The IRS has been aggressive recently in pursuing tax cheats who have hidden assets in offshore accounts. Penalties for not reporting the existence of foreign accounts are steep, which concerns even honest businesses and individuals that are unsure about their filing obligations.
Generally, U.S. taxpayers with a financial interest in foreign financial accounts are required to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (often referred to as the “FBAR”), when the aggregate value of those accounts exceeds $10,000 at any time during a calendar year. Such accounts include, but are not limited to, checking, savings, securities, brokerage, mutual fund and other pooled investment accounts held outside the United States. Individuals with signature authority over, but no financial interest in, one or more accounts with the same qualifications must file an FBAR as well. This latter requirement has caused much confusion and concern among executives with some level of discretion over their employers’ foreign financial accounts.
Last February the Treasury Department published final amendments to the FBAR regulations to clarify filing obligations. These regulations became effective on March 28 and apply to FBAR filings reporting foreign financial accounts maintained in calendar year 2010 and for all subsequent years.
These new regulations also specifically apply to people who only have signature authority over foreign financial accounts and who properly deferred their FBAR filing obligations for calendar years 2009 and earlier. The deadline for these individuals to file the FBAR was extended until Nov. 1, 2011.
The IRS also ended an offshore voluntary disclosure initiative as of Sept. 9. During this initiative, the IRS offered a uniform penalty structure for taxpayers who came forward to report previously undisclosed foreign accounts, as well as any unreported income generated or held in those accounts, during tax years 2003 through 2010. Even though the window to participate in the program has closed, the initiative’s FAQs make clear that those with only signature authority on foreign accounts should still file delinquent FBAR reports.
Signature Authority Exception
What does signature (or other) authority mean, as far as the IRS is concerned? The final regulations define signature or other authority as follows:
Signature or other authority means the authority of an individual (alone or in conjunction with another) to control the disposition of money, funds or other assets held in a financial account by direct communication (whether in writing or otherwise) to the person with whom the financial account is maintained.
According to this definition, executives and other employees aren’t necessarily required to file an FBAR simply because they have authority over their business’ foreign financial accounts. Under the final regulations, the Financial Crimes Enforcement Network (FinCEN) grants relief from the obligation to report signature or other authority over a foreign financial account to the officers and employees of five categories of entities that are subject to specific types of Federal regulation. Among these categories are publicly traded companies listed on a U.S. national securities exchange, and companies with more than 500 shareholders and more than $10 million in assets. For publicly traded companies, officers and employees of a U.S. subsidiary may not need to submit an FBAR either, as long as the U.S. parent corporation files a consolidated FBAR report that includes the subsidiary. These exceptions only apply when the employees or officers don’t have a financial interest in the accounts in question.
However, the regulations provide that the reporting exception is limited to foreign financial accounts directly owned by the entity that employs the officer or employee who has signature authority. The exception doesn’t apply if the individual is employed by the parent company, but has signature authority over the foreign account of the company’s domestic subsidiary. Further, foreign accounts owned by foreign subsidiaries of a U.S. corporation are not eligible for this reporting exception.
For example, if the Acme Corp. owns foreign financial accounts, the executives with signature authority over those accounts must also be employees of Acme Corp. in order to qualify for the exception. If a U.S. subsidiary of Acme Corp. owns those accounts, the executives with signature authority over the accounts must be employed by the subsidiary (not Acme Corp. directly), and Acme Corp. must file a consolidated FBAR that includes the subsidiary for the exception to apply.
Determining Signature Authority
Even if a company’s officers or executives do not qualify for the signature authority exception, it is still possible that they may not be required to file. According to the final regulations:
The test for determining whether an individual has signature or other authority over an account is whether the foreign financial institution will act upon a direct communication from that individual regarding the disposition of assets in that account. The phrase “in conjunction with another” is intended to address situations in which a foreign financial institution requires a direct communication from more than one individual regarding the disposition of assets in the account.
