Could Tax Treaties Exempt Expatriates from Filing FBARs?
Expatriates often have a foot in two (or more) countries, physically and financially speaking. This can make it difficult to understand their U.S. tax filing requirements. Add to that the extra requirement of filing FBARs disclosing foreign financial accounts, and an expatriate’s tax situation can grow exceptionally complex. But a recent decision from the U.S. District Court for the Southern District of California could allow tax treaties to exempt expatriates from filing FBARs and paying penalties for non-filing.
Mexican Resident and Green Card Holder Assessed FBAR Penalties
Alberto Aoreste was born and raised in Mexico. He went to school there, worked there until his retirement in 2012, and lived in Mexico City for over 50 years. He also always filed his Mexican tax returns as a Mexican resident. By 2012 and 2013, he maintained 5 Mexican bank accounts which, together, had balances of over $10,000 U.S. Dollars.
In 1980, Mr. Aoreste and his wife purchased a vacation condominium in Florida. In 1984, he applied for lawful permanent residency status and became a U.S. Green Card holder. That status was never revoked. In 2011, his wife became a naturalized U.S. citizen, but Mr. Aoreste never did.
After Mrs. Aoreste became a citizen, the couple filed United States tax returns as “married filing jointly” in 2012 and 2013, but they did not include Reports of Foreign Bank and Financial Accounts (FBARs) or Form 8833, Treaty-Based Return Position Disclosure. The latter form is used to notify the IRS of a person’s exemption from tax obligations under an international tax treaty.
The IRS began an audit of the Aorestes in 2016 after they withdrew from the now-closed Offshore Voluntary Disclosure Program, and Mr. Aroeste filed two sets of corrected tax returns for 2012. The second corrected return included Form 8833, asserting that he was covered under the United States - Mexico Income Tax Convention. However, that did not stop the IRS from imposing $100,000 in non-willful FBAR penalties on May 12, 2020. Mr. Aoreste paid a portion and then sued to recover the penalty, but the IRS counter-sued to collect the rest of what was owed.
Who Has to File FBARs with the IRS?
The Bank Secrecy Act says that every “United States person” who has a financial interest in, or signature authority over one or more foreign financial accounts with a combined balance of more than $10,000 must disclose the existence of those accounts every year by filing FBARs.
This applies to more than just U.S. citizens. The IRS’s regulations say a “United States person” includes a “resident of the United States” including those who are lawful permanent residents in the United States at any point during that calendar year. A “lawful permanent resident” is someone who has been granted the privilege of residing permanently in the United States according to federal immigration laws as long as that status has not been revoked.
Here, Mrs. Aroeste was a naturalized citizen, and the parties had agreed she was required to file FBARs, so she settled the claims against her. But Mr. Aroeste said the fact that he held a Green Card wasn’t enough to make him a “United States person” for FBAR filing purposes.
Are Expatriates Considered “United States Persons”?
The same regulation discussed above says a person is no longer a “United States Person” if:
- Their lawful permanent residency status is revoked or abandoned, or
- They are entitled to be treated like a resident of a foreign country under a tax treaty
The magistrate judge in Aroeste v US called this a “potential escape hatch” that excuses certain expatriates from filing FBARs. But when both Mr. Aroesta and the IRS filed motions for summary judgment, the District Court found that Mr. Aroesta was a lawful permanent resident, a resident alien, and a United States person for FBAR filing purposes. It cited cases that previously held that moving out of the country wasn’t enough. Taxpayers must formally renounce or abandon their Lawful Permanent Resident status to discontinue their filing requirements.
District Court Says Tax Treaty Excused Mexican Expatriate’s Past FBAR Failures
Mr. Aroesta said he still didn’t have to file FBARs because he was a Mexican resident and the United States - Mexico Income Tax Convention applied to him. The IRS didn’t dispute his Mexican residency, but said he had failed to assert that Treaty’s protections by filing Form 8833 until after the audit began. Mr. Aroesta admitted he filed that form 3-4 years too late, but he argued that the consequence of that late filing was a financial penalty, not the loss of treaty protections. The District Court agreed.
The District Court then looked to whether Mr. Aroeste could show he was a Mexican resident on the basis of the treaty, based on:
- His permanent home
- Which state has closer personal and economic relations (center of vital interests)
- His habitual abode
- His nationality
- Or by mutual agreement of competent authorities in the two States
The District Court found that Mr. Aroeste was a resident of both the U.S. and Mexico. Both the homes in Florida and Mexico were always available to him, but the Court found that Mexico City was his permanent home based on where his doctors, family, friends, and the majority of his personal items were located. It noted that mail sent to the Florida condo was forwarded to Mexico City. The Florida condo was used for vacations and holidays. Mr. Aroeste also votes in Mexico and maintains health insurance and cell phone service in Mexico. In fact, he spent over 75 percent of his time there.
The IRS argued that dual residents like Mr. Aroeste must still be treated as United States persons based on the preamble to the Bank Secrecy Act Regulations. However, the District Court said those regulations could not refute the plain language of the law and applicable tax treaty. So called “tie breaker rules” meant that Mr. Aroesta’s status as a Mexican resident shielded him from past FBAR failures because he could be treated as a nonresident alien.
Ultimately, the District Court found that Mr. Aroeste was a United States person, but stopped being treated as a lawful permanent resident when he became a resident of Mexico under the Treaty, did not waive the Treaty’s benefits, and notified the IRS of that treatment, so the IRS could not assess FBAR penalties against him, though it could assess penalties for Mr. Aroeste’s late disclosure of his Treaty position. This reduced the penalties from $100,000 to just $2,000.
What Aroeste v US Means for Expats Worldwide
The decision in Aroeste v US could have wide-ranging implications for expats in many countries worldwide. The U.S. has similar treaties with Canada, Japan, various European countries, and many others. Aoreste means that nonresident aliens living in those countries may be able to take advantage of those treaties to avoid filing annual FBARs and avoid FBAR penalties.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 35 years experience. If you have questions regarding expatriation and FBAR filing requirements, contact Joe Viola to schedule a consultation.