Kotholos – New Case Shows IRS Aggression in Asserting FBAR “Willful” Penalty

I have been blogging recently (here and here) about the IRS’ aggressive stance in determining what constitutes a taxpayer’s “willful” failure to file an FBAR and the fact that mounting court cases show the judiciary is buying in to the IRS’ position.  Courts appear to be more easily upholding a finding of “willfulness” when it comes to offshore holdings.  My concern with this trend is that “mild” facts might be treated as “nonwillful” today, but by tomorrow they will be “bad” facts supporting a finding of “willfullness” under the IRS broadening view of “willful” behavior for civil FBAR penalties.

We now have an important case to watch in this regard: United States v. Marika Kotholos (W.D. N.Y. 17-cv-00531).  Ms. Kotholos is being sued by the Government for almost $4.75 million in civil “willful” FBAR penalties (including statutory additions and interest).  Ms. Kotholos is a housewife who has been living in Greece since 1994 with her Greek husband.  Yikes! The Government complaint is here; Ms. Kotholos’ answer is here.

United States v. Marika Kotholos

Here’s what I can tell about the Kotholos facts:

Ms. Kotholos is a US citizen and has been living in Greece as a homemaker since 1994 with her non-US husband, Mr. Maragakis, a Greek national.  Initially the family had bank accounts in Greece, but due to privacy and security concerns, the funds from these accounts were moved to Switzerland in 1998.  Later, in 2005, a Lichtenstein family foundation (“Foundation”) and a Hong Kong company were created. It is unclear why these were created, but the US court is seeking to find out.  Ms. Kotholos was listed as a beneficial owner of the Foundation and the Hong Kong company.

In letters rogatory (e.g., to the court in Lichtenstein here to obtain testimony from a director of the Foundation; to the court in Greece here to obtain testimony from Ms. Kotholos’ husband) the US court seeks assistance from the foreign courts to ascertain the underlying reasons for the creation of these entities.  For those readers who are unfamiliar with “letters rogatory” or “letters of request”, these are simply formal requests from a court in one country to a foreign court for some type of judicial assistance. Usually, the assistance requested is for the service of process or the taking of evidence. If you ever need to prepare a letter rogatory, here’s a very helpful and amusing guide

Swiss accounts were established at UBS for each of the Foundation and the Hong Kong company.  It appears that some funds were the nonresident alien husband’s property (thus, in principle, income earned on these funds may not be subject to US tax).  The accounts were established in Switzerland due to a lack of security and lack of privacy with banks in Greece.  Greek bank employees were said to gossip about clients and their holdings and kidnapping was a concern to the family.

The excerpt, below, from the taxpayer’s answer addresses the issue of her “nonwillfulness” in failing to file an FBAR (I did not include any of the taxpayer’s other arguments such as the statute of limitations). On its face, the answer puts forth some sound reasons that can indicate “nonwillfulness”, but significantly I did not find it directly addressed why the Lichtenstein Foundation or the Hong Kong company were created as part of the structure.

