After the headlines about the IRS' going after secret Swiss bank accounts, investors are learning to their dismay that they could face fines and prosecution for failing to report other foreign assets, such life insurance, to both the IRS and the Treasury Department.
Numbered bank accounts used to shelter wealth from the Internal Revenue Service are in the spotlight in the wake of the recent UBS AG scandal, but clients who own other types of foreign assets may be unaware that those accounts also must be disclosed to the Department of the Treasury, said Melissa Gillespie, a New York-based international tax attorney.
In addition to reporting investment income and capital gains on their income tax returns, U.S. citizens and residents with a financial interest or signature authority over a foreign financial account that's worth more than $10,000 at any time of the year must report that account to the Treasury Department through a form called the Foreign Bank Account Report.
Along with foreign bank ac-counts, that treatment applies to foreign life insurance policies with a cash surrender value greater than $10,000, trusts with foreign financial accounts, investments in gold bullion and foreign-type individual retirement accounts, or pension plans that are in the client's control.
Foreign annuities with a balance that exceeded $10,000 any day during the year must also be reported to the Treasury.
“There are many clients who may have received an inheritance from a foreign-based relative which may be maintained in a foreign account — or foreign clients who moved to the U.S. many years ago and maintained a foreign account or have an inheritance,” Ms. Gillespie said.
“They had no intention of avoiding taxes, and all of a sudden, they're in trouble,” she added.
Penalties for those who non-willfully fail to file FBARs and report the income from those foreign financial accounts on their income tax returns — as well as fail to join the IRS' voluntary-disclosure program by Sept. 23 — can be as high as $10,000 per year. The punishment is even greater for those who deliberately avoid reporting to the Treasury Department and the IRS.
Even those who join the voluntary-disclosure program on time but don't report the income from those foreign financial accounts on their tax return will face penalties on the last six years of underreported income, and a flat 20% FBAR penalty on the highest balance in the foreign account over that period. Plus, they still have to file six years' worth of amended income tax returns and FBARs.
Clients don't have to be sophisticated overseas investors to get in trouble. For example, immigrants who obtain residency in the United States could receive assets from their parents back home and not realize that they have to file FBARs.
“It's very common for European and Asian families with significant wealth,” said Troy E. Thompson, a tax attorney and adviser at Thompson Advisory Services LLC of Portland, Ore. “The father will distribute shares of stock in a privately held family firm, but it might not be clear to the kids, or they may not think it's really theirs, because the dad is still alive.”
Trusts with foreign financial accounts are also tricky. Trustees of U.S. trusts with foreign accounts must file FBARs. Meanwhile, beneficiaries of foreign or U.S. trusts who have a present interest in more than 50% of the trust's assets or who receive more than 50% of the income must also file FBARs.
Discretionary beneficiaries of these trusts also need to file, regardless of the size of their interest, Ms. Gillespie added. This can be especially troublesome, as sometimes these beneficiaries are children, she said.
An insurance policy inside an insurance trust will also require the beneficiary to file, said Gideon Rothschild, a partner at Moses & Singer LLP who specializes in domestic and international estate planning. He has been working on several dozen late FBAR filings that are in the voluntary disclosure program.
Complicating the ordeal for clients, advisers may not know how to direct their clients if foreign financial accounts aren't their specialty or if a client's tax practitioner doesn't bring it to their attention.
Such was the case for Anja Luesink, an adviser with Luesink Financial Planning LLC in New York. A citizen of the Netherlands, Ms. Luesink holds bank accounts overseas, including retirement accounts and annuities.
Though she had been reporting the income from those assets on her tax returns, her tax adviser never told her that she also needed to file a FBAR.
It was last year at a Financial Planning Association meeting that she first heard about the reporting requirements.
Since Ms. Luesink had reported the income from the accounts on her tax returns, she was able to file her FBAR without penalties from the IRS.
A LESSON LEARNED
The ordeal came with a lesson for Ms. Luesink.
“I intend to write a newsletter to my clients and people I know just to inform them about the FBAR,” she said. She will e-mail clients this week to notify them of the IRS' voluntary-disclosure deadline.
“All I can do is give them the advice to file, and they'll have to implement it themselves,” Ms. Luesink said.
As long as taxpayers correctly report income from the foreign accounts on their tax return and come forward to file their late FBARs by Sept. 23, they won't face a fine. But for those who neglected to pay taxes on the foreign accounts, it's another story.
Mr. Thompson has a client who not only missed past FBAR filings but also failed to report income from the foreign account on his tax return. Such cases need to be reported to the IRS' criminal-investigations unit before the client can apply for voluntary disclosure.
“Although it seems the IRS isn't looking to prosecute people unless there's a lot of unreported income involved or they're promoters of tax evasion strategies, people have to write out big checks,” Mr. Rothschild said. “It's going to cost about 40% of the account balance for most people by the time you're done with taxes and penalties.”
E-mail Darla Mercado at firstname.lastname@example.org.