The IRS has invested millions of dollars and has hired thousands of auditors to conduct FBAR audits on US taxpayers that it suspects of not filing or mis-filing FBAR forms. For taxpayers who haven't filed FBARs or who have filed incorrect FBARs, the situation is daunting. FBAR penalties are not based on income, but rather calculated on the highest account balances. Additionally, the IRS and Department of Justice are seeking to make an example of those who haven't filed FBAR correctly. The good news: If handled correctly the risks of an FBAR audit can be diminished.
The problem an FBAR audit can cause
Even if we assume that the IRS will not press criminal charges, which are honestly, not very likely, the true threat of an FBAR audit is that of significant penalties. This is how it works. Suppose Raj, a surgeon, grew up in India and has worked around the world. He's been living in Houston since 2004, having just gained permanent residency from his H1-B Visa in 2009. Therefore, he has been a US person for tax purpose and subject to FBAR filing. He has never reported his bank accounts in India and Switzerland, and never declared the income. Ever since 2004 the accounts had a highest value of $800,000 USD and made an average of $25,000 in interest income. Let us assume that the IRS has profiled dual Indian-American taxpayers who have recently gained citizenship or residency status, who have a Federal AGI in excess of $250,000 for audits. And Raj, meeting all these characteristics, is selected for an FBAR audit.
The threat of willful penalties in an FBAR Audit
The biggest problem for Raj, assuming the Department of Justice in not interested in pressing criminal charges, is the imposition of FBAR penalties. If an IRS FBAR auditor makes a determination that Raj was willful in not filing his FBAR forms, they may impose an FBAR penalty of 50% of the account balance. Per year! For example, if these accounts were domestic, the IRS could only penalize based as a percentage of the tax avoided. In this case, only $25,000 in income was avoided. That means, no matter what the total tax avoided per yer was it would be no more than $8750 (the highest rate of 35%). Assuming the IRS charged normal audit penalties, including civil fraud, with interest, we could assume the increase would make each year about $16,000 + change.
But compare this to an FBAR audit. The auditor gets to assess all the penalties above as if it were a domestic under-reporting of income, but in addition the IRS can assess, if found to be willful, a 50% FBAR penalty of the account balance...per year. So the IRS can assess the FBAR penalty 50% of 800,000 = 400,000 X 6 years = $2.4 million dollars. The FBAR penalties alone are more than what Raj has! The IRS would probably just send him a bill of what they could expect to get from him.
NOTE: We have not seen the IRS assess multiple willful FBAR penalties. Yet.
If you are ever selected for an FBAR audit, the most important thing your representation should do is convince the auditor not to assess the willful penalty of 50%. If you need assistance with mis-filed or unfiled FBARs, contact us. We can help.