Cracking The Code On FBAR Penalties: IRS Collection Hurdles Explained

The Financial Crimes Enforcement Network, FinCEN Form 114, Report of Foreign Bank and Financial Accounts, is a crucial yet frequently misunderstood requirement for U.S. persons with foreign financial accounts. The FBAR may be familiar to many Americans living abroad, but it remains largely unknown to many U.S.-based individuals who might still have an obligation to file it. This can happen if, for example, they inherit a foreign account, a foreign relative grants them signature authority over an overseas account, or if a U.S. parent receives control over a foreign account set up for their child. Awareness of these requirements is crucial, as failing to file can lead to significant penalties.

My earlier article explained the purpose behind FBAR, who must file it, the types of foreign financial accounts that must be reported and more. This article explores civil FBAR penalties and why it is more difficult for the IRS to enforce collection.

FBAR Penalties

Civil FBAR penalties can be divided into two primary categories: willful and non-willful FBAR violations. The distinction hinges in part, on the account holder’s intent and awareness regarding the obligation to file the FBAR.

FBAR Nonwillful Violations

Nonwillful violations carry a maximum penalty of $10,000 per violation per year. The IRS may exercise discretion and, in some cases, reduce or waive nonwillful penalties, depending on the circumstances.

In Bittner v. United States, 21-1195 (February 28, 2023), the U.S. Supreme Court addressed how nonwillful FBAR penalties should be calculated. The Court ruled that nonwillful violations should be assessed per FBAR form, rather than per individual account as argued by the government. This decision significantly reduced the potential financial penalties faced by individuals who commit nonwillful violations but have multiple foreign accounts.

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Under what circumstances is an FBAR violation “nonwillful”? Well, it’s hard to say; no definition is provided in the statute or regulations. To better understand what constitutes a nonwillful FBAR violation, it helps to first grasp what is meant by a willful violation. The trend has shown that the IRS is aggressive in asserting that the taxpayer’s violation was willful.

FBAR Willful Violations

Willful violations carry far more severe penalties and are imposed when the failure to report is found to be intentional, or when there is evidence of “willful blindness” or “reckless disregard” of the FBAR filing obligation.

“Willful blindness” is a form of “deliberate ignorance” and involves the concept that an individual could readily obtain information, which if they did, would inform them that their actions or inactions could be in violation of a law. “Recklessness" occurs when someone’s actions or failure to act involve an obvious and unjustifiable risk of harm or danger. For example, this could include failing to read or understand clear instructions on tax forms that reference foreign account reporting requirements.

Penalties for willful violations can reach the greater of $100,000 or 50% of the account balance at the time of the violation, per year of non-compliance. This can result in substantial fines, particularly if multiple years are involved. The determination of willfulness relies on facts and circumstances, such as whether an individual took steps to conceal their accounts, ignored advice to comply, or deliberately failed to seek clarification about their obligations.

FBAR Penalty Collection Challenges

FinCEN has delegated authority over FBAR matters to the IRS. While IRS has authority to collect FBAR penalties, its powers are far narrower than its extensive powers to collect taxes. FBAR penalties are not imposed by the Internal Revenue Code, and consequently, they are not “tax” penalties. Because these penalties are not tax-related, collection and enforcement are unique and more challenging for the U.S. government.

When a tax debt is involved, the IRS can impose a lien in favor of the government on the taxpayer's property and seize assets to satisfy those tax debts. A U.S. passport can be denied or revoked for seriously delinquent tax debt. However, these measures do not apply directly to FBAR penalties since they are categorized as non-tax debts. Consequently, collecting such penalties involves different mechanisms.

Constraints Enforcing FBAR Penalties

To enforce FBAR penalties, the IRS generally relies on two main options.

FBAR Collection Lawsuit

First, it can refer the debt to the Department of Justice for a collection lawsuit. This path, while viable, presents significant challenges. The DOJ may not always be able to pursue collection actions due to resource limitations or other priorities, and even when it does, obtaining a final judgment can take years. This delay often enables debtors to engage in asset protection strategies, making it more challenging for the government to actually recover penalty amounts that are owed.

Various international issues may come into play including the ability of the U.S. government to attach assets located abroad and the possible use of treaty provisions. Generally, attachment and garnishment mechanisms cannot extend beyond the U.S. to reach assets held in a foreign country, for example, attaching foreign bank accounts. The U.S. lacks jurisdiction over those foreign assets.

Jurisdiction over the person of the U.S. debtor, however, permits the court to order the debtor to repatriate the assets back to the U.S. Once repatriated, the assets are subject to U.S. jurisdiction and can be attached. Whether the debtor complies with the repatriation order is another issue.

Granting a repatriation order is not done lightly since it involves grappling with the laws of a foreign jurisdiction. The complexities were demonstrated in the case of United States v. Monica Harrington et al (No. 1:19-CV-02965 Dist. Ct. Dist. Colo. Feb. 28, 2024). The Harrington court made clear that before such an order can be granted the court must carefully examine whether it has the authority to do so and must often understand various relevant foreign laws in the process.

Offset Procedures To Collect FBAR Penaltie

The second option available for collecting FBAR penalties is through the process of "offset" using the Treasury Offset Program, managed by the Bureau of Fiscal Services. This program enables the collection of FBAR penalties by offsetting an individual's debts against any government payments owed to them, such as tax refunds or Social Security benefits.

These collection constraints highlight a fundamental distinction between FBAR penalties and typical tax liabilities. Though noncompliance can lead to substantial financial consequences, the mechanisms available for recovering FBAR debts are different and, at times, less expedient compared to those used for tax enforcement.

Conclusion

It may be more difficult for the IRS to enforce collection of FBAR penalties since these are not tax-related. Despite this, most taxpayers want peace of mind and wish to avoid penalties altogether. It helps to know that in many cases, delinquent FBARs can be filed without incurring penalties. Seek proper guidance from a qualified tax professional to navigate the process and ensure compliance with all FBAR reporting requirements. Taking proactive steps can help mitigate potential issues and bring that all-important, peace of mind.

I help with tax matters around the globe.

Reach me at vljeker@us-taxes.org

Visit my US tax blog www.us-tax.org It is an invaluable guide in all areas of U.S. international tax. It will help you stay on top of legislative developments, keeping you ahead of US tax changes impacting your life, family or business.