Example 1:
Assume that John has an undisclosed offshore account with a maximum account balance of $ 40,000 (USD) in tax year 2012. He decides to make a quiet disclosure. Assume that he otherwise satisfies the conditions for penalty mitigation. The best way of analyzing this problem is to do so in three-steps:
Step 1: Is the account subject to FBAR reporting? Under the FBAR rule, a U.S. person must file an FBAR if that person has a financial interest in or signature authority over any financial account(s) outside of the U.S. and the aggregate maximum value of the account(s) exceeds $ 10,000 at any time during the calendar year. Here, the maximum value of the account in 2012 is $ 40,000, which exceeds $ 10,000. Therefore, John had a duty to file an FBAR.
Step 2: Does John satisfy the threshold requirements for penalty mitigation? Yes.
Step 3: What level applies? Because the maximum balance of John’s account never exceeded $ 50,000, he qualifies for a Level I mitigation penalty for tax year 2012. Keep in mind that Level I covers maximum aggregate balances up to and including $ 50,000.
Step 4: What is John’s penalty under the mitigation guidelines? Because it is unknown whether the IRS will treat John’s failure to disclose his offshore account as a nonwillful violation or as a willful violation, it is a good idea to calculate his FBAR penalty under both the nonwillful mitigation guidelines and the willful mitigation guidelines.
If the examiner determines that John’s failure to disclose his offshore account was not willful, then the Level I nonwillful mitigation guidelines apply. The nonwillful mitigation penalty corresponding to Level I is $500 for each violation, not to exceed an aggregate penalty of $5,000 for all violations. Here, John’s nonwillful FBAR mitigation penalty for tax year 2012 would be $ 500.
On the other hand, if the examiner determines that John’s failure to disclose his offshore account was willful, then the Level I willful mitigation guidelines apply. The willful mitigation penalty corresponding to Level I is the greater of (a) $ 1,000 or (b) 5% of the maximum balance during the year of the account to which the violation relates.
In order to determine which amount is greater, (a) or (b), it is necessary to determine what 5% of the maximum balance of John’s offshore account was for tax year 2012. Here, the maximum balance of John’s offshore account was $ 40,000 in 2012. And five percent of $ 40,000 is $ 2,000. Because five percent of the maximum account balance is by far the greater value – i.e., $ 2,000 is greater than $ 1,000 – and the willful mitigation penalty is the greater of (a) or (b), John’s willful mitigation penalty for tax year 2012 would be $ 2,000.
Example 2:
Assume now that John has three undisclosed offshore accounts with three different banks: (1) Lloyd’s Bank, (2) Barclay’s, and (3) Hargraves. The maximum balances in each account for tax year 2012 are as follows:
(1) Lloyd’s: $ 10,000 (USD)
(2) Barclay’s: $ 30,000 (USD)
(3) Hargraves: $ 40,000 (USD)
John decides to make a quiet disclosure. Assume that he otherwise satisfies the conditions for penalty mitigation.
As in example one, we apply the same three-step framework:
Step 1: Are the accounts subject to FBAR reporting? Under the FBAR rule, a U.S. person must file an FBAR if that person has a financial interest in or signature authority over any financial account(s) outside of the U.S. and the aggregate maximum value of the account(s) exceeds $ 10,000 at any time during the calendar year.
Here, the maximum value of each account in 2012 is as follows: $ 10,000, $ 30,000, and $ 40,000, respectively. The aggregate maximum value is obtained by tallying up all three values, which equals $ 80,000. Because $ 80,000 exceeds $ 10,000, John had a duty to file an FBAR.
This is a good time to pause to discuss the aggregate maximum value rule and the impact it has on the disclosure of John’s Lloyd’s account. Although, at first blush, it might appear as though John’s Lloyd’s account does not trigger an FBAR reporting requirement because its maximum balance does not exceed $ 10,000, nothing could be farther from the truth.
While the maximum balance of the Lloyd’s account alone might not trigger an FBAR reporting requirement, the fact remains that when combined with the other two maximum account balances, it does. And under the aggregate maximum value rule, that’s all that counts. Indeed, the maximum balances of all three accounts — when tallied — far exceed the $ 10,000 reporting threshold. Therefore, even the Lloyd’s account must be reported on an FBAR.
Step 2: Does John satisfy the threshold requirements for penalty mitigation? Yes.
Step 3: What level applies? If you said Level I, you would have fallen into a trap. Keep in mind that it is the “maximum aggregate balance” for all accounts that determines the penalty amount under the guidelines, the operative word being, “aggregate.”
As previously discussed, determining the maximum aggregate balance is a two-step process: Step one includes determining the maximum balance at any time during the calendar year for each account. And step two requires adding the individual maximum balances to find the maximum aggregate balance.
