IRS and FBAR Audits – Foreign Asset Non-Compliance

“FBAR audits” related to foreign income and asset non-compliance can be very intensive. The IRS can and will obtain records from you, your financial institutions, accountants, and other advisors.

While IRS may make an FBAR inquiry, it is more common for the IRS to audit the return and FBAR non-compliance in parallel.

Failing to file an FBAR can carry some hefty penalties. Failing to file and FBAR and failing to report foreign income can be disastrous.

Clients sometimes ask if they should come into compliance or do nothing and take their chances. Hopefully this will convince anyone that is out of compliance with foreign asset and income reporting to voluntary comply.

How IRS gets information about your foreign account

There a number of ways the IRS can be tipped off to the existence of your foreign accounts.

  • FATCA information exchange
  • CTRs and SARs filed by your U.S. bank
  • Whistleblower claims
  • John Doe summons, treaty requests, and deferred prosecution agreements

Information Document Request

Every IRS examination begins with the issuance of an Information Document Request (IDR). These are documents that you must provide to the IRS.

If you refuse to or are unable to provide the requested documents, the IRS will summons 3rd parties, such as accountants and financial institutions to obtain that information. If the 3rd parties are located abroad, there are additional hurdles the government has to jump through but they will get the information, for example, by issuing a John Doe summons or making a treaty request.

The below is an IDR for a client we represented in an FBAR/income tax audit of their foreign accounts non-compliance. The client failed to voluntary disclose their foreign assets before the audit.

Form 4564 – Information Document Request

For each of the following requests, produce the requested information for each foreign account, under any name, over which you had signature authority and/or other authority and/or over which you exercised control during the year XXXX.

These requests include, but are not limited to, your personal accounts, custodial accounts, business accounts, rental accounts, trust accounts, IBC accounts, LLC accounts, and other corporate accounts.

1. For each account produce the documents identifying the bank and/or financial institution name, address, and telephone number.

2. For each bank account, produce all documents in your possession, custody, and control including, but not limited to:

a. Account application (regardless of date)
b. Monthly or periodic statements
c. Wire transfer authorizations and confirmations
d. Deposit slips and deposited items
e. Credit and debit memos and advices
f. Canceled checks
g. Passbooks
h. Check registers
i.  Loan applications (regardless of date)
j. Promissory Notes
k. Letters of credit
l. Money orders
m. Cashier’s checks
n. Safe deposit box rental agreements (regardless of date)
o. Safe deposit box visitation ledgers
p. All correspondence
q. All memorandum files maintained by the bank reflecting communications with yourself or anyone on your behalf
r. All documents verifying the origin of all funds used to open the accounts and funds deposited into the accounts (regardless of date)
s. Signature cards (regardless of date)
t. Substantiation of expenses associated with the account

3. For each bank account, produce the Know Your Customer Account information given to and maintained by the bank by you or on your behalf, including but not limited to all account set up documents (regardless of date), such as signature cards, opening deposit slips, passport copies, certificates of beneficial ownership, letters of reference, certificates of clean funds and/or other sources of Anti-Money Laundering documentation.

4. For each certificate of deposit, time deposit or equivalent account, produce all statements reflecting the purchase, earnings, basis, redemption and disposition of the deposit account. All documents verifying the origin of all funds used to open the accounts and funds deposited into the accounts (regardless of date).

5. For all transfers of funds between any and all bank accounts and/or financial accounts,
produce:

a. List of transfers
b. Documents showing the source of the funds transferred
c. Documents showing the deposits of funds transferred
d. Advice memos, correspondence or other directions the taxpayer sent or received

FOREIGN CREDIT, DEBIT, SMART, AND CHARGE CARDS

Produce all records for the year(s) XXXX relating to foreign credit, debit, smart, or charge cards of which you had the use, issued either in your name or the name of any entity in which you held an ownership or beneficial interest, directly or through any nominee, agent, power of attorney, letter of direction, or any device whatsoever. These records should include, but are not limited to:

10. Card application

11. Cardholder agreement

12. All credit, debit, smart, or charge cards issued

13. Customer relationship records or other similar records identifying persons with signature or other authority over the account

14. Monthly or periodic charge statements

15. Charge receipts

16. Cash advance confirmations

17. Records of payments or funds transferred to account to pay balances due

FOREIGN INVESTMENT ACCOUNTS

For each of the following requests, produce the requested information for foreign brokerage accounts, mutual funds, security accounts, hedge funds, private equity funds, and other investment funds, including every account or fund in which you had a beneficial interest or over which you had signature authority and/or other authority and/or over which you exercised control during the year 2016. These requests include, but are not limited to your personal accounts, custodial accounts, business accounts, rental accounts, trust accounts, IBC accounts, LLC accounts, and other corporate accounts.

