Many times, a death will expose a family secret about some improper or even illegal act done years ago by the decedent. When the guilty secret comes out, the consequences may be harmless. The gossip may provide entertainment at family gatherings for years, but in some cases, the consequences can be much more severe. When the family secret is an undisclosed foreign account, the beneficiaries of that account can face significant financial penalties. With thoughtful advice, we can guide families through the process of disclosing a deceased relative’s secret foreign account.
Disclosure Requirements
Any U.S. person who holds a foreign financial account worth more than $10,000 must report it annually on the Foreign Bank Account Report (FBAR). A “U.S. person” includes any U.S. citizen or Green Card holder living anywhere in the world. “U.S. person” also includes any U.S. entity and any person who happens to be a resident of the United States for income tax purposes. A “foreign financial account” means any bank account and any brokerage account or other account maintained with a financial institution. This can include insurance policies and annuities with cash values and shares in mutual funds or pooled funds. If a U.S. person holds several accounts and the total of all the accounts exceeds $10,000, then all the accounts must be reported. If a U.S. person’s account exceeds $10,000 for one day, it must be reported.
FBARs are similar to U.S. tax forms, but they’re not filed with the Internal Revenue Service. FBARs are filed electronically with the Financial Crimes Enforcement Network (FinCEN), the financial crimes division of the Treasury Department. Folks who file FBARs may not notice the difference because typically accountants prepare FBARs together with tax returns. The FBAR e-filing authorization form may be signed along with any other e-filing authorization forms, so FBAR reporting can become a normal part of the annual tax process.
Since 2017, the FBAR filing deadline has been April 15. However, FinCEN has granted an automatic 6-month extension for all taxpayers each year from 2017 onward. This automatic extension moves the filing deadline to Oct. 15. For 2016 and earlier years, the filing deadline was June 30, and there was no extension. In all cases, the filing deadline is absolute and universal for all U.S. persons. For example, if a U.S. corporation has an FBAR reporting obligation, it must file the FBAR on a calendar year basis before the Oct. 15 deadline, even if it files taxes on a fiscal year basis.
Just like there’s an absolute deadline for filing the FBAR, there’s an absolute statute of limitations on an unfiled FBAR. If a taxpayer fails to file an FBAR, the statute of limitations will begin to run on the day after the filing deadline for that FBAR. The statute of limitations will expire six years after the failure to file.
Even though the FBAR may seem like a normal tax return, it’s very different from U.S. tax forms. The FBAR is only informational. It doesn’t generate any tax. It isn’t filed with the IRS, and the rules and procedures for filing FBARs are different than for tax returns. Most importantly, the penalties for not filing FBARs can be much more severe than the penalties for not filing a tax return.
Beneficiaries’ Disclosure Obligations
There are a few ways that Grandpa’s secret account may create personal reporting obligations for beneficiaries. At Grandpa’s death, the account will pass to beneficiaries through a beneficiary designation, joint ownership, probate, a trust or some other vehicle. The start date of the beneficiary’s reporting obligation depends on the beneficiary’s interest in the foreign account. For example, if the account passes by beneficiary designation, the new owner must begin reporting the account as of the decedent’s death. This is because the beneficiary’s ownership interest begins at the decedent’s death.
If the account passes by joint ownership, on the other hand, the liability can begin years before the decedent’s death. This is because each joint owner of a foreign account has a separate reporting obligation as soon as the joint ownership is created. All joint owners who are U.S. persons must report the entire account value each year, even if they never contribute to or access the funds in the account. Because joint owners’ reporting obligations can overlap with a decedent’s liability, joint owners can face serious penalties for a decedent’s undisclosed accounts.
If the account passes through an estate or trust, the personal representative or trustee responsible for the foreign account must report it on their individual FBAR. The person with signatory authority over the account must report it even if they have no financial interest in the account. The estate or trust also must file an FBAR, so the fiduciary will report the account both on their individual FBAR and on the FBAR for the estate or trust. Additionally, any beneficiary with more than a 50% beneficial interest in a trust or estate must file as the “owner” of any foreign account in that trust or estate. All these reporting obligations are separate, so multiple individuals can have an obligation to report the same foreign account in the same year.
