The Potential for the IRS to Become Even More Aggressive When Imposing Penalties for Not Filing FBARs for Foreign Accounts

As we’ve written, the law requires US taxpayers to report their ownership, signatory authority or other control over foreign financial accounts with a value in excess of $10,000.  The means of reporting such accounts are (1) on IRS Form 1040, Schedule B, where a taxpayer “checks the box” that he or she has such ownership or control over a foreign account, (2) on a form known as the “FBAR”, Report of Foreign Bank and Financial Accounts, FinCEN Form 114 (formerly TD 90-22.1), and (3) on IRS Form 8938, Statement of Specified Foreign Financial Assets.

The penalties for failure to file the FBAR are severe.  If the IRS determines that the failure was “willful”, then the penalties can be as high as $100,000 per year, per account, or 50% of the value of the account for each year of non-filing of the FBAR, whichever is higher.  If the failure to file the FBAR was non-willful, then the penalties are up to $10,000 per year, per account.  It is thus conceivable that the penalties can exceed the value of the account itself.  In such a case, the taxpayer remains obligated for the full amount of penalties, even after the funds in the foreign account are depleted by the penalties.  In other words, if the penalties exceed the value of the foreign account(s), the taxpayer is still “on the hook” for the full penalty amounts.

Note that the 50% penalty per account, per year is what the law allows the IRS to impose in penalties.  However, the IRS usually assesses the 50% penalty for one year only, usually the year with the highest account balance.  This is true even in criminal tax fraud prosecutions, when the government prosecutes taxpayers who failed to declare their foreign accounts.  In such prosecutions, the punishments which follow settlements, plea bargains and guilty pleas usually include one single FBAR penalty equal to 50% of the highest balance year, not 50% for each year which the law would otherwise allow.

A recent case, U.S.A. v. Zwerner, may change the usual practice of the IRS asserting the 50% penalty for one year only.  In Zwerner’s case, the IRS imposed the 50% penalty for each of four years of FBAR non-filing.  The highest balance in Zwerner’s unreported account was $1,691,054.  The FBAR penalties asserted by the IRS came to a total of $3,488,609.  On May 24, 2014, a jury in Federal District Court in Florida upheld FBAR penalties of $2,241,809.

The take-away from the Zwerner case is as follows:

1.   The IRS may now be emboldened to impose FBAR penalties for multiple years.  As noted, previous practice was for the IRS to assert the FBAR penalty for one year only, even in criminal tax fraud cases.  The IRS’ assertion of multiple year FBAR penalties in Zwerner’s case could have been seen as an outlier case.  However, after the jury upheld the multiple year FBAR penalties, the IRS, and prosecutors around the country, could rely on Zwerner to assert multiple year penalties.  This would be a change in IRS practice that would make the already-severe FBAR penalties even more crippling to taxpayers who did not file FBAR forms.

2.  Mr. Zwerner attempted to come into tax compliance; however, he did so not through the IRS Offshore Voluntary Disclosure Program (OVDP), but via an attorney who contacted the IRS Criminal Investigations (CI) Division on an anonymous basis.  Zwerner then filed amended tax returns with foreign income now reported, along with FBARs.  This is known as a “quiet disclosure”, and resulted in an audit.  One take-away from this case is that quiet disclosures do not work, as we’ve written before, and there is a substantial likelihood of an audit as a result of a quiet disclosure.  An additional lesson is that one must proceed with extreme caution with regard to unreported offshore accounts, and utilize tax attorneys who are experienced in offshore matters, U.S. tax compliance and IRS interaction.

3.  One possible negative conclusion from the Zwerner case is that coming into tax compliance by volunteering information to the IRS in an attempt to “clean up” offshore assets is risky, that the IRS will reward such positive intentions with severe FBAR penalties.  However, it should be noted that Mr. Zwerner’s attempts at compliance were themselves questionable.  First, his attorney came forward on an anonymous basis.  Second, Zwerner’s attempt at compliance, as noted above, was a “quiet disclosure”.

Taxpayers who seek to clean up their offshore non-compliance have a more reliable method, which is the IRS Offshore Voluntary Disclosure Program (OVDP).  Formally entering the OVDP subjects both the taxpayer and the IRS to a procedure and rules.  Taxpayers will benefit from the IRS not referring the matter to the US Department of Justice (DOJ) for a criminal tax fraud prosecution.  In addition, the penalties within the OVDP are pre-determined, usually 27.5% of the highest aggregate foreign account balance, which is in lieu of the more severe FBAR penalties (and other penalties) that would apply outside the OVDP (such as those penalties that applied to Mr. Zwerner’s quiet disclosure).  In short, the OVDP would have provided Zwerner with a much better result.

 4.  The jury found that Mr. Zwerner was “willful” in not filing his FBARs.  Further incriminating facts were that the accounts were in the name of two foundations, entities similar to trusts which are often used to create a layer between a US taxpayer and foreign assets, and further obscure the true beneficial ownership of the foreign assets.  Yet, Zwerner attempted to come into tax compliance.  Via counsel, he approached the IRS even before he was under audit or investigation, and when the IRS did not already know about his foreign accounts.  He attempted to do good and correct his past non-compliance, and he was rewarded with staggering FBAR penalties.  An additional point here is that an attempt at compliance at a later date may not negate non-compliance at an earlier date.  It is the equivalent to the IRS saying “thank you for reporting the accounts and paying taxes on the income in the accounts.  However, we are still going to hang you for not doing it properly initially.”  Again, the penalty within the OVDP would have been lower, and would have applied instead of the much higher penalties for willfully not filing the FBARs.