21. For each account or fund, produce all documents in your possession, custody, control, including but not limited to:

a. Account application (regardless of date)
b. Substantiation of basis for all stocks and other investments held in the accounts
c. Signature cards (regardless of date)
d. Monthly or periodic statements
e. Annual account summaries
f. Performance reports
g. Directions given to the financial institution on investment strategies and
diversification
h. Requests, authorizations and confirmations on specific trades
i. Wire transfer authorizations and confirmations
j. All correspondence including written, facsimiles, digital and electronic
k. All memorandum files maintained by the bank reflecting communications with yourself and/or anyone on your behalf
l. Know-your-customer (KYC) files or other similar records maintained for anti- money laundering purposes (regardless of date), including but not limited to account set up documents, identification documents such as passports, driver’s licenses, opening deposit slips, certificates of beneficial ownership, letters of reference, certificates of clean funds and other sources of funds documentation.
m. All documents verifying the origin of all funds used to open the accounts and/or deposited

For each of the following requests, produce the requested information for foreign entities/structures, including each entity/structure in which the taxpayer exercised control and/or held an ownership interest, legal interest, fiduciary interest and/or beneficial interest at any time during the year XXXX.

23. For each entity/structure, produce all documents relating to the creation, governance, and operation of each entity/structure including but not limited to:

a. Organizational documents, deeds of incorporation, by-laws, registrations, articles of incorporation, statutes, memoranda of association, partnership agreements, joint venture agreements (regardless of date)
b. Ownership documents including those reflecting your percentage of legal ownership, percentage of beneficial ownership, and all changes of ownership (regardless of date)
c. Stock records book and/or other listing of shareholders and stock certificates
d. Documents designating beneficiaries, designating trustees, designating protectors, designating partners, designating percentage ownership
e. Correspondence files
f. Powers of attorney, letters of wishes, letters of direction or similar documents granting authority to agents to act on behalf of the entity/structure

24. For each entity/structure, produce all books and records including, but not limited to:

g. General ledgers
h. General journals
i. Sales journals and similar records of sales
j. Cash receipt journals and similar records of cash receipts
k. Cash disbursement journals and similar records of cash disbursements
I. Account payable journals and similar records of accounts payable
m. Payroll journals and similar records of payroll
n. Sales and purchase invoices
o. Real estate closing records
p. Minute books
q. Contracts and agreements
r. Records of bank, brokerage and other investment accounts
s. Financial statements-both audited and unaudited-including but not limited to income statements and balance sheets
t. Rental agreements
u. Documents reflecting rental income and expenses
v. Correspondence files
w. Certificates of good standing
x. Records reflecting the names, street addresses, e-mail addresses and telephone
numbers of the legal and beneficial owners
y. Records reflecting the names, street addresses, e-mail addresses, and telephone numbers of the board of directors, board of supervisors and managing directors
z. Records reflecting the names, street addresses, e-mail addresses, and telephone
numbers of the officers and all employees
aa. Records reflecting the names, street addresses, e-mail addresses, and telephone
numbers of all business partners
bb. All records of dissolution, termination, name change, winding up or similar record of
cessation of operations
cc. Foreign tax returns

25. For each entity/structure produce all documents distributed, sent and/or transmitted by or to any legal, fiduciary and/or beneficial owners to and from professionals ( e.g., attorneys, accountants, bankers, brokers, trust advisory, etc.), including but not limited to contracts, agreements, advisories, schedules, letters, memoranda, notes and instructions.

26. For each entity/structure, produce documents reflecting the name, address and telephone number of the person(s) controlling the assets of the entity/structure.

27. All written contracts, agreements, and all other documents pertaining to the assignment and transfer of ownership interest in and rights to use the real, personal or intangible property to you or on your behalf.

28. All powers of attorney giving you authority to act on behalf of any person or entity. All powers of attorney executed by you giving another the authority to act on your behalf or on behalf of any person or entity over which you exercised control.

29. All certificates of beneficial ownership, stock certificates, including bearer shares or other similar evidence of ownership interests owned by the taxpayer.

