It should come as no surprise that the IRS has authority to assess FBAR civil penalties.  However, what might come as a surprise is that an FBAR violation doesn’t automatically mean that a penalty will be asserted.  Why not?  Examiners are expected to exercise discretion, taking into account the facts and circumstances of each case, in determining whether penalties should be asserted.  For example, the examiner may determine that the facts do not justify asserting a penalty.  In that case, the examiner will issue an FBAR warning letter, Letter 3800.

According to IRM 4.26.16.4, the sole purpose of the FBAR penalty is to promote compliance with the FBAR reporting and recordkeeping requirements.  In exercising their discretion, examiners should consider whether issuing a warning letter and securing delinquent FBARs, rather than asserting a penalty, will achieve the desired result of improving compliance in the future.

Other factors to be considered when applying examiner discretion include: (1) whether the person who committed the violation has been previously issued a warning letter or has been assessed the FBAR penalty; (2) the nature of the violation and the amounts involved; and (3) the cooperation of the taxpayer during the examination.

The following is an example of when it would be more appropriate to issue a warning letter than assert penalties.  Jake has five small foreign accounts with a combined balance of $ 20,000.  He did not report any of these accounts.  However, the income from each account was properly reported and Jake made no effort to conceal their existence.  Under these circumstances, it would be more appropriate to issue a warning letter.

To the extent that a penalty is warranted, there are two types: non-willful and willful.  Both types have varying upper limits, but no floor.  For example, the maximum nonwillful FBAR penalty is $ 10,000.  And the maximum willful penalty is the greater of (a) $ 100,000 or (b) 50% of the total balance of the foreign account.

Just like the decision to impose a penalty, the actual amount of the penalty is left to the discretion of the examiner.  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 mitigation guidelines 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.  At the same time, the examiner might determine that the penalty should be increased.

Under the guidelines, the penalty amount is tied to a 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.

Before a taxpayer can qualify for the mitigation guidelines, he or she must satisfy four threshold conditions:

• First, 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;
• Second, 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;
• Third, the person must have cooperated during the examination; and
• Fourth, 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.

A variety of defenses can be raised to the civil FBAR penalty.  One such defense is reasonable cause.  In the context of an FBAR violation, if the taxpayer reasonably relied on the written advice of a tax practitioner after having disclosed the account to the practitioner, then the entire penalty can be negated.  To that end, reasonable cause is an absolute defense.

Another potential defense to the assertion of a civil FBAR penalty is that it is time-barred because the statute of limitations has expired.  The statute of limitations for asserting an FBAR penalty is six years from the date of the violation.  What is the date of a filing violation?  It is June 30 of the year following the calendar year for which the account is being reported.  This 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 has occurred.

To summarize, an examination that uncovers unfiled FBARs can lead to one of two outcomes, as they relate specifically to the civil consequences: on the one hand, the examiner may choose to issue the taxpayer an FBAR warning letter (i.e., Letter 3800) in lieu of asserting a penalty.  On the other hand, the examiner may believe that a penalty is warranted.  If so, the penalty mitigation guidelines will apply assuming, of course, that the taxpayer satisfies the threshold conditions.

To the extent that the examiner attempts to assert a willful FBAR penalty, one must not forget that the burden of establishing willfulness is on the IRS.  Assuming that the IRS can carry its burden, then a willful FBAR penalty will be imposed.  Otherwise, the nonwillful FBAR penalty will apply.

No discussion of the civil penalties surrounding the failure to file an FBAR (and/or filing a false FBAR) would be complete without a discussion about some of the other penalties that might apply.  Below is a list of the most common penalties that are associated with an FBAR violation:

(1) Beginning with the 2011 tax year, a penalty for failing to file Form 8938, reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities and interests in foreign entities, as required by IRC 6038D.  The penalty for failing to file each one of these information returns is $ 10,000, with an additional $ 10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $ 50,000 per return.

(2) An accuracy-related penalty on underpayments imposed under IRC 6662.  Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty.

(3) Fraud penalties imposed under IRC 6651(f) or 6663.  Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that essentially amount to 75 percent of the unpaid tax.