Can the IRS Impose FBAR Penalties if You Don’t Owe Taxes?

woman reviewing tax documents

Many retired U.S. taxpayers don’t owe taxes at the end of the year. If their income from pre-tax retirement accounts and Social Security is offset by medical expenses or other allowable deductions, they may not have enough income to report, or any tax obligations to pay. But a recent District Court decision from Pennsylvania shows that retired taxpayers can still face substantial FBAR penalties, even if they don’t owe taxes on their foreign accounts.

Working Abroad Built Decades of Foreign Financial Accounts

Richard Collins was born in Canada and became a naturalized U.S. citizen in 1972 after receiving his Ph.D. from the University of California at Berkeley. That same year, Collins began working abroad. He spent 9 months of 1972 as a researcher at the University of Paris in France. While he was there, he opened a Swiss bank account that was eventually acquired by UBS AG. The next year Collins liquidated all his U.S. assets and returned to France, where he worked for the next decade. He opened a second bank account at Le Credit Lyonnais, which he funded with his French wages.

In 1983, Collins moved back to Canada, where he worked as a professor until 1994. He set up a new Canadian bank account at HSBC, where he received his Canadian wages. While in both France and Canada, Collins would occasionally transfer money from these wage-funded accounts into his UBS account for retirement.

Then in 1994, Collins returned to the United States. He continued to work as a professor and military consultant until he retired to Cranberry Township, Pennsylvania in 2002. Throughout his time in the U.S., Collins properly reported all his U.S. income, including retirement income. In 2008, when UBS was closing all American-owned accounts, Collins transferred that money to a new account at Wegelin & Co., another Swiss financial institution.

Despite the UBS transfer, Collins reportedly did not realize he was required to disclose his foreign financial accounts until 2010. He voluntarily came forward, and participated in the IRS’s Offshore Voluntary Disclosure Program (OVDP), but he didn’t complete it. In his later federal pre-trial statement, Collins argued that he would not have been eligible for the program because he didn’t owe taxes at the time. However, the IRS does have a Delinquent FBAR filing program for taxpayers whose foreign assets don’t produce income or who properly reported the income and paid the taxes. Mr. Collins’ attorney appeared familiar with the procedure, so it isn’t clear why he didn’t use that program instead.

Retired Professor Thought He Owed No Taxes When the IRS Imposed Willful FBAR Penalties

The U.S. Legislature created the Bank Secrecy Act in 1970 -- three years before Dr. Collins moved to France. This law requires U.S. taxpayers to disclose assets over $10,000 held in foreign financial institutions. Taxpayers must file these FBAR reports even if the accounts earn no income, and they don’t owe any taxes. Under the current version of the law, willful failure to file FBARs can result in substantial penalties: up to $100,000 or 50% of the balance of the account at the end of the tax year -- whichever is higher. Even non-willful violations can result in $10,000 penalties.

Because Collins failed to file FBARs in 2007 and 2008, when the post OVDP audit was over, the IRS assessed two penalties totaling more than $300,000. However, given the size of Collins’s accounts in Switzerland, France, and Canada, these penalties were significantly smaller than they could have been under the Bank Secrecy Act.

Still, Collins objected, saying that he had not willfully violated the statute, he didn’t owe any taxes, and his wife had already paid a $1,000 penalty, which should have satisfied any obligation he had. When the IRS completed its automatic OVDP opt-out audit it determined that Collins’s assumptions about his tax status were wrong: he did owe taxes on at least one of the foreign financial accounts. His accountant had failed to properly report the income Collins received from his Swiss bank account as income under the Passive Foreign Investment Company (PFIC) plan. Collins may have thought he didn’t owe taxes when he started the OVDP program, but the audit showed he was wrong. Still, the Bank Secrecy Act’s FBAR reporting requirements weren’t affected by that false belief: the penalty could be assessed either way.

Collins also raised several other issues including whether the IRS had imposed too high a penalty under its own regulations, and whether the statute allowed unconstitutionally excessive fines. In the end, the Court disagreed with all of Collins’ objections, upholding the FBAR penalties and finding that Collins had the money to pay them.

Can You Rely on Old Embassy Advice?

The Collins case also raises an interesting take on a common question about what happens when taxpayers get bad advice. A central theme in Mr. Collins’s defense was that professionals along the way told him he didn’t owe anything to the IRS.

When Collins first moved to France in 1973, he spoke with officials at the U.S. Embassy in Paris and asked them about reporting his foreign income. They said that if he paid French taxes on the French income, there would be no U.S. tax obligation. No one at the embassy mentioned he had to report his foreign financial accounts. Later, a UBS bank counselor told Collins this was also true for foreign-earned interest income.

Collins started to work with a U.S. CPA in 2005. He testified that he reported his foreign accounts to his CPA, but apparently, the CPA told him he didn’t have to worry about reporting the foreign assets. He prepared Collins’s tax returns as though he had no foreign financial accounts, including answering “No” to a related question on Schedule C of Collins’s 1040 tax returns.

Federal courts have generally held that taxpayers can’t simply rely on the CPA to get everything right. Even just signing a tax return that falsely states there are no foreign financial accounts can be used to prove a willful FBAR violation. Here, the Court found that decades-old advice from embassy officials and bank counselors weren’t enough to forgive Collins’s ignorance. Nor could his accountant’s errors excuse his own failure to file the necessary reports.

Mr. Collins learned a hard lesson from his time in court: U.S. taxpayers are responsible for knowing what the law is when they have foreign financial accounts, and need to hold their accountants to it. That is why working with CPAs and tax attorneys with experience handling foreign financial affairs is so important. If you trust what someone told you from decades past, or who hasn’t done international work before, it could result in willful FBAR penalties and interfere with your retirement plans.

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.