For businesses and individuals with accounts in foreign banks, brokerages, or other non-U.S. financial institutions, a number of recent court cases could indicate future changes. For example, the U.S. Supreme Court has significantly limited the possible penalties for foreign account holders who unintentionally don’t meet the reporting requirements for their foreign accounts. The court’s decision has been seen as a hopeful direction by other foreign account holders who have incurred similar penalties.
Individuals and entities with foreign financial accounts should pay attention to easily-overlooked reporting requirements and how recent court rulings might impact those requirements.
FBAR Reporting Requirements
Businesses often find it advantageous—or even necessary—to maintain accounts in non-U.S. banks or other financial institutions. The reasons vary from facilitating sales to foreign customers or expediting payments to offshore suppliers to making payroll for non-U.S. employees or simplifying overseas travel arrangements.
The Bank Secrecy Act (BSA) requires taxpayers to report such accounts to the U.S. Treasury Department every year by filing a Financial Crimes Enforcement Network (FinCEN) Form 114, “Report of Foreign Bank and Financial Accounts” (FBAR). More specifically, any individual taxpayer, corporation, partnership, limited liability company, trust, or estate must file an FBAR if they have a financial interest in or signature authority over at least one account located outside the U.S. if the aggregate value of all such accounts exceeds $10,000 at any time during the calendar year.
The FBAR filing requirement also applies to a company employee who has signature authority over a foreign account, even if the employee has no personal interest in the account. Although the FBAR is not filed as part of a federal tax return, the IRS is responsible for enforcing these requirements and can penalize any business or individual that fails to report.
The penalties can be sizable—$10,000 for each non-willful violation, and the greater of 50 percent of the account’s value or $100,000 for willful violations. How these penalties are calculated—and the distinction between willful and non-willful violations—have been the subjects of several recent court cases that could affect anyone subject to the FBAR reporting requirements.
Calculating Penalties: The Supreme Court Rules
A recent U.S. Supreme Court decision significantly curtailed the potential federal penalties for non-willful failure to file FBARs. Historically, the IRS has contended that each failure to disclose a foreign account is a separate violation; therefore, taxpayers who were simply unaware of their requirement to file an FBAR could be subject to a $10,000 fine for each unreported account every year.
But on February 28, the Supreme Court ruled that this was an incorrect interpretation of the BSA. In a 5-4 decision, the court agreed with a taxpayer who contended that the $10,000 penalty applies to each missing report, not to each account that should have been listed on that report. In this instance, it meant the taxpayer, a U.S. citizen with numerous business dealings and investments in Romania, owed a penalty of $50,000 for five years of missing reports rather than the $2.72 million the IRS was demanding.
The court’s opinion, as written by Justice Neil Gorsuch, stated that “the BSA treats the failure to file a legally compliant report as one violation carrying a maximum penalty of $10,000, not a cascade of such penalties calculated on a per-account basis.” That ruling, along with another recent court request, has encouraged other petitioners who are challenging FBAR penalties on other grounds.
Willful Versus Non-Willful Violations
The distinction between willful and non-willful violations of FBAR requirements is another area of longstanding contention among tax practitioners and the IRS. In many cases, the IRS has prosecuted taxpayers as willful violators, even if they were unaware of the reporting requirement. The agency argued that the BSA’s use of the term “willfulness” encompasses actions that are reckless or “willful blindness”—and for the most part, the courts have agreed.
But the Supreme Court recently asked the government to respond to a pending case in which a taxpayer contends the agency defines “willfulness” too broadly, to the point where practically any violation could be deemed willful. The court’s request for a government response suggests the justices might be open to considering the case. Some taxpayer advocacy groups have also discussed challenging the FBAR penalties on grounds that they violate the Eighth Amendment’s prohibition against “excessive fines.”
These recent court actions indicate that new limitations on FBAR penalties may be in the offing. At the moment, the best plan for any business or individual with a foreign financial account is to file the FBAR, as required, to avoid any problems.
The tax professionals at Dembo Jones are ready to help you understand foreign reporting requirements and how you can comply for your accounts. Please contact us so we can begin assisting you with this process.