Tax Traps - US Citizens And US Tax Resident Foreign Nationals With Assets Abroad Foreign Bank Accounting Reporting Form TD F 90-22.1

by George Hayduk

The $10,000 Penalty Scheme

A few notorious cases of international tax abuse have resulted in our politicians enacting a vindictive penalty scheme. While the original target of this legislation was wealthy US citizens hiding money offshore, the rules now apply to all US "tax residents" which includes foreign nationals on nonimmigrant visas, and US citizens and lawful permanent residents residing here and abroad. Tax treaties will offer no protection from these penalties.

The penalty for a simple reporting failure (failure to file the FBAR by June 30 each year or failure to properly disclose offshore financial accounts) is $10,000 and as noted below it can get worse.

Historically IRS FBAR enforcement has been lax and a lack of compliance resulted. Tax advisors often ignored the form and most tax software simply defaults to "No" on the Schedule B (Form 1040) question asking if you have an offshore bank account.

That environment is now changing; the Obama administration is aggressively going after offshore reporting failures; and, due to the worldwide financial crisis, expect the trend towards increased financial transparency and international cooperation to continue. It is not wise to think you will stay under the radar screen and these violations can easily cross the line into a criminal matter.

FBAR reporting applies to US tax residents who have an ownership interest or signature authority over financial accounts abroad that total in the aggregate more than $10,000. This has turned into an expanding definition and covers all kinds of "offshore" financial accounts except direct ownership in share certificates or other assets. As in all these cases when it comes to apply a government definition to the real world a great deal of uncertainty arises. The instructions to the October 2008 revision to Form TD F 90-22.1 must be consulted.

Compliance failure leaves a fertile and rewarding ground for IRS enforcement, as FBAR's received even one day late can generate a $10,000 penalty for non-willful violations. The relevant law can be found in 31 USC Sec. 5311-5331. This is non-tax legislation (the "Bank Secrecy Act"). Initially these rules were administered by the Financial Crimes Enforcement Network - Department of the Treasury and were delegated to the IRS in 2003.

To make matters worse, there is a new penalty for willful violations; the greater of $100,000 or 50 percent of the balance in the account. "Willful" has been defined as a "voluntary intentional violation of a known legal duty"(Ratzlaf v. United States, 510 U.S. 135 (1994)).

For those with compliance failures here, a window of opportunity exists to correct matters with reduced or eliminated penalty.

On May 6, 2009 the IRS issued an announcement in the form of a FAQ addressing questions that have arisen concerning the recent revisions to their Voluntary Disclosure Program. In a nutshell:

• Voluntary Disclosure is a program where taxpayers with unreported income can come forward and avoid the most draconian penalties and possible criminal investigation.
• The taxpayer must come forward prior to the IRS commencing an investigation
• The taxpayer must come forward by 23 September 2009.
• Taxpayers will have to pay back taxes on unreported income, interest, accuracy or delinquency penalties and an FBAR penalty of 20% of the highest asset value in past six years of the unreported account. The 20% may be reduced to 5% in certain "benign" fact patterns.

For those who do not have unreported offshore income - but did not file FBARs, the IRS has stated that no penalty will be imposed if you file the unfiled FBARs by 23 September 2009 with copies of tax returns for the relevant years. This is good news for these individuals provided they have no unreported income and comply with the deadline.

Problem Areas

There is no excuse for US taxpayers who intentionally avoid reporting offshore income. They must come forward and deal with the alternate penalty regime that is now offered or face more serious difficulties down the road. The problem is that there are a number of fairly innocent categories of taxpayers who can get seriously hurt by this new enforcement initiative.

Inequities are likely to result in following areas:

• Problem Categories of Taxpayers. In our website www.expattaxandlaw.com we have referred to two categories of US taxpayers that by definition have tax reporting failures. They are the "inadvertent USC" and the "reluctant USC". The former are US citizens simply by virtue of having been born in the US, or abroad, to a USC parent. The reluctant USC (this category can include green card holders as well) is a USC who has moved abroad and whose remaining ties to US are very tenuous. These individuals are typically late and often somewhat shoddy with respect to their US reporting obligations. In many cases, they will have foreign tax credits to eliminate their US liability but the $10,000 FBAR penalty would apply in any event. More often than not the "reluctant USC" has not "intentionally" failed to report, their focus is simply not on the increasing complex US compliance system. They may be negligent - but nevertheless face vindictive penalties. Hopefully the IRS will be flexible in these situations, but we are dealing with a large bureaucracy and a government in need of revenue. These taxpayers must keep in mind that if they want to legally exit the US tax system there are formal procedures they must follow (see Form 8854).
• Problem Categories of Financial Accounts. This reporting scheme is all about reporting interests in "foreign bank accounts". The problem is that the definition has expanded to cover just about any type of financial account (investment funds, personal pensions etc). In many cases it is not obvious that you have an account that is covered by these rules.

The following briefing note has been produced the Law Office of George J. Hayduk. This note is for informational purposes and does not represent tax or legal advice. For further information please visit www.expattaxandlaw.com. This briefing note is part of a series that addresses tax and legal issues for the international person with a US connection.

About The Author

George J. Hayduk is a former member of AILA and is a member of the Connecticut Bar. His practice is limited to tax and legal matters that impact the international family with a US connection. Mr. Hayduk is a 1984 graduate of Hofstra Law School and a has MBA in Finace from Iona College. He has published numerous artilces about international pension and retirement planning matters. Visit www.expattaxandlaw.com for more details on FBAR reporting and IRS offshore enforcement. His blog can be reached through his website.

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