at least 183 days out of the current year, or at least 31 days during the current year and the sum of the number of days as calculated in IRC section 7701(b)(3) ); and (3) the resident alien election (i.e., filing a first-year election to be treated as a U.S. resident alien under IRC section 7701(b)(4)).
(3) Entities. Domestic entities may be corporations, partnerships, LLCs, estates, or trusts. The key to determining whether an entity is required to file an FBAR is the law under which it was created (e.g., state certificate of incorporation). A foreign entity that has elected to be treated as a U.S. entity for U.S. tax purposes and a foreign subsidiary do not need to file an FBAR. However, a domestic parent (or U.S. individual) may be obligated to file an FBAR if it has a financial interest in a foreign subsidiary that owns an offshore account.
The entity’s tax exemption and disregarded federal tax status are irrelevant for FBAR reporting purposes. For example, a domestic charitable organization, IRC under section 501(c)(3) and a single-member LLC may be obligated to file an FBAR (in conjunction with his or her owner), despite their tax situation.
Domestic subsidiaries may be exempt from filing an FBAR, however, if their parent entities name them in a consolidated FBAR. A parent may file a consolidated FBAR on behalf of itself and its subsidiary if it is formed under U.S. law, owns a greater than 50-percent interest in its subsidiary, and files an FBAR (which includes its financial and other information as well as its subsidiary’s). Thus, Subsidiaries O2, a California corporation, and O3, a Nevada corporation, do not need to file an FBAR when Parent O1, a Delaware corporation, files a consolidated FBAR (identifying all reportable accounts, itself, and its subsidiaries; see Part V of FinCEN Form 114).
Question 2: Does the Filer Have a Financial Interest in a Foreign Financial Account?
This question involves three special terms, namely, “foreign,” “financial account,” and “financial interest.” First, what does “foreign” mean, for FBAR purposes? It does not refer to the financial institution’s nationality, but to its geographical location outside the United States, District of Columbia, the Indian lands, and the territories and insular possessions of the United States. So, an account in a branch of a French bank that is located in New York is not a reportable account. By contrast, an account in a branch of a U.S. bank that is located in France is a reportable account.
What about “financial account”? This includes but is not limited to the following:
- bank account, or an account maintained with a person engaged in the business of banking, such as a checking account;
- securities account, or an account with a person engaged in the business of buying, selling, holding, or trading stock or other securities, for example a brokerage account;
- commodity futures or options account;
- insurance or annuity policy with a cash value, such as a whole life policy;
- mutual fund or similar pooled fund, meaning a fund that issues shares to the general public that have a regular net asset value determination and regular redemption (foreign hedge funds and private equity funds are excluded); and
- any account with a person that is in the business of accepting deposits as a financial agency. See 31 C.F.R. (Code of Federal Regulations)
Let us examine a couple of financial account examples. In a 2016 case, the district court ruled that a U.K. poker fund, used for the exclusive purpose of facilitating poker playing, was not a financial account. Similarly, a credit card is generally not an account. However, the IRS posited, in I.R.S. Legal Memorandum 2006-03-026 (Jan. 20, 2006), that a credit card may constitute an account if the cardholder was making advance payments and using the card like a debit card or checking account. Likewise, a safe deposit box is customarily not an account; however, if it is used in ways similar to an account, such as holding and issuing cash to the owner and facilitating the transmission of funds or extension of credit, then the IRS may argue that it is an account (IRS’s expressed position at the June 12, 2009 ABA Section of International Law’s Committee on International Taxation).
Finally, what does “financial interest” mean? The regulations define it as a U.S. person being the foreign account’s owner of record or having ownership or control over the owner of record, which rises to a level of having a financial interest. Generally, it can be any one of these possibilities: (1) an owner of record; (2) an agent; or (3) a U.S. person with greater than a 50-percent interest in an entity (either directly or indirectly) that owns a foreign account. Let us examine each of these situations in more detail:
Owner of record (or legal-title holder). A U.S. person has a financial interest if he or she is the legal owner or titleholder of a foreign account, regardless of whether he or she benefits from the account. This is true even if the account is used for the benefit of a non-U.S. person. If there are multiple U.S. persons who share ownership or title to the account, then each of them has a financial interest and a separate FBAR obligation (e.g., each U.S. co-trustee of a trust with an offshore account).
