U.S. Supreme Court to Hear Foreign Financial Account Penalty Case
$50,000 or $2.72 million? Those are the penalty amounts for the non-willful failure to timely file to report foreign financial accounts at issue in U.S. v Bittner, which will be argued before the U.S. Supreme Court in November. The question is whether the penalty is computed per year, per report or per year, per foreign financial account.
A U.S. person with a financial interest in or signatory authority over a foreign financial account is required to file a Foreign Bank and Financial Accounts Report (FBAR) each year. The reporting obligation extends to many types of filers and accounts, not just individuals with foreign bank accounts.
- U.S. Persons: The “U.S. persons” subject to reporting requirements include U.S. citizens, wherever they live; foreign persons residing in the U.S. (resident aliens), regardless of their citizenship; and entities organized under the law of a State of the United States or the District of Columbia (but not of a territory of the United States), including partnerships, limited liability companies, corporations, and trusts.
- Reportable Accounts: Accounts in a foreign country required to be reported include bank accounts, securities accounts, insurance and annuities with cash value, brokerage and commodities accounts, mutual funds, and ETFs.
Filing is required if a U.S. person has a financial interest in or has signatory authority over foreign financial accounts in excess in the aggregate of $10,000 in value at any time during the calendar year. The measure is the value of the account, not income from the account. Presently, the filing due date coincides with the filing due date for individuals—April 15—with an automatic extension to October 15 (October 17th in 2022). The penalty for a non-willful failure to timely file a complete FBAR is $10,000.
On its face, the $10,000 non-willful penalty amount bears a reasonable relationship to the $10,000-filing threshold. At least it does not exceed the filing threshold. However, there is more to this story—much more.
First, the filing requirement is an annual filing requirement. Thus, the non-willful failure to report an account for multiple years can result in a failure-to-file penalty for each year an account is not reported, up to six years.
Second, the Internal Revenue Service (IRS) typically applies the non-willful penalty per account and per year, not per failed FBAR filing per year. Thus, with the IRS’s approach, there can be a significant multiplier effect. This is the specific issue before the Supreme Court in Bittner. Mr. Bittner, an immigrant from Romania to the U.S., became a naturalized U.S. citizen while also retaining his Romanian citizenship. He returned to Romania where he established and invested in numerous business enterprises and then ultimately returned to the U.S. Mr. Bittner was unaware of the FBAR reporting requirements, but once he became aware of them and retained an accountant familiar with the FBAR reporting requirements, he eventually filed FBAR reports for five years covering numerous foreign personal and business accounts, albeit late. In Bittner, the per year and per report non-willful penalty is $50,000. If the per year and per account method is used, the non-willful penalty is $2.72 million due to the number of accounts involved.
Finally, there is a further multiplier effect when more than one person is required to file an FBAR for the same foreign financial account. This is common in typical personal financial and wealth planning situations. For example:
- Principal and Agent: If a U.S. person, the Principal, names another U.S. person as Agent under a financial power of attorney and the Principal has foreign financial accounts, both the Principal and the Agent are required to file FBAR reports, subject to the aggregate $10,000 reporting threshold.
- Aging Parent Abroad: Elizabeth is a U.S. citizen living in Illinois. Elizabeth does not have any foreign financial accounts. Elizabeth’s aging mother Martha is a dual U.S. and Canadian citizen living in Ontario. Martha named Elizabeth as Agent under a financial power of attorney for all of her property, including her bank and brokerage accounts in Canada. If the aggregate value of Martha’s accounts in Canada exceeds $10,000 at any time during the year, both Martha and Elizabeth have FBAR reporting obligations, and will both be subject to penalties if they fail to file.
- Adult Child Working Abroad: Elizabeth’s unmarried adult son, Henry, is a U.S. citizen living and working in London. Henry also named Elizabeth as Agent under his financial power of attorney for all of his property, including his bank and brokerage accounts he has opened in London. Similarly, if the aggregate value of Henry’s accounts in London exceeds $10,000 at any time during the year, both Henry and Elizabeth have FBAR reporting obligations, and will both be subject to penalties if they fail to file.
- Grantor, Trustee(s), and Beneficiaries: If a Grantor establishes a trust which holds a foreign financial account, the Grantor, each Trustee, and certain Beneficiaries may have FBAR reporting obligations for the same account held by the trust. The Grantor will have reporting obligations if the Grantor is treated as the owner of the trust for income tax purposes under the grantor trust income tax rules. The Trustee or Trustees will have a reporting obligation as the holders of the legal title to the foreign financial account. Each Beneficiary with a present financial interest in more than 50% of the assets of the trust or who receives more than 50% of the current income from the trust is required to file an FBAR. There is, however, an exception for a Beneficiary if the U.S. Trustee or U.S. agent of the Trustee filed. All reporting is subject to the aggregate $10,000 reporting threshold.
- Charles, a U.S. citizen and resident, established a Gift Trust for his daughter, Charlotte, also a U.S. citizen and resident. Main Street USA Trust Company and Charles’ wife, Ellen, are the Trustees. The trust is irrevocable, but Charles is treated as the owner of the trust for income tax purposes under the grantor trust income tax rules. The trust holds two foreign financial accounts, $6,000 each, $12,000 in the aggregate. Charles, as Grantor, has an FBAR reporting obligation and Main Street USA Trust Company and Ellen, as Trustees and legal title holders, each have FBAR reporting obligations. Charlotte should not be required to report unless the others do not report. If Charles, Main Street USA Trust Company, Ellen, and Charlotte each non-willfully fail to timely report both foreign accounts, under the IRS calculation the penalties related to the $12,000 accounts for one year may total $80,000 (2 accounts, 4 failed filers, $10,000 each). If the oversight continues for 5 years, the penalties may total $400,000 (2 accounts, 4 failed filers, 5 years, $10,000 each).
In addition to the multiplier effect with financial powers of attorney and trusts, changes in accounts, Agents, Trustees, and Beneficiaries can all give rise to changing FBAR filing requirements from year-to-year.
The consequences of the ruling of the Court are relevant for every U.S. person with a reportable foreign financial account. The Bittner case is a timely reminder to attend to 2022 FBAR filings as the October 17, 2022, extended tax filing deadline approaches. For future filing years, it is a reminder to review FBAR filing requirements annually.
If you have questions regarding your wealth planning and foreign financial accounts, contact a member of the LP Trust and Estates Group.