On May 13, 2015, the Internal Revenue Service issued SBSE-04-0515-0025, titled “Interim Guidance for Report of Foreign Bank and Financial Accounts (FBAR) Penalties.” The issuance provides limitations for assessment of FBAR penalties under the vast majority of circumstances presented by taxpayers. The issuance provides both clarity as to worst-case scenarios faced by taxpayers when FBAR penalties are assessed and additional considerations for coming into compliance when remedying prior omissions.
The stated purpose of the notice is “to implement procedures to improve the administration of the Service’s FBAR compliance program.” The issuance applies to all open matters where an FBAR penalty is a consideration. It includes procedures for assessment of penalties and a checklist for agents to complete regarding the same.
Specifically, the new procedures modify Internal Revenue Manual Sections 4.26.16 and 4.26.17. Section 4.26.16(2) provides methodology for calculating willful FBAR penalties. This section states that “[i]n no event will the total penalty amount exceed 100 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination.” This clarification is significant, as the Service is authorized by statute to assess a penalty of the greater of $100,000 or 50% of the account balances of all reported foreign financial accounts per year for each year in which the statute of limitations is open. The statute of limitations for an FBAR penalty assessment is six years. Therefore, previously, the Service was theoretically able to assess 50% penalties for as many as six years , which could have created an overall penalty of roughly 300% of the account balances. While such an assessment has not been made by the Service in any public matters (likely due in no small part to Eighth Amendment concerns), this new certainty as to the highest amount of penalties that taxpayers can be face is clearly advantageous.
As for nonwillful violations, IRM 6.26.16(3) states that, in most cases that involve multiple nonwillful violations, examiners will recommend one penalty for each open year not to exceed $10,000. This development is particularly important, as the Service is authorized by statute to assess penalties of $10,000 per account per year (with the same six-year statute of limitations). Under the statutory structure, yearly penalties could quickly accumulate for taxpayers whose offshore assets were split between numerous accounts. For example, under the statutes, taxpayers with six offshore accounts could be assessed nonwillful penalties of $60,000 per year (regardless of account balances) for up to six years. The new IRM provisions limit this penalty in most cases to $10,000. IRM 6.16.26(3) does state that, in certain cases, penalties may be assessed on a per account basis and can be warranted when considering the conduct of the taxpayer, as well as the aggregate balance of the accounts.
As indicated, the new IRS notice lessens the hypothetical ceiling for penalties for the vast majority of taxpayers with offshore reporting failures. The issuance has wide-ranging effects which will be seen outside the realm of taxpayers under audit by the Service. In relation to retrospective failures to report foreign accounts on FBARs, the Service has instituted two retroactive compliance programs which have become extremely popular with taxpayers and practitioners: the Offshore Voluntary Disclosure Initiative and the Streamlined Program. Under the latter program, participation is restricted to those whose failures to report foreign financial assets, report income generated by those assets on their tax return, and pay tax on that income were due to “non-willful conduct.” This term is only loosely defined under the program. Therefore, risk exists for taxpayers because, if they attempt to enter the program and are later deemed ineligible, enormous FBAR penalties would be imposed upon rejection. IRM 6.16.26(2) and (3) provide limitations to the amount of penalties they could face, and allow for a clearer calculation of risk when determining their program choice.
As to the Offshore Voluntary Disclosure Initiative, taxpayers entering the program agree to a one-time 27.5% penalty based on the value of foreign accounts and assets, regardless of their actions or perceived level of willfulness (the penalty can be higher in limited circumstances). However, taxpayers who enter the program but later determine that assessment of a 27.5% penalty is unwarranted are able to “opt-out” of the program and have the Service assess penalties outside the program. Therefore, the new IRS notice is helpful to taxpayers who take this approach (and incentivizes more taxpayers to do so), as it provides clarification and limitation as to the amount of penalty a taxpayer could face in such circumstances.
Patrick J. McCormick is an associate with the firm. He earned his J.D. from Vanderbilt University Law School in 2008, and his LL.M. from the New York University School of Law in 2009. Mr. McCormick handles an assortment of tax and estate issues, but specializes in the areas of international tax, offshore disclosures, tax controversy matters, and business planning techniques (including captive insurance companies).