Reports of Foreign Financial Accounts Due to IRS by June 30

June 19, 2009

The last year has seen the IRS more rigorously enforce its rules requiring taxpayers with foreign financial accounts to file a Form TD F 90-22.1, Report of Foreign Bank and Financial Authority (more commonly called an “FBAR”). The most publicized effort by the IRS is its continued quest to force Swiss banking giant UBS disclose the names of approximately 40,000 individuals who have not reported the existence of foreign bank accounts or paid taxes on the income earned by the accounts. And while most of the attention paid to this issue focuses on U.S. citizens with foreign bank accounts, rules issued by the IRS last fall, which the IRS revised only a few weeks ago, are intended to ultimately force many non-U.S. citizens and residents to also comply with the FBAR reporting requirement.

If you (or a client) are required to file an FBAR for your 2008 tax year, you must do so on or before June 30, 2009.

The FBAR rules are discussed in more detail below.

General Rules

The Bank Secrecy Act requires “United States persons” to file an FBAR if they have a “financial interest” in or “signature authority” over any “financial account” in a “foreign country” with a total value of more than $10,000 at any time during the year.

  • United States Person: A “United States person” is a citizen of the United States; a resident of the United States; a United States corporation, partnership, estate, or trust; or a person in and doing business in the United States. The IRS does not generally consider a person to be in and doing business in the United States unless that person is conducting business within the United States on a regular and continuous basis. The IRS does not consider people who are merely visiting the United States or who sporadically conduct business in the United States to be in and doing business in the United States for FBAR reporting purposes. Thus, while this definition would not encompass people who are not United States citizens or residents who visit the United States only occasionally to meet clients or who are artists, athletes, or entertainers who only come to the United States occasionally to participate in exhibits, sporting events, or performances, it will include many foreign businesses and individuals with any type of more than incidental United States contacts – simply because they do business in the United States. As a result, under this definition, foreign individuals and businesses in and doing business in the United States will definitely need to examine whether they have an FBAR filing requirement.
  • Financial Interest: A “United States person” has a “financial interest” in a “financial account” if (1) the “United States person” owns or has legal title to the “financial account;” (2) the owner or holder of legal title to the “financial account” acts as an agent, nominee, attorney, or in some other capacity on behalf of the “United States person,” (3) the owner or holder of legal title to the “financial account” is a corporation, partnership, or trust in which a “United States person” directly or indirectly owns more than 50% of the (a) total value of the corporation’s shares or voting power for all the corporation’s shares, (b) partnership profits or capital, or (c) beneficial interest in the trust’s assets or the trusts current income, as may be applicable, or (4) the owner or holder of legal title to the “financial account” is a trust, or a person acting on behalf of a trust, if the trust was established by the “United States person” and the trust has a trust protector.
  • Signature Authority: A person has signature authority over a “financial account” if the person can (1) control the disposition of money or other property in the “financial account” by delivering a document with their signature to the bank or other person who maintains the account or (2) exercise comparable power over a “financial account” by directly or indirectly communicating with the bank or other person who maintains the account. Note that this definition will often include senior management, and even lower-level accounting personnel, at many companies.
  • Financial Account: A “financial account” includes any bank, securities, securities derivatives, or other financial instruments accounts. It also means any savings, demand checking, deposit, time deposit, or any other account (including debit card and prepaid credit card accounts) maintained with a financial institution or other person engaged in the business of a financial institution. Notably, individual bonds, notes, or stock certificates are not a “financial account,” and unsecured loans to a foreign trade or business that is not a financial institution are also not a “financial account.”
  • Foreign Country: A “foreign country” is any geographical area outside the United States. Note that the key is the geographical location of the “financial account,” not the nationality of the financial institution in which the “financial account” is held. Thus, a “financial account” held by a United States-based bank in an overseas branch is a “financial account” held in a foreign country, while a “financial account” held by a foreign-based bank in a branch in the United States is not held in a foreign country.

There are substantial penalties for failing to timely file the FBAR or filing an improper FBAR. First, the IRS can impose a penalty of up to $10,000 on anyone who violates, or causes any violation of, the FBAR reporting requirements, and it can do so without having to show that the violation was willful. Second, if the IRS can prove that the violation of the FBAR reporting requirement was willful, it can impose a penalty of the greater of $100,000 or 50% of the money in the foreign account. Persons required to file an FBAR may be able to avoid the $10,000 penalty by showing (1) the violation was not willful, (2) they acted “with reasonable cause,” and (3) they reported the income in the foreign bank account on their income tax return. However, there is no similar exception for a willful violation of the FBAR filing requirements.