There’s one big caveat to all these reporting requirements for inherited accounts. Only U.S. fiduciaries and U.S. beneficiaries have FBAR reporting requirements. If the decedent was a U.S. person but the estate and all its fiduciaries and beneficiaries are non-U.S. persons, then the FBAR filing obligations may end on the decedent’s death. If an estate is foreign for U.S. income tax purposes, then it has no ongoing FBAR filing requirements.
When an undisclosed foreign account is passing to more than one U.S. person, it’s important for all U.S. beneficiaries to communicate and coordinate regarding their reporting. If an undisclosed account is passing equally to three U.S. persons and only one of them reports, the two who fail to disclose it risk severe penalties. This dynamic can put great pressure on family relationships, because some beneficiaries are more risk averse than others. As advisors, often we can convince hesitant beneficiaries to file FBARs by explaining the severe penalties for willful nondisclosure.
Penalties
When a U.S. person fails to disclose a foreign financial account on a timely filed FBAR, the civil penalty can be as high as half the unreported account. The size of the penalty depends on whether Grandpa’s nondisclosure was “willful.” For example, if Grandpa chooses not to disclose his $3 million account in Singapore while he’s living, he can face a penalty of $1.5 million. On the other hand, if Grandpa thinks he’s filed his FBARs electronically but he didn’t due to a technical glitch, then he might face no penalties. When a U.S. person willfully fails to file the FBAR, the maximum civil penalty is half the value of the unreported account.
Even though FBARs are filed with FinCEN, the IRS conducts all enforcement. FBAR penalties aren’t automatic, so they can only be assessed after audit. This means that a U.S. person’s first notice of a possible FBAR penalty will be an audit notice. It also means that FBAR penalties are litigated in the U.S. Tax Court and other federal courts, just like any tax penalty.
There’s a growing catalog of federal court decisions involving FBAR penalties for willfulness. Almost all of the published cases involve very bad facts on the taxpayer side, and together they create a body of law that strongly supports the IRS’ enforcement power. For example, courts have defined “civil willfulness” to include “reckless indifference”1 and “willful blindness.”2 The IRS must prove willfulness, but only by a preponderance of the evidence,3 and the taxpayer is presumed to know all of the law regarding FBAR reporting.4
Courts have upheld the 50% penalty for civil willfulness consistently and repeatedly.5 Courts have concluded that 50% is the penalty necessary to encourage folks to disclose their foreign accounts, so it isn’t excessive.
Even if a U.S. person doesn’t meet the standard for civil willfulness, the IRS may assess penalties of up to $10,000 per person, per undisclosed account, per year if there was no reasonable cause for the failure to file. Just as for willfulness penalties, nonwillful civil penalties must be assessed after an examination. They’re not automatic.
A U.S. person can escape penalties altogether by showing reasonable cause, but the legal definition of “reasonable cause” has become so narrow that it would be very difficult to prove in court. It’s best to avoid court proceedings if possible. The IRS has dealt generously with many taxpayers who have filed past-due FBARs using the IRS’ available procedures.
Fixing an Undisclosed Account
If a taxpayer’s returns haven’t been selected for audit yet, there are several ways to resolve the problem of an undisclosed account. None of these options are available once a return has been selected for audit. Each of these options is subject to change at any time, without notice. It’s best to review the available procedures before advising a client and immediately before filing.
If a taxpayer has resided outside the United States at least 330 full days in any of the most recent three calendar years, the taxpayer may qualify for the Streamlined Foreign Offshore Procedures. A streamlined filing includes three years of income tax returns, six years of FBARs and a statement that the failure to file resulted from non-willful conduct. The streamlined instructions define “non-willful conduct” as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.” An offshore streamlined filing can resolve all outstanding reporting obligations with no FBAR penalty, although income tax interest and penalties may apply. The IRS won’t give any confirmation of a release of liability, and the IRS reserves the right to audit, but if the IRS takes no action, the streamlined process resolves all prior liability.
If a taxpayer doesn’t meet the residency requirements for the offshore procedures but meets all other requirements, the taxpayer may qualify for the Streamlined Domestic Offshore Procedures. The domestic process is the same as the offshore process, but there’s an FBAR penalty of 5% of the highest unreported balance in any year. The FBAR penalty applies in addition to any income tax interest and penalties.