30. All profession and commercial licenses owned by you directly or indirectly

31. Provide a schematic diagram of all entities, foreign and domestic, in which you held an ownership interest, either legal or beneficial. This diagram should include partnerships, joint ventures and trusts as well as corporate entities, including their foreign branches and any other . type of entity provided for by foreign laws, in which you held a direct or indirect, legal or beneficial, ownership interest.

dd. Indicate your percentage of ownership interest in each entity.
ee. Indicate the country in which the entity was created or organized.
ff. Indicate the country where the entity operates.
gg. Indicate whether the entity was formed for a particular purpose and what assets are held by the entity.
hh. Indicate any changes in ownership
ii. Provide detailed information regarding any corporation or other entities which you owned but which you no longer own. Include the tax treatment of each change.

PROFESSIONALS

For each of the following requests, produce records both foreign and domestic for each of the year 2016:

51. Produce all financial statements prepared by you, for you, or on your behalf for any purpose.

52. Provide the name, street address, e-mail address, telephone number of each private banker, broker, trust advisor, investment or other financial advisory, advisor on privacy matters, lawyer and accountant from whom you have received advice either directly or indirectly

53. Produce all business cards for professionals in your possession and/or within your control

54. Produce all records relating to any payments by you or on your behalf for professional fees including: management fees, accounting fees, legal fees, consulting fees, brokerage fees,
other personal service fees, salaries or wages, insurance premiums, royalties, lease or rental
fees, loan fees, interest.

55. Produce all records relating to any payments by any nonpublic entity in which you held a direct or indirect ownership or beneficial interest or over which you exercised control, either directly or through a nominee, power of attorney, letter of direction, letter of wishes or any device whatsoever for professional fees including: management fees, accounting fees, legal fees, consulting fees, brokerage fees, other personal service fees, salaries or wages, insurance premiums, royalties, lease or rental fees, loan fees, interest.

TRAVEL

For each of the following requests, produce records both foreign and domestic for each of the year 2016:

61. All of your original U.S. passports, both current and expired

62. All of your original foreign passports, both current and expired

63. If you destroyed a passport, explain in detail how you destroyed it, when you destroyed it and why you destroyed it

64. If you lost a passport or it was stolen, provide a copy of Form DS-64 Statement Regarding a Lost or Stolen Passport filed with the U.S. State Department

65. Produce your current state driver’s license and all foreign driver’s licenses

66. All vehicle registrations foreign and domestic

67. All records of foreign travel including but not limited to commercial transportation, private leasing, visas, hotel and meal expenses

TAX INFORMATION

For each of the following requests, produce copies of all of the returns, schedules and forms you filed for each of the years XXXX through XXXX:

68. All Schedules K-1 ‘s received.

69. All Form 1099 information returns received.

70. All Form 1099 information returns issued by you.

71. Complete copies of all U.S. Partnership Return of Income Forms 1065 including all schedules and attached information returns for which you were either a General Partner or named as the Tax Matters Partner.

72. Complete copies of all U.S. Corporation Income Tax Returns Form 1120 and 1120S, including all schedules and attached information returns for each corporation of which you owned more than 50 percent of the total combined voting power of all classes of stock or more than 50 percent of the total value of the stock of the corporation.

73. Complete copies of all U.S. Income Tax Return of a Foreign Corporation Forms 1120F, including all schedules and attached information returns for which you owned more than 50 percent of the total combined voting power of all classes of stock or more than 50 percent of the total value of the stock of the corporation.

74. Complete copies of all U.S. Income Tax Return for Estates and Trusts Form 1041, including all schedules and attached information returns for which you were the fiduciary or a beneficiary of the Estate or Trust.

75. Complete copies of all U.S. Income Tax Return for Nonresident Alien Form 1040NR (used also for foreign trusts), including all schedules and attached information returns for which you were the taxpayer, administrator, executor, fiduciary, trustee, grantor or a beneficiary.

76. Copies of all Annual Information Returns of Foreign Trust with a U.S. Owner Form 3520-A filed for the years.

77. Copies of all Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts Form 3520 for which you are or are treated as an owner.

78. Copies of all Annual Withholding Tax Returns for U.S. Sourced Income of Foreign Persons Form 1042.

79. Copies of all Foreign Person’s U.S. Source Income Subject to Withholding.

80. Copies of all Information Returns to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts Forms 5471.

81. Copies of all Information Return of a 25-percent Foreign Owned Corporation or Foreign Corporation Engaged in a U.S. Trade or Business Form 5472.

