The FBAR, the Financial Crimes Enforcement Network (FinCEN) Form 114, was developed by the U.S. Department of the Treasury to collect and analyze information about financial transactions in order to combat domestic and international money laundering and terrorist financing.
As Americans age, those decreasing few who still maintain a foreign bank account confront a sobering conundrum. What do they do about it? Perhaps their plan years ago was to protect assets, to ensure privacy or even to avoid confiscatory taxes. But while they were not looking, the offshore account they funded in the 1990’s grew to a sizeable pot of money. The irony is that their departure may have the opposite effect from what they intended long ago – making the account very visible, vulnerable to creditors like the U.S. government and depriving their loved ones of the benefit of their savings.
Take the case of the fictitious Earl Higginbotham who faces this all-too non-fictitious problem. Finally acknowledging the possibility of his own mortality, Earl visits his estate planning lawyer, the venible Mr. Stoneface. A befuddled Mr. Stoneface then poses two daunting questions to Earl. “You have what?”; followed closely by, “When were you planning on telling me?”
Holding an offshore account in and of itself is no crime. It is not even morally questionable. It may even be salutatory. But many in Mr. Higginbotham’s shoes are shocked to learn the U.S. disclosure requirements portend severe penalties if they disclose the account, and even severer one if they do not. Mr. Higginbotham’s questions for Mr. Stoneface abound. So, I did not disclose the account. How serious can an omission of disclosure really be? But don’t these penalties die with me? How do I transfer these funds without having them confiscated by the U.S. government? How will my personal representative deal with this mess if I do not? The answer it turns out is as unclear as the afterlife. But one thing is certain, if Mr. Higginbotham takes no action, his death will visit upon his heirs the very same dilemma he now seeks to avoid.
How bad can this be?
Let us start by looking at the first question Ms. Higginbotham poses. To fully understand the abyss into which Mr. Higginbotham stares, we need to look once again at just how seriously fraught with peril the tortuous road for nondisclosure has become. His problems really do not end with, or perhaps even concern tax lability, as many foreign accounts generate little income if they generate any income at all. Rather, his problems center around the reporting requirements. And prominent among these is not an IRS form itself at all. The form that carries the most ominous penalties is appropriately referred to as the “FBAR.”
The FBAR, the Financial Crimes Enforcement Network (FinCEN) Form 114, was developed by the U.S. Department of the Treasury to collect and analyze information about financial transactions in order to combat domestic and international money laundering and terrorist financing. The filing requirements have a long history – they stem from the 1970, “Currency and Foreign Transactions Reporting Act,” commonly referred to as the Bank Secrecy Act (Title 31 U.S.C. §§ 5311-5314, 5316-5332) – but they have been given renewed vigor following the events of Sept. 11, 2001.
Unless Mr. Higginbotham was a poor saver, he is subject to these requirements. The FBAR filing threshold is already low. With the ravages of inflation, it will become inexorably negligible. Today, taxpayers with a foreign bank account exceeding $10,000 are required to file the FBAR form; and this threshold is determined by looking at accounts in the aggregate for any point during the year. To grasp of how inflation erodes the filing requirement, a future Mr. Higginbotham, in the next two decades, will be required to report less than $4,000 in present value.
Mr. Higginbotham of course did not file the form (and it must be filed electronically). And as a result, the penalties he confronts are some of the highest in the Internal Revenue Code (the Code). A non-willful violation generates a penalty of up to $10,000 per year for the years that remain open under the statute of limitations (31 USC 5321(a)(5)). If his failure to report is considered willful, then the penalty is the greater of 50 percent of what is not reported or $100,000. For example, if his account balance was $6,000,000, he could face a maximum penalty of $3,000,000 if the transgression was willful. However, for each year the FBAR is not filed, the penalty is imposable again. Therefore, it is quite possible for the maximum FBAR penalty to be multiples of the balance in offshore accounts, whether or not the failure to report was willful. And as we will see below, the IRS has relished the opportunity to impose penalties that not only wipe out the account but require the taxpayer to pony up more funds.