The maximum balances of each account are: (1) $ 10,000, (2) $ 30,000, and (3) $ 40,000, respectively. After tallying up the individual maximum balances of all three accounts, the total comes to $ 80,000. Thus, the maximum aggregate balance is $ 80,000.
Because the maximum aggregate balance of John’s three accounts is $ 80,000 and because the maximum aggregate balance for Level I penalties cannot exceed $ 50,000 at any time during the year, John does not qualify for Level I penalties. Instead, he qualifies for Level II. Thus, John gets bumped up to Level II as a result of the aggregation rule. Recall that Level II covers maximum aggregate balances between $ 50,000.01 and $ 250,000.
This is a good time to take a slight digression to make an important point. Although no single account by itself exceeds the $ 50,000 threshold, the fact remains that the sum total or aggregate does. And that’s all that is required to trigger level 2 penalties. In other words, no single account has to contain a maximum balance that exceeds $ 50,000 in order to trigger level 2 penalties, so long as the aggregate of them all exceeds $ 50,000.
Step 4: What is John’s penalty under the mitigation guidelines? Because it is unknown whether the IRS will treat John’s failure to disclose his offshore accounts as a nonwillful violation or as a willful violation, it is a good idea to calculate his FBAR penalties under both the nonwillful mitigation guidelines and the willful mitigation guidelines.
If the examiner determines that John’s failure to disclose his offshore accounts was not willful, then the Level II nonwillful mitigation guidelines apply. The nonwillful mitigation penalty corresponding to Level II is $ 5,000 for each account violation, not to exceed 10% of the maximum balance in the account during the year. Ten percent is the cap.
Let’s begin with John’s Lloyd’s account, the maximum balance of which is $ 10,000. Because $ 5,000 exceeds $ 1,000, or 10% of the maximum balance of the Lloyd’s account in tax year 2012, John’s nonwillful mitigation penalty for Lloyd’s would be capped at $ 1,000.
Next up is John’s Barclay’s account, the maximum balance of which is $ 30,000. Because $ 5,000 exceeds $ 3,000, or 10% of the maximum balance of the Barclay’s account in tax year 2012, John’s nonwillful mitigation penalty for Barclay’s would be capped at $ 3,000.
Last but not least is John’s Hargraves account, the maximum balance of which is $ 40,000. Because $ 5,000 exceeds $ 4,000, or 10% of the maximum balance of the Hargraves account in tax year 2012, John’s nonwillful mitigation penalty for Hargraves would be capped at $ 4,000.
If you’re keeping track, John’s total nonwillful FBAR penalties under the penalty mitigation guidelines for tax year 2012 is $ 8,000 (i.e., $ 1,000 + $ 3,000 + $ 4,000). Of course, the examiner might find that John’s failure to disclose his offshore accounts was willful, in which case the Level II willful mitigation guidelines would apply. The willful mitigation penalty corresponding to Level II is the greater of (1) $ 5,000 per violation or (2) 10% of the maximum balance during the calendar year for each Level II account.
Let’s begin with John’s Lloyd’s account. In order to determine which amount is greater, (a) or (b), it is necessary to determine what 10% of the maximum balance of the Lloyd’s account was for tax year 2012. Here, the maximum balance of the Lloyd’s account was $ 10,000 in 2012. And ten percent of $ 10,000 is $ 1,000. Because the latter is less than $ 5,000 – i.e., $ 1,000 is less than $ 5,000 – and the willful mitigation penalty is the greater of (a) or (b), John’s willful mitigation penalty for the Lloyd’s account would be $ 5,000.
Next up is John’s Barclay’s account, the maximum balance of which is $ 30,000. Ten percent of $ 30,000 is $ 3,000. Because the latter is less than $ 5,000 – i.e., $ 3,000 is less than $ 5,000 – and the willful mitigation penalty is the greater of (a) or (b), John’s willful mitigation penalty for the Barclay’s account would also be $ 5,000.
Last but not least is John’s Hargraves account, the maximum balance of which is $ 40,000. Ten percent of $ 40,000 is $ 4,000. Because the latter is less than $ 5,000 – i.e., $ 4,000 is less than $ 5,000 – and the willful mitigation penalty is the greater of (a) or (b), John’s willful mitigation penalty for the Hargraves account would also be $ 5,000.
If you’re keeping track, John’s total willful FBAR penalties under the penalty mitigation guidelines for tax year 2012 is $ 15,000 (i.e., $ 5,000 + $ 5,000 + $ 5,000).
Conclusion
This example serves an important purpose. It teaches two concepts. First, that FBAR penalties are determined per account, not per unfiled FBAR. And second, that penalties apply for each year of each violation. Taken together, this means that FBAR penalties can be aggregated, one on top of the other, catapulting one’s liability into the penalty stratosphere.