Recently, the IRS has made the FBAR penalty enforcement a top priority and this is alarming the taxpayers worldwide. There are few things that you need to keep in mind when negotiating FBAR penalties with the IRS. This post will discuss them all.
1. The penalties for noncompliance are staggering
Yes, the FBAR penalties can be unfair. And remember that the penalties will be based on the account size and not on how much tax you avoided. Unlike other IRS penalties out there, there is always a huge risk when dealing with FBAR penalties and you should never take this lightly.
2. The two types of FBAR penalties
If the IRS feels that you made an innocent mistake and “not willfully” ignored to file your FBAR, your “get off gently” penalty will be $10,000 per overseas account. Say if you have five foreign accounts that you failed to report on your FBAR, the IRS can penalize you $50,000 per year.
In case if you “intentionally” avoided filing your FBARs, your “disastrous penalty” will be 50% of your account value and you should be aware to the fact that a willful violation can also lead to jail time. The “disastrous penalty” can also be assessed multiple times and this can wipe out your entire savings in seconds.
3. The taxpayer's burden of proving “reasonable cause”
You are obligated to pay the penalty the IRS deems necessary. The IRS can assume the “disastrous” penalty and they aren't required to prove willfulness. It will be the taxpayer that bears the heavy burden of proving that their failure to comply was due to reasonable cause and not from “willful neglect”.
4. Your appeal option
You can move to the court however you must exhaust all administrative remedies within the IRS first. Otherwise, you can pay assessments in full and then sue in a district court for refund. But before carrying out this option, it must be thoroughly discussed with an experienced tax professional. It is strongly recommended to exhaust administrative remedies that are available with the IRS appeals process since this has several advantages. First, you don’t have to pay any penalty right until the end. Second, you can be successful with IRS remedies itself thus making court filings unnecessary. And third, even if the administrative remedies doesn't yield you success, an tax attorney can negotiate with the IRS and lower your FBAR penalties without going for a trial as long your case is well documented and properly supported.
5. The OVDI route
When compared to past Voluntary Disclosure Programs where people mainly used it to avoid criminal charges, the current OVDP/FBAR Amnesty is intended to save people from the threat of huge or disastrous FBAR penalties. So to minimize your FBAR penalty, it is recommended to use the OVDP as a starting point.
When you make use of the OVDP, there is more chance of getting favorable review during the discussion of your potential “reasonable cause”. But outside the OVDP, the IRS does not treat people as favorably as those who make themselves visible under the OVDP. It doesn't matter whether you made an innocent mistake or made an unadvised “quiet” or “soft” disclosure, the ground will be much less sturdy when it is outside the OVDP.
The IRS audit division has a way of reaching into the every corner of an individual life. By not facing the criminal court, you may avoid the prison time but losing your entire wealth through these audits can be nearly as devastating as sitting in a prison. This OVDP route can serve as a springboard and limit the staggering penalties to not more than 27.5% of your highest balance.