82. Copies of all Information Returns of U.S. Persons with Respect To Certain Foreign Corporations filed.

83. Complete copies of Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons including Form(s) 1042S, Foreign Person’s U.S. Source Income Subject to Withholding, filed.

84. Complete copies of all foreign tax returns.

85. All amended tax returns and amended informational returns

86. All tax returns and informational returns prepared but not filed.

87. Original or copy of any tax organizer or questionnaire you prepared and submitted to your CPA in each of the years 2015 through 201 7.

88. The tax materials use by you and those submitted by you to your CPA for preparation of
your U.S. tax returns in each of the tax years XXXX through XXXX.

89. Copies of all tax advice received from any source worldwide. This request includes, but is not limited to, advice and discussions with bankers, wealth managers, tax preparers, and CPAs.

Initial Interview – “Eggshell Audits” and “Reverse Eggshell Audits”

The initial interview is important in an audit. You don’t know what information the IRS has, and the IRS probably doesn’t know the full extent of your non-compliance. These are “eggshell audits” or “reverse eggshell audits.”

Generally, your representative will attend the initial interview on your behalf, unless the IRS issues an administrative summons and requires you to appear also.

The interview can be several hours long, depending on the complexity of the case.

After the initial interview, there may be follow up interviews,  and continued production of documents to the IRS. The examiner will review those documents over the course of a few months or even up to a year or longer.

Taxes and Penalties

After an examiner has conducted the initial interview and reviewed documents, they will likely discuss their findings with the fraud coordinator. The fraud coordinator will determine whether badges of fraud exist and whether civil fraud penalties should be asserted, or if the case should be referred to IRS Criminal Investigations.

If the case isn’t referred to CI, the following are some of the civil information return penalties that can be assessed:

  1. Form FinCEN 114 (FBAR):
    • The IRS can impose a $10,000 penalty for each non-willful violation of the FBAR filing requirement. This can be assessed per account, per year.
    • Where a person willfully fails to file an FBAR, the IRS may impose a penalty equal to the greater of $100,000 or 50 percent of the account’s highest balance.
  2. Form 8938:
    • If you are required to file Form 8938 but do not file a complete and correct Form 8938 by the due date (including extensions), you may be subject to a penalty of $10,000.  See Treas. Reg. 1.6038A-4(a)(1).
    • If you do not file a correct and complete Form 8938 within 90 days after the IRS mails you a notice of the failure to file, you may be subject to an additional penalty of $10,000 for each 30-day period (or part of a period) during which you continue to fail to file Form 8938 after the 90-day period has expired. The maximum additional penalty for a continuing failure to file Form 8938 is $50,000. See Treas. Reg. 1.6038A-4(d)
    • If you underpay your tax as a result of a transaction involving an undisclosed specified foreign financial asset, you may have to pay a penalty equal to 40 percent of that underpayment.
    • If you underpay your tax due to fraud, you must pay a penalty of 75 percent of the underpayment due to fraud.
    • In addition to the penalties already discussed, if you fail to file Form 8938, fail to report an asset, or have an underpayment of tax, you may be subject to criminal penalties.
  3. Form 3520:
    • The penalty for failure to report a large gift (or bequest) from a foreign person on a timely, complete, and accurate Form 3520 is 5 percent of the amount of such foreign gift (or bequest) for each month for which the failure continues after the due date of the reporting U.S. person’s income tax return (not to exceed 25% of such amount in the aggregate). IRM 20.1.9.10.4
  4. Form 5471 & 5472:
    • The initial penalty is $10,000 per failure.
    • The noncompliance penalty adjustment permits the Service, in its sole discretion, to deny deductions and adjust cost of goods sold with respect to the related party transaction(s) based upon information available to the Service. IRC 6038(d)(3).
  5. Form 926:
    • Anyone who fails to any exchanges or transfers of specified foreign properties must pay a penalty equal to 10 percent of the fair market value of the property at the time of the exchange. IRC § 6038B
  6. Form 8865:
    • The initial penalty is $10,000 per failure.
    • If any failure continues more than 90 days after the day on which the notice of such failure was mailed to the taxpayer (90-day period), additional penalties of $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of the 90-day period will apply. The maximum continuation penalty is limited to $50,000 per failure.
    • The maximum total penalty under IRC 6679 is $60,000 per failure (an initial penalty maximum of $10,000 plus the continuation penalty maximum of $50,000 per failure).

In addition to the above foreign asset reporting penalties, various tax return penalties (civil fraud, failure to pay, failure to file, and interest) are applied in combination with the above penalties.