When FBAR Noncompliance Turns Criminal: Case Study Example

When FBAR Noncompliance Turns Criminal

When FBAR Noncompliance Turns Criminal 

When a US Person has ownership over a foreign account, investment, or asset that is required to be reported to the IRS and/or FinCEN on the FBAR, and fails to do so — there is a spectrum of penalties and violations that may occur. As a preliminary matter, FBAR penalties are usually civil in nature. That means that despite the absurdity involving the amount of FBAR penalties that a Taxpayer can get hit with, at the end of the day there is no risk of confinement or incarceration from a civil violation. Once the Taxpayer is assessed an FBAR penalty (and depending on how motivated the Taxpayer is), they can dispute the penalty with the IRS and even litigate it in Federal Court — and may not be required to submit prepayment as required under the Flora Rule. In fact, many Taxpayers have been successful in litigating against the Federal Government.

Criminal FBAR Violations Can Happen

While a Taxpayer’s noncompliance rarely reaches a level that results in a criminal violation, it does happen. Oftentimes, criminal FBAR violations involve facts beyond just missed reporting of foreign accounts, such as money laundering, structuring, and tax evasion. Here is a relatively straightforward case study about how FBAR noncompliance can turn criminal. 

Once Upon a Time, Taxpayer Filed FBARs

Dean is a US citizen who is originally from a foreign country. In prior years and up until about five years ago, Dean had reported all of his foreign income along with his foreign bank account to the IRS — as he was aware of the annual FBAR reporting requirements. Thus, Dean was fully in compliance with all his domestic and overseas income and reporting. Then, Dean started making significantly more money from foreign sources and decided he does not want to report this money to the US government. Going forward, Dean decides to intentionally limit the amount of foreign income he reports on his US tax return and asks for his foreign customers to pay him in cash and other untraceable currency — his goal is to artificially reduce his US tax liability.

Taxpayer’s Account is Too Large for his Liking

Initially, Dean had only one foreign bank account. But, the account balance was getting too high for Dean’s liking and he was concerned about the bank reporting him, despite the fact that he had a great relationship with the foreign bank and they told him that they would not report him. To accomplish this, the bank had Dean transfer his account to a numbered account — to only be identified by a number and a dummy foreign entity associated with that number (and not Dean personally).

He Intentionally Splits the Money Into Several Foreign Accounts

In order to avoid detection, Dean structures and smurfs the larger account into several smaller accounts at various institutions, under different names, and across different foreign jurisdictions in order to avoid the foreign equivalent of CTR (Currency Transaction Reports) and SAR (Suspicious Activity Reports). He does not identify that he is a US person to any of the foreign jurisdictions.

Taxpayer Intentionally Does Not Report the Accounts Nor File FBAR

For the past five (5) years, Dean has been intentionally reducing the amount of income on his US tax return as well as intentionally not filing the annual FBAR, Form 8938, and Form 8621 for the passive investments he maintains overseas. In addition, Dean stopped filing Schedule B, because he was under the misimpression that by not filing Schedule B, he would not be making any affirmative misrepresentation about the FBAR (or lack of filing) — but this is incorrect.

*Had Dean never filed Schedule B because he was unaware of the form, then it generally would have worked out better for him on the FBAR penalty front than if he knew about the Schedule B and either filed it incorrectly or simply did not file the FBAR – See Hughes Case for Willful and Non-Willful Violations.

IRS Learns of Taxpayers Noncompliance

Unfortunately for Dean, one of the foreign financial institutions where Dean maintains several of his foreign bank accounts realized that Dean was a US Person — because many years ago it turns out Dean had opened an account at that institution and while the account primarily had a zero balance and remained dormant most of the time, the bank’s system shows Dean as a US Citizen. Therefore, the foreign financial institution includes Dean in their exchange of information for US person account holders to the US government. The US government then decides it is going to audit Dean, as they also learn that Dean failed to include a significant amount of underreported income.

Reverse Eggshell Audit, Special Agents, and Criminal Prosecution

As is commonplace with many human beings in general — they tend to be too smart for their own good. Dean was almost sure that the IRS was bluffing so when he went into the audit, he doubled down and confirmed that he had no foreign accounts nor any unreported foreign income. This is referred to as a reverse eggshell audit because the IRS already has the information at the time of audit.

As a result, the IRS Agent referred the matter to the IRS Special Agents. After an extensive investigation into Dean’s finances, they came to the conclusion that based on the numerous intentional misrepresentations about his foreign account balances along with intentionally failing to report the FBAR and filing false returns (an affirmative act), Dean has crossed over from a civil willful violation into criminal FBAR noncompliance and tax evasion. Thus marked the beginning of the end for Dean.

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