Legal Ruling on Complex Disclosure Rules for US Ex-Pats

US citizens who live outside the United States have the specter of the IRS and offshore compliance requirements over their heads, and often fear the threat of six-figure penalties and statutory fines if they are caught failing to report all their income and assets. If you have a non-US corporation, a non-US trust, invest in certain registered accounts, or have financial assets over certain thresholds, you are at increased risk.

Since 2004, the IRS has repeatedly saddled US citizens with fines in excess of $100,000 for failing to comply with foreign bank account and financial account disclosure laws. A US person who has a financial interest in non-US financial assets is required to file a Foreign Bank Account Report (currently FinCEN form 114) if the total value of their assets exceeds $10,000 at any time during the year. For willful violations of this filing requirement, the fines can be exorbitant.

U.S. v Colliot

The potential amount of these penalties has been under dispute in a court case, U.S. v Colliot. Dominique Colliot was assessed penalties for FBAR disclosure violations of $548,773 for 2007, $196,082 for 2008, and smaller penalties for 2009 and 2010. These massive penalties show the risks that US citizens face if they fail to properly disclose their foreign financial assets.

Colliot sued the U.S. government, alleging that the penalties were arbitrary and capricious, and that the IRS had incorrectly applied its own laws in calculating the penalty. The two relevant laws are 31 U.S.C. §5321(a)(5) and a related regulation, 31 C.F.R. §103.57.

§5321(a)(5) previously stated that the civil penalties in these situations could be equal to the greater of $25,000 or the balance of the unreported accounts, up to a maximum of $100,000. The related regulation, C.F.R. §103.57 agreed with the provision, using similar wording and identical numerical values.

However, in 2004, the provision in §5321 was amended by Congress and increased the maximum civil penalty which could be assessed for failing to comply with FBAR disclosure laws. The new law stated that the civil penalty for willful failure to file would be the greater of $100,000 and 50% of the balance in the unreported account.

This new provision now actually contradicted its related regulation, which continued to state that the maximum allowable penalty for a willful failure to file was $100,000. And although the IRS updated the provision for inflation and re-numbered it during a reorganization, it did not update it to align with the new §5321.

The Court therefore ruled on the side of Colliot, stating in a May 15, 2018 conclusion that the IRS cannot assess penalties in excess of the threshold set by 31 C. F. R §1010.820 (formerly 31 C.F.R §103.57). Of course, this regulation may be amended by the IRS to line up with the higher penalties in §5321, but for taxpayers who were assessed penalties between 2004 and that point, they may have a claim against the IRS to have a portion of those penalties reversed.

Despite this win for Colliot, it is important to remember that the IRS may still levy penalties of up to $100,000 per incidence of failing to properly report foreign financial assets. For US ex-pats living in Canada who have not been filing their US tax returns, this is a good opportunity to speak to a tax professional about the voluntary disclosure programs which would allow them to get up to date with their filing without the risk of incurring heavy penalties.