Will a Treaty Supersede the Requirement to File FBAR?

Using a Treaty to Challenge the FBAR Requirements

The IRS takes the position that a treaty cannot be used to challenge FBAR filing requirements. In our prior FBAR treaty article from back in 2022, we explain the IRS’ position under their Publication 5569 and Practice Unit Guide. But, in 2023, a new court case challenged the IRS’ position about treaty rights and FBAR rules. There is currently a very important case brewing at the federal court level (Aroeste v US) involving a nuanced FBAR foreign account penalty conundrum. In general, there are three categories of individual taxpayers who have to file FBAR: US Citizens, Lawful Permanent Residents, and Foreign Nationals who meet the Substantial Presence Test. But what happens if a taxpayer resides overseas and makes a treaty election to be treated as a foreign person so that they are not considered a US person for tax purposes? In other words, if someone is a permanent resident of the United States but claims treaty benefits to be treated as a foreign person, are they still considered a US person for FBAR filing purposes?  Let’s take a look at what the court says.

Reporting the FBAR vs Filing Tax Returns

One important aspect of this analysis is realizing that there are two competing filing requirements. FBAR reporting is not about taxes or tax filing – but rather international information reporting tax return filing requirements are handled under Title 26 of the US code. Conversely, FBAR filing requirements are handled by title 31 of the US code — although the FBAR regulations do refer to Title 26. 

2023 Update Federal Court in Aroeste

Previously, our international tax attorneys authored an article involving a taxpayer who was claiming he did not have to file the annual FBAR (Foreign Bank and Financial Account Reporting) because he lived overseas and made a treaty election to be treated as a foreign person for U.S. tax purposes — albeit a late election. That is because if the Taxpayer was deemed to be a foreign person for US tax purposes, it would mean the Taxpayer would file Form 1040NR as a non-resident alien instead of Form 1040 for taxpayers who are U.S. persons for tax purposes. And, since the FBAR requirement is for U.S. persons, the question then became whether making a treaty election would qualify the taxpayer as being a foreign person for tax purposes and not subject to FBAR filing requirements. In this case, the Federal Court agreed with the taxpayer and held that the taxpayer was not required to file the FBAR.

• • • Case Name: Aroeste

    • Case Number: Case No.: 22-cv-00682-AJB-KSC

    • Date of Court Order: 11/20/2023

    • Court Location: USDC Southern District of California

What the IRS says (Pub 5569)

Publication 5569 is designed to summarize FBAR filing requirements. Here is what the publication specifically provides for taxpayers who make treaty elections to be treated as foreign residents:

• • • “Example: Kyle is a permanent legal resident of the U.S. Kyle is a citizen of the United Kingdom. Under a tax treaty, Kyle is a tax resident of the United Kingdom and elects to be taxed as a resident of the United Kingdom. Kyle is a U.S. person for FBAR purposes. Tax treaties with the U.S. do not affect FBAR filing obligations.”

In other words, the IRS takes the position that making a treaty election to be treated as a foreign resident does not negate the FBAR filing requirement.

The Court Rules in Favor of Taxpayer on FBAR

The court disagreed with the U.S. government and ruled in favor of the Taxpayers. Here, the court concluded that the Taxpayer did not have an FBAR filing requirement at the time the penalties were issued against him:

• • • “Specifically, the Court finds Aroeste is a United States person, but ceased to be treated as a lawful permanent resident of the United States because he commenced to be treated as a resident of Mexico under the Treaty, did not waive the benefits of such Treaty, and notified the Secretary of the commencement of such treatment. Thus, Aroeste is not subject to FBAR penalties. The Government must discharge Aroeste’s liability for penalties still outstanding for the non-filing of a FBAR for the years 2012 and 2013 pursuant to 31 U.S.C. § 5321, totaling $21,851.76, and must refund Aroeste’s payment of $3,004.”

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms and do not qualify for an exception or exclusion to FBAR filing, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.