How the IRS Investigates FBAR Violations

Foreign Nationals & Expats

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How the IRS Investigates FBAR Violations

In this article are the IRS’ internal procedures for investigations of FBAR violations. After the foreign bank reports the non-compliant taxpayer’s account information to the foreign taxing authority, the information is then provided to the IRS. For those countries without intergovernmental agreements (IGAs), the account holder’s information will be sent directly to the IRS. Or the IRS has discovered the non-compliance based on stated or implied sources of foreign income on filed tax returns or information forms. Regardless of how the IRS obtains the information, what follows next is an investigation by an IRS examiner of the potential FBAR violation(s).

FBAR Basics

Statutory Authority

‘FBAR’ is the acronym for the Foreign Bank and Financial Account Report, FinCEN 114, previously Form TD F 90.22-1. Title 31 § 5314 provides the general authority for the Secretary of the Treasury to require U.S. persons to keep records and file reports of their transactions with foreign financial agencies. The specific filing requirement for the FBAR is contained in the regulations for the Bank Secrecy Act, Treasury Regulations 31 CFR 1010.350.

In addition to the above statutory sources, the Internal Revenue Manual contains guidelines for the IRS to administer the policy, including criteria for asserting FBAR penalties. IRM 4.26.16 provides the criteria for assertion of FBAR penalties and IRM 4.26.17 contains the procedures for conducting Title 31 examinations.

Read more about foreign bank account reporting requirements.

FBAR Penalties

FBAR violations can lead to civil and/or criminal penalties. The monetary penalty may not exceed $10,000 per violation; however, where the violation is willful, the penalty is the greater of $100,000 or 50% of the balance in the account on the date of violation.

IRS examiners investigate civil FBAR violations, assess FBAR penalties, and collect FBAR penalties that are paid at the time of assessment; however, there is a separate Treasury agency that collects unpaid FBAR penalty assessments. Persons file FBARs for each calendar year, and the due date of the FBAR is April 15 (previously June 30) of the year following the year of reporting.

There is no penalty if there is reasonable cause for violation and the person files correct FBARs.

Investigation into an FBAR Violation

Discovery of a Potential Violation

FBAR violations are discovered by at least three ways:

  • The IRS receives information from a foreign institution
  • A tax return states or implies a foreign source of income and there is no corresponding FBAR filing
  • An information return states or implies a foreign source of income and there is no corresponding FBAR filing

Failure to file an FBAR is a Title 31 violation. Additionally, the IRS will investigate if there is a potential Title 26 violation which can include:

  • Possible unreported income from an undisclosed foreign account;
  • Tax due from an activity related to the undisclosed foreign account; and
  • Failure to file a Title 26 information return related to an entity that owns, or a transaction that appears in the undisclosed foreign account.

Was there a Duty to File?

The examiner will determine whether the taxpayer had a duty to file. To prove the taxpayer had a FBAR filing requirement, the IRS must prove the following:

  1. The taxpayer is a U.S. Person
  2. The taxpayer has a financial interest, signature authority, or other authority over the account
  3. Each account is a foreign financial account
  4. The aggregate balance of the foreign financial accounts exceeded $10,000 at any time during the calendar year

Was there Reasonable Cause?

Once there has been a determination that there was a duty to file and the taxpayer failed to file, the examiner will determine if there was a reasonable cause for the non-compliance. Whether a person has reasonable cause for failing to file an FBAR must be determined based upon the specific facts and circumstances of each case. Normally the most important factor to consider is whether the person acted in good faith, taking into account the experience, knowledge, and education of the person. In many cases a good faith reliance of the advice of a tax professional is the basis of a reasonable cause argument. Whenever there is a reliance defense it is important to verify that the tax professional was a qualified tax professional. Foreign bankers, investment advisors, or other similar persons normally are not qualified to give advice on U.S. tax matters. To have good faith reliance on a tax professional means that the taxpayer disclosed not only the existence of the account, but also all of the relevant facts regarding the account. Even a person that received bad advice from a competent and qualified tax professional and, in good faith, followed that advice could have reasonable cause.

