The environment that taxpayers with unreported offshore bank accounts find themselves in today is downright frightening. Some have likened it to “McCarthyism,” the term that has its origins in the period of U.S. history known as the “Second Red Scare.” Beginning in 1950 and lasting until 1956, “McCarthyism” was characterized by heightened political repression against communists, as well as a campaign spreading fear of their influence on American institutions and of espionage by Soviet agents.

Originally coined to criticize the anti-communist pursuits of Republican U.S. Senator Joseph McCarthy (Wisconsin), “McCarthyism” soon took on a broader meaning. The term is now used more generally to describe reckless, unsubstantiated accusations, as well as demonized attacks on the character or patriotism of political adversaries.

Some believe that “McCarthyism” has been reincarnated today, through the government’s aggressive pursuit of U.S. taxpayers with undisclosed foreign accounts. This level of heightened scrutiny can mean but one thing: the government is branding every taxpayer with an unreported offshore account with the letter “C” for “Criminal.”

While there have been may voices crying out for change, the one that stands out in front of all others is that of Nina Olson’s, the National Taxpayer Advocate. In her annual report to Congress, Ms. Olson made it clear that this is 2015, not 1931, and that not every taxpayer with an unreported offshore account is the modern-day equivalent of “Al Capone,” the American gangster whose seven-year reign as Chicago crime boss came to an abrupt end in 1931 when he was convicted of tax evasion and sentenced to eleven years in prison.

Caught between FATCA and the draconian penalties looming over their heads like the “Sword of Damocles,” those who have been branded with the “Scarlett Letter” find themselves in the untenable position of having to choose between a limited number of choices, none of which is popular. Not surprisingly, the fear of what could happen if they make the “wrong choice” is so palpable that the thought of disclosing their foreign accounts by any means other than the IRS’s compliance-driven initiatives or the offshore voluntary disclosure program (OVDP) doesn’t even enter their minds.

Those who are brave enough to ask the question usually couch it in a way that pre-supposes a negative answer: “Is making a ‘quiet disclosure’ a wise choice in such a hostile environment?” By “quiet disclosure,” I am specifically referring to filing delinquent FBARs.

My answer to this question is that “one size does not fit all.” Indeed, certain cases are ripe for quiet disclosure, while others aren’t. While the necessary ingredients needed to make a quiet disclosure are not a “hallmark” of the typical undisclosed foreign bank account case, just because the moon and stars do not align for the vast majority of cases does not mean that it should be abandoned altogether.

Before throwing out the idea of making a “quiet disclosure” with the bathwater, consider this. A quiet disclosure furthers the IRS’s mission of encouraging voluntary compliance and self-policing by allowing taxpayers to self-correct. Thus, by overlooking the delinquent FBAR submission procedures, you might be making a huge mistake.

Cases that are ripe for “quiet disclosure” can be broken down into two main categories. For each category, assume that the taxpayer is a U.S. person with an offshore bank account that meets the definition of “foreign financial account” for purposes of triggering an FBAR-reporting requirement. Assume also that the failure to report the account was accidental and inadvertent:

(1) Failure to file FBAR, but foreign accounts were fully disclosed on U.S. income tax return and all taxable income was properly reported (along with payment of U.S. taxes resulting therefrom): The taxpayer properly reported his foreign financial accounts on his U.S. income tax return and paid all tax on the interest generated by those accounts. However, he neglected to file FBARs.

(2) Failure to file U.S. tax return and failure to file FBAR – but corresponding U.S. tax liability is negligible: The taxpayer is a non-resident who has failed to file U.S. tax returns and FBARs to report her financial interest in a personal foreign checking account at ABC Bank in Country B. However, she complied with Country B’s tax laws and properly reported all of her income on Country B’s tax returns. After taking into consideration the foreign tax credit for taxes paid to Country B, not to mention the light interest income generated by the account, even if she had properly disclosed these accounts, her corresponding U.S. tax liability would have been negligible.

Below are two common fact patterns that are custom-tailored for each category. As many of you know, my motto is “learning by doing.” Merely reading about what steps to take to solve a tax problem is no different than reading about how to ride a bicycle. Unless you get on the bicycle and fall off a few times, all the reading in the world isn’t going to teach you how to ride it. Similarly, the only way to become proficient at solving tax problems is by trudging through hypotheticals that stretch your knowledge and understanding of the arcane and nebulous rules that have come to define the U.S. international tax regime to its outer limits.