Worse, whether or not the failure to file was willful is a low bar. Technically, this depends on whether or not Mr Higginbotham voluntarily committed an intentional violation of a known legal duty (Internal Revenue Manual section 126.96.36.199.5.3.1). Although the government has the burden to prove this, the only thing they would need to show is that Mr. Higginbotham knew of the reporting requirements (those same requirements, of which Mr. Stoneface advised him to prevent a malpractice suit by Mr. Higginbotham, Jr.) but purposefully chose not to report. What weight of proof is required is unsettled. The IRS itself actually believes the burden of proof is by clear and convincing evidence (IRS CCA 200603026), but some courts have sua sponte and inexplicably imposed a lesser, preponderance-of-the-evidence standard.
“But I didn’t know about the law,” Mr. Higginbotham whines. “So, what,” responds Mr. Stoneface, “you do now.”
“And whether you can claim ignorance of the law is dicey in any event.”
Mr. Stoneface is right. Two cases, U.S. v. Williams, 110 AFTR 2d 2012-5298, 489 Fed. Appx. 655 (4th Cir. 2012) and U.S. vs. McBride, 908 F. Supp. 2d 1186 (D. Utah 2012), show that courts have found taxpayers who simply failed to discuss their financial strategy with their respective accountants to be willful. They were willful because they put themselves in a position of being willfully ignorant. And if Messrs. Williams’ and McBride’s omissions were viewed as purposeful ignorance by the court, then doing nothing after actually discussing the issue with his counsel would seem to qualify Mr. Higginbotham for the willful side of the penalty. In short, subjective knowledge is not required for a taxpayer to have willfully failed to timely with the FBAR requirements. Of course, the penalties attach irrespective of any tax owed; so theoretically, even if Mr. Higginbotham suffered an economic loss in his foreign account he would still have to account for the penalties.
“Alright, damnit,” Mr. Higginbotham blurts, “please make it stop.” To make matters worse, Mr. Stoneface advised him, in certain circumstances a willful violation will also be criminal in nature. If so, the criminal penalties include up to a $250,000 fine or five years in jail. And because the willful failure to file an FBAR is a felony, it can result in collateral consequences such as the loss of the rights to vote and bear arms. It can hamstring the defendant by taking away his professional licenses. And for a permanent resident, it can mean deportation after jail time has been served.
“You’ve told me far too much,” sighs an exasperated Mr. Higginbotham, as he slumps further into Mr. Stoneface’s leather chair. “Well, actually not quite enough,” Mr. Stoneface responds.
The FBRA is not the only reporting requirement. To be sure, to be sure, several year ago Congress enacted the The Foreign Account Tax Compliance Act (FATCA), which creates separate requirements which “do not replace or otherwise affect a taxpayer’s obligation to file FBAR.”1
Unlike FBAR form filed with FinCEN, the Form 8938 (the Statement of Specified Foreign Financial Assets), which provide details about the foreign accounts, is filed with the Internal Revenue Service. Form 8938’s filing requirement is triggered in part by the taxpayer checking off the item in Schedule B (Line 7a of Part III) of their Form 1040, regarding the foreign bank account. The requirement exists whether account balance of the foreign financial assets totals more than $50,000 on the last day of the year or more than $75,000 at any time during the year for single filing statue ($100,000 and $150,000, respectively for married taxpayer filing jointly).
The filing of the IRS form is critical. The statute of limitations on a fraudulent return never runs, meaning that the failure to identify the account can create a permanent tax problem.
The taxpayer who signs a return without disclosing the existence of a foreign account may be considered to have committed tax fraud and perjury, both felonies. Indeed, there are at least thirteen possible additional forms that a taxpayer would need to file. These include the Forms 926 (Transfers to Foreign Corporations), Form 1042 (Payment to Foreign taxpayers) and a penalty of other potential filings; including, Forms 3520, 5471, 5472, 8233, 8621, 8833, 8840, 8858, 8865, 8938 and W-8BEN.
Does death do the penalties part?
After Mr. Higginbotham met Mr. Stoneface’s demand for an increased retainer, Messrs. Higginbotham and Stoneface resumed their discussion. Mr. Higginbotham asked a question often contemplated by kindred spirits. “Suppose I just die. Isn’t death enough punishment? Won’t the penalties just go away?” But Mr. Stoneface answers that question with a qualified “no,” explaining that Mr. Higginbotham is also potentially gifting a serious problem to his offspring. “Unfortunately, the sins of the father may leave your childrens’ (or Mrs. Higginbotham’s) teeth ajar.”
“What is the reach of the responsibility?” “Well, suffice it to say that it may very well live beyond you, Mr. Higginbotham. To begin with, Mr. Higginbotham, if you granted your wife or child signature authority over the account, or through a power of attorney there exists signature authority, the reporting requirements can be imposed upon them as your nominee or alter ego, even if they have no financial interest in the account.”
