IRS Examination Process for FBAR Compliance: How an Audit Works

FBAR Noncompliance Audit

FBAR Noncompliance Audit

FBAR Audit: Not all FBAR noncompliance audits commence in the same way — but they all generally start with an unwanted notice form the IRS. For example, sometimes a taxpayer is under audit or examination for a completely unrelated matter which then leads to questions about foreign income and money — and ultimately FBAR reporting. Other times, a taxpayer may have received a soft letter regarding noncompliance with various international information reporting forms, including Form 8938. In this type of situation the taxpayers already in the IRS is cross-hairs on matters involving offshore assets and foreign account compliance. The form 8938 audit then leads to an FBAR Audit. Finally, sometimes a taxpayer is simply audited because they did not properly comply with FBAR filing rules and the IRS initiates an examination.

Let’s review what an FBAR noncompliance audit is.

FBAR Audits for Noncompliance 

In order to get a baseline understanding of how IRS examiners and other personnel handle an FBAR noncpliance audit, a good place to start is the Internal Revenue Manual (IRM). While the IRM does not have the force of law it is a good starting point on matters involving Foreign Bank And Financial Account Reporting (aka FinCEN Form 114)

4.26.16.1 – FBAR Overview

• • • The Report of Foreign Bank and Financial Accounts (FBAR), Financial Crimes Enforcement Network (FinCEN) Report 114, is required when a U.S. person has a financial interest in, or signature authority over, one or more foreign financial accounts with an aggregate value greater than $10,000 at any time during the reporting period (calendar year). If a report is required, certain records must also be kept.

• • • In April 2003, the IRS was delegated civil enforcement authority for the FBAR. IRM 4.26.16 covers FBAR law. FBAR examination procedures are covered in IRM 4.26.17.

What does this Mean?

While the FBAR is a “FinCEN Form,” enforcement was delegated to the IRS in 2003, so that the IRS is now responsible for enforcing FBAR compliance penalties.

4.26.16.2 – FBAR Authorities

• • • The requirement to report foreign bank and financial accounts was added to the United States Code (USC) in 1970 as part of the “Currency and Foreign Transactions Reporting Act of 1970” , which came to be known as the “Bank Secrecy Act” or “BSA.” These anti-money laundering provisions, as amended, were codified at 31 USC 5311 – 5332, excluding section 5315. The Secretary of the Treasury delegated the authority to administer civil compliance with Title II of the BSA to the Director, FinCEN.

    • IRS Criminal Investigation (CI) has authority to enforce the criminal provisions of the BSA. While FinCEN retains its rule-making authority for FBAR, it redelegated civil FBAR enforcement authority to the IRS. See IRM 4.26.16.2.2(4), below.

What does this Mean?

The FinCEN form 114 is not a tax form. It was developed in accordance with AML (Anit-Money Laundering) principles over 50-years ago.

4.26.16.2.1 – FBAR Statutory Authority

• • • The statutory authority for the FBAR is 31 USC 5314. Section 5314 directs the Secretary of the Treasury to require a resident or citizen of the United States to keep records and/or file reports when making transactions or maintaining a relationship with a foreign financial agency.

    • 31 USC 5321(a)(5) and (a)(6) establish civil penalties for violations of the FBAR reporting and recordkeeping requirements. See IRM 4.26.16.6 below for a discussion of penalties.

What does this Mean?

The authority for the FBAR derives from title 31 (Money and Finance, sections 5314 et seq.

4.26.16.6.4 – Penalty for Nonwillful FBAR Violations

• • • For violations occurring after October 22, 2004, a penalty, not to exceed $10,000 per violation, may be imposed on any person who violates or causes any violation of the FBAR filing and recordkeeping requirements. 31 USC 5321(a)(5)(B).

    • The penalty should not be imposed if:

    • The violation was due to reasonable cause, and

    • The person files any delinquent FBARs and properly reports the previously unreported account.

    • Examiners have discretion in determining the penalty amount and should use the mitigation guidelines in making their determinations. See the discussion of the mitigation guidelines below. See Exhibit 4.26.16-1. Examiners should take the facts and circumstances of each case into account when determining if a warning letter or penalties that are less than the mitigation guidelines are appropriate. The purpose of FBAR penalties is to promote compliance with the FBAR reporting and recordkeeping requirements.

What does this Mean?

If the IRS determines a taxpayer non-willful, they can issue penalties up to $10,000 per violation. There is ambiguity in enforcement as to whether violation refers to account, years, or each account, per year – not to exceed 50% value (which is the willful penalty)

*The $10,000 adjusts for inflation.

4.26.16.6.5 – Penalty for Willful FBAR Violations

• • • The penalty for willful FBAR violations may be imposed on any person who willfully violates or causes any violation of any provisions of 31 USC 5314 (the FBAR filing and recordkeeping requirements). 31 USC 5321(a)(5)(C).

    • The penalty applies to individuals as well as financial institutions and nonfinancial trades or businesses for all years.

    • For violations occurring after October 22, 2004, the statutory ceiling is the greater of $100,000 or 50% of the balance in the account at the time of the violation.

    • There may be both a reporting and a recordkeeping violation regarding each account.

    • The date of a violation for failure to timely file an FBAR is the end of the day on June 30th of the year following the calendar year for which the accounts are being reported. This date is the last possible day for filing the FBAR so that the close of the day with no filed FBAR represents the first time that a violation occurred. The balance in the account at the close of June 30th is the amount to use in calculating the filing violation.

