Until June 18, 2014, US residents who failed to file FBAR forms and report income from “offshore” accounts on their US tax returns had significant penalty exposure and were not eligible for most relief provisions. IRS Notice IR-2014-73 changes this, and provides additional options to US residents.
Background and “Old” Rules
(“FBAR” means foreign bank account reporting, and “FBAR form” means FinCEN Form 114, which was previously Form TDF 90-22.1. A “US resident” is an individual residing in the US who is a citizen, green card holder or required to file under the substantial presence test.)
By way of background, FBAR penalties arise if a taxpayer fails to disclose offshore bank accounts by filing FBAR forms and also fails to report the related income. (There are no FBAR penalties if the taxpayer reports all of the income on the offshore accounts.) Penalty relief has always been available to US citizens living overseas. Through use of the “streamlined procedure,” these nonresident taxpayers will avoid FBAR penalties (and all other penalties) by (1) filing delinquent or amended income tax returns for the prior three years and paying all delinquent tax and interest, (2) filing delinquent FBAR forms for the prior six years, and (3) filing a certification. But this avenue was not available to US residents. A common example is a US resident who inherits a foreign account and fails to file FBAR forms and report nominal interest income. Such a person was relegated to either (i) paying a 27.5% penalty under the Offshore Voluntary Disclosure Program, or (ii) filing the delinquent FBARs with reasonable cause penalty waiver requests and hoping the $10,000/account/year penalty would be waived.
IRS Notice IR-2014-73 liberalizes relief available to US residents.
New Streamlined Procedure Relief for US Residents
Under the new domestic streamlined procedure, US residents can become tax compliant without exposure of the regular FBAR penalties by paying the “Title 26 miscellaneous offshore penalty” equal to 5% of the highest aggregate year-end balance in offshore accounts over the last six years.
In general, a US resident is eligible for the streamlined procedure relief only if the failure to file FBAR forms was not willful. For example, failure to file is non-willful if due to negligence, inadvertence, mistake or a good faith misunderstanding of law. Also, no streamlined procedure relief is available if the IRS has already initiated a civil examination of the taxpayer’s returns for any period.
A US resident must take the following action in order to use the streamlined procedure: (1) file Form 1040X amended income tax returns for the prior three years and pay all delinquent taxes and interest, (2) file FinCEN 114 FBAR forms for the prior six years, (3) file a six-page certification with detailed information about offshore accounts for the prior six years, (4) pay the 5% penalty. The certification at (3) above must include specific reasons for failing to report income on offshore accounts and file the related FBAR forms. Also, if the taxpayer relied on professional advice, the advisor’s name, address, telephone number and summary of advice must be included.
The new streamlined procedure for US residents is an improvement, albeit painful. For example, if a US taxpayer failed to file FBAR forms and report nominal interest income on an offshore account of only $100,000, the cost of compliance is $5,000 plus professional fees for amended returns, delinquent FBARs and the certification. Some taxpayers may try to avoid all penalties by relying solely on a reasonable cause penalty waiver request. Under this route, the taxpayer must still file amended income tax returns and delinquent FBARs. The risk is that the taxpayer might be tagged with a $10,000/year/account penalty in lieu of the 5% penalty. On balance, most taxpayers will probably gulp and accept a 5% penalty in lieu of the uncertainty and risk of the alternatives.