If the examiner determines there was reasonable cause, then no penalty will be imposed. The taxpayer will receive an FBAR warning letter, Letter 3800, Warning Letter Respecting Foreign Bank and Financial Accounts Report Apparent Violations. A warning letter may also be sent in cases where it appears that the foreign income has been reported and where the taxpayer cooperates during the examination.

Example: An individual failed to report the existence of five small foreign accounts with a combined balance of $20,000 for all five accounts, but properly reported the income from each account and made no attempt to conceal the existence of the accounts. The examiner must consider all the facts and circumstances of this case to determine if a warning letter is appropriate in this case or if it would be appropriate to determine civil FBAR penalties. IRM 4.26.16.6  (11-06-2015)

FBAR Penalty Determination

Where there is no reasonable cause and where a penalty would be appropriate, the examiner will then determine whether there was willfulness.

Willfulness

The penalty for willful violations cannot exceed the greater of $100,00 or 50 percent of the balance in the account at the time of the violation. Since the FBAR is due by April 15 (June 30 prior to 2016 filing) of the following calendar year, the willful FBAR penalty is computed using the balance on the due date of the FBAR. The penalty for non-willful violations cannot exceed $10,000 per year, regardless of the number of accounts. If an account is co-owned by more than one person, a penalty determination must be made separately for each co-owner. The penalty against each co-owner will be based on his her percentage of ownership of the highest balance in the account. If the examiner cannot determine each owner’s percentage of ownership, the highest balance will be divided equally among each of the co-owners.

The primary difference between the willful penalty and the non-willful penalty is the degree of fault of the person who failed to comply with the FBAR reporting requirements. A willful FBAR penalty is appropriate where there was a voluntary, intentional violation or disregard of a known legal duty. Notice that the two important concepts here are knowledge and intent. As we just discussed, a willful penalty is not appropriate where the person had knowledge of his FBAR filing requirement but lacked intent to violate the law because in good-faith he relied upon the advice of a tax professional. A non-willful penalty is appropriate where there was an involuntary, unintentional violation or disregard of a legal duty. In other words, the person lacked an intent to violate the law, but nonetheless did violate the law and did not have a reasonable cause for doing so. A non-willful penalty is also appropriate where there are indications of willfulness, but there is not sufficient evidence to prove willfulness. Read more about how the IRS determines willfulness in FBAR cases.

Document Requests

In making a determination of willfulness, the examiner may request and review documents from the taxpayer and third parties. Documents that may be used include:

  1. Copies of statements for the foreign bank account.
  2. Notes of the examiner’s interview with the foreign account holder/taxpayer about the foreign account.
  3. Correspondence with the account holder’s tax return preparer that may address the FBAR filing requirement.
  4. Documents showing criminal activity related to the non-filing of the FBAR (or non-compliance with other BSA provisions).
  5. Promotional material (from a promoter or offshore bank).
  6. Statements for debit or credit cards from the offshore bank that, for example, reveal the account holder used funds from the offshore account to cover everyday living expenses in a manner that conceals the source of the funds.
  7. Copies of any FBARs filed previously by the account holder (or FinCEN Query printouts of FBARs).
  8. Copies of Information Document Requests with requested items that were not provided highlighted along with explanations as to why the requested information was not provided.
  9. Copies of debit or credit card agreements and fee schedules with the foreign bank, which may show a significantly higher cost than typically associated with cards from domestic banks.
  10. Copies of any investment management or broker’s agreement and fee schedules with the foreign bank, which may show significantly higher costs than costs associated with domestic investment management firms or brokers.
  11. The written explanation of why the FBAR was not filed, if such a statement is provided. Otherwise, note in the workpapers whether there was an opportunity to provide such a statement.
  12. Copies of any previous warning letters issued or certifications of prior FBAR penalty assessments.
  13. An explanation, in the workpapers, as to why the examiner believes the failure to file the FBAR was willful.

