U.S. transplants face harsh FBAR penalties

In recent years, the Internal Revenue Service (IRS) has increased its focus on reporting of foreign financial accounts by U.S. persons. This is evidenced by the renewed IRS emphasis on receiving the Form TD F 90-22.1 Report of Foreign Bank and Financial Accounts, (also known as FBAR reporting).

In February 2011, final changes to the regulations were released by The U.S. Department of the Treasury which clarified FBAR reporting. These final regulations help shed some light on which of your clients may be affected by FBAR and what the implications are for those clients.

The FBAR report applies to any clients who are considered a U.S. person who has a financial interest in, or signature or other authority over foreign financial accounts that have an aggregate value exceeding $10,000 (USD) at any time during the calendar year. For FBAR purposes, a U.S. person is defined as any client who is a U.S. citizen, or a U.S. resident under the Internal Revenue Code – including holders of U.S. “green cards” and also includes certain U.S. corporations, trusts, estates and partnerships.

This definition includes U.S. citizens and residents living in Canada and applies to a long list of investments that may be held here in Canada. Non-U.S. foreign financial accounts that require reporting include Canadian bank accounts, brokerage investments, mutual funds or similar pooled funds, life insurance or annuities with cash values and also includes registered plans, such as RRSPs, RESPs and TFSA’s where the combined value of these assets exceed $10,000. With such a low threshold, the FBAR reporting requirements may apply to many US clients living here in Canada.

The FBAR report must be filed annually by June 30th of each following year. That is, for the 2010 calendar year, affected clients must file their FBAR report by June 30th 2011. Failure to file the FBAR report could result in stiff civil penalties and may, in some cases constitute a criminal offence. For non-willful violations, clients could be subject to penalties ranging from $500 to $10,000 per account. The amount of the penalty is up to the discretion of the IRS. There may be some relief for non-willful violations if it can be demonstrated that there was reasonable cause for delinquent FBAR reports and also, if the income from foreign accounts were properly reported to the IRS on the clients U.S. tax returns.

Willful violations come with very severe penalties. Clients who knowingly fail to file the FBAR report could be subject to civil penalties equal to the greater of $100,000 or 50% of the total value of the foreign assets per year, assuming the client is non-compliant for multiple years. In addition, clients could be subject to criminal charges as well. Failing to file the FBAR report comes with criminal charges that include prison time and fines of up to $500,000.

There is no question that there are many U.S. persons living in Canada who are unaware of the FBAR reporting requirements and could be subject to harsh penalties if the IRS tracks them down. Fortunately for these clients, the IRS recently introduced an amnesty program that can help clients who have failed to file FBAR reports in the past. Under the IRS Offshore Voluntary Disclosure Initiative (OVDI), clients will have the opportunity to come clean and get caught up in their tax filings. Clients who enter the current program will be required to file original or amended tax returns for the years 2003 through 2010 to report any income omitted from their foreign accounts. In addition, the client will need to submit all required information returns, including the FBAR Form TD F 90-22.1. The amnesty period is available until August 31st, 2011 by which date the IRS must receive all necessary documents and tax returns.

Clients who decide to come forward and file under the amnesty program are still required to pay taxes on unreported foreign income, interest and a 20% ‘accuracy-related’ penalty on those unpaid taxes. However, the IRS will offer some relief by reducing the 50% basic penalty down to 25% of the highest account balance in the unreported accounts over the period covered under the program. Where the clients account balances are smaller than $75,000, the penalty may be reduced to 12.5% or even as low as 5% where the IRS determines that your clients’ non-compliance is less severe. While the penalties sound very harsh, and there is no doubt that they are, they pale in comparison to the penalties that may apply to your clients who file involuntarily.

This is the second amnesty program that the IRS has offered (the first was available in 2009) and, coincidentally, they have indicated that it may the last. If you have clients who are U.S. citizen, residents or green card holders who are exposed to FBAR filings but have failed to report income properly in the U.S. in the past, now is the time to recommend that they visit a tax professional about filing under the IRS Offshore Voluntary Disclosure Initiative. Doing so will allow those clients to catch up on their U.S. tax and information return filings before the program concludes at the end of August.

Frank Di Pietro

Tax & Estate

Frank Di Pietro, CFA, CFP, is assistant vice-president of tax and estate planning at Mackenzie Investments. He can be reached at fdipietr@mackenzieinvestments.com.