Wrong Answer on Schedule B Dooms Taxpayers' Attempt to Rely on Accountant's Tax Advice as Reasonable Cause to Avoid FBAR Penalties
Many American taxpayers and business owners use accountants or CPAs to prepare their taxes. Their involvement in the tax process may be as little as signing the return and cutting a check, without ever really considering their accountant's advice. But a new federal court case says taking a laissez faire approach to tax reporting could cut you off from "reasonable cause" defenses to FBAR penalties.
FBAR Reporting Requirements Apply to All Foreign Financial Accounts, Even Canada
The United States Bank Secrecy Act represents the IRS's attempt to track foreign financial assets and capture taxes owed by U.S. taxpayers on income and assets held overseas. To do that, it requires U.S. taxpayers to report each foreign financial account they have a financial interest in or authority over for each year in which the aggregate value of the foreign accounts exceeds $10,000 at any time during the calendar year.
These FBAR reporting requirements apply to all U.S. taxpayers, including citizens and immigrants with legal status. They apply no matter where the person maintains a primary residence, or where the foreign financial accounts are located. It even applies to our closest neighbors, Canada and Mexico.
The FBAR reporting requirement is separate from the federal income tax return filing process. However, Schedule B, Part III, to Form 1040, requires taxpayers to disclose any interest or dividend interest above a relatively low threshold amount (currently $1,500) on any "foreign account" they control. Part III contains a questionnaire which asks (in the 2006 version) for a "Yes" or "No" answer to the following question:
At any time during [the tax year], did you have a financial interest in or signature authority or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account? See instructions for exceptions [e.g., $10,000 aggregate threshold] and filing requirements for Form TD F 90-22.
Ironically, this language — buried at the bottom of Schedule B — is perhaps the only way the IRS puts the average taxpayer on notice that the FBAR filing requirement even exists. As a result, whether the "Yes" or "No" box is checked on Part III of Schedule B constitutes a crucial piece of evidence the IRS uses to determine whether a failure to filed PBAR reports will be ruled "willful or "non-willful."
Can Reliance on Your Accountant to Complete Schedule B Correctly Save You from FBAR Penalties ?
Larry and Linda Jarnagin were U.S. taxpayers. Larry had dual U.S.-Canada citizenship since 1989. Linda had Canadian residency status. The couple owned a cattle ranch in British Columbia, and corporate real estate, apartment complexes and a nightclub in the American southwest. They spent much of each year north of the border. Regular readers of this blog may recall that the Jarnagins had gone through a series of accountants over the years. But starting in 2006, they failed to file FBARs disclosing their bank account at the Canadian Imperial Bank of Commerce (which at one time held over $4 million). When the IRS imposed FBAR penalties on the couple, they objected, saying they had relied on their accountants to properly repair their tax returns and related documents.
The Bank Secrecy Act allows the IRS to impose penalties of up to $10,000 per taxpayer, per year for failing to file FBARs. The IRS proposed total penalties of $100,000, (2 taxpayers over 5 years). After further negotiations, that amount was reduced to $80,000. But the Jarnagins objected, and, after paying the penalty, filed a lawsuit in the U.S. Court of Federal Claims to get their money back, claiming wrongful assessment and collection of penalties. They said their failure to file was "due to reasonable cause" because they hired a competent CPA and relied on his preparation of their tax returns.
But the Court disagreed. While the Bank Secrecy Act does excuse FBAR violations with "reasonable cause", the court said that a taxpayer must demonstrate that he or she exercised "ordinary business care and prudence" and still failed to file. This is a case-by-case determination, based on the facts and circumstances in the case, including the experience, knowledge, and education of the taxpayers, and the steps they took to determine their proper tax liability.
Relying on an accountant's advice can sometimes meet that standard. But simply hiring a CPA does not excuse the taxpayers from their individual duties to exercise ordinary business care and prudence. They must take an active role in the preparation of their tax returns and FBARs.
What the Jarnagins Did Wrong
The problem wasn't with the accountants used by Larry and Linda Jarnagin. The court assumed that each tax preparer was competent to do their job. But the Jarnagins didn't take the necessary steps to receive their most recent accountant's advice, or review the documents he prepared.
The Jarnagins testified that neither of them had actually read their tax returns before signing them. Nor did they take much time to consult with their tax preparer or receive his advice. Like many taxpayers, they provided the requested information, and then came back asking where to sign, and how much they owed.
But the Jarnagins never explicitly told their accountant about the Canadian account. He prepared their tax returns by stating on Schedule B that they had no foreign financial accounts. Because the couple didn't read the return carefully, they never noticed this misstatement, or asked their accountant about the need to disclose the account. In the court's view, they didn't receive accountant's advice on the issue. Exercising ordinary business care and prudence, the court said, would require the couple to read carefully and question their accountant about the omission, raising the issue of FBAR reporting requirements.
U.S. taxpayers are entitled to rely on their accountant's advice to avoid FBAR penalties. But to qualify for that defense they must do their part to ensure the CPA has the information he or she needs to give the right advice. Taxpayers are advised to regularly discuss all of their financial circumstances with their tax preparers to make sure they file the proper tax returns and avoid FBAR penalties.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years’ experience. If you have questions regarding FBAR penalties, contact Joe Viola to schedule a consultation.