“Second,” Mr. Stoneface explained “a penalty (and any tax liability) can effectively attach to the personal representative directly.” He is right again. Pursuant to Title 31 U.S.C section 3713 any personal representative who pays any part of a debt of the estate before paying a claim of the government is lability to the tend of the payment for unpaid claims of the government. As a result, if Mr. Higginbotham’s son, acting as the personal representative had notice of the government claim or of “facts that would lead a reasonably prudent person to inquire as to the existence of the debt owed …” he will be charged with the responsibility.
See, United States v. Coppola, 85 F.3d 1015 (2d Cir. 1996).
“But perhaps more importantly, there is a sort of after-life or at least limbo for the penalties that could have been applied to the decedent,” Stoneface explained. In fact, if Mr. Higginbotham is caught red handed, the FBAR penalties may survive him regardless of whether or not the personal representative knew of the account.
A case on point here is U.S. v. Est. of Schoenfeld, 3:16-CV-1248-J-34PDB, 2018 WL 4599743 (M.D. Fla. Sept. 25, 2018), which has traveled though the international tax bar like wildfire. Under the facts in Schoenfeld, Steven Schoenfeld a U.S citizen, opened a Swiss bank account with UBS AG, which generated income from interest and devices. A decade later, UBS warned Mr. Schoenfeld and others that their account information may be provided to the IRS. In 2010, UBS closed Schoenfeld’s account and wired the funds to a U.S. brokerage account, which sole beneficiary was Schoenfeld’s son, Robert. Seeing this, the IRS assessed Schoenfeld a penalty of $614,300 – half the value of the account.
In 2015 Schoenfeld passed away, after having appointed Robert to act as his personal representative. The U.S. then proceeded to file a complaint against Robert in 2016. After some expansive but futile procedural maneuvering, the court held that the government’s claim was still valid, despite Schoenfeld’s death. It found that the government properly alleged in the amended complaint that Robert was the distributee of Steven’s estate. “[A]s the Personal Representative named in Steven’s will and the sole beneficiary of his Estate, Robert [was] a proper party to this suit.” Id. In reaching this decision, the court cited to United States v Park another recent decision along the same lines (U.S. v. Park, 16 C 10787, 2017 WL 4417826 (N.D. Ill. Oct. 5, 2017).
Now, it could be argued that this penalty ought to die with Mr. Higginbotham because it is punitive (i.e., penal) in nature and violates of the 8th Amendment to the U.S. Constitution. In fact, it is true that American courts have long recognized a well settled principle: that an action brought against a deceased party cannot continue “unless the cause of action, on account of which the suit was brought, is one that survives by law.” Ex parte Schreiber, 110 U.S. 76, 80 (1884). Further, they have long understood “that remedial actions survive the death of [a party], while penal actions do not.” United States v. NEC Corp., 11 F.3d 136, 137 (11th Cir. 1993), as amended, (Jan. 12, 1994). But while the Congress never specifically expressed its intention to ensure the FBAR claim survives death, the courts confronted with this question have found the FBAR penalty is remedial, not penal.
Quoting from the test instructed in Hudson v. United States, 522 U.S. 93, 118 S.Ct. 488, 139 L.Ed.2d 450 (1997), the NEC court found that a remedial action “compensates an individual for specific harm suffered,” whereas a penal action “imposes damages upon the defendant for a general wrong to the public.” The NEC Court found that Congress showed it preference FBAR penalties are civil by titling the statutory section as “Civil Penalties.” And despite the draconian nature of the penalty, the court astonishingly found little “evidence, much less the clearest proof,” that the FBAR penalty was “punishment.” The court noted that the BSA authorizes a penalty against all individuals who violate Section 5321, regardless of intent (known as “scienter”). And although the court found that Section 5321 promoted retribution and deterrence, emblematic of penal codes, it sluffed this aside decrying “all civil penalties [as having] some deterrent effect.” Id. The court found the FBAR penalty serves the additional alternative purpose of reimbursing the government for the cost of investigating and recovering the funds. Last, the court found that the FBAR penalty was not excessive in relation to this purpose. The likelihood that this will be challenged as prosecutorial aggressiveness pushes the civil towards the criminal is of no consequence to Mr. Higginbotham.
