Mr. FBAR – He Lurks in Every Corner – Katholos Case Expands Meaning of “Financial Interest”

We have another important FBAR case. The case is significant for 2 distinct reasons 1) clarification, and some may say, an ‘expansion’ of the definition of “financial interest” in an account requiring FBAR reporting and 2) a firm demonstration how far the Internal Revenue Service (IRS) will go to assert a civil “willful” FBAR penalty.

Next week’s post will look at the “willfulness” issue. Today’s post will examine point 1 – the court’s clarification of what it means to have a “financial interest” in an account, thus requiring FBAR reporting (assuming the aggregate dollar threshold is met).  This point involves an entity, specifically a Hong Kong corporation, with which the taxpayer was somehow involved.  The Hong Kong company held title to a Swiss account at UBS.  The case has now been dragging on for four years. I first blogged about Marika Katholos in September 2018.  One can only imagine the legal costs and hours of lost sleep for the taxpayer.

In US v Katholos No17cv531 WDNY Aug 10 2022, the United States government is seeking judgment against Ms. Katholos for an outstanding civil “willful” FBAR penalty (over $4.47 million) “for her failure to report …her financial interest in…a foreign financial account during the 2007 calendar year.” Detailed facts are set out in my prior blog post, but at that time, the court did not have a full explanation as to why certain foreign entities, such as the Hong Kong corporation, had been created by the Katholos family.  The reasons are explained in the more recent August decision.  The relevant facts are set out below as these relate to what is meant by having a “financial interest” in an account.

More factual details later. First, let’s review what the rules tell us about having a “financial interest” in a foreign account.

“Financial Interest” in a Foreign Account

FinCEN Form 114, Report of Foreign Bank and Financial Accounts, is used to report a financial interest in or signature or other authority over a foreign financial account.

The FBAR regulations and instructions spell out what these terms mean. Our focus today will be on what it means to have a “financial interest”.  From the instructions, which essentially parrot the regulations:

Financial Interest. A United States person has a financial interest in a foreign financial account for which:

1. the United States person is the owner of record or holder of legal title, regardless of whether the account is maintained for the benefit of the United States person or for the benefit of another person; or

2. the owner of record or holder of legal title is one of the following:
a. An agent, nominee, attorney, or a person acting in some other capacity on behalf of the United States person with respect to the account;

b. A corporation in which the United States person owns directly or indirectly:
(i) more than 50 percent of the total value of shares of stock or (ii) more than 50 percent of the voting power of all shares of stock;

c. A partnership in which the United States person owns directly or indirectly:
(i) an interest in more than 50 percent of the partnership’s profits (e.g., distributive share of partnership income taking into account any special allocation agreement) or (ii) an interest in more than 50 percent of the partnership capital;

d. A trust of which the United States person: (i) is the trust grantor and (ii) has an ownership interest in the trust for United States federal tax purposes. See 26 U.S.C. sections 671-679 to determine if a grantor has an ownership interest in a trust;

e. A trust in which the United States person has a greater than 50 percent present beneficial interest in the assets or income of the trust for the calendar year; or

f. Any other entity in which the United States person owns directly or indirectly more than 50 percent of the voting power, total value of equity interest or assets, or interest in profits.

“Financial Interest” Includes “Beneficial Ownership” – FBAR Required!

Even though the FBAR regulations and instructions do not clearly equate “beneficial ownership” with having a “financial interest”  in an account for FBAR reporting purposes, the Katholos court clarifies that having beneficial ownership (even without legal title) implicates FBAR reporting. The issue when an individual has “beneficial ownership” can get very tricky and requires a deep dive into the facts.

In Katholos, the facts are not fully clear, but here is what I have gleaned.  A Hong Kong corporation was created in 2005, but it is not clear who created it, perhaps the father of the taxpayer, Ms. Kathalos.  She seemed in any event, to act in a robotic capacity on behalf of her father.  The Hong Kong company had legal title to a UBS Swiss account (Storchen Finance Account).   It did not appear that Ms. Katholos funded the account, but perhaps she funded some of it.  She was listed as one of the beneficial owners of the Storchen Finance Account. The facts did not point to the Hong Kong company being a simple “nominee” for Ms. Kathalos; that situation would be more clearly covered by the FBAR regulations and instructions. See 2.a., above.

While legal title to the Swiss account was in the name of the Hong Kong company, it seems that the company could be said to have been acting in some capacity on behalf of Ms. Katholos.  (See the language at 2.a).  Why?  On a total of three occasions in a time span of 12 years, Ms. Katholos apparently treated at least some of the funds in the account as her own. We are not talking about regular use. Three events in total were listed by the court; 2 occurred in 2007 and 1 in 2017.  On one occasion she directed the Hong Kong company to send payments from the Storchen Finance Account to her personal account in Greece,  on another she directed the Hong Kong company to send funds from the Storchen Finance Account to a bank in Cyprus and finally she requested a loan be made to a 3d party from the account.  These incidents apparently led the Katholos court to determine she had “beneficial ownership” in the Storchen Finance Account.

The point to be made here is that sporadic use counts.  The court did not even refer to the language I quoted from 2.a, above. The court simply says that because Ms. Katholos had “status as a beneficial owner, the Court concludes that [she] had a financial interest in the [account].” In other words, beneficial ownership in an account means you have a financial interest in the account and have FBAR reporting duties lurking in the background. This applies even if you are not the only beneficial owner.

Implications for the American Abroad

Many Americans abroad are married to non-US persons. Foreign financial accounts are often titled solely in the name of the non-US spouse and funded solely by earnings of that spouse, with the US spouse having no signature authority over the account.  However, the inquiry does not stop there according to the Katholos court.  FBAR filing may be required of the US individual if he or she is treated as having “beneficial ownership” in the account.

Beneficial ownership can arise in various ways. For example, if the couple are living in a community property jurisdiction, even though a spouse is not named on the account, it could be community property over which the spouse has a legal and beneficial interest.  Even without community property rules, spouses often use funds without thinking and such use can raise beneficial ownership issues.

Take my example of the account solely titled in, and funded by, the non-US spouse.  It is not uncommon that the US spouse will ask the foreign spouse to send money on behalf of the US spouse for some purpose.  For example, a wedding gift to a friend, funds needed for a relative, to pay expenses solely belonging to the US spouse and so on  These kinds of acts can indicate that the US spouse has beneficial ownership to the account.   This of course means Mr. FBAR is at the door.

It is now critical that Americans abroad be thinking of Mr. FBAR all the time!  He clearly lurks in every corner.

Listen to a podcast discussing this issue with attorney John Richardson.

Reach out to me if you need help with FBAR issues.

Want to learn more about FBAR and earn CPE credits?  My comprehensive CPE course is here. 

Posted October 6, 2022

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