IRS Guidance Makes FBAR Penalties More Predictable
When you discover that the IRS is investigating you for failing to report foreign financial accounts it can be intimidating. If you are facing the possibilities of FBAR penalties and criminal imprisonment, Your first question will likely be, "What's going to happen to me?"
Until recently, the answer to this crucial question has been, "It depends." It could depend on the facts and circumstances in your case, the reason you failed to file, and even which IRS examiner got assigned to your matter. With all that uncertainty, it was even hard for tax attorneys to predict FBAR penalties with any degree of confidence.
In response to this concern, in 2015, the IRS published the "Interim Guidance for Report of Foreign Bank & Financial Accounts (FBAR) Penalties." This guideline was adopted into the Internal Revenue Manual for the the Bank Secrecy Act on November 6, 2015, and applies to any new or pending case since that time.
The guidance provides an internal checklist and direction as to the investigation of any failure to file the FBAR. It also directs FBAR penalties issued for willful and non-willful violations of the Bank Secrecy Act.
FBAR Examination Procedures
In every FBAR examination, the new guidance requires examiners to:
- Determine a recommended penalty pursuant to the guidelines
- Consult an Operating Division FBAR Coordinator, and
- Receive approval of the recommended penalty from a group manager.
If the examiner finds that there has been a willful FBAR violation, the Chief Counsel must provide a written advice memorandum explaining whether the recommended penalty complies with the law. Where criminal penalties may be warranted, the Fraud Technical Advisor must be consulted to facilitate the referral. These requirements build cross-checks into the FBAR examination system to ensure consistency across examiners and within the department.
The guidelines also clarify murky areas of the Bank Secrecy Act, particularly where a person has multiple foreign financial accounts. The appropriate penalties depend greatly on whether the IRS examiner finds that the violation was willful or non-willful.
Willful FBAR Penalties
If an IRS examiner finds that a person willfully failed to file the FBAR, he or she will recommend a penalty for each year the FBAR was not filed. The total penalty amount in most cases will be 50% of the highest aggregate balance of all unreported financial accounts. That amount will be allocated among each year of the violation based on he value of the accounts in that year as compared to the highest year.
An IRS examiner can recommend a higher or lower amount, based on the facts and circumstances of the matter. However, the total can never be more than 100% of the highest aggregate value of the unreported financial accounts during the non-reporting period.
Non-Willful FBAR Penalties
If, instead, an IRS examiner believes the person's violation was non-willful, he or she may determine that no penalty is necessary if there was a reasonable cause for the violation and the person later corrects the error by completing the required FBAR.
In cases where a FBAR penalty is appropriate, the IRS examiner may assert only a single penalty up to $10,000 for one year only, with the group manager's approval, or may assert a penalty for each year the FBAR was not filed. There will only be one penalty each year, no matter how many foreign accounts went unreported. The amount of the penalty will be based on the aggregate balance of the accounts up to $10,000. Even in the most serious non-willful FBAR violation cases, the penalty will be capped at 50% of the highest aggregate balance for all unreported financial accounts during the non-reporting period.
In determining whether a violation was willful or non-willful, IRS examiners are now required to consider mitigation guidelines which describe a number of mitigation threshold conditions that must exist before the examiner can set the penalty. If the threshold is met, the examiner sets a preliminary penalty calculation based on those guidelines, with a maximum of $10,000 per year. This will be the final penalty unless the facts and circumstances of the case warrant a different decision.
If the Internal Revenue Manual mitigation threshold conditions are not met, examiners do not have to make a calculation based on the guidelines. Instead, examiners assert a separate penalty for each account for each year, up to 50% of the highest aggregate balance.
Examiners are required to make a separate determination for each owner of a foreign financial account, including whether a violation occurred and whether it was willful or non-willful. The penalty will be adjusted based on the co-owner’s percentage ownership of the highest balance of the account. If ownership percentages are unclear, the amount will be divided equally among the co-owners.
All of these guidance requirements make it easier for tax attorneys and taxpayers to predict FBAR penalties. While there is still discretion within the categories, the guidelines help ensure consistency among examiners.
FBAR Case File Documentation Requirements
The new IRS guidelines also assist in challenging an FBAR penalty by ensuring proper documentation within the case file. IRS examiners are required to fully develop and adequately document their analysis of willfulness. This documentation must meet with the group manager's approval and will include:
- Penalty calculations
- A case file checklist
- The Chief Counsel’s written advice memorandum, and
- A copy of Letter 3709, advising the taxpayer of the FBAR penalty.
The Chief Counsel's memorandum, which is only required when willful penalties are assessed, states whether Counsel believes:
- An FBAR violation occurred
- The FBAR violation was willful
- The proposed penalty is within the statutory limit.
By obtaining and reviewing the administrative file, tax attorneys can review the evidence supporting a willfulness determination and better advise tax clients regarding the likelihood of success on appeal.
An FBAR penalty is no small matter. It can amount to thousands of dollars and in the most severe cases even send a person to federal prison. With the new IRS guidelines, taxpayers and their tax attorneys will be better able to assess the strengths and weaknesses of their circumstances, and predict the penalties.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding FBAR requirements or penalties, contact Joe Viola to schedule a consultation.