An executive who merely participates in the decision to allocate assets, or who has the ability to instruct others with signature authority over a reportable account, is not considered to have signature authority him- or herself, unless the foreign financial institution will accept instructions from that executive with regard to disposing account assets. If the individual in question only advises or oversees the account’s direction, it is possible he or she doesn’t have to file.
Penalties for Not Filing
According to the FBAR filing instructions, a person who is required to file a FBAR may be subject to a civil penalty up to $10,000 if he or she fails to properly file. If there is reasonable cause for the failure and the account balance is properly reported, no penalty will be imposed.
Although not defined in the final regulations or the FBAR filing instructions, it appears that the Department of Treasury will follow the reasonable cause standard defined in the Internal Revenue Code (Sections 6664 and 6724) and the Treasury Regulations (Sections 1.6664-4 and 301.6724-1). Generally, these are circumstances out of the taxpayer or entity’s control. Note that the IRS does not consider being unaware of the FBAR filing requirement as a reasonable cause.
Determining whether “the account balance was properly reported” is less clear. Individuals report their interest and dividend income on Schedule B of their income tax returns. Part III of Schedule B pertains to foreign accounts and trusts. Checking “yes” in this section to indicate a financial interest in or signature authority over a financial account in a foreign country may or may not be sufficient for meeting the “properly reported” standard. Reporting all of the income generated by the foreign account may or may not be sufficient either. According to a reader of Palisades Hudson’s Current Commentary blog, the latter does not satisfy the requirement to avoid penalty. The reader is a U.S. citizen living in New Zealand and is married to a nonresident alien. He mentioned that he reported all of his income from foreign financial accounts on his U.S. individual income tax return, but has been assessed the penalty because he did not file a FBAR.
The penalty is more severe, of course, for a person who willfully fails to report an account or account identifying information. Such person may be subject to a civil monetary penalty equal to the greater of $100,000, or 50 percent of the balance in the foreign financial account at the time of the violation, as well as possible criminal penalties. The reasonable cause exception does not apply to willful violations.
In the course of researching this topic, I contacted the IRS Bank Secrecy Act Telephone Helpline to get a better understanding of the penalty for employees with signature authority over, but no financial interest in, an employer’s foreign financial account. According to the representative with whom I spoke, the penalty would not be assessed on the employees for merely having signature authority over assets for which they have no beneficial interest. The representative has not seen an instance in which the employee was assessed a penalty for not having filed a FBAR under these circumstances.
The IRS representative also mentioned that the IRS has been very lenient on such filers. If anything, she said, the penalty would be assessed on the employer, if the business had not been reporting the accounts and the income generated in those accounts. If it is determined that the executives have a filing requirement, the representative said that the executives should file the FBAR by completing Parts I (Filer Information) and IV (Information on Financial Account(s) Where Filer has Signature Authority but No Financial Interest in the Account(s)), along with an attachment explaining why this is the first time the executive is filing the FBAR.
If it is still unclear whether an employee qualifies for the signature authority exception and it appears that the employee has discretion over a business’ foreign financial accounts, we recommend filing the FBAR. The form generally does not take much time to prepare, and the potential cost of not doing so is too high to justify the risk.
Executives who prepare – or hire an accountant to prepare – FBARs for business accounts over which they have signature authority must also report any personal foreign financial accounts for which they have a financial interest or signature authority (regardless of the balances in those accounts). The filing requirement mandates that all foreign financial accounts be reported if the aggregate value of the foreign accounts exceeds $10,000 at any time during the calendar year.
While foreign financial accounts have become a favorite IRS target, executives and the companies who employ them generally needn’t worry. Awareness of the rules and attention to the accounts will ensure tax compliance and the avoidance of incurring needless penalties.
Advisors authorized to practice before the IRS, like Palisades Hudson, must caution clients in any written communication that could be construed as tax advice that: Any advice contained herein (1) was not written and is not intended to be used, and cannot be used, for the purpose of avoiding any federal tax penalty that may be imposed on the taxpayer, and (2) may not be used in connection with promoting, marketing or recommending to another person any transaction or matter addressed herein.