FOREIGN ACCOUNT REPORTING: Legislative Recommendations to Reduce the Burden of Filing a Report of Foreign Bank and Financial Accounts (FBAR) and Improve the Civil Penalty Structure
A U.S. citizen or resident with foreign accounts exceeding $10,000 can be subject to disproportionate civil penalties for failure to report the accounts on a Report of Foreign Bank and Financial Accounts (or FBAR) by June 30 of the following year. Another penalty may apply if the accounts exceed $50,000 and the person does not report them on Form 8938, Statement of Specified Foreign Financial Assets, which is part of the tax return.
Even those who inadvertently failed to file an FBAR (i.e., “benign actors”) are afraid they could be hit with the elevated penalties applicable to willful violations because the government may rely on circumstantial evidence of willfulness or willful blindness. Such fears have prompted some to enter the IRS’s offshore voluntary disclosure (OVD) programs and agree to pay penalties of such severity that they appear to have been designed for bad actors. The median penalty applied to taxpayers with the smallest accounts (i.e., those in the 10th percentile with accounts of $17,368 or less) under the 2011 OVD program, is more than eight times the unreported tax—over ten times the 75 percent penalty for civil tax fraud.
In June 2014, the IRS reduced the amount it requires certain benign actors to pay under its settlement programs. However, it did not allow those who have already signed closing agreements to receive the same, more reasonable program terms, in effect punishing them for addressing the problem quickly. Unexpected and disproportionate FBAR penalties may violate a taxpayer’s rights to be informed and to a fair and just tax system. Because they cause some people to agree to excessive OVD settlements, they may also erode the rights to pay no more than the correct amount of tax, challenge the IRS’s position and be heard, and appeal an IRS decision in an independent forum, as discussed in prior reports.
For small accounts, the maximum penalty may be an even greater percentage. For example, someone with a total of $10,000 in five different foreign accounts ($2,000 in each) could be subject to a non-willful FBAR penalty of $300,000 (six years times five accounts times $10,000) or 30 times the account balance. If the IRS deems the violation willful, the penalty could rise to $3 million (six years times five accounts times $100,000) or 300 times the account balance.
Other information reporting penalties are more proportionate than FBAR penalties. For example, there is no penalty for failing to file a U.S. income tax return if there is no unpaid tax. The penalty for failure to file most information returns and payee statements is generally $100 per return, rising to 10 percent of the unreported amount for intentional violations. By contrast, the FBAR penalty may apply even if the FBAR is one day late and even if the taxpayer has no net underreported tax (e.g., because of foreign tax credits) as a result of underreporting income from the account.
To address the disproportionality of the civil FBAR penalty, the National Taxpayer Advocate recommends legislation to:
Cap the civil FBAR penalty at the lesser of
(a) Ten percent of the unreported account balance or five percent for non-willful violations (similar to the IRS’s mitigation guidelines), and
(b) Forty percent of the portion of any underpayment attributable to the improperly undisclosed accounts (similar to the penalty for undisclosed foreign financial assets (e.g., assets not reported on Form 8938) under IRC § 6662(j)).
Eliminate or waive the civil penalty for failure to report an account on an FBAR if there is no evidence the account was used in connection with a crime and:
a. The account information was already provided to the IRS, for example, on a Form 8938, Statement of Specified Foreign Financial Assets, or by a third party (e.g., a financial institution or government);
b. The amount of unreported income from the account does not create a substantial understatement under IRC § 6662(d); or
c. The taxpayer resides in the same jurisdiction as the account.
One form would be better than two, if confidentiality concerns are addressed.
If it aligns the FBAR and Form 8938 thresholds and deadlines, Congress should also consider consolidating the reporting requirements. Indeed, between 1970 and 1977, the Treasury Department only required taxpayers to report foreign accounts under the BSA on tax returns using Form 4683, U.S. Information Return on Foreign Bank, Securities & Other Financial Accounts.
In 1977, after taxpayer privacy laws were expanded under IRC § 6103, the IRS required people to report these accounts on a different form—not part of the return—so it could share the information with other federal agencies such as FinCEN.79 Therefore, if Congress requires the Treasury Department to combine these forms, it may also want to clarify that certain information on the combined form is not deemed part of the tax return and is not subject to IRC § 6103.
In connection with any such change, however, Congress should require the IRS to limit and prominently identify on the form, any information that may be disclosed to FinCEN.80 Without transparency and specificity, some taxpayers might withhold other information from the IRS based on a concern that it could be disclosed to other agencies. Foreign account information may be distinguished from other tax-related information because it is already required to be reported to FinCEN.