An exception exists for a married couple that jointly owns a foreign account(s). In that case, the couple may file a joint FBAR as well as complete and sign FinCEN 114a, Record of Authorization to Electronically File FBARs. Nevertheless, to prevent the risk of joint FBAR liability due to a noncompliant spouse, each spouse may file his or her own separate FBAR. If one spouse has signature authority and/or separately owns other offshore account(s), then each spouse should separately report his or her FBAR, including those jointly held account(s).
Agent, nominee, attorney, or a person acting on behalf of a U.S. account beneficiary. A U.S. person has a financial interest in an account if he or she uses an agent (or other person acting on his or her behalf) to acquire account benefits. For example, if U.S. citizen Oscar opens a foreign account in the name of his brother Ollie, who maintains it for Oscar’s benefit, such as in paying Oscar’s bills, then Oscar has a financial interest. If Ollie is a U.S. citizen or resident, then Ollie also has an FBAR reporting requirement.
Note: Financial interest encompasses those U.S. persons who may desire to avoid an FBAR obligation with a non-U.S. agent or nominee who obtains account benefits on their behalf (i.e., FBAR responsibilities follow economic reality). Thus, if a U.S. individual structures a foreign entity (e.g., trust or corporation) to own his or her overseas accounts, that individual still has a financial interest in the offshore accounts. The regulations’ anti-avoidance provision captures situations in which U.S. individuals create entities for the purpose of evading their FBAR obligations.
Person with a direct or indirect interest (e.g., voting power or equity interest) that is greater than 50 percent in an entity (e.g., corporation or trust) that is the record owner or titleholder of a foreign account. This situation may take on various scenarios, but we will focus on corporations and partnerships. If a domestic or foreign corporation directly or indirectly owns an overseas account, then a U.S. person who owns more than half of the total value of the corporate shares of stock or voting power of all shares of stock has an FBAR reporting obligation. Similarly, if a domestic or foreign partnership owns an offshore account, then a U.S. person who directly or indirectly owns more than half the partnership’s profits or capital has an FBAR reporting requirement.
To illustrate, U.S. resident Odell owns 75 percent of a California parent corporation that, in turn, owns 100 percent of a foreign subsidiary that has a foreign account. Both Odell and the California parent must file an FBAR because they are both U.S. persons with a majority financial interest in the total value of shares of the foreign subsidiary’s stock (even though Odell’s interest is indirect).
In contrast, if Odell owns only 40 percent of the California parent corporation while each of his children own 20 percent, none of the family members have an FBAR financial interest (unless, as described above, the anti-avoidance rule applies). Nevertheless, they may still have an FBAR reporting requirement if they have signatory authority over the offshore account.
Question 3: Does the Filer Have Signature or Other Authority Over the Foreign Account?
Signature or other authority is defined as an individual (either alone or in conjunction with another) who can control the disposition of account assets (e.g., withdrawing funds) by directly communicating (e.g., in writing or by oral mandate) with the person in charge of maintaining the account. 31 C.F.R. § 1010.350(f)(1). In other words, “signature or other authority” means that a financial institution will act upon a person’s direction (although more than one individual’s communication is required), regardless of whether the power is exercised.
Generally, a person who can control the deposits and withdrawal of bank funds has signature or other authority. The mere ability to control the investment of funds does not constitute such authority. Likewise, there is no such authority when an individual is an intermediary in the chain of command regarding the disbursement of account property. However, if the intermediary were introduced for the purpose of evading FBAR reporting, then the IRS can impose a higher FBAR penalty for a willful violation.
Let us look at an example: Omar opened an Australian account and hired an Australian attorney for the purpose of serving as the power of attorney over the account. Omar gave his partner the authority to make the account’s investment decisions and to instruct the attorney, but not the bank. Here, Omar has a financial interest because he is the owner of the account. Additionally, his attorney has signature authority allowing him to control the disposition of account funds by directly communicating with the bank representative who maintains the account. However, Omar’s partner has no such authority because he can control only the investment of account funds and is unable to control any transmission of these funds.
FBAR reporting exceptions apply to the following officers and employees who have signature or other authority but no financial interest: (1) certain financial institutions; (2) certain authorized service providers; or (3) certain entities whose security is listed on any national security exchange or registered under section 12(g) of the Security Exchange Act. See 31 C.F.R. § 1010.350(f)(2).
