FBAR Audit: What to Expect From an IRS Examination

A Report of Foreign Bank and Financial Accounts (FBAR) is a document used to disclose foreign financial accounts to the Financial Crimes Enforcement Network (FinCEN). U.S. persons, including citizens, residents, and various legal entities, must file an FBAR if they have a financial interest or signature authority over foreign accounts with a combined value over $10,000 at any point during the year. The purpose of the FBAR, or FinCEN Form 114, is to help the government combat financial crimes by tracking offshore assets. The Internal Revenue Service (IRS) enforces FBAR compliance and may conduct a formal review, known as an FBAR examination, to verify that a taxpayer has accurately reported all foreign accounts.

Triggers for an FBAR Examination

Specific actions or data points often prompt the IRS to conduct an FBAR examination. A primary trigger is an inconsistency between information on an FBAR and details on an income tax return. For example, reporting foreign interest income on a Form 1040 without a corresponding FBAR filing can signal an undisclosed account.

The Foreign Account Tax Compliance Act (FATCA) also provides the IRS with information by requiring foreign financial institutions to report on accounts held by U.S. taxpayers. An audit can be initiated if the data received from a foreign bank under FATCA does not match what a taxpayer has reported.

The IRS also receives information from other sources that can lead to an examination. These sources include whistleblower tips or an ongoing audit for other tax matters that uncovers evidence of foreign accounts. Additionally, patterns of large or unusual international wire transfers can be flagged by financial institutions and reported for scrutiny.

Certain characteristics may also place a taxpayer in a higher-risk category, increasing the likelihood of an examination. This includes holding dual citizenship, residing abroad as a U.S. citizen, or working in industries with a higher incidence of financial crime. While these factors alone do not guarantee an audit, they contribute to the IRS’s decision to verify compliance.

The FBAR Audit Process

The FBAR audit process begins when the IRS issues a formal notification letter, such as Letter 6557 or Letter 4265. This letter informs the individual of the examination and is followed by an Information Document Request (IDR) for specific records. The statute of limitations for the IRS to assess FBAR penalties is six years from the FBAR’s due date, but it may remain open indefinitely if a report was never filed.

Taxpayers are asked to provide comprehensive bank statements for all foreign accounts for the years under review. The request may also include records showing the source of the funds in the accounts, correspondence with the foreign financial institutions, and copies of any previously filed FBARs.

A central part of the examination is the taxpayer interview, where an IRS agent will ask detailed questions about the taxpayer’s foreign financial activities. Questions focus on the purpose of the accounts, the taxpayer’s understanding of their filing obligations, and the reasons for any discrepancies or failures to file. The examination concludes when the agent has gathered enough information to make a formal determination.

Determination of Willfulness and Penalties

After the examination, the IRS determines penalties based on whether the failure to file was “willful” or “non-willful.” A non-willful violation occurs due to a mistake, negligence, or inadvertence. The penalty for a non-willful violation is up to $16,536 per year that a report was not filed.

A willful violation is the intentional violation of a known legal duty and can be established even without direct proof of intent. The IRS can infer willfulness from a taxpayer’s conduct through concepts like “willful blindness” or “reckless disregard.” Willful blindness applies if a taxpayer made a conscious effort to avoid learning about their FBAR requirements, while reckless disregard involves acting in a way that shows a plain indifference to a known or obvious risk of non-compliance.

The civil penalty for a willful failure to file is up to the greater of $165,353 or 50% of the highest aggregate balance of the unreported accounts for the year of the violation. Because this penalty can be applied for multiple years, the total amount can exceed the original balance of the accounts. In some situations, a willful violation can also be referred for criminal investigation.

Criminal penalties can include fines of up to $250,000 and five years of imprisonment, which can increase to $500,000 and ten years of imprisonment if the violation is part of a broader pattern of illegal activity. The determination of willfulness is based on facts uncovered during the audit, such as the taxpayer’s sophistication and whether they tried to conceal the accounts.

Responding to Audit Findings and the Appeals Process

Once the IRS agent concludes the examination and proposes a penalty, the taxpayer is notified of the findings. If they agree with the determination, they can sign an agreement form and arrange to pay the assessed amount.

If the taxpayer disagrees with the findings, they have the right to challenge the decision. The first step is to request a conference with the agent’s manager to discuss the areas of disagreement and present additional arguments.

Should the disagreement persist, the taxpayer can appeal to the IRS Independent Office of Appeals. To do so, the taxpayer must submit a written protest outlining the disputed findings and the legal basis for their position. An appeals officer will then conduct an impartial review of the case to resolve the controversy.