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FBAR Penalties Exceed Foreign Account Balance but Window for Voluntary Compliance Remains Narrowly Open

06.06.14 written by

Within the last few days, a federal district court has held that a U.S. taxpayer, who maintained a bank account in Switzerland, is liable for cumulative penalties that exceed his Swiss account balance for failing to file Reports of Foreign Bank and Financial Accounts (FBARs) for 2004 through 2006. Mr. Carl R. Zwerner, through his counsel, attempted to file the delinquent FBARs quietly and without the benefit of one of the IRS voluntary disclosure programs. The federal district court found that his quiet disclosure did not cure his past filing delinquencies.

U.S. taxpayers must report on their income tax returns all income from whatever source derived including all foreign-sourced income. Additionally, U.S. taxpayers must file FBARs annually, if their foreign accounts exceed $10,000 at any time during the reporting year. The IRS has the discretion to assess failure to file penalties for failing to file FBARs in varying amounts up to a maximum penalty of 50 percent of the high value of the account for each year the account was not reported. More recently—although not applicable in Mr. Zwerner’s case discussed below—additional reporting requirements have been enacted, which further require U.S. taxpayers to report foreign reportable assets when their values exceed specified thresholds depending on the taxpayer’s filing status and country of residence. Other information returns must be filed for entities and trusts.

For those taxpayers with unreported taxable income from offshore financial accounts or who have failed to file other information returns, including the FBAR, the IRS offers the Offshore Voluntary Disclosure Program (OVDP), which involves filing amended income tax returns for the eight prior tax years and paying taxes, interest, accuracy penalties or delinquency penalties of either 20 or 25 percent, respectively. Also, the so-called “high water mark” penalty applies that could be as much as 27.5 percent of the high value of the accounts that were not reported. In exchange for the payment of these civil taxes, interest, and penalties, the IRS is willing to forego criminal prosecution relating to the delinquencies and only the returns for the eight-year look back will be reviewed. 

In an effort to avoid the 27.5 percent penalty of the OVDP, some taxpayers, like Mr. Zwerner in the case discussed below, opt to “quietly disclose” their foreign financial accounts by filing amended tax returns and filing the required FBARs for each reporting year. But, such “quiet disclosure” may lead to severe FBAR penalties. See United States v. Carl R. Zwerner, Case # 1:13-cv-22082-CMA (SD Florida, June 11, 2013).

Last week, the Southern District Court of Florida found that Mr. Zwerner must pay FBAR penalties amounting to 150 percent of the value of his Swiss bank account—50 percent of the account balance for each year the account was outstanding. Jurors found that Mr. Zwerner must pay the maximum FBAR penalty—50 percent of the high value of the account—totaling $2,241,809 even though the highest account balance during the period of delinquent reports was no more than $1,691,054. This penalty was upheld in spite of many mitigating factors in Mr. Zwerner’s favor. Mr. Zwerner, by his own admission, is unsophisticated in his understanding of U.S. tax laws but made efforts to come clean to the IRS and quietly disclose the existence of his Swiss account. In 2008, Mr. Zwerner reported his interest in the Swiss bank account on his timely filed 2007 Form 1040 and filed a delinquent FBAR for the same year. In 2009, Mr. Zwerner, through his legal counsel, anonymously disclosed his Swiss bank account to the IRS Criminal Investigation Division—who in turn advised that no criminal action would take place. Accordingly, Mr. Zwerner quietly disclosed his Swiss account by filing amended returns for 2004, 2005, and 2006 and FBARs for those years.

Despite Mr. Zwerner’s attempts to come clean to the IRS, Mr. Zwerner was audited in 2010. In 2011, Mr. Zwerner tried to join the 2011 Offshore Voluntary Disclosure Initiative (OVDI)—an earlier version of the current OVDP. But, under the terms of the OVDI (and the current OVDP), Mr. Zwerner was prohibited from participating in the program because he was already under an IRS audit.

Even though the OVDP program is costly, this case demonstrates that there could be a worse result. There may still be time for a taxpayer who has not been contacted by the IRS to voluntarily report previously undisclosed foreign accounts. With the onset of the Foreign Account Tax Compliance Act (“FATCA”) that will take effect as early as July 1, 2014, taxpayers who have not yet done so should consider participation in the IRS OVDP while it is still possible. FATCA requires foreign banks to report foreign account balances held by U.S. taxpayers to the IRS. Once the IRS begins to investigate these accounts, it will be too late to participate in the OVDP. FATCA will require foreign financial institutions to issue Forms 1099-like reports of taxpayer account information as early as July 1. Also, the IRS can request additional information from the foreign banks for years 2014 and prior. Consequently, taxpayers who have a history of non-filing and who have not yet gone into the OVDP program might expect civil consequences like those experienced by Mr. Zwerner and even worse, possibly with the addition of criminal prosecution to boot.

Krugliak, Wilkins, Griffiths & Dougherty Co., LPA (KWGD) has helped a number of taxpayers through this process. Please contact David J. Lewis at 330-535-4830 to discuss your foreign reporting obligations and options.

This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.