 5.  It remains to be seen whether the jury’s award of multiple year FBAR penalties will be upheld, or whether the award violates the Excessive Fines Clause of the Eighth Amendment to the United States Constitution.  The court will address this issue next.  Stay tuned, as the outcome will have an effect on enforcement of FBAR penalties across the country.

Please contact us with any questions about the FBAR form, foreign assets and U.S. tax compliance.

Offshore Asset Protection Trusts and FBAR Reporting

We again remind readers that FinCEN Form 114 (formerly TD 90-22.1), the Report of Foreign Bank and Financial Accounts (the “FBAR”), for calendar year 2013, is due by June 30, 2014.   The FBAR must be filed electronically.

As we wrote previously, in 2011, the U.S. Treasury Department changed the FBAR filing requirements to now apply to U.S. grantors of foreign trusts, and in some cases their U.S. beneficiaries.

The FBAR is required to be filed by a U.S. person who has a financial interest in, or signature or other authority over, any foreign financial account (including bank, securities or other types of financial accounts), if the aggregate value of the financial account(s) exceeds $10,000 at any time during the calendar year.  If you are subject to the FBAR filing requirement, the 2013 FBAR is due by June 30, 2014.

U.S. grantors (also known as settlors) of foreign asset protection trusts are deemed to be the owners of all trust assets for tax purposes.  Thus, the FBAR filing requirement applies to such grantors, whether or not they actually control trust assets and whether or not they receive distributions from the trust.

The 2011 revised regulations now extend the FBAR requirement to some U.S. beneficiaries of foreign trusts, including foreign asset protection trusts.  The new regulations apply to U.S. beneficiaries of a foreign trust who have a reportable financial interest in the trust.  A U.S. person has a reportable financial interest if the U.S. person had more than a fifty percent (50%) present beneficial interest in the assets of a trust or if the U.S. person received more than fifty percent of the income of the trust.  The beneficial interest in the assets of the trust must be a “present” beneficial interest for the FBAR to apply.  A beneficiary of a purely discretionary trust, i.e., where trust distributions are made solely in the discretion of a trustee (asset protection trusts created by this firm are purely discretionary trusts) does not have a “present” interest.  However, with respect to the trust income, a beneficiary who receives more than fifty percent of trust’s “current” (i.e., annual) income has a financial interest that is reportable on the FBAR.

Under prior FBAR regulations, there was ambiguity as to whether a discretionary trust beneficiary was subject to the FBAR.  Usually, beneficiaries of a foreign asset protection trust receive distributions at the discretion of the foreign trustee.  The new rules clarify that only a present beneficial interest gives rise to the FBAR and only beneficiaries who receive more than fifty percent of a trust’s current income are subject to the FBAR.

Please also note the following with respect to the FBAR requirement:

  • Even if the trust account was closed during 2013, if the account existed at any point during 2013, an FBAR is required.
  • The requirement to file the FBAR exists irrespective of whether you filed new IRS Form 8938, Statement of Specified Foreign Financial Assets.  Please contact us for a copy of our memorandum regarding new Form 8938.
  • The June 30, 2014 deadline is the deadline for receipt of the FBAR by the Treasury Department.
  • Even if you have an extension for filing your tax returns, the 2013 FBAR is still due by June 30, 2014.  There are no extensions for the FBAR deadline.
  • The FBAR is now required to be filed electronically.

 We also take this opportunity to remind you again that foreign asset protection trusts also give rise to filing IRS Forms 3520 and 3520-A, as well as Form 8938.

 Having established an offshore asset protection trust to safeguard your assets from attack by creditors and litigants, it is crucial to preserve the integrity of the trust and to be in compliance with all IRS requirements.  Please contact us with any questions.

Everything You Wanted to Know about Antigua Private Foundations

Our senior partner Kenneth Rubinstein was the author of the International Foundations Act of 2007, passed by the Parliament of Antigua and Barbuda and enacted into law.  Kenneth also wrote Antigua’s International Trust Act and International LLC Act.

Kenneth has now authored the chapter on Antigua and Barbuda private foundations which is part of Private Foundations World Survey, edited by Johanna Niegel and Richard Pease, Oxford University Press, 2013.  The chapter contains detailed information on Antigua as an Offshore jurisdiction, Antigua’s foundation law, foundation governance, asset protection issues, taxation issues, as well as discussion on issues of forced heirship and divorce.

For additional information, please see:

Antigua Asset Protection Laws Drafted by Rubinstein & Rubinstein Become Effective

Author of Antigua Asset Protection Laws Clarifies Antigua’s Offshore Position

 

Contact our Asset Protection attorneys today regarding foundations and trusts,

Antigua and other offshore jurisdictions

Call (212) 888-6600 to schedule a consultation

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