Tax Law Center Blog

It’s important to be aware of the caution and risks associated with foreign banks reporting balances to the IRS, particularly in the context of Form 8938 compliance. While Form 8938 audits are very rare, below are important considerations for client advisors to avoid complications:

The Role of Foreign Banks in FATCA and Information Reporting

The Foreign Account Tax Compliance Act (FATCA), enacted in 2010, is a cornerstone of the IRS’s efforts to combat offshore tax evasion. FATCA mandates that foreign financial institutions (FFIs) report information about financial accounts held by U.S. persons (citizens, residents, and certain entities) directly to the IRS. This reporting includes the account holder’s name, address, Taxpayer Identification Number (TIN), account balance, and any income earned on the account.

Foreign banks, therefore, play a crucial role in providing the IRS with data on U.S. taxpayers’ offshore assets. This information is a primary source for the IRS to identify potential non-compliance with U.S. tax laws, including the obligation to file Form 8938 starting in 2014.

How Foreign Bank Reporting Can Trigger Form 8938 Audits

1. Discrepancies with Form 8938 Filings: The IRS compares the information received from foreign banks under FATCA with the information reported by U.S. taxpayers on Form 8938. If there are discrepancies between the bank-reported balances and the amounts disclosed on Form 8938, it can trigger an audit. For example, if a foreign bank reports a year-end balance of $250,000 for a U.S. taxpayer, but the taxpayer only reports $9,000 on Form 8938, this inconsistency is a red flag for the IRS.
2. Failure to File Form 8938: If a foreign bank reports an account balance exceeding the Form 8938 filing thresholds for a U.S. taxpayer, and the IRS has no record of the taxpayer filing Form 8938, this is a significant audit trigger. The IRS will likely investigate why the form was not filed and whether other foreign assets should have been reported.
3. Indications of Control or Ownership: Foreign bank reporting can also reveal information about U.S. taxpayers who have signature authority or other control over foreign accounts, even if they are not the direct owners. If this information is not reflected on Form 8938 (if filing is required based on other assets), it can lead to scrutiny.
4. Transactions Suggesting Unreported Income: Large or unusual transactions reported by foreign banks, especially those involving jurisdictions known for tax secrecy, can prompt the IRS to investigate the source of the funds and whether related income was properly reported. This can then lead to an examination of Form 8938 filings.
5. Bank “FATCA Letters”: Some foreign banks send letters to account holders they believe have a U.S. connection, informing them of their reporting obligations under FATCA. Receipt of such a letter by a client should be taken very seriously, as it indicates the bank has identified them as a U.S. person, and the IRS may also be aware of the account. Ignoring this can significantly increase risk.

Risks for Taxpayers Due to Foreign Bank Reporting

1. Increased Audit Probability: The primary risk is a higher likelihood of being audited by the IRS. The data provided by foreign banks makes it easier for the IRS to identify potential non-compliance.
2. Penalties for Non-Compliance: Failure to properly report foreign financial assets on Form 8938 can result in significant penalties. The penalty for failing to file Form 8938 is $10,000 per year, with an additional penalty of up to $50,000 for continued failure after IRS notification. Furthermore, a 40% penalty can be applied to any understatement of tax attributable to undisclosed foreign assets.
3. FBAR Penalties: In addition to Form 8938, U.S. persons with foreign bank accounts exceeding $10,000 in aggregate at any point during the year are also required to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). The IRS often examines FBAR compliance in conjunction with Form 8938. Penalties for FBAR violations can be severe, especially for willful violations.
4. Criminal Investigations: In cases of intentional or willful non-compliance, taxpayers could face criminal investigations.
5. Loss of Voluntary Disclosure Options: If taxpayer is under audit, their options for using IRS voluntary disclosure programs to mitigate penalties may be limited.

Cautions for Tax Advisors

1. Emphasize Accurate and Complete Reporting: Advise clients on the importance of accurately and completely reporting all specified foreign financial assets on Form 8938, ensuring consistency with information that may be reported by foreign banks.
2. Thorough Due Diligence: Conduct thorough due diligence to identify all of a client’s foreign financial assets, including bank accounts, investment accounts, and other reportable assets.
3. Reconcile Client Information with Potential Bank Reporting: Where possible, try to reconcile client-provided information with what might be reported by foreign banks, especially for accounts with significant balances.
4. Advise Clients Receiving FATCA Letters: If a client receives a letter from a foreign bank regarding FATCA, advise them to seek immediate professional guidance to assess their reporting obligations and potential risks.
5. Understand FBAR and Form 8938 Overlap: Be aware of the interplay between FBAR and Form 8938 filing requirements, as the same foreign bank accounts may need to be reported on both forms.

In summary, the reporting of foreign bank account information to the IRS is a significant factor that can trigger audits related to Form 8938 and FBAR. All advisors must be vigilant in educating their clients about these requirements and ensuring accurate and comprehensive reporting to mitigate the substantial risks associated with non-compliance.