Meet the Zuhovitzky’s, the quintessential international couple: Jonathan (a naturalized US citizen and Israeli citizen living in Germany) and Esther (an Austrian and Israeli citizen who was never a US citizen or resident). I blogged about them and the IRS’ aggressive stance on asserting so-called FBAR penalties against Jonathan for having a power of attorney (POA) over Esther’s Swiss bank account at UBS. The case was settled in March 2021 with IRS dropping all the penalties. Now the couple is suing UBS for disclosing the account to the IRS in the first place. Disclosure was made by UBS pursuant to a John Doe summons served on the bank. It will be interesting to see how that separate lawsuit turns out.
Let’s look at the case of Jonathan and Esther Zuhovitzky and learn some important FBAR rules when it comes to international couples and POAs.
Quick Background
The Report of Foreign Financial Accounts (Form 114), or FBAR, is required by the “Bank Secrecy Act” and regulations issued by the Financial Crimes Enforcement Network (FinCEN) of the US Treasury. Hefty penalties apply for non-filing.
The Internal Revenue Service (IRS) had assessed a “willful” civil penalty against Jonathan Zuhovitzky, a financial and investment advisor, who for some time had been resident in Germany. Before they were married, his wife, Esther, had opened a bank account with UBS in Switzerland, funding it with money she had inherited from a non-US person. Beginning in 1988 Jonathan held a power of attorney (POA) for his wife’s account. More detailed facts are set out in the taxpayer’s Complaint and at my earlier tax blog post here.
IRS audited the taxpayer and the case was referred to the Criminal Investigation Division (CID) of the IRS. The CID agent stated it would be closing the case for the following reasons: the taxpayer’s wife was not a US citizen and she was the sole beneficial owner of the account, there was no unreported income involved; and the agent could not adequately establish “willfulness” on Jonathan’s part for the failure to file an FBAR reporting this account over which he had only a POA. Despite these findings the IRS agent assessed a willful FBAR penalty against the taxpayer in an amount over US$5.1 million! Through various levels of appeals and taxpayer’s lawsuit on the matter, the FBAR penalty with interest and various additional penalties added on top, reached the staggering total amount over US$9.8 million. Some of Jonathan’s Social Security benefits were garnished during this trying time.
IRS settled the case (Order of Settlement) and the FBAR penalty was reduced to zero. Most likely, IRS was quite concerned with the uncertainties of the outcome if the case went to trial. Settlement was probably viewed as the best route for the agency to take. Remember, Jonathan had no beneficial interest in the UBS account; he never contributed to it, the funds were inherited by his non-US wife from a foreign relative prior to their marriage. Jonathan merely had signature authority over the account through the POA granted to him by Esther. No unpaid taxes were involved whatsoever and a total penalty over US$9.8 million is clearly draconian under these facts.
Some Lessons to Learn
When international spouses of different nationalities live, work and hold assets in multiple countries, FBAR issues multiply. The myriad facts often create difficulties knowing who needs to disclose which accounts on the FBAR. A US person that has a “financial interest in” or “signature authority over” foreign financial accounts must file an FBAR if the aggregate value of the foreign financial accounts exceeds US$10,000 at any time during the calendar year.
“Financial Interest” – A Tricky Concept
Under the current FBAR instructions, a US person is considered to have a financial interest in a foreign financial account under numerous circumstances, including when the US person holds title to the account merely as a nominee for a foreign person. This situation often arises when for the sake of convenience, a US adult child holds title to an account beneficially owned by an elderly foreign parent.
A trickier case –under the FBAR instructions, the US person is treated as having a “financial interest” in a foreign financial account held in the name of a person acting as an “agent, nominee, attorney, or in some other capacity on behalf of” the US person. The vague reference to “some other capacity on behalf of” can be read quite broadly.
For example, it can arguably cover a situation involving a foreign country’s community property regime when the community property rules give one spouse an interest of some kind in a foreign financial account that is held solely in the name of the other spouse who is a nonresident alien. It can also arguably cover the case when the spouses do not live in a community property jurisdiction and even when they maintain separate financial accounts. I see this arise, for example, when in the case of gifts for the couple, well-meaning relatives deposit gifts of cash to the couple, sending it to the account owned solely by the foreign spouse. By virtue of holding cash that belongs in part to the US spouse, the foreign spouse can be viewed as acting as an “agent, nominee or …. in some other capacity on behalf of” the US spouse, thus giving the US spouse a finanical interest in that account.
POA’s – Not All are Equal
A POA is a legally recognized authorization giving a designated person (the “agent” or “attorney-in-fact”) the power to act for another person, the “principal”, with regard to the principal’s property, finances, investments, or medical care.
As mentioned, having signature authority over a foreign financial account can raise FBAR filing duties. “Signature authority” is the authority of an individual (alone or in conjunction with another individual) to control the disposition of assets held in a foreign financial account by direct communication (whether in writing or otherwise) to the bank or other financial institution that maintains the financial account. A POA typically provides such authority and it is important to note that whether or not the authority is ever exercised is irrelevant to the FBAR filing requirement.
Not all POAs are the same – you may have heard of a “durable” POA or a “springing” POA. Each will raise special FBAR concerns.
A “durable” POA is often given before the principal has any kind of mental or physical incapacity and is therefore fully capable of managing his or her own financial affairs. As such, there may be a long period of time during which the powers are not exercised by the power holder. The holder will often not have any knowledge about the assets or accounts of the principal and unless the power holder inquires and gathers information regarding the principal’s accounts it is easy to understand how FBAR duties can be overlooked. In fact, sometimes the power holder may not even be aware that he has been appointed by the principal. The POA may be retained in escrow with the principal’s estate planner or attorney and is released to the agent only when the attorney learns it is needed. Arguably, such lack of knowledge could be a defense to FBAR penalties.
Some jurisdictions permit what are called “springing” powers. These are powers that do not become effective until the principal suffers some kind of mental or physical incapacity. Even if the agent knows he holds the POA, he may not be informed that it has become effective. Again, this lack of knowledge could be a defense to FBAR penalties, but one can imagine there will be disputes with the IRS over such matters. In addition to the FBAR issues that are raised, springing powers raise other issues – such as when the principal might be treated as incapacitated. Will a medical doctor need to certify this? Is the opinion of one doctor sufficient?
Some financial institutions may not recognize the POA at all, especially if the POA was executed in a jurisdiction that is different from that where the financial account is located.
Tax professionals should be aware of all of these issues and ask the appropriate questions on tax organizers and at their client meetings. It is most important to ensure that all parties understand the FBAR implications that come about with the use of POA’s.
Posted January 20, 2022
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