Litigation Activity Keeps Spotlight on Reporting of Foreign Financial Accounts
With penalties including monetary fines and possible jail time, the Internal Revenue Service (IRS) and Department of the Treasury have shown how seriously they treat violations related to foreign financial account reporting. Considering such tough penalties, it is critical to understand who is required to file, what information is needed, and how recent cases could impact you.
Basic Filing Information
U.S. persons (which include individual citizens and resident aliens as well as U.S. entities) are required to file a report with the Department of the Treasury when they have a financial interest in or signature authority over a foreign financial account(s). This report is required when the aggregate balance in the account(s) is greater than $10,000 at any time during the calendar year. This foreign bank account report is commonly referred to as an FBAR and is filed on Form 114 with the Department of the Treasury (through their Financial Crimes Enforcement Network or FinCEN). Form 114 is due on April 15 each year with an automatic extension available to Oct. 15.
Failure to file an FBAR can carry a civil penalty of $10,000 for each non-willful violation (adjusted for inflation). For willful violations, the penalty is the greater of $100,000 or 50 percent of the amount of the account for each violation; additionally, criminal penalties can be imposed.
Recent FBAR Cases
1. United States v. Williams (489 F. App’x 655 (4th Cir. 2012))
The Williams case was the first significant case concerning the imposition of willful FBAR penalties. The taxpayer owned multiple foreign bank accounts to hold funds received from foreign sources. From 1993 to 2000, he deposited more than $7 million in the accounts, which generated over $800,000 in passive income. The taxpayer admitted that he knew of his obligation to report the accounts and associated income to the IRS and Treasury and chose not to do so. The IRS pursued criminal charges against the taxpayer, leading to the taxpayer pleading guilty to income tax evasion. The court sentenced him to nearly four years in jail, a $25,000 fine, and more than $3.5 million in restitution. The IRS initiated a civil examination for the missed FBAR filings and in January of 2007 asked the taxpayer to file an FBAR for calendar year 2000. The statute of limitations on an FBAR filing is six years from the due date of the filing. The taxpayer filed the missing FBAR, but the revenue agent then assessed civil penalties on the grounds that the taxpayer willfully violated the law and assessed a penalty of $100,000 per account.
The taxpayer appealed the assessment, and the district court agreed with the taxpayer that the guilty plea in the criminal case should not support civil penalties on the FBAR issue. However, the Fourth Circuit Court of Appeals did not agree. They determined that willfulness can be inferred from a taxpayer’s conduct and desire to conceal financial information as well as to avoid learning about reporting requirements.
2. United States v. McBride (908 F. Supp. 2d 1186 (D. Utah 2012))
The McBride case was another case that dealt with the willfulness standard and penalty imposition for FBAR cases. The taxpayer’s company had a series of foreign accounts and entities that were housing money from foreign operations. The taxpayer failed to correctly answer the foreign account related questions on Form 1040, Schedule B, Part III, signing and dating his Form 1040 for 2000 and 2001, answering these questions “no” for both years. Additionally, the taxpayer failed to file an FBAR for those years. Under audit, a revenue agent asserted a civil FBAR penalty (for each of 2000 and 2001) of $25,000 per account for a total of $100,000 for each year.
The district court ruled on several issues related to this case but spent the majority of their time looking at the issue of willfulness. Essentially, willfulness includes knowing of the FBAR filing requirement and recklessly disregarding it. The fact that the taxpayer answered “no” to the questions on Schedule B and signed and dated his tax return supports the fact that the taxpayer had knowledge of the requirement and intentionally ignored it.
Interestingly enough, the penalty imposed by the IRS agent was significantly lower than the statute required. Based on the statute, the agent could have assessed as much as $664,507 in penalties.
3. United States v. Bohanec, 118 AFTR 2d 2016-5537 (DC CA 12/8/2016)
The Bohanec case also looked at the issue of willfulness related to failure to file FBARs. The Bohanecs had foreign accounts in Switzerland, Austria, and Mexico in which foreign customers deposited commission money. The last income tax return that they filed was in 1998, and they failed to file income tax returns from 1999-2011. The Bohanecs entered the Offshore Voluntary Disclosure Program (OVDP), which required them to file their last eight income tax returns and last six FBARs. They completed and submitted them; however, they failed to report the Austrian and Mexican accounts, as well as Canadian commission income and income from online sales in their OVDP filing. The Bohanecs were subsequently removed from the OVDP program. The IRS then issued a notice for deficiency of additional tax, failure to file penalties, and civil fraud penalties of $492,163.61. Additionally, they applied the 50 percent FBAR willful penalty to the value of the foreign accounts. The Bohanecs contested the FBAR penalty in court. The only issue addressed by the court was the issue of willfulness.
