In the same way that the decision to impose a FBAR penalty is discretionary, so too is the decision for what the actual amount of that penalty should be. Because FBAR penalties do not have a set amount, the IRS has developed penalty mitigation guidelines to assist examiners in exercising their discretion in applying these penalties. The mitigation guidelines apply to both nonwillful and willful penalty amounts.
The penalty mitigation guidelines are not etched in stone. They are only intended as an aid for the examiner in determining an appropriate penalty amount. Indeed, the examiner may determine that a lesser penalty amount than the guidelines would otherwise provide is appropriate. Or, the examiner might determine that the penalty should be increased.
Under the guidelines, the penalty amount is tied to a fixed, predetermined “maximum aggregate balance” for all accounts to which the violations relate. For example, under the nonwillful penalty guidelines, if the maximum aggregate balance for all accounts to which the violations relate did not exceed $ 50,000 at any time during the year, a Level I Nonwillful penalty applies. The corresponding penalty is $ 500 for each violation, not to exceed a total of $ 5,000 in penalties.
Level I willful FBAR penalties contain the same $ 50,000 threshold. However, unlike the Level I Nonwillful penalty, the corresponding Level I willful penalty is the greater of (1) $1,000 per violation or (2) 5% of the maximum balance during the year of the account to which the violations relate for each violation. Determining the “maximum aggregate balance” for all accounts is a two-step process:
(1) First, determine the maximum balance at any time during the calendar year for each account.
(2) Second, add the individual maximum balances to find the maximum aggregate balance. How does a person determine whether he qualifies for mitigation? There are four threshold conditions:
i. The person must have no history of criminal tax or Bank Secrecy Act convictions for the preceding ten years and have no history of prior FBAR penalty assessments;
ii. No money passing through any of the foreign accounts associated with the person can be from an illegal source or used to further a criminal purpose;
iii. The person must have cooperated during the examination; and
iv. The IRS must not have determined 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.
Most taxpayers qualify for mitigation. If the examiner determines that the taxpayer’s failure to disclose his offshore accounts was not willful, then the nonwillful mitigation guidelines apply. But if the examiner determines that the taxpayer’s failure to disclose his offshore accounts was willful, then the willful mitigation guidelines apply.
And here is where an important distinction must be made between the cumulative effect of FBAR civil penalties and the one-time miscellaneous penalty under OVDP. Contrary to popular belief, the offshore penalty under OVDP is not determined by aggregating the penalty for each year during the disclosure period.
Instead, the offshore penalty under OVDP is determined by isolating the highest year’s maximum aggregate account balance during the period covered by the voluntary disclosure (i.e., the most recent eight years for which the due date has already passed), and using that balance as the “base” to calculate a single offshore penalty at the applicable rate (generally, 27.5%).