Is a Tax Treaty Your Ticket to FBAR Freedom: What to Know

Is a Tax Treaty Your Ticket to FBAR Freedom

Claim Nonresidence Under a Treaty to Challenge FBAR Penalty?

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. 

Federal Court in Aroeste

The court determines that at least preliminarily, the tax treaty may impact FBAR filing requirements

As provided by the Court:

5-Step Analysis

• • • “A non-U.S. citizen is treated as a “resident alien” if he or she is a “lawful permanent resident of the United States at any time” during an applicable calendar year. An individual is a “lawful permanent resident” if he or she has been “lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with immigration laws” and if “such status has not been revoked (and has not been administratively or judicially determined to have been abandoned).” Id. § 7701(b)(6). However, “lawful permanent resident” status ceases to exist—at least for tax purposes—if an individual “commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, does not waive the benefits of such treaty applicable to residents of the foreign country, and notifies the Secretary of the commencement of such treatment.” Id.1

      • The upshot of this statutory and regulatory framework applicable to this action, in which tax treaties provide a potential escape hatch that excuses certain “United States persons” from filing FBARs, can be expressed as a 5-step process:

• • • • • • Under 26 U.S.C. § 7701(b)(6), anyone allowed to permanently reside within the United States by virtue of US immigration laws is a “lawful permanent resident” for tax purposes unless an applicable tax treaty allows that person to be treated as a resident of a foreign country for tax purposes only;

          • (2) Under 26 U.S.C. § 7701(b)(1)(A)(i), any “lawful permanent resident” is a “resident alien”;

          • (3) Under 31 C.F.R. § 1010.350(b)(2), any “resident alien” is a “resident of the United States”;

          • (4) Under 31 C.F.R. § 1010.350(b), Any “resident of the United States” is a “United States person” required to file an FBAR;

          • (5) Therefore, any person allowed to permanently reside in the United States by virtue of US immigration laws must file an FBAR unless that person is entitled to be treated as a resident of a foreign country under a tax treaty.

• • • It is undisputed that Mr. Aroeste is, and for many years has been, a “lawful permanent resident” of the United States as a matter of immigration law. Doc. No. 41 at 15:11-24. To use the colloquial terminology, he has a “green card.” Id. His status as a “lawful permanent resident” in turn makes him a “resident alien,” which means he is a “resident of the United States” and therefore, by operation of the statutes and regulations, at least presumptively a “United States person” required to file FBARs.”

Will the Tax Treaty Supersede Lawful Permanent Residency for FBAR?

• • • “The question is whether the Treaty provides him an escape hatch. Because the United States and Mexico indisputably have a tax treaty, Mr. Aroeste would not be a lawful permanent resident within the meaning of 26 U.S.C. section 7701(b)(6) if he commenced to be treated as a resident of Mexico under the Treaty (with the additional caveats enumerated in the statute); which might in turn have ultimately excused him from the requirement to file FBARs as a “United States person.” The Court therefore concludes a determination of Mr. Aroeste’s tax residency under the Treaty is directly relevant to—indeed it is outcome determinative of— the issue of whether he was required to file the FBARs at issue in this lawsuit.”

The Government’s Position

• • • “The United States first suggests application of the Treaty is irrelevant here because the Treaty only concerns income taxes and excises taxes, and Mr. Aroeste was assessed FBAR penalties under a wholly different body of law. See Doc. No. 36 at 7.

    • But this argument does not refute the plain language of the FBAR regulations, which explicitly invoke provisions of Title 26, including the provision that requires consideration of an individual’s status under an applicable tax treaty for the purpose of determining whether an individual is a “United States person” subject to FBAR filing.”

Court’s Ruling

• • • “The legal question of Mr. Aroeste’s residency under the Treaty during tax years 2012 and 2013 is directly relevant to this matter. The IRS’s administrative record contains information that is relevant to that issue because it contains the information the IRS considered in determining that Mr. Aroeste was a resident of the United States under the Treaty for tax years 2012 and 2013. It is, therefore, discoverable. However, only information in the record related to determining Mr. Aroeste’s status under the Treaty during tax years 2012 and 2013 is relevant and subject to production because other tax years are not at issue in this matter.”

Can a Tax Treaty Supersede FBAR Requirements?

In general, the Internal Revenue Service is taking the position that simply invoking a treaty election to be treated as a foreign resident would be insufficient to eliminate FBAR reporting. Included this in the most recent version of Publication 5569, which provides the following:

• • • • “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.”

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 that 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. 

Golding & Golding: About Our International Tax Law Firm

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

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