For all other officers and employees who have signature or other authority but no financial interest, the regulations impose a duty to file an FBAR. However, the IRS has granted several extensions (from May 31, 2011 to December 8, 2015) and a new filing due date of April 15, 2017. See FinCEN Notice 2015-1. On March 1, 2016, FinCEN proposed to modify the regulations by exempting certain officers, employees, and agents of domestic entities with signature or other authority but no financial interest, provided that the FBAR is otherwise reported by the entities and that the entities maintain records regarding these individuals for at least five years.
Question 4: Is the Aggregate Value of All the Foreign Financial Account(s) Greater Than $10,000 at Any Time during the Calendar Year?
Now it is time to dust off your calculators! Aggregate value refers to the highest total amount of all those offshore accounts (in which you have either a financial interest or signature or other authority) at any time from January 1 to December 31.
You may rely on periodic quarterly or more frequently issued statements so long as they reasonably reflect the maximum account balance during the year. So, if you make several-thousand-dollar deposits in one month and withdraw all those monies before the end of the monthly statement, then your statement will not fairly reflect the largest account balance.
To determine your maximum account balance, you must value each account’s largest amount separately. Based on the Treasury Reporting Rates of Exchange’s (https://www.fiscal.treasury.gov/) end-of-year conversion rates, each account’s local currency value is transformed into U.S. dollars. You then add the maximum values of all your foreign accounts to see if you exceed the threshold of $10,000. Make sure that you do not double count the same monies transferred from one account to another.
For example, Oliver opened three Swiss bank accounts: A ($3,000 balance), B ($3,000 balance), and C ($2,000 balance). Presently, Oliver need not file an FBAR because the total account value of his overseas accounts is below $10,000. Suppose, however, that he closes bank account C and transfers the entire amount to account D. Suppose further that the value of each of his accounts increased by $1,000 during the following year. In that case, although none of the accounts (A, B, or D) individually exceed the threshold amount, their aggregate value does, so Oliver has an FBAR obligation. Note also that the transferred monies from account C to account D are counted only once.
What Are the Rules for U.S. Persons With a Financial Interest in or Signature or Other Authority for 25+ Foreign Financial Accounts?
Currently, the regulations provide that, if a U.S. person has a financial interest in 25 or more accounts, then that person may provide certain basic information regarding these accounts. A similar rule applies to those with signature or other authority over 25 or more accounts. See 31 C.F.R. § 1010.350(g). However, detailed information should be available upon the request of either the IRS or FinCEN (i.e., recordkeeping is still mandatory). On March 1, 2016, FinCEN proposed to make detailed information about all such offshore accounts mandatory, despite their numerousness.
In summary, the FBAR is a yearly, mandatory report on offshore accounts that helps the government to combat tax evasion, money laundering, and other illegal activity. As can be seen from the above FBAR requirements, there can be multiple filers for one account, such as joint owners and account co-signers. Accordingly, each filer may be subject to a penalty for noncompliance.
Civil penalties range from $10,000 for a non-willful violation (i.e., good-faith inadvertence, mistake, or negligence) to the greater of $100,000 or 50 percent of the amount of the transaction or account balance at the time of the willful violation (e.g., an intentional violation or a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements). Both criminal and civil penalties may be imposed simultaneously, as well as non-FBAR penalties (e.g., an accuracy-related penalty). However, the IRS may apply mitigation measures, provided that certain conditions are met. In addition, there is penalty relief if the violation was: (1) due to reasonable cause (i.e., a violation despite an exercise of ordinary business care and prudence); and (2) the amount of the transaction or the balance of the account at the time of the transaction was properly reported.
If you believe you have an FBAR filing requirement (or may be a delinquent FBAR filer), you should consult with your tax professional. Quietly disclosing your late FBAR may open you to risks (e.g., filing an amended return and past-due FBAR without reasonable cause and enrollment in an FBAR amnesty program). There are different options for delinquent FBAR filers; for example, the streamlined program for a non-willful violation and the offshore volunteer disclosure program (OVDP) for a willful violation, which may be better than paying the full penalty. Of course, it is best to avoid all penalties by timely filing; therefore, remember that, when it comes to the FBAR, do not be an ostrich!