Take-Away: While the owner of a foreign bank account is supposed to disclose the existence of that account, some owners play the ‘audit game’ and fail to report their account(s) or they think the law does not apply to them. That failure to disclose a foreign financial account does not disappear just because the account owner dies. The failure to file can creates an expensive problem for their heirs who inherit those foreign financial accounts.

Background: Any U.S. person who holds a foreign financial account, e.g. bank accounts, brokerage accounts, insurance policies with cash surrender values or annuities, mutual funds, pooled funds, etc., worth more than $10,000 must report it annually on the Foreign Bank Account Report (FBAR.) An FBAR is similar to a U.S. tax form, but it is not filed with the IRS. Rather the form is filed with the Financial Crimes Enforcement Network (FinCEN) which is the financial crimes division of the Department of Treasury. This report is an informational form only and it does not generate a tax. However, while the FBAR is filed with FinCEN, the IRS conducts all enforcement to collect penalties for noncompliance. If the U.S. person holds several foreign financial accounts and the total of those several accounts exceeds $10,00, then all of the accounts must be disclosed. If a U.S. person’s account exceeds $10,000 just for one day during the calendar year, it must be reported. The statute of limitations expires six years after the failure to file a FBAR for the year. An FBAR filing deadline is April 15, but there is an automatic 6-month extension for all individuals, thus making the FBAR filing due date October 15 of each year.

Penalties: The penalties for not filing FBARs can be much more severe than the penalties for not filing an income tax return. When a U.S. individual fails to disclose a foreign financial account on a timely filed FBAR, the civil penalty can be as high as one-half of the unreported account balance. The size of the penalty turns on whether the account owner’s nondisclosure was willful.

Example: Assume the owner of a foreign account, Charlie, spends  close to half of the calendar year in Belize during the winter months. Charlie opens a financial account in Belize City, which holds at any one time $1.0 million because his thought, for a time, that he was going to build a retirement condominium on the beach in Belize which later never materialized. Charlie chose not to disclose his $1.0 million account while he is living. Charlie can face a civil penalty of $500,000. If Charlie dies without having filed his FBARs, then the $500,000 penalty becomes a debt of Charlie’s estate because when a U.S. citizen like Charlie willfully fails to file a FBAR, the maximum civil penalty is one-half the value of the unreported account at its largest balance during the year. In contrast, if Charlie thought he filed his FBAR electronically reporting his Belize account but he didn’t do so due to a technical glitch in that case, Charlie might not face any civil penalty.

50%: Penalties are litigated in the U.S. Tax Court and other federal courts, just like any other tax penalty. These court cases have strongly supported the IRS’ enforcement power over FBARs. The courts have defined civil willfulness to include reckless indifference and willful blindness, i.e. the ‘ignorance is bliss’ defense won’t work. While the IRS must prove willfulness, its burden of proof is only by a preponderance of evidence, and the foreign financial account owner is presumed to know all of the law with regard to FBAR reporting obligations. Several federal court decisions have repeatedly upheld the 50% penalty for civil willfulness and have concluded that 50% is the penalty that is necessary to encourage owners to disclose their foreign financial accounts, and accordingly a 50% penalty is not excessive.

$10,000: Even if the account owner does not meet the standard for a civil willfulness, the IRS may assess penalties of up to $10,000 per person, per undisclosed account, per year if there was no reasonable cause for their failure to file. While an account owner can escape this penalty by showing reasonable cause, reasonable cause is very narrowly interpreted by the courts, thus making it difficult to prove and escape liability in court.

Inheriting a Foreign Bank Account: An undisclosed foreign financial account can cause personal reporting obligations for beneficiaries of the account.  If the foreign financial account passes to beneficiaries through beneficiary designation, joint ownership, probate, a trust or some other non-probate transfer mechanism, the beneficiary’s reporting obligation will have different starting dates.

  • Beneficiary Designation: If the foreign financial account passes by beneficiary designation, the beneficiary who inherits the foreign financial account must begin reporting it as of the date of the decedent’s death-because the beneficiary’s ownership interest begins immediately on the decedent’s death.

