Delinquent international information returns and FBARs: the reasonable cause route when all income was reported

Which route fits which client

The IRS offers three published routes for offshore noncompliance, and the Form 14457 instructions list them as alternatives to the Voluntary Disclosure Practice for a taxpayer who committed no tax or tax-related crime. The choice turns on two questions: was any income unreported, and was the conduct willful.

The Form 14457 instructions describe the last two as follows: a taxpayer who reported all income and paid all tax but failed to file FBARs should consider the delinquent FBAR procedures, and one who reported all income and paid all tax but failed to file international information returns should consider the delinquent international information return procedures. If income was omitted, even a small amount, the delinquent procedures are the wrong tool, because the return is being amended for tax and the penalty exposure includes accuracy-related penalties the streamlined procedures were designed to settle.

The delinquent international information return procedures

The IRS page is short, and its terms are these. Taxpayers who have identified the need to file delinquent international information returns, “who are not under a civil examination or a criminal investigation by the IRS and have not already been contacted by the IRS about the delinquent information returns should file the delinquent information returns through normal filing procedures.” That is the whole procedure: there is no special address, no certification form and no program acceptance.

Filing mechanics from the page:

• “All delinquent international information returns, other than Forms 3520 and 3520-A, should be attached to an amended income tax return and filed according to the applicable instructions for the amended return.” For a Form 5471 that means a Form 1040-X or 1120-X for each year, even if nothing on the return changes.
• Forms 3520 and 3520-A are filed on their own, under their own instructions.
• A reasonable cause statement may be attached to each delinquent return for which reasonable cause is asserted. For Forms 3520 and 3520-A the page asks the filer to write Reasonable Cause Statement attached at the top of the first page.

The page ends with the point every client should hear before filing: “Penalties may be assessed in accordance with existing procedures.” The procedures do not promise penalty relief; they describe how to file and how to put the reasonable cause position in front of the IRS. The amended returns are not automatically audited but may be selected under the normal audit selection processes.

Nothing on the page conditions the filing on having reasonable cause: anyone not under examination or already contacted may use normal filing, and penalty consideration follows the ordinary rules described in international information return penalties.

Why a penalty may arrive anyway

The page says it directly: “During the processing of the delinquent information return, penalties may be assessed without considering the attached reasonable cause statement. It may be necessary for taxpayers to respond to specific correspondence from the IRS and submit or resubmit reasonable cause information.” In practice a Form 5471 or 5472 attached to an amended return can be penalized during processing, and the statement attached to the return may not be read until the taxpayer responds to the penalty notice (for a business, commonly a CP215). Plan for the response at the time of filing: keep the statement and its exhibits ready to send again with the notice.

Forms 3520 and 3520-A are treated differently. The page states: “Note that for Form 3520 and Form 3520-A reasonable cause statements will be considered prior to a penalty being assessed.” The red-ink notation at the top of the form is what routes the statement to a reviewer before assessment, so omit it and the form may be processed as an ordinary late filing.

IRM 4.63.3.18.13.2, written for VDP examiners, confirms the systemic behavior from the IRS side: where a taxpayer filed delinquent IIRs directly with the campus, examiners should review the modules for automatically assessed penalties, and abate them where not warranted. Outside a VDP case no examiner is assigned, so the taxpayer's response to the notice is what triggers that review. The appeal and refund routes for an assessed penalty are covered in appealing a penalty abatement denial and refund claims for paid penalties; these penalties are not subject to deficiency procedures, so there is no Tax Court prepayment forum.

The reasonable cause statement

The IRS page does not prescribe a format. The substantive standard is the one in reasonable cause generally: ordinary business care and prudence, judged on all the facts. Elements that belong in a statement for a delinquent information return, drawn from how the IRS evaluates these cases:

• Which form and years, and the fact that all income from the foreign entity, trust or asset was reported on the filed returns and the tax paid, with the lines on the returns where it appears.
• How the filing requirement arose and why the taxpayer did not know of it: the nature of the interest (for example, a minority stake acquired by inheritance, or an employer-provided foreign pension), what the taxpayer disclosed to the preparer, and what advice was given.
• When and how the failure was discovered, and that the delinquent forms were filed as soon as it was.
• Compliance history for the entity and the taxpayer, and the steps taken to prevent recurrence.
• A declaration under penalties of perjury, signed by the taxpayer, since the IRS treats an unsigned narrative as weaker evidence.

Reliance on a professional is the most common argument and the weakest when stated baldly. It is stronger when the statement shows the preparer was engaged for the foreign reporting, was given the facts that would have revealed the requirement, and gave advice (or failed to) on which the taxpayer relied. Where the taxpayer was never asked and never volunteered the foreign holding, say so and explain why a reasonable person in the taxpayer's position would not have known to raise it. Boilerplate statements filed with every form are what the IRS has described as not meeting the standard; each year and form should get its own facts.

