In a recent Order On Joint Discovery Motion, U.S. Magistrate Judge Karen S. Crawford of the U.S. District Court for the Southern District of California highlighted a potential escape hatch that could excuse certain “United States persons” from filing Form 114, “Report of Foreign Bank and Financial Accounts,” commonly known as the “FBAR”.
In Aroeste v. United States, Case No. 22-cv-682-AJB-KSC (S.D. Cal. February 13, 2023), the Judge outlined a five-step process to determine if a “lawful permanent resident” (i.e., “green card holder”) who elects to be treated as a resident of a foreign country under a tax treaty is exempt from filing an FBAR.
Background
Historically, the IRS’s position has been that if a taxpayer is a U.S. resident by virtue of having met the “substantial presence test” or by having been “lawfully accorded the privilege of residing permanently in the U.S. as an immigrant in accordance with immigration laws” (i.e., having been issued a “green card”) and if “such status has not been revoked (and has not been administratively or judicially determined to have been abandoned) , and that taxpayer elects to be treated as a U.S. non-resident under an income tax treaty, the election applies only for purposes of determining income tax liability, but for all other purposes of the Internal Revenue Code (IRC), including FBAR reporting, the taxpayer is treated as a resident.
The IRS position is based on Treas. Reg. §301.7701(b)-7(a)(3), which states:
(3) Other Code Purposes. Generally, for purposes of the Internal Revenue Code other than the computation of the individual’s United States income tax liability, the individual shall be treated as a United States resident.
Order On Joint Discovery Motion
Taxpayer Alberto Aroeste was a green card holder who lived in Mexico and took the position that he was a Mexican resident and a non-resident for U.S. tax purposes under the U.S.–Mexico tax treaty’s tiebreaker rules. He argued that because he was a resident of Mexico under the tax treaty, he was not required to file an FBAR. The IRS disagreed and contended that an FBAR filing requirement continued to exist despite the treaty claim.
The U.S. Magistrate Judge in the Order On Joint Discovery Motion stated that “the upshot of the 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:
(1) 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.
BDO Insights
The court ordered that “the United States must produce all portions of the administrative record, whether generated during the initial audit or during any subsequent proceedings, which are relevant to Mr. Aroeste’s residency under the Treaty during tax years 2012 and 2013.” All documents were to be produced by February 27, 2023.
For now, we must wait and see what comes from the discovery. The U.S. Magistrate Judge has made her position known in the Order On Joint Discovery Motion, but we may not have heard the last from the U.S on this matter.
Thomas McGlynn
Iliyan Tzakov
BDO in United States