Penalty Mitigation

A person may be subject to less than the maximum FBAR penalty if the person meets four conditions:

  1. The person has no history of criminal tax or BSA convictions for the preceding 10 years, as well as no history of past FBAR penalty assessments.
  2. No money passing through any of the foreign accounts associated with the person was from an illegal source or used to further a criminal purpose.
  3. The person cooperated during the examination (i.e., IRS did not have to resort to a summons to obtain non-privileged information; the taxpayer responded to reasonable requests for documents, meetings, and interviews; and the taxpayer back-filed correct reports).
  4. IRS did not sustain a civil fraud penalty against the person for an underpayment for the year in question due to the failure to report income related to any amount in a foreign account.

The Bank Secrecy Act (BSA) allows the Secretary of the Treasury some discretion in determining the amount of penalties for violations of the FBAR reporting and record keeping requirements. There is a penalty ceiling but no minimum amount. This discretion has been delegated to the FBAR examiner.

Below are the Penalty Mitigation Guidelines

FBAR Penalty Mitigation Guidelines - Per Person Per Year 
NON-WILLFUL (NW) PENALTIES
To Qualify for Level I-NW - Determine Aggregate BalanceIf the maximum aggregate balance for all accounts to which the violations relate did not exceed $50,000 at any time during the calendar year, Level I – NW applies to all violations. See IRM 4.26.16.3.6, Aggregate Value Over $10,000, above for instruction on determining the maximum aggregate balance.
The Level I-NW Penalty is$500 per violation, not to exceed a total of $5,000 per year.
To Qualify for Level II-NW - Determine Aggregate BalanceIf the maximum aggregate balance of all accounts to which the violations relate exceeds $50,000, but does not exceed $250,000, Level II-NW applies to all violations.
The Level II-NW Penalty is$5,000 per violation.
To Qualify for Level III-NW - Determine Aggregate BalanceIf the maximum aggregate balance of all accounts to which the violations apply exceeds $250,000, Level III-NW applies to all violations.
The Level III-NW Penalty is$10,000 per violation, the statutory maximum penalty for non-willful violations.
PENALTIES FOR WILLFUL VIOLATION
To Qualify for Level I-Willful - Determine Aggregate BalanceIf the maximum aggregate balance for all accounts to which the violations relate did not exceed $50,000 during the calendar year, Level I-Willful mitigation applies to all violations. See IRM 4.26.16.3.6, Aggregate Value Over $10,000, above for instruction on determining the maximum aggregate balance.
The Level I Willful Penalty isThe greater of $1,000 per year or 5% of the maximum aggregate balance of the accounts during the year to which the violations relate.
To Qualify for Level II-Willful – Determine Aggregate BalanceIf the maximum aggregate balance for all accounts to which the violations relate exceeds $50,000 but does not exceed $250,000, Level II-Willful mitigation applies to all violations. Level II-Willful penalties are computed on a per account basis.
To Qualify for Level III-Willful - Determine Aggregate BalanceIf the maximum aggregate balance for all accounts to which the violations relate exceeds $250,000 but does not exceed $1,000,000, Level III-Willful mitigation applies to all violations. Level III-Willful penalties are computed on a per account basis..
The Level III-Willful Penalty isFor each account for which there was a violation, the greater of 10% of the maximum account balance during the calendar year at issue or 50% of the account balance on the day of the violation.
To Qualify for Level IV-Willful - Determine Aggregate BalanceIf the maximum aggregate balance for all accounts to which the violations relate exceeds $1,000,000, Level IV-Willful mitigation applies to all violations. Level IV-Willful penalties are computed on a per account basis..
The Level IV-Willful Penalty isFor each account for which there was a violation, the greater of 50% of the balance in the account at the time of the violation or $100,000 (i.e., the statutory maximum penalty).

If you’ve been contacted by the IRS regarding an undisclosed foreign account or have been issued a penalty, do not panic. You can often mitigate the penalties or have the penalties abated completely. It is not advisable to handle an FBAR investigation on your own. Contact a tax attorney that handles such matters.

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