Recent Development in Definition of “United States Person”

The expansive definition of “United States person” to include people who are not United States citizens or residents but who are in and doing business in the United States resulted from a recent revision to the FBAR reporting form. Prior to December 31, 2008, the definition of “United States person” did not include people who are not United States residents or citizens but who are in and doing business in the United States. However, a revised FBAR form, effective for all tax years beginning on January 1, 2009, included this requirement.

The new requirement was immediately met with a barrage of criticism on the grounds that the IRS was overstepping its bounds. The IRS received a large volume of questions and comments regarding the requirement, its interpretation, and its application.

As a result, on June 5, 2009 the IRS announced that it would allow taxpayers to rely on the old definition of “United States person” when determining whether they have a filing requirement in 2009. Thus, for this year, as well as past years, but not necessarily for next year, taxpayers and others can rely on the definition of a “United States person” as a citizen of the United States; a resident of the United States; or a United States corporation, partnership, estate, or trust. This announcement affects all persons preparing, or deciding whether to prepare, an FBA for the forthcoming June 30, 2009 deadline.

Recent Voluntary Disclosure Initiative

On March 26, 2009, the IRS announced a new voluntary disclosure initiative, imposing a specific penalty structure and the chance to avoid criminal prosecution, for taxpayers who voluntarily disclose their previously undisclosed foreign bank accounts. The IRS aimed this voluntary disclosure initiative at those “United States persons” who, during the last six years, have had a “financial interest” in or “signature authority” over any “financial accounts” in a “foreign country” with a total value of more than $10,000 at any time during the year.

Under the voluntary disclosure initiative, the IRS requires disclosures relating to the taxpayer’s past six years. For all six years, taxpayers must pay all outstanding taxes, related interest, and an accuracy or delinquency penalty with respect to the unpaid taxes. In addition, the IRS requires taxpayers to pay a penalty equal to 20% of the amount of money held in the foreign bank accounts and/or entities in the year with the highest aggregate account/asset value. The IRS will reduce that 20% penalty to a 5% in cases where (1) the taxpayer did not open or cause any accounts to be opened or entities formed, (2) there has been no activity during the period when the account or entity was controlled by the taxpayer, and (3) all U.S. taxes have been paid on the funds in the account or entity (other than taxes on account earnings).

This initiative applies only to taxpayers who voluntarily disclose their foreign bank accounts on or before September 23, 2009, including those taxpayers whose names are on lists the IRS has obtained from third-parties, such as foreign banks, if the IRS has not yet opened an investigation (civil or criminal) on the taxpayer. Taxpayers who do not voluntarily disclose their foreign bank accounts may potentially face full examination, tax penalties, FBAR penalties, and potential criminal prosecution.

Conclusion

The FBAR rules help the IRS trace taxpayer money held off-shore in foreign banks which are not subject to the same reporting requirements as United States banks. The FBAR filing requirement enables the IRS to more easily identify tax evasion and embezzlement, and it allows other government agencies to target money used in drug trafficking, racketeering, and terrorism.

As a result, United States citizens, residents, corporations, partnerships, estates, and trusts doing business oversees, making investments overseas, or holding credit or debit cards issued by foreign banks may be required to file an FBAR. Not doing so, even by accident, can result in a substantial penalty. If you have not filed an FBAR during the past six years, the voluntary disclosure initiative may provide you with a mechanism to eliminate your potential civil and criminal liability in an efficient and monetarily minimal manner.

This year, of course, the FBAR reporting rules do not apply to people who are not United States citizens or residents but who are in and doing business in the United States. Next year, however, this rule may be different. As a result, if you are not a United States citizen or resident but are in and doing business in the United States, you should take care next year to ensure that you comply with the FBAR reporting requirements.

Finally, note that the FBAR is not an income tax return and is filed separately from your income tax return. However, keep in mind that United States income tax returns do include a question requiring acknowledgement of whether you have any financial accounts that will require you to file an FBAR. So even though you do not have to file an FBAR until June 30, you should know well before June 30 whether you have to file the FBAR.

McGuireWoods’ legacy team in London is a leading advisor and provider of tax advice and solutions in the United Kingdom for private clients in the United Kingdom, Europe and across the globe. The London Private Client team enjoys an outstanding reputation in many quarters, particularly in cross-border tax issues related to international structures involving onshore and offshore trusts and insurance products, income and inheritance planning, the provision of advice to private and international banks for the review of their off-shore offering to their client base, and international tax reporting obligations.

McGuireWoods' Civil and Criminal Tax Controversy/Litigation Group routinely handles tax controversies and litigation against the Internal Revenue Service and has broad experience representing clients in matters related to the reporting of foreign income, FBAR reporting requirements, and the FBAR voluntary disclosure initiative.

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