The court concluded that willfulness, for purposes of the FBAR, includes recklessness. They cited several cases that concluded that willfulness includes a reckless disregard of a statutory duty. Additionally, the court looked to the foreign account related questions on Schedule B and indicated that the answer to that question showed that the taxpayers knew of their filing requirement and disregarded it.
4. United States v. Bussell, 120 AFTR 2d 2017-5444 (CA 9 10/25/2017)
In 2002, the taxpayer was found guilty of multiple charges in criminal court relating to tax evasion and hiding assets in bankruptcy. The court imposed a $2,393,527 criminal judgment. The criminal judgment was amended in 2005 and 2009, and ultimately the taxpayer was ordered to pay a special assessment of $300, a fine of $50,000, costs of prosecution of $55,626, and restitution to non-federal victims totaling $1,200,871. In 2013, the IRS assessed a civil penalty of $1,221,806 for failure to disclose her financial interests in an overseas account on her 2006 return. The taxpayer did not pay the penalty, and the IRS filed suit.
The district court found that the taxpayer had willfully failed to file an FBAR but reduced the fine. The court threw out the taxpayer’s argument that the fine was excessive under the Eighth Amendment because the offense was solely a reporting offense and not a serious crime. The court reasoned that while tax evasion was not as serious as some crimes, it clearly fits into the class of persons targeted by the Bank Secrecy Act. Additionally, the taxpayer could not prove that the money at issue was derived from a lawful source, which would provide greater Eighth Amendment protection. However, the court did determine that the assessment exceeded the maximum penalty in the statute. Therefore, the court reduced the penalty to $1,120,513.
The taxpayer appealed the district court decision. However, the 9th U.S. Circuit Court of Appeals rejected all arguments offered by the taxpayer, including the argument that the penalty violated the Eighth Amendment and an international treaty preventing double taxation between the U.S. and Switzerland.
Though petitioned by the taxpayer to review the decision, the Supreme Court refused, making the 9th U.S. Circuit Court of Appeals’ decision final.
5. Bedrosian v. United States, 2017 U.S. Dist. LEXIS 56535 (ED PA 2017)
The taxpayer in this case had years of non-compliance with the FBAR for two Swiss bank accounts. In 2007, he filed an FBAR but only listed the one account that had a smaller value and omitted the larger account. The IRS audited his return in 2011 as a result of the Swiss bank turning over information regarding U.S. account holders to the U.S. government. The penalty imposed was the largest penalty possible for a willful failure to file violation in the amount of $975,789. Bedrosian filed suit and took the issue to court.
The district court once again looked at willfulness and the definition that should be applied to FBAR cases. In this case, the court declined to infer that the taxpayer was aware of the larger Swiss bank account and found that the government had not effectively established that the taxpayer was anything more than negligent. The court stated that in order to determine whether the taxpayer’s actions were willful they had to look at the taxpayer’s knowledge, intent, and state of mind. The IRS did not successfully prove that, and thus the penalties imposed were not lawful and needed to be refunded.
Most practitioners expect that the IRS will appeal this decision.
In conclusion, the Williams, McBride, Bohanec, and Bussell cases all relate to the idea that that a taxpayer shows willfulness not only when the rule is violated but when it is recklessly violated, including lack of knowledge of the rule. Bedrosian concludes that willfulness is only shown when there is a voluntary, intentional violation of a known legal duty. Given the uncertainty as to the definition of willfulness, it is very important to report an interest in foreign accounts correctly on Form 1040, required FBARs, and other information reporting forms (i.e., Form 8938, etc.). The penalties imposed can be severe and draconian, and there is too much uncertainty in the court system as to how any violations will be treated. If you are uncertain about how to accurately report your foreign accounts or have questions about filing, please contact your KSM advisor.
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