Need an FBAR Escape Hatch?

The Report of Foreign Bank and Financial Accounts (FinCEN Form 114) commonly called the FBAR is a crucial reporting requirement for US persons (citizens, green card holders and those meeting the substantial presence test) with foreign financial accounts. With the deadline for the 2023 FBAR set for October 15, my Forbes article provides information to review the basics and ensure compliance.  FinCEN has extended the due date until May 1, 2025 for certain persons affected by the hurricanes.  More detail here.

Today’s post will focus on a possible method to avoid FBAR filings for the green card holder who is no longer living in the United States and who lives in a favorable treaty country.

Treaty Tie-Breaker

It has been the position of the Internal Revenue Service (IRS) that the FBAR, must still be filed to report any foreign accounts, even though a green card holder has made a treaty tie-breaker claim.  In Aroeste v. United States, here, the U.S. District Court, So. Dist. California (Nov. 20 2023) put that position to rest. It concluded that under the “treaty tie-breaker” rules of the US tax treaty with Mexico the taxpayer, who held a green card for almost 30 years but had spent all of his life in Mexico, was a resident of Mexico and had no duty to file FBAR.

The FBAR regulation’s definition of a “United States person”responsible for filing FBAR includes “[a] resident of the United States” which is defined as “an individual who is a resident alien under 26 U.S.C. [Internal Revenue Code] 7701(b) and the regulations thereunder ….” 31 C.F.R. § 1010.350(b)(2).   A lawful permanent resident (green card holder) is a resident alien, but IRC section 7701(b)(6) provides that “[a]n individual shall cease to be treated as a lawful permanent resident of the United States if such 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.”

The Aroeste court determined that the taxpayer was within the exception contained in IRC section 7701(b)(6) even though: (i) Form 8833 notifying the IRS of his treaty claim was filed late, and (ii) the taxpayer failed to file Form 8854 regarding his expatriation (which occurred automatically upon claiming the treaty tie-breaker).   Briefly, all US citizens who relinquish US citizenship and all long-term residents who cease to be lawful permanent residents of the United States must file Form 8854 in order to certify, under penalties of perjury, that they have been in compliance with all federal tax laws during the five years preceding the year of expatriation.

The court held that while Mr. Aroeste’s failure to timely file Form 8833 could give rise to a late filing penalty, it could not result in denial of the treaty tie-breaker. As for Form 8854, the reasoning of the court was that the failure to file Form 8854 did not prevent Mr. Aroeste from claiming the treaty benefits. This was because the government had not complied with the Administrative Procedure Act when it issued IRS Notice 2009-85, the only available guidance for expatriation.  The court determined that Notice 2009-85 was invalid.

Conclusion

In conclusion, the court found that the taxpayer did not have an FBAR reporting obligation since he ceased to be a lawful permanent resident of the United States under the treaty tie-breaker rules. Furthermore, the IRS arguments regarding failures to timely file Form 8833 and Form 8854 did not negate the taxpayer’s ability to avail himself of the treaty tie-breaker.

The Aroeste case is a very significant taxpayer-win.   Aside from providing an FBAR escape hatch in the right circumstances, it has far reaching implications concerning IRS Notice 2009-85 and should be carefully considered by tax pro’s dealing with expatriation matters.