An update on foreign financial account reporting.

• Author: Holloway, Susanne
• Position: Cover story

PREVIEW

* Due to the IRS's increasing focus on foreign financial account reporting, practitioners must keep up to date on the latest developments in the area.

* Taxpayer reluctance to report offshore assets, and the potentially onerous penalties for failing to do so, make this a challenging area for practitioners.

* Learn best practices for ensuring that engagement letters, organizers, and client interviews duly cover reportable foreign financial accounts.

Foreign financial account reporting remains a significant area of concern for practitioners. The IRS has yet again listed tax avoidance by hiding money or assets in unreported offshore accounts as one of its "Dirty Dozen" tax scams for the 2016 filing season. (1) The Service considers offshore tax filings a top priority area to which it has directed considerable resources to its compliance enforcement efforts. These efforts appear to have succeeded. The primary reporting form for foreign financial accounts is the Treasury Department's Financial Crimes Enforcement Network (FinCEN) Form 114 (formerly TD F 90-22.1), Report of Foreign Bank and Financial Accounts (FBAR). FinCEN reported receiving a record-high 1,163,229 FBARs in 2015, an increase of 8% from 2014. (2) In addition, the Service has increased awareness of foreign account reporting by requiring applicable taxpayers to file Form 8938, Statement of Specified Foreign Financial Assets. More than 300,000 Forms 8938 were filed with tax returns for tax year 2014. (3)

The risk of the IRS's discovering unreported foreign accounts has increased dramatically, as has the risk of civil and potential criminal penalties. Although tax practitioners are often their clients' trusted financial confidants and advisers, clients often have a peculiar reluctance to share foreign account information with them. Thus, for practitioners, the reporting areas involving foreign financial accounts can be particularly challenging.

Tax practitioners who have clients with offshore activities are familiar with the Form 8938 and FBAR reporting requirements, as well as myriad other potentially applicable international tax forms. (4) Many other tax practitioners are also now aware of Form 8938, as it has been a tax return attachment requirement, where applicable, since tax year 2011. However, the foreign account reporting requirements reach far beyond individuals and entities that are visibly active internationally and can snare individuals who have only a tangential or indirect interest in a foreign financial account.

Even practitioners who have only a handful of clients with limited offshore activities or foreign accounts need to be attuned to the reporting requirements for foreign assets and accounts. Familiarity with the FBAR is particularly important, as tax practitioners may not be preparing and filing an FBAR for their clients but may have an obligation to advise a client that an FBAR filing is or may be required, and an FBAR filing obligation may be clearly apparent if the practitioner is preparing Form 8938. Further, the filing thresholds for an FBAR are considerably lower than for a Form 8938, and the failure-to-file penalties can dwarf tax obligations arising from income not reported on foreign bank accounts.

The discussion below comprehensively revisits the reporting requirements for an FBAR and highlights FBAR reporting requirements that differ from those of Form 8938. In addition, the discussion reviews several recent judicial decisions that interpret the FBAR penalty provisions and sets forth some recommended best practices involving these reporting obligations.

FBAR Background

While Form 8938 arose out of the Foreign Account Tax Compliance Act (FATCA) (5) as a result of congressional concerns regarding international tax noncompliance, the FBAR reporting requirements arose from the Bank Secrecy Act of 1970 (BSA). (6) The BSA attempted to address broader congressional concerns regarding offshore banking, with its stated purpose "to require certain reports or records where they have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities, including analysis, to protect against international terrorism." (7) The preamble to the Treasury regulations promulgated under FATCA noted that different policy considerations apply to Form 8938 and an FBAR. Although some information required by the forms may be duplicative, in many cases, different categories of persons are required to file the forms, different thresholds apply, and different assets and information are required to be reported on each form. (8)

The foreign bank account reporting requirement originates in 31 U.S.C. Section 5314, which requires that U.S. residents or citizens keep records and file reports when the resident or citizen "makes a transaction or maintains a relation for any person with a foreign financial agency." The reporting form is an FBAR, which is filed electronically with FinCEN. The specific requirement for filing an FBAR is found in 31 C.F.R. Section 1010.350:

Each United States person having a financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country shall report such relationship to the Commissioner of Internal Revenue for each year in which such relationship exists and shall provide such information as shall be specified in a reporting form prescribed under 31 U.S.C. 5314 to be filed by such persons. However, U.S. persons described in 31 C.F.R. Section 1010.350 only must report foreign financial accounts if their aggregate maximum values exceed $10,000 at any time during the calendar year. (9) This filing threshold is considerably lower than for Form 8938, which for single individuals (and, after Dec. 31, 2015, for certain domestic entities) starts at $50,000 (10) on the last day of the tax year, and can be as high as $600,000 for married individuals living abroad. (11) However, similar to Form 8938, the FBAR's $10,000 threshold is an aggregate maximum value determination; it is not on an individual account-by-account basis. Thus, an individual could have multiple foreign bank accounts, securities accounts, or retirement accounts, each of which is under the $10,000 threshold, but if they total more than $10,000 at any time during the calendar year, they all must be reported on an FBAR.

The FBAR instructions (12) give detailed guidance for computing the aggregate maximum values. The maximum value of each separate account (determined in the local currency) must be determined; the "maximum value" is a reasonable approximation of the greatest value of currency or nonmonetary assets in the account during the year. (13) An account holder can rely on periodic account statements, provided they fairly reflect the maximum account value during the year. (14) Local currency must be converted to U.S. dollars using the applicable Treasury Financial Management Service rate applicable for the last day of the calendar year. (If that rate is not available, the instructions permit the use of another verifiable exchange rate, so long as the source of the rate is provided.) (15) If the aggregate maximum values for all accounts exceed $10,000, an FBAR must be filed. (16)

Unlike Form 8938, which is filed with the tax return, an FBAR is filed electronically through the BSA E-Filing System. For reporting years before 2016, it must have been received by June 30 of the year immediately following the calendar year being reported (no provision was made for extensions). (17) However, for tax years beginning after Dec. 31, 2015, the due date of an FBAR is April 15 of the following year, with a maximum six-month extension allowed. (18)

The following definitions are crucial to understanding the FBAR filing requirements.

Who Is a United States Person?

A United States person is a citizen of the United States; a resident of the United States; or an entity created under the laws of the United States, its states, its territories and possessions, the District of Columbia, or the Indian Tribes. (19) Residency is determined by applying the residency tests in Sec. 7701(b), and for definitional purposes, the United States includes its states, territories, and possessions; the District of Columbia; and the Indian lands. (20) The IRS FBAR Reference Guide specifically notes that tax treaties between the United States and foreign countries do not affect residents' FBAR filing obligations. (21)

The FBAR rules define "persons" required to report more broadly than do the Form 8938 requirements. Form 8938 filing requirements apply to individuals and, as noted above, for tax years after 2015, certain specified domestic entities, (22) but the FBAR requirements apply to individuals, corporations, partnerships, trusts, estates, and limited liability companies, as well as entities disregarded for tax purposes. (23) The regulations under Sec. 6038D require that a specified person look through a disregarded entity for reporting foreign assets on Form 8938; however, the FBAR requirements impose a separate, independent reporting obligation on such entities.

What Is a Bank, Securities, or Other Financial Account in a...