Joint Ownership: If the foreign financial account passes by joint ownership to the survivor, the potential liability can begin years before the decedent’s death. Each joint owner of the foreign financial account has a separate reporting obligation when the joint account was created. All joint owners who are U.S. persons must report the entire account value each year, even if they never contributed to or had access to the funds held in the account. Because joint owners’ reporting obligations can overlap with a decedent’s liability, joint owners can face serious penalties for a decedent’s undisclosed accounts.

Example: When Charlie opened his bank account in Belize City, he decided to add his daughter Diane as a joint owner of the account ‘in case something happens to me and Diane needs to have access to the account.’ Diane is never told about her father Belize account. Diane had a reporting obligation the day her name was added to Charlie’s foreign financial account, and for each year thereafter while her name was on the account. (Thanks Dad!)

Estate or Trust: If the foreign financial account comes from an estate or a trust, the personal representative or the trustee responsible for the account must report it on their individual FBAR. The person with signatory authority over the account must report it even if they have no financial interest in the account. The estate or trust also must file an FBAR, so the fiduciary will report the account both on their individual FBAR and on the FBAR filed for the estate or trust. In addition, any beneficiary with more than a 50% beneficial interest in a trust or an estate must file as the ‘owner’ of any foreign financial account held in that trust or estate. All of these reporting obligations are separate, so multiple individuals can have an obligation to report the same foreign financial account in the same calendar year on a timely filed FBAR.

Exception: An exception to the reporting requirements for an inherited foreign financial accounts is that only U.S. fiduciaries and beneficiaries have FBAR reporting obligations. If the decedent was a U.S. person but the estate and all of its fiduciaries and beneficiaries are non-U.S. persons, the FBAR filing obligations may end with the decedent’s death.

When an undisclosed foreign financial account passes to more than one U.S. person, those persons need to communicate and coordinate with regard to their reporting obligations. If an undisclosed account passes equally to three U.S. individuals, and only one of them reports the account, the two who failed to disclose the account on their FBARs risk severe penalties. Some beneficiaries are more risk averse than others, which can lead to lots of stress in  family relationships.

Example: Charlie’s Belize financial account also had the names of his other to children, Tom and Dick as joint owners along with Diane. Charlie never reported the existence of this account on an FBAR. Charlie dies. Diane intends to file a FBAR with regard to this Belize account. Her brothers, like their late father, are big risk takers who rationalize that if ‘Dad was never caught, neither will we if we move the funds out of Belize and back into accounts in our own names back home.’ Tom and Dick are outraged with Diane because she feels compelled to file an FBAR and report her inheritance and also address the penalties that accrued each year that Charlie had not filed an FBAR with regard to the account.

Estate Liability: An estate can face penalties for the decedent’s willful failure to disclose a foreign financial account while the decedent was still alive. If the IRS had opened an examination and assessed penalties while the decedent was living, then the penalties will be treated as a debt of the decedent and payable from the decedent’s estate. [U.S. v Estate of Schoenfeld, 344 F. Supp. 3d 1354 (M.D. Florida, 2018.)] If the estate’s assets have been distributed, the IRS can use all of its collection powers to collect the FBAR penalties from the recipient-distributees of the decedent’s assets. [U.S. v Jung Joo Park, 389 F. Supp. 561 (N.D. Illinois, 2019.)] Even if the IRS had opened an examination while the decedent was living but had not assess penalties until after the account owner’s death, the IRS can still collect penalties from the decedent’s estate. Accordingly, if an estate or a trust has some risk of penalty that arises from an undisclosed foreign financial account, the fiduciary should report the account and hold back enough assets from the distributions to pay a potential 50% penalty, plus significant litigation costs. An estate can be held liable for FBAR penalties even after funds have been distributed to beneficiaries, and if the fiduciary cannot recover those distributed assets from the beneficiaries, the fiduciary will face personal liability. While the 6-year statute of limitations is running, the fact that older years escape liability may not provide a decedent’s estate much relief, as the FBAR penalty will be based on the highest unreported balance. In short, if the highest unreported balance was in the last year of the decedent’s life, then the FBAR liability will remain consistent throughout the 6-year statute of limitations period.

Conclusion: When an undisclosed foreign financial account surfaces after the account owner’s death, the beneficiaries of that account can face significant financial penalties.