United States citizens, residents and other persons must annually report their direct or indirect financial interest in, or signature authority over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $ 10,000 at any time during the year.  The maximum value of an account is the largest amount of currency – and non-monetary assets – that appear on any quarterly or more frequent account statement issued for the applicable year.

The seminal issue in cases involving a failure to file an FBAR is whether the taxpayer should disclose the foreign account by amending the original tax return and filing a delinquent FBAR or by participating in the Offshore Voluntary Disclosure Program.  The objective of the Offshore Voluntary Disclosure Program is to bring taxpayers that have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax into compliance with United States tax laws.

OVDP enables noncompliant taxpayers to resolve their tax liabilities and minimize their chance of criminal prosecution.  When a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure program, the IRS will not recommend criminal prosecution to the Department of Justice.  In other words, the taxpayer is immune from prosecution.

In order to provide practical and sound advice to clients who have to choose between two extremes — i.e., making a “noisy disclosure” or a “quiet disclosure” — it is necessary for the tax practitioner to assess risk.  That is perhaps their most important function.  Because there is no more serious a risk of failing to file an FBAR than criminal prosecution, every risk assessment should necessarily include a thorough analysis of whether the taxpayer is at material risk of prosecution.

Indeed, willfully failing to file an FBAR and willfully filing a false FBAR are not petty disorderly persons offenses or misdemeanors.  Instead, they are felonies under 31 U.S.C. § 5322.  And if you thought the punishment was no more severe than probation or house arrest, you’d be sadly mistaken.  Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $ 500,000.

Some background information about the draconian penalties that attach to the crime of willfully failing to file an FBAR are in order.  Those who watch the criminal tax enforcement system know that DOJ Tax prosecutes only cases of material misconduct.  A taxpayer not at material risk for prosecution is not the same as a taxpayer at “no risk” of prosecution.  This implies that any person for whom this question is even relevant must be willing to assume some risk.  And that leads to an important point: foregoing OVDP is not a decision for the faint of heart, the risk-averse, or for anyone without some tolerance for risk.  The only guarantee against prosecution is by entering the program.  To put it bluntly, the risk-averse should seek shelter in the OVDP bunker and be done with it; perhaps with the thought of opting out later if circumstances change.

One small word is all that distinguishes a civil tax matter from a criminal tax matter.  That word is “willfulness.”  It is the cornerstone to any criminal tax matter.  It is defined by courts as an “intentional violation of a known legal duty.”

In the criminal setting, the government carries the heavy burden of proving – beyond a reasonable doubt – that the taxpayer acted willfully.  The definition of willfulness can be bifurcated into two parts.  As explained in the IRM: “Willfulness is demonstrated by the [taxpayer’s] knowledge of the reporting requirements and the [taxpayer’s] conscious choice not to comply with the requirements.”[i]

In the FBAR context, the only thing that a person need know is that he has a reporting requirement.  If a person has that requisite knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR.

Under the theory of “willful blindness,” willfulness may be attributed to a person who has made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements.  At the outset, it is important to recognize that the theory of willful blindness is not widely embraced by all of the federal circuits.  Indeed, many circuits have unanimously rejected it because it dilutes the “mens rea” requirement by replacing willfulness with “deliberate ignorance,” thus lessening the government’s burden on such a critical element of a criminal offense.

Nevertheless, it is always good to have an example.  Assume that Tom, a U.S. citizen, has a foreign bank account at Credit Suisse in Switzerland.  He admits knowledge of the account but fails to answer a question concerning ownership of the account on Schedule B of his income tax return.

This section of the return refers taxpayers to the instructions for Schedule B that provide further guidance on the responsibilities for reporting foreign bank accounts and discusses the duty to file Form 90-22.1.  By referring to these resources, Tom could have learned of the filing and recordkeeping requirements quite easily (at least according to the IRS’s view).

Because it is reasonable to assume that a person who had a foreign bank account would have read these instructions, Tom’s failure to learn of the reporting requirement on Schedule B provides some evidence of willful blindness.  However, the mere fact that Tom did not check the box on Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness.  Indeed, other factors must exist before the government can prove that the violation was due to willful blindness.  One such factor is efforts taken to conceal the existence of the accounts and the amounts involved.

What is willfulness?  Willfulness is a state of mind.  Seldomly can it be proven by direct evidence.  Instead, it is usually established through circumstantial evidence – i.e., by conduct or acts from which a person’s state of mind can be inferred.  For FBAR purposes, this could include concealing signature authority, interests in various transactions, and interests in entities transferring cash to foreign banks.

IRM 4.26.16, Report of Foreign Bank and Financial Accounts (FBAR), provides some examples.  Two are particularly instructive.  The first illustrates the existence of willfulness and the second illustrates the absence of it.  The underlying theme that you will see running through these examples is that the IRS is not concerned about taxpayers who did not file FBARs, so long as they have reported and paid tax on all taxable income.  Such taxpayers need only file a delinquent FBAR and include a statement explaining why it was filed late.  Why?  Because the purpose of the program is to provide a way for taxpayers who did not report taxable income in the past to come forward voluntarily and resolve their tax matters.

In the first example, willfulness may exist.  Tom, a U.S. citizen, has a foreign bank account with Credit Suisse.  He files an FBAR in earlier years.  However, he fails to file one in subsequent years, despite having an obligation to do so.  When asked to explain why he didn’t file an FBAR in subsequent years, Tom does not have a reasonable explanation.  Further compounding Tom’s problem is the fact that he failed to report a substantial amount of interest associated with that same account during the years that he failed to file the FBAR.

In the second example, willfulness does not exist.  Fred, a U.S. citizen, has three foreign bank accounts with Credit Suisse.  He files an FBAR in 2007, but omits one of these accounts.  Fred closed the omitted account just a few weeks before June 30, 2008, the date that he filed his FBAR for tax year 2007.  However, Fred reported all income associated with the omitted account on his 2007 tax return.

When asked why he didn’t disclose the omitted account, Fred explains that it was due to unintentional oversight.  During a subsequent examination, Fred provides all of the information requested pertaining to the omitted account.  None of the information discloses anything suspicious about the account.

A question that comes up frequently is does the fact that an unreported foreign account contains a de minimis maximum balance (and generated an insignificant amount of interest income) mean that it will be immune from audit?  In other words, will the account be able to fly under the IRS’s radar without being detected?

The short answer is “no.”  As the IRS has said time and time again, no amount of unreported income is considered de minimis for purposes of determining whether there has been tax non-compliance with respect to an account or asset.

The IRS reviews amended returns and could select any amended return for examination.  As such, it will continue to identify amended tax returns reporting increases in income.  The IRS will closely review these returns to determine whether enforcement action is appropriate.  To the extent that the IRS initiates a civil examination, the taxpayer will no longer be eligible to come in under the OVDP.