IRS Announces Severe Actions for Undisclosed Foreign Bank and Financial Accounts.

Filing requirements - The filing requirements apply to any “United States person”, which is defined as those who fit into one of the following categories:

A Citizen of the United States / Green Card holders / Foreign persons residing in the US for extended periods of time (ie. H-1B, L-1, TN and other Visa holders)

Domestic Partnerships / Domestic Corporations / Domestic Trusts /Individuals that have signing authority over a non-US account (if such person can control the disposition of money or other property). Filing requirements also apply to those with direct or indirect control over a foreign or domestic entity with foreign financial accounts, even if the taxpayer does not have foreign financial accounts of its own.

Foreign Financial Accounts - Foreign “financial accounts” include a wide variety of items, such as:

Bank accounts (savings, demand, checking, deposit or any other account maintained with a financial institution). / Securities or brokerage accounts.

Mutual funds / Debit and Prepaid Credit Cards maintained with a financial institution / Certain types of Annuities or pension accounts / Retirement Plans.

Interests in partnerships, trusts or other pass-through entities having foreign accounts.

Background. - The IRS is currently conducting a highly-publicized, large-scale audit program targeting taxpayers who have avoided or evaded U.S. income taxes through the use of undisclosed Swiss and other foreign bank and financial accounts. The deadline for submissions under the amnesty program is August 31st 2011.

Foreign Bank and Financial Account Reporting Requirements. - FBAR Reports. Treasury Regulations under the Federal Bank Secrecy Act require any “U.S. person” who has a “financial interest” in, or signature or other comparable authority over, one or more “financial accounts” maintained in a foreign country to file an annual report identifying their foreign accounts if the aggregate account value exceeds $10,000 during the calendar year. Those annual reports, commonly referred to as “FBAR Reports,” must be filed with the Department of Treasury on Form TD F 90-22.1 separate and apart from income tax returns. FBAR Reports for a particular calendar year normally are due on June 30th of the succeeding year.

For purposes of the FBAR reporting rules: A “U.S. person” is a citizen or resident of the U.S. or a domestic partnership, corporation, LLC, estate or trust. The term “financial account” is defined broadly and includes any bank, securities, securities derivatives, or other financial instrument account. Typically, this would include, but is not confined to, offshore savings, deposit or checking accounts at a bank or offshore brokerage accounts. A U.S. person has a “financial interest” in a foreign “financial account” if the account is owned by the U.S. person. A U.S. person also has a “financial interest” in any foreign “financial account” that is owned by: (i) a corporation, partnership, trust or other entity in which the U.S. person has a greater than 50% ownership or beneficial interest; or (ii) a trust established or otherwise controlled by the U.S. person.

Even if a U.S. person does not have a “financial interest” in a foreign “financial account,” FBAR reporting is required if the U.S. person has signature or comparable authority over the account and the $10,000 threshold is exceeded.
Foreign financial accounts aggregating over $10,000 at any time during a year are subject to the FBAR annual reporting requirement even if the accounts are owned by tax-exempt U.S. persons or are non-income-producing.
Foreign financial accounts do not include, however, accounts maintained at a U.S. branch or other U.S. office of a foreign financial institution.

Notice 2009-62 Relief from FBAR Reporting Requirements. In late 2008, the IRS indicated that foreign “financial accounts” subject to FBAR Reporting include interests in commingled funds maintained outside the U.S. (e.g., foreign mutual funds, foreign private equity funds, foreign hedge funds, etc.). The IRS’s expansive interpretation of “financial account” to include foreign commingled funds was roundly criticized as an unwarranted deviation from prior practice. In response to that criticism and to extend the FBAR filing deadline for certain U.S. persons, on August 10, 2009 the IRS issued Notice 2009-62. That Notice extends to June 30, 2010 the deadline for submitting required FBAR Reports for 2008 and earlier years by: (i) persons with mere signature or other comparable authority over, but no ownership or other financial interest in, a foreign financial account; and (ii) persons with an ownership or other financial interest in, or signatory authority over, a foreign financial account in which the assets are held in a commingled fund.

U.S. persons who qualify for the extended FBAR return due date may wish to avail themselves of the extension to catch up on delinquent FBAR filings. The extended FBAR due date is not available, however, for taxpayers who own or otherwise have a financial interest in foreign financial accounts other than foreign commingled funds. Nor does the extended due date for some FBAR filings provide relief from the civil and potential criminal penalties associated with failures to properly report and pay taxes on income earned in foreign financial accounts.