    • The date of a violation for failure to keep records is the date the examiner first requests records. The balance in the account at the close of the day that the records are first requested is the amount used in calculating the recordkeeping violation penalty. The date of the violation is tied to the date of the request, and not a later date, to assure the taxpayer is unable to manipulate the amount in the account after receiving a request for records. The balance in the account at the close of the day on which the records are first requested is the amount to use in calculating the penalty for failing to keep records as required by statute.

    • IRS developed guidelines for the exercise of the examiner’s discretion in arriving at the amount of a penalty for a willful violation. See discussion of mitigation, below.

What does this Mean?

If the IRS determines a taxpayer willful, they can issue penalties up to $100,000 per violation or 50%, whichever is HIGHER.

*The $100,000 adjusts for inflation.

Exhibit 4.26.16-1 FBAR Penalty Mitigation 

• • • FBAR Penalty Mitigation Guidelines for Violations Occurring After October 22, 2004

    • The Bank Secrecy Act (BSA) allows the Secretary of the Treasury some discretion in determining the amount of penalties for violations of the FBAR reporting and record keeping requirements. There is a penalty ceiling but no minimum amount. This discretion has been delegated to the FBAR examiner.

    • The examiner may determine that the facts and circumstances of a particular case do not justify a penalty.

    • If there was an FBAR violation but no penalty is appropriate, the examiner must issue the FBAR warning letter, Letter 3800.

    • When a penalty is appropriate, IRS established penalty mitigation guidelines to ensure the penalties determined by the examiner’s discretion are uniform. The examiner may determine that:

    • A penalty under these guidelines is not appropriate, or

    • A lesser amount than the guidelines otherwise provide is appropriate.

    • The examiner must make this determination with the written approval of that examiner’s manager. The examiner’s workpapers must document the circumstances that make mitigation of the penalty under these guidelines appropriate. When determining the proper penalty amount, the examiner should keep in mind that manager approval is required to assert more than one $10,000 non-willful penalty per year, and in no event can the aggregate non-willful penalties asserted exceed 50% of the highest aggregate balance of all accounts to which the violations relate during the years at issue. Similarly, manager approval is required to assert willful penalties that, in the aggregate, exceed 50% of the highest aggregate balance of all accounts to which the violations relate during the years at issue, and in no event can the aggregate willful penalties exceed 100% of the highest aggregate balance of all accounts to which the violations relate during the years at issue.

    • To qualify for mitigation, the person must meet four criteria:

    • The person has no history of criminal tax or BSA convictions for the preceding 10 years and has no history of prior FBAR penalty assessments.

    • No money passing through any of the foreign accounts associated with the person was from an illegal source or used to further a criminal purpose.

    • The person cooperated during the examination.

    • IRS did not determine a fraud penalty against the person for an underpayment of income tax for the year in question due to the failure to report income related to any amount in a foreign account.

What does this Mean?

The IRS agent/examiner has discretion to reduce or eliminate an FBAR penalty.

4.26.16.6.7 – FBAR Penalties – Examiner Discretion

• • • The examiner may determine that the facts and circumstances of a particular case do not justify asserting a penalty.

    • When a penalty is appropriate, IRS penalty mitigation guidelines aid the examiner in applying penalties in a uniform manner. The examiner may determine that a penalty under these guidelines is not appropriate or that a lesser penalty amount than the guidelines would otherwise provide is appropriate or that the penalty should be increased (up to the statutory maximum). The examiner must make such a determination with the written approval of the examiner’s manager and document the decision in the workpapers.

    • Factors to consider when applying examiner discretion may include, but are not limited to, the following:

    • Whether compliance objectives would be achieved by issuance of a warning letter.

    • Whether the person who committed the violation had been previously issued a warning letter or assessed an FBAR penalty.

    • The nature of the violation and the amounts involved.

    • The cooperation of the taxpayer during the examination.

    • Given the magnitude of the maximum penalties permitted for each violation, the assertion of multiple penalties and the assertion of separate penalties for multiple violations with respect to a single FBAR, should be carefully considered and calculated to ensure the amount of the penalty is commensurate to the harm caused by the FBAR violation.

What does this Mean?

There are various factors the agent/examiner must consider before modifying FBAR penalties. It is generally referred to as “totality of the circumstance.”

4.26.16.6.8 – Managerial Involvement and Approval of FBAR Penalties

• • • Managers must perform a meaningful review of the examiner’s penalty determination prior to assessment.

    • The manager must verify that the penalties were fairly imposed and accurately computed; that the examiner did not improperly assert the penalties in the first instance; and that the conclusions regarding “reasonable cause” (or the lack thereof) were proper.

    • For BSA cases, written managerial approval must be documented on the Violations Summary Form – Title 31, workpaper 400-1.1.

    • For SB/SE examination cases, written managerial approval must be documented on the Penalty Approval Form, workpaper 300.

    • For LB&I cases, managerial approval must be documented on the penalty leadsheets.

    • For SB/SE campus cases, written managerial approval must be documented on Form 4700, Examination Workpapers.

What does this Mean?

Approval to reduce or eliminate FBAR penalties following an FBAR noncompliance audit and examination requires a Manager’s approval

FBAR Noncompliance Audits are Complicated Examinations

In conclusion, an FBAR noncompliance audit can be a scary and overwhelming experience — especially in light of the penalties. But, IRS agents do have the authority to reduce or eliminate FBAR penalties if the circumstances justify it.

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