So, what is Mr. Higginbotham to do?
Mr. Higginbotham is presented with a Hobson’s choice. He can do nothing and let time and the vicissitudes of risk make the decision for him. As Abraham Lincoln once observed, “time is the greater quickener.” Or he can make a disclosure, either visibly or quietly. Each path is fraught with peril, made no less so by an underbrush of uncertainty obscuring both.
Consider first, the pitfalls and perks of doing nothing, beginning with the pitfalls. Unfortunately, for Mr. Higginbotham, he bears an increasingly high risk, depending on his health, that the offshore account will be uncovered in his lifetime. This results from a confluence of technological advances, tectonic shifts in global information exchange culture and the aggressiveness with which the U.S. has use its increasingly lethal arsenal of punitive and informational weaponry. In fact, the IRS bragged about its enhanced digital tools for sniffing out those who are skirting the tax laws.2
Add to this that banks increased cooperation is a rational reaction to the perceived cost benefits, as high-profile cases get publicized. Indeed, the first well-publicized target was UBS in Switzerland who ultimately turned over the name of more than 4,000 U.S. taxpayers with Swiss accounts. UBS agreed to pay a $780 million fine as a result of its guilty plea to help American evade taxes. Indeed the U.S. government has even secured convictions of foreign bank executives for violating FATCA, sending a signal to the institutions that there is a human costs to shielding their U.S. customers.
Sensational stories of high-profile cases have also caused many taxpayers with foreign accounts to capitulate, and this has meant the IRS can focus limited resources on a smaller pool of violators. As of December 2012, the IRS had collected more than $5.5 billion in back taxes, interest and penalties from more than 39,000 taxpayers, according to the U.S. Government Accountability Office (GAO Rep’t 13-318). Since 2009, more than 1,500 have been indicted for crimes related to international activities according to the IRS (IR-2018-52).
And they are reacting rationally to the ruthlessness with which the government has pursued non-filing. While the Schoenfeld litigation was dramatic, another highly publicized case of U.S. v. Carl Zwerner proves age and infirmity serves as no barrier.
Eighty-seven-year-old Carl Zwerner opened an account in Switzerland in the 1960’s under the name of two different foundations he created. He used the proceeds for personal expenses, failing to report his financial interest in the Swiss bank account on a FBAR and any income earned on his original tax returns for 2004 to 2007. When a Southern District of Florida jury found that Zwerner willfully failed to file FBARs for the years 2004 through 2006, Zwerner faced a 2.2 million penalty on an account of less than 1.7 million. He ultimately settled the matter for $1.8 million in penalties and interest. See, U.S. v. Carl Zwerner, Civil Docket Case #1:13-cv-22082-CMA.
More bad news, of course, is that Mr. Higginbotham’s personal representative will likely have to deal with the issue, if he does not. Not only would the probate court require disclosure of these account, but the foreign bank would demand a power of attorney and perhaps more.
And at the same time, the institutional targets have been softened by global information exchange treaties, the U.S. Department of Treasury and Justice have hardened their blades and honed their craft. Behind every FBAR matter resolved by the IRS is a taxpayer who sat down with the IRS to divulge information. And therefore, there is an increasingly high risk that foreign banks and taxpayer will name other holders of foreign accounts, allowing Treasury and Justice to cast an ever-widening net. Because of collaboration, the number of jurisdictions still available for concerning assets has decreased with a concomitant increase in in attention to the few that remain.
In the event Mr. Higginbotham dies without the IRS discovering the accounts, there may be the glimmer of a silver lining. IRS private guidance issued of Oct. 22, 2007 (Cited in Journal of Tax Practice & Procedure by CCH) seems to suggest that if a personal representative files the FBAR for the first time on behalf of the estate, the representative is not expected to file all the FBARs the decedent should have filed. Of course, it is prudent that amended returns for the decedent be filed by the personal representative, which can be filed under any of the IRS’ voluntary disclosure options depending on the facts of the case. If the personal representative can show that he or she was not complicit in the failure to file, this practice of disclosure after death may yield a favorable result, although this is far from certain. It should be noted that voluntary disclosure after death was not something Mr. Schoenfeld or Zwerner availed themselves of.