Income Tax Return Reporting of Foreign Accounts. In addition to the FBAR reporting rules, U.S. Federal tax law requires U.S. taxpayers to properly report on their U.S. Federal income tax returns, and timely pay applicable income taxes on, any interest, dividends, gains or other income earned on their offshore bank and financial accounts, whether or not such foreign accounts are subject to FBAR reporting. In connection with that requirement, and as an adjunct to FBAR reporting, U.S. persons must specifically disclose annually on their U.S. Federal income tax returns, under penalty of perjury, whether they own or have other financial interests in, or have signature or other authority over, any foreign bank and other foreign financial accounts during the tax year in question. The requirement to disclose ownership of foreign financial accounts aggregating over $10,000 on income tax returns applies to individuals (Form 1040, Schedule B), corporations (Form 1120, Schedule N), partnerships (Form 1065, Schedule B) and trusts and estates (Form 1041, Schedule G).

Use of foreign financial accounts may also trigger or effect the need to file special IRS information returns reporting transactions with offshore trusts, foreign gifts, and transfers to certain foreign corporations and foreign partnerships.

Penalties for Non-Compliance with Reporting Requirements - Civil penalties for failure to timely file a FBAR Report can be severe - up to $10,000 for each unintentional violation or, in the case of willful violations, the greater of $100,000 or 50% of the account balance at the time of the violation. Under certain conditions, the IRS may abate FBAR failure to file penalties in whole in part for “reasonable cause.” Criminal penalties may also be imposed for willful violations of the FBAR reporting requirements. In addition to the FBAR failure to file penalties, various Federal tax penalties can apply if a taxpayer fails to properly report taxable income on its undisclosed foreign accounts. Those tax-related penalties can include: (i) additional accuracy-related tax penalties of up to 20% of the underpaid tax; (ii) delinquent return penalties of up to 25% of the unpaid tax if no return is filed; (iii) civil fraud penalties of 75% of the tax understatement in the case of fraud; and (iv) in the case of willful violations, prosecution for criminal tax evasion.

IRS Voluntary Disclosure Practice - As part of the IRS crack-down on undisclosed foreign financial accounts, the IRS has announced that it intends to: (i) fully enforce civil penalties for FBAR Report non-compliance as far back as 2003; (ii) impose all applicable civil tax penalties on non-compliant taxpayers who fail to report income on foreign financial accounts for all open years; and (iii) in cases of willful disregard of the applicable reporting requirements, bring criminal prosecutions.

As an adjunct to its audit program, the IRS has also implemented and publicized an internal “Voluntary Disclosure Practice” (i.e., an amnesty policy) under which taxpayers who have failed to comply with the FBAR and related income tax reporting rules and who are not currently under IRS audit may voluntarily come into compliance with those rules with reduced, or in some cases no, penalty exposure. U.S. taxpayers who only recently became aware of the FBAR filing requirements should consider whether they failed to comply with FBAR reporting requirements for prior years and, if so, whether they should participate in the amnesty program. Taxpayers currently subject to any IRS audit may not participate in the amnesty program.

Under the amnesty program, if a U.S. person failed to timely file required FBAR reports for any year between 2003 and 2009, the taxpayer can take advantage of the amnesty program by filing the delinquent FBARs by August 31st 2011, together with copies of the filer’s income tax returns for the years in question and an explanation of the reason for failure to timely file (e.g., the taxpayer was unaware of the FBAR filing requirements). The IRS has stated that otherwise applicable FBAR late filing penalties will not be imposed for late filings of FBAR Reports under the amnesty program so long as the taxpayer properly and timely reported and paid all income taxes due on any income earned on the foreign accounts in question.

If a taxpayer also failed to timely report and pay income taxes due with respect to income earned from its undisclosed foreign accounts, the taxpayer can still participate in the amnesty program, but the taxpayer must pay: (i) all taxes and statutory interest due with respect to the unreported foreign account income; (ii) an accuracy-related penalty of 20% of the tax underpayment or, if no return was filed, a delinquent return penalty up to 25% of the tax underpayment; and (iii) an additional FBAR penalty of 20% of the highest account balance during the year of the FBAR violation in which the account balance was greatest.