Let’s begin with a fact pattern that is custom-tailored to fit the first category. Joan is a U.S. citizen who lived abroad for three years from 2011 to 2013. While living abroad, Joan opened a personal checking account with a bank located in Country X in 2011. Assume that the highest balance in that account during the three years (2011, 2012, and 2013) was $ 150,000 (US).

Joan never filed an FBAR. However, she filed U.S. income tax returns for all three years. In doing so, she disclosed her foreign account on Schedule B and properly reported all of the interest income generated by that account. Thus, Joan reported, and paid tax on, all taxable income resulting from her unreported foreign account.

Joan just recently learned that she should have been filing FBARs in prior years after hiring an accountant to prepare her 2014 return. She wants to come into compliance. What should she do? According to the IRS’s recent bulletin entitled, “Options Available to Help Taxpayers With Offshore Interests,” Joan should file delinquent FBARs for the last three years and attach a statement explaining why they were filed late. Specifically, she should state that she was previously unaware of her obligation to report this account, but that as soon as she became aware, she acted swiftly to fix the problem.

Will the IRS impose a penalty for Joan’s failure to file these FBARs? So long as there is no tax liability and Joan has not previously been contacted by the IRS – i.e., no audit has commenced and/or no request was made by an IRS agent for delinquent FBARs – the answer is, “no.” Because neither of these conditions has occurred, no FBAR penalty will be asserted.

A variation of this theme also applies to situations where the taxpayer failed to file other international information forms, besides the FBAR, but no tax was due.

Consider the following example. Tommy Taxpayer is a U.S. citizen who owns a Controlled Foreign Corporation and a foreign trust. He has been living overseas since 2011. Tommy failed to file the necessary international information forms, specifically Form 5471 (for Controlled Foreign Corporations) and Form 3520 (for Foreign Trusts). However, Tommy did file U.S. tax returns where he reported, and paid U.S. tax on, all income resulting from these transactions.

Just as in the case of Joan’s failure to file FBARs, the bulletin recommends that Tommy file delinquent forms – here, Forms 5471 and 3520 – according to their respective instructions. In addition, Tommy should attach a statement explaining why they were filed late.

Cutting to the chase, will the IRS impose penalties for Tommy’s failure to file Forms 5471 and 3520? So long as there is no tax liability and Tommy has not previously been contacted by the IRS – i.e., no audit has commenced and/or no request was made by the IRS agent for delinquent Forms 5471 or 3520 – the answer is, “no.” Because neither of these conditions has occurred, no penalties for failing to file Forms 5471 or 3520 will be asserted.

The following is a fact pattern that is custom-tailored to fit the second category. Trevor is a U.S. citizen who works and lives in Country A. He has a brokerage account in Country A that he opened in 2008. The account had a high balance of $ 150,000 (US) and generated interest income of $ 2,000 (US) each year. Trevor complied with Country A’s tax laws and properly reported all of his income on his Country A tax returns.

Unfortunately, Trevor did not do the same when it came to his U.S. tax obligations. Not only did Trevor fail to file U.S. income tax returns, but he failed to file FBARs disclosing his financial interest in this account. This was due to the fact that he mistakenly assumed that he only had to report the account on his Country A tax return.

After reading recent press releases and learning about his U.S. income tax return and FBAR-reporting obligations, Trevor hired a tax preparer to assist him in coming into compliance with his U.S. tax obligations.

After applying the foreign tax credit for taxes paid to Country A, Trevor’s U.S. tax liability – resulting from the interest generated by his unreported County A account – amounted to less than $ 1,500 (US) per year for each of the last six years.

What should Trevor do? According to the IRS’s recent bulletin entitled, “Options Available to Help Taxpayers With Offshore Interests,” Trevor must do the following:

(1) File delinquent U.S. income tax returns for the past three years (i.e., 2011 thru 2013);

(2) File delinquent FBARs disclosing his foreign account for the past six years (i.e., 2008 thru 2013);

(3) Attach a statement to the FBAR explaining why the FBARs were filed late. For example, Trevor might state that he was previously unaware of his obligation to report this account, but that as soon as he became aware, he acted swiftly to fix the problem.

(4) Payment of all tax and interest due must accompany the submission.

Next:  Part II – The Risks Associated With Making A Quiet Disclosure

Original Post By: Michael DeBlis