If a taxpayer’s nondisclosure was criminally willful, the taxpayer may resolve liability through the voluntary disclosure process. From 2009 through Sept. 28, 2018, the IRS offered a series of specific voluntary disclosure procedures and initiatives to resolve civil and criminal liability for undisclosed foreign accounts. They included the option to file, then opt out if the taxpayer wanted to negotiate an assessment lower than the program’s standard penalties. The most recent voluntary disclosure publication excludes any opt out process and includes very high penalties. In public presentations, IRS representatives have discouraged filing under this process except in cases of potential criminal liability.
In addition to the streamlined programs and the voluntary disclosure process, the IRS has published delinquent filing procedures for FBARs and other information returns. These procedures involve filing past due returns with a reasonable cause statement. Taxpayers have been filing in this manner for many years, and it was previously referred to as “quiet filing.” In past years, IRS representatives condemned quiet filing, and the IRS pursued penalties against taxpayers who filed in this manner. Today, the practice is authorized, and many submissions result in no penalty. However, taxpayers with bad facts face risk of audit. As noted above, current case law has left very little room for actual reasonable cause so if there’s an audit, penalties are likely.
Estate’s Liability
Can an estate face a penalty for a decedent’s willful failure to disclose an account while the decedent was living? The answer will depend on the facts of the case.
If the IRS opened an examination and assessed penalties while the decedent was living, then the penalties likely are a debt of the decedent, payable from the estate.6 This may be difficult to enforce if all the assets, the estate and the beneficiaries are overseas, but the IRS can use all its collection powers to collect FBAR penalties.7 If the IRS opened an examination while the decedent was living but didn’t assess penalties until after the decedent’s death, the IRS still may be able to collect.8
One theory remains untested in published decisions. If the IRS didn’t conduct any examination while the decedent was living, the estate may be able to avoid willfulness penalties by arguing that willfulness can’t be determined after a decedent has died. This argument is effective with regard to criminal liability. However, many taxpayers have tried and failed to convince courts to apply criminal law standards and protections to civil willfulness cases.
Estate/Trust Administration
If an estate or trust has some risk of penalty from an undisclosed account, the fiduciary should consider reporting under one of the methods described above and retaining enough assets in the estate or trust to pay a 50% penalty plus litigation costs. An estate can be held liable for FBAR penalties even after funds have been distributed to beneficiaries. If a fiduciary can’t get funds back from the beneficiaries, the fiduciary may face some personal liability. Because FBAR penalties can be so high, whenever a decedent had an undisclosed account, it’s best to retain funds to protect against potential FBAR liability. The retention period should be based on the FBAR’s statute of limitations. Each year after the decedent’s death, one year of FBAR liability expires. By Oct. 16 of the seventh year after the decedent’s death, all liability for the decedent’s FBAR reporting has expired. At that time, if the estate and fiduciary have met all their separate FBAR filing obligations, then the liability is gone, and the assets can be distributed. The IRS doesn’t issue closing letters under the delinquent or streamlined procedures, so even if the estate files under one of those procedures, it must wait out the statute of limitations.
While the 6-year statute of limitations is running, the fact that older years escape liability may not provide the estate any relief. The FBAR penalty will be based on the highest unreported balance. If the highest unreported balance was in the last year of the decedent’s life, then the FBAR liability will remain consistent throughout the 6-year statute of limitations period.
Endnotes
1. United States v. Bohanec, 263 F. Supp.3d 881 (D.C. Cal. 2016).
2. U.S. v. McBride, 908 F. Supp.2d 1186 (D.C. Utah 2012).
3. Ibid.
4. Greer v. Commissioner, 595 F.3d 338, 347 n.4 (6th Cir. 2010).
5. U.S. v. Bussell, 117 A.F.T.R.2d 2016-439 (D.C. Cal. 2015).
6. U.S. v. Estate of Schoenfeld, 344 F. Supp.3d 1354 (M.D. Fla. 2018).
7. U.S. v. Jung Joo Park, 389 F. Supp.3d 561 (N.D. Ill. 2019).
8. Ibid.