Next, consider voluntary disclosure. For the past decade, the IRS has maintained a safe harbor for taxpayers who wanted to disclose offshore accounts that they feared may have exposed them to criminal penalties. This so-called Offshore Voluntary Disclosure Program (OVDP) was beneficial because – although the OVDP problem voluntarily subjected taxpayer to fines – thee fines were reduced. Moreover, the threat of criminal prosecution evaporated if the disclosure was timely. Over the years, tens of thousands of taxpayers have availed themselves of the program. But on Sept. 28, 2018, the IRS closed its OVDP program. Only taxpayers who submitted the required disclosures and materials no later than Sept. 28, 2018 could avail themselves of the program.
While time has run out on the OVDP program, Mr. Higginbotham may take advantage of a lesser known voluntary disclosure process. Long before the offshore program came into existence, voluntary disclosure was a policy of the IRS. Taxpayers with criminal exposure could potentially avoid criminal prosecution is they voluntarily came into compliance. See I.R.M. 188.8.131.52. Known as the Streamlined Filing Compliance Procedures process, this avenue exists for taxpayers who have both failed to file their FBARs and to properly and timely report the income earned on their foreign financial accounts on their tax returns due to negligence, inadvertence or mistake. The procedures allow taxpayers, who meet certain eligibility criteria to get into compliance with fewer penalties. For nonresident taxpayer, there are often no penalties.
Whether or not Mr. Higginbotham can use this approach depends on the evidence. The key criterion is that that taxpayer’s noncompliance be non-willful. And to reduce false submissions, the IRS requires that the taxpayer certify, in detail, the facts supporting the non-willfulness.
Two cautionary points here deserve mention. First, should Mr. Higginbotham avail himself of this process, but yet submit a non-willful certification in doing so, he may be exposed to criminal prosecution under, among other things, 18 U.S.C. 1001 (the same statute Paul Manafort was charged with violating). The IRS will normally not settle a FBAR case without having a face-to-face meeting with the taxpayer (See, IRM Ex. 4, 4.26.16-2), where they will probe his theory of non-willfulness. There are other requirements as well. For instance, if the IRS has initiated a civil examination of taxpayer’s returns for any taxable year, regardless of whether the examination relates to undisclosed foreign financial assets, the taxpayer will not be eligible to use the streamlined procedures. Returns submitted under either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures may be selected for audit
There are also “Delinquent FBAR Submission Procedures,” which are available to taxpayers who have reported their income earned in foreign accounts but who did not file the required FBARs. There is no guarantee, though, that the SFCP will remain open forever; and the IRS is encouraging those taxpayers who have offshore compliance issues who meet all of the qualifications of the SFCP to use that procedure while it is still available.
There is one more option that is a hybrid. Mr. Higginbotham may make what is known as stealth disclosures, either a “quiet disclosure” or a “first time disclosure.” Under this first alternative, Mr. Higginbotham would file an amended tax returns and FBAR as far back as the statutes of limitation (e.g., three years or more) in the hope of avoiding assessment of even the smaller penalties. However, commentators do refer to this as a high-risk tactic as the cat has long been out of the bag. A Government Accountability Office report has flagged quiet disclosures as being on the increase and has urge the IRS to look for amended returns to better ferret out these quiet disclosures.
In a first-time disclosure, the Mr. Higginbotham would disclose the presence of the account on his return for the first time, hoping to bury the prior transgressions. However, “new disclosures” like “quiet disclosures” are not an unknown device to the IRS, which is casting a more jaundice eye upon the practice. As the Government Accountability Office has pointed out here, the number of taxpayers checking the “foreign bank account” box on Schedule B doubled between 2003 and 2010, while curiously during that same period, the number of FBA filed more than tripled.
Mr. Higginbotham finds himself in an unenviable position, as do all taxpayers who have offshore tax compliance issues after OVPD. It matters not whether they opened the foreign account for a nefarious or benign reason. Which course the law recommends to such taxpayers is not manifestly clear, and the IRS seemingly relishes in making it unclear, perhaps to warrant selective enforcement. Which course the facts recommend, in turn depends on the circumstances. But the sobering decision to disclose, how to disclose or to leave the entire mess to the personal representative is one that must ultimately be made by the taxpayer. Doing nothing is itself a decision. And if that path is taken, time and fortune will dictate the uncertain result. Rest in peace.
1 See, https://www.irs.gov/businesses/comparison-of-form-8938-and-fbar-requirements
2 See, “IRS Criminal Investigation chief Plans New Enforcement Programs,” Accounting Today (August 2, 2017).