Tax Treaty Shields Green Card Holder From FBAR Penalties But Not Late Filing of Form 8833

According to Law360, a Mexican national who holds a U.S. green card doesn't owe penalties for failing to report his foreign bank accounts, even though he told the U.S. government late that he claimed Mexican residency under an international tax treaty.

Alberto Aroeste, who was assessed $100,000 in foreign bank account reporting penalties by the Internal Revenue Service for failing to report his accounts for 2012 and 2013, doesn't have to pay the outstanding $21,900 bill, U.S. District Judge Anthony K. Battaglia said in an order on November 20, 2023. Aroeste is also owed a $3,000 refund for payments he already made to the IRS, the judge added.

But Aroeste owes a $1,000 penalty for each of the two tax years for failing to tell the U.S. until he filed amended returns in 2016 that he claimed treatment under a Mexico-U.S. tax treaty as a resident of Mexico, Judge Battaglia said. Aroeste, who is in his 80s, lived with his wife in Mexico City, where he spent more than 75% of his time during the tax years at issue, according to the opinion.

Aroeste argued he was not required to file Form 8833 disclosing his treaty-based return position for 2012 and 2013 under a U.S. Treasury Department regulation that exempted people whose residency had been determined under a treaty and separate from the Internal Revenue Code. 

While Judge Battaglia Sided With The U.S. Government,
Which Argued That The Regulation Did Not Relieve Aroeste
Of The Requirement To File The Disclosure Form,

He Agreed With Aroeste's Argument That His Claim For
Treaty Status, Even Made Late, Entitled Him To
The Benefits Or Application Of Treaty Law.

The judge cited two cases, including the 1999 U.S. Tax Court decision in Pekar v. Commissioner, in which courts found that untimely notice of a treaty position still afforded taxpayers treaty protection.

Rather Than FBAR Penalties, Aroeste Is Subject To The $1,000 Penalties Laid Out In Internal Revenue Code Section 6712 For Failing To Comply With The Requirement To File A Treaty-based Return Position Under IRC Section 6114, The Judge Said.

Judge Battaglia also rejected the government's argument that Aroeste should have filed an expatriation statement form, Form 8854, with his returns, saying he agreed with Aroeste that the form is not legally binding. The form is required under IRS Notice 2009-85, but that notice failed to comply with the notice-and-comment requirements of the Administrative Procedures Act, the judge said, citing the 2022 case Mann Construction v. U.S. 

Aroeste and his wife told the court in their complaint last year challenging the FBAR penalties that they briefly joined the IRS' voluntary offshore disclosure program for reporting foreign accounts in 2014. Their current attorneys directed them to drop out in 2016, and the couple said they refiled their 2008 through 2014 returns. Alberto Aroeste refiled as a nonresident for those years, and Estela Aroeste, after she became a U.S. citizen in 2011, filed as married filing separately, according to their complaint.

The IRS began auditing the couple after they dropped out of the disclosure program, the couple said, and the agency ultimately assessed $10,000 in nonwillful penalties against Alberto Aroeste for each of his five Mexican bank accounts in 2012 and 2013. It also assessed a $5,000 penalty against his wife for each of her accounts during the same period, as well as a $500 penalty for each account she held jointly with her husband for 2013. The government abandoned its effort to recover the $27,000 debt from Estela Areoeste in May in exchange for a settlement.

The government told the court in August that in addition to missing the deadline for notifying the U.S. that he claimed protected treaty status, Aroeste originally filed jointly with his wife, which, because of her dual citizenship, prevented him from claiming protected status under the treaty outlined in Article 4 of the U.S.-Mexico Income Tax Convention. Ultimately, the government decided not to accept Aroeste's amended returns, making them invalid, the government argued.

Aroeste's lawyer, Patrick Martin of Chamberlain Hrdlicka, told Law360 that the ruling was significant. It upends the IRS' practice of stripping individuals of tax-treaty protection for failing to file forms on time, including forms that aren't legally binding, Martin said.

The IRS has tried to pin $3 million in information reporting penalties on Aroeste since it began its audit, Martin said. 

Aroeste, who has a vacation condominium in Florida, has never permanently resided in the U.S. and only had a green card because the Mexican employer he worked for was a U.S. subsidiary and required it in order to participate in its pension plan, Martin said.

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