Foreign financial asset filing requirements: Coming into compliance.

• Author: Standard, James W., Jr.

On occasion, taxpayers holding investments in foreign financial assets or with foreign financial institutions may find themselves in the uncomfortable position of realizing that they have failed to report their holdings on their federal income tax returns or have otherwise failed to report these holdings in accordance with federal law. This article provides a summary of options available to such taxpayers to come into compliance with their reporting obligations.

Reporting obligations in general

Under Sec. 6038D, an individual taxpayer is generally required to file a Form 8938, Statement of Specified Foreign Financial Assets, with his or her U.S. tax return if he or she meets three criteria. Briefly, these criteria are as follows:

* The taxpayer is a "specified person." This includes U.S. citizens and resident aliens of the United States and certain nonresident aliens. (1)

* The taxpayer has an interest in "specified foreign financial assets." These generally include any financial accounts maintained by a foreign financial institution and other foreign financial assets held for investment that are not in an account maintained by a U.S. or foreign financial institution. (2)

* The aggregate value of the specified foreign financial assets exceeds a certain threshold. For married taxpayers filing joint tax returns and living in the United States, this threshold is (1) $100,000 on the last day of the tax year, or (2) $150,000 at any time during the tax year. For other individuals, the amounts are $50,000 and $75,000 respectively. (3)

Apart from this information return reporting obligation, a U.S. citizen or resident also must file a FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), to report a financial interest in financial accounts located outside of the United States if the aggregate value of those accounts exceeds $10,000 at any time during the year. (4)

This article first discusses the penalties that can be imposed for failure to satisfy these foreign financial asset filing requirements and then explores options available to taxpayers who have neglected to file their FBAR or information return to come into compliance with their reporting obligations.

Penalties associated with the failure to file timely or accurate returns

Broadly speaking, there are a variety of civil penalties that can be imposed in connection with the failure to pay a tax due or timely submit accurate returns. Briefly, these are as follows:

* Accuracy-related penalties: Generally, where there is an underpayment of tax that is due to negligence or disregard of rules and regulations, a penalty may be imposed in an amount equal to 20% of the underpayment. (5) The penalty is increased to 40% of the underpayment in the case of an undisclosed foreign financial asset understatement. (6)

* Delinquency penalties: Generally, where there is a failure to timely file a return, a penalty may be imposed in an amount equal to 5% per month, up to a maximum of five months, of the net amount due. (7) In cases where there is a failure to timely file a return, but no amount of tax is due, a minimum penalty may be imposed.

* Fraud penalties: Where there is an underpayment of tax that is due to fraud, a penalty may be imposed in an amount equal to 75% of the underpayment. (8) Where there is a failure to timely file a return that is due to fraud, a penalty may be imposed in an amount equal to 15% per month, up to a maximum of 75%, of the net amount due. (9) In certain circumstances, criminal penalties may also be assessed in cases of fraud.

* Information return penalties: Where a taxpayer must file a Form 8938, disclosing his or her interest in "specified foreign financial assets," fails to do so for any tax year, the taxpayer is subject to a penalty of $10,000. If the taxpayer does not file the required Form 8938 for more than 90 days after the IRS sends the taxpayer a notice of the failure to file the form, the taxpayer will incur an additional penalty of $10,000 for each 30-day period (or fraction thereof) during which the failure to file continues after the expiration of the 90-day period, up to a total additional penalty of $50,000. (10)

The reasonable-cause defense

A defense to the accuracy-related penalties and fraud penalties described above may exist if the taxpayer had reasonable cause for his or her underpayment and acted in good faith with respect to it. (11) A defense to the delinquency penalties may exist if the taxpayer's delinquent filing was due to reasonable cause and not willful neglect. (12) Similarly, a defense to the failure to file an information return disclosing a taxpayer's interest in specified foreign financial assets may exist if the taxpayer's failure to file was due to reasonable cause and not willful neglect. (13)

"Reasonable cause" generally means that the taxpayer has exercised...