Delinquent FBARs

The IRS FBAR page gives the direction: “If the IRS hasn't contacted you about a late FBAR and you're not under civil or criminal investigation by the IRS, you should file late FBARs as soon as possible to keep potential penalties to a minimum.” Filing is electronic only, through FinCEN's BSA E-Filing System, and the current FinCEN Form 114 is used for every year even though the reporting rules of the year in question govern whether a report was due. IRM 4.26.16.3.11 explains the explanation field: “Page one of FinCEN Form 114 should detail the reason the FBAR was not filed timely and a reason selected from the drop-down box. The 'Other' selection allows for a 750-character text box explanation.” The FBAR page notes that a taxpayer using a compliance option such as the streamlined procedures follows that option's instruction for the explanation box instead.

The penalty position is set out in the same IRM section: “A penalty will not be asserted for an account if it is determined that the failure to report the account on a timely filed FBAR was not willful, the failure to report the account on a timely-filed FBAR was due to reasonable cause, and the account was properly reported on the delinquent FBAR.” All three conditions must be met for the account, which is why the delinquent FBAR must be complete and accurate for every account, not just the one that prompted the filing. 31 USC 5321(a)(5) sets the non-willful penalty at a statutory maximum of $10,000 per violation (adjusted annually for inflation) and provides that no penalty applies where the violation was due to reasonable cause and the account was properly reported; the IRS FBAR page warns that the dollar figures in older materials may be out of date because of the annual adjustments.

Two practical points. First, an FBAR that was filed but omitted an account is amended, not filed as delinquent: check the Amended box, enter the prior report's BSA identifier (or fourteen zeros if unknown) and complete the whole report (IRM 4.26.16.3.12). Second, the 750-character box is the entire reasonable cause submission the IRS will see unless an examination follows, so it should name the reason (for example, unaware of the requirement for an inherited account; relied on a preparer who was told of the account), state that all income was reported, and state that the report is complete. Keep a copy of each filed FBAR and the BSA confirmation; the IRS can verify filing on the FinCEN query system, but the taxpayer's proof is the confirmation.

Representation for FBAR matters needs a Form 2848 that says so: the IRS FBAR page specifies the description of matter as Matters relating to Report of Foreign Bank and Financial Accounts or FBAR Examination, the tax form number as FinCEN Form 114, and the applicable calendar years. A general state-law power of attorney is also accepted.

Audit exposure and what the IRM tells examiners

Neither procedure buys audit protection. The delinquent returns page says amended returns, including amended information returns, may be selected for audit under the processes that apply to any return. If an examination follows, the reasonable cause statement filed with the return is the taxpayer's first position on penalties and will be measured against the records; the willfulness question for FBAR purposes is decided on the whole course of conduct, and the Form 14457 instructions and the streamlined pages both reserve criminal referral where willfulness is found.

Where the forms relate to a foreign entity, the IRS expects every year's return. IRM 4.63.3.18.13.2 (in the VDP context) states the IRS requires every information return for the disclosure period, and that a dissolved foreign entity excuses later years only on clear and convincing evidence of dissolution; the same section notes that simply asserting that an entity was abandoned does not end the filing requirement. Outside VDP there is no six-year cap: under IRC 6501(c)(8) the time to assess any tax on the return to which an unfiled Form 5471, 5472, 3520, 8938 or similar relates does not expire until three years after the form is furnished (limited to the related items where the failure was due to reasonable cause), so the question of how many years to file is a statute question as much as a penalty one. See the assessment statute of limitations.

On the examiner's side, IRM 4.63.3.18.13.2 directs that where an examiner secures a delinquent information return and decides a penalty is not warranted, the return is marked Delinquent Return Secured by Examination and Penalties Considered by Examination in red before processing, so the campus does not assess systemically. That marking is only available in an examination; a taxpayer filing on their own cannot invoke it, which is another reason the campus assessment often comes first.

Mistakes that cost clients the procedure

• Using it when income was unreported. Even a few hundred dollars of unreported foreign interest means the return is being amended for tax, and the IRS pages route that case to the streamlined procedures or VDP. The information return penalty exposure is the same, but the accuracy-related exposure and the willfulness question are not addressed by this route.
• Filing after contact. The procedures are available only to taxpayers who “have not already been contacted by the IRS about the delinquent information returns.” A soft letter about a foreign account, or an examination of any year, ends eligibility and the filing becomes a response inside that process.
• Attaching Form 5471 to nothing. Forms other than 3520 and 3520-A go with an amended income tax return for the year. A loose Form 5471 mailed to the campus is not filed under the procedures and may not be associated with the account.
• Omitting the red notation on Form 3520. The pre-assessment review of reasonable cause for Forms 3520 and 3520-A depends on the notation at the top of page one.
• One statement for all years. The page contemplates a statement attached to each return. A single generic narrative invites a systemic assessment and a weak record on appeal.
• Treating the FBAR box as a formality. The 750 characters are the reasonable cause record for the FBAR. Write them.
• Stopping at the forms. Where the entity's income should have been reported (Subpart F, GILTI, PFIC), the case is not a delinquent-forms case, and the IRC 6501(c)(8) exposure runs to the whole return.

Questions practitioners ask