AFFIRMATIVE DEFENSE NO. 1: MARIKA DID NOT ACT WILLFULLY

  1. The administrative record and Complaint fail to establish any factual basis for assertion of a willful FBAR penalty against Marika. 31 U.S.C. § 5321(a)(5)(C) imposes a civil money penalty for willful failures to file certain reports required to be filed under 31 U.S.C. § 5314, including the FBAR. As outlined in the statute, the amount of the willful penalty may be 50 percent of the high balance in the account at the time of the alleged failure to file the FBAR form. On the other hand, if a taxpayer does not act willfully—for example, if she failed to file the FBAR because she did not know the form existed or was required to be filed—the civil money penalty under 31 U.S.C. § 5321 shall not be greater than $10,000.
  2. Willfulness is a required element of the penalty asserted by the Government against Marika. The Government’s effort to reduce the FBAR penalties to judgment fails because the Government cannot meet its heavy burden to establish a necessary element for enforcement of the penalty—that Marika knew of the FBAR filing obligation and willfully failed to file the form for the 2007 tax year.
  3. The Complaint’s case for willfulness appears to rest on three major factual allegations, all of which are either incorrect or misleading. First, the Government alleges that Marika was on “inquiry notice” about FBAR reporting because of a 2007 federal income tax return. At the time of the filing of the Complaint, however, the Government possessed information demonstrating that Marika did not sign the 2007 federal income tax return that allegedly put her on “inquiry notice” regarding her FBAR obligations. Further demonstrating that she did not review this return, the 2007 return filed for Marika contains numerous, obvious errors: Marika’s name is misspelled and her address is incorrectly given in Elma, New York.
  4. Marika’s history of filing U.S. returns since her move to Greece in 1994 demonstrates that she was not fully aware of the relevant U.S. tax rules for reporting income overseas. Prior to 2009, federal tax returns were filed for Marika to report her interests in family assets that generated income in the U.S., such as annuities or rental income from real estate. When there was no U.S. income in a particular year, returns generally were not filed. In many or most cases prior to early 2009, Marika did not see or sign federal tax returns filed for her.
  5. Second, the Internal Revenue Service’s (“IRS’s”) interview with Marika’s return preparer Charles Koelemeyer, conducted more than four years after the relevant events, only demonstrates that he knew of FBAR reporting requirements well after the time period at issue. It does not demonstrate that he ever advised Marika about these requirements—or even that he ever spoke to her directly about taxes or U.S. reporting—prior to January 2009. Instead, once Marika learned of the relevant U.S. reporting requirements, she attempted to make a voluntary disclosure to the IRS in February 2009, months before the start of the formal Offshore Voluntary Disclosure Program. Marika’s effort was rejected as untimely because, on information and belief, UBS had delivered her name to the IRS within one week prior to her disclosure.
  6. Finally, the Government alleges that Swiss bankers took actions, including signing forms, to conceal the relevant accounts from U.S. authorities. These are simply not allegations that Marika acted willfully: the allegations describe actions taken by Swiss bankers, not by her and her family. Instead, the long history of Marika and her family in Greece demonstrates that the UBS accounts were not set up for a U.S. tax-avoidance purpose. Marika moved to Greece in 1994, shortly after college, and has been a homemaker and caretaker of her children since that time. Marika’s father Theodore Katholos (now deceased) (“Mr. Katholos”) immigrated to the U.S. in the mid-1960s with a second-grade education in Greece, and became successful in the painting and contracting business in Buffalo, New York through hard work and determination, not through formal schooling. Mr. Katholos was largely unable to read or write in English. He was very successful in business, particularly given his background, but he lacked sophistication and training in tax matters. In the 1980s, Mr. Katholos seriously considered emigrating back to Greece, and so did Marika. When Mr. Katholos retired in 1997, he had intended to move back to Greece permanently.
  7. The Katholos family set up accounts in Switzerland in 1998, moving their funds from Greek banks because of concerns about privacy and security. They felt there was a great risk that the Greek banks were corrupt, and that there were no true guarantees for deposits. Also, in dealings with Marika’s and her husband George’s local bank in Greece, there seemed not to be a policy on secrecy. Information on account values was easily discussed (basically, gossiped about) among employees, a great deal of whom were local residents. These concerns only heightened when Marika and George contemplated starting a family. Their first child was born in 1999, shortly after the Swiss accounts were established. The occurrences of kidnapping are unfortunately not so uncommon in Greece.
  8. In dealings with the Swiss bank, Marika’s father Theodore Katholos was the primary decision-maker. Marika had signatory authority because of Mr. Katholos’ limited reading and writing skills and because she was the one member of the family located in Europe, with more convenient access to the bank.
  9. In short, the security offered by the Swiss banking system—and not tax avoidance in the U.S.—was the motivating factor in setting up the relevant accounts. Marika’s meetings and conversations with Swiss banking advisors are consistent with the purpose of opening the accounts in Switzerland—to ensure privacy and security for Katholos and Maragakis family assets, in contrast to the unstable Greek banking system where these assets had been previously held. There is no factual allegation in the Complaint (other than summary legal assertions) supporting a conclusion that the accounts were established for any U.S. tax purpose.

What’s Next?

The Kotholos complaint shows the IRS is really flexing its FBAR muscles in the courthouse! Compare the Kotholos facts to those in another recent FBAR “willful” penalty case, Kimble v. United States (CFC Dkt. no. 17-421 T), here.  The Kimble facts could not get much worse for the taxpayer, so I can see why Kimble should be held liable for a “willful” failure to file!  Marika Kotholos, however?  I think the IRS’ aggressive stance stems more from the following: the relevant bank was UBS (a bank on the notorious bad boy list); it involves the country of Switzerland which has been in the cross-hairs for some time; the accounts are large and that means big tax dollars and penalties can be collected.   It appears to me that the total picture is ignored, however – the accounts were originally set up in Greece, the country of taxpayer’s home with her Greek husband. The accounts were only moved to Switzerland after several years because of what sound like valid security and confidentiality concerns. The taxpayer and her family do not sound very sophisticated from a tax perspective even though they have done well financially. I question whether they understood the implications of setting up the Foundation or the Hong Kong company.  Somehow I doubt it. The pattern of tax filings indicates Ms. Kotholos (and her US accountant) did not understand the complexities of the US tax regime when it comes to offshore assets. The year at issue was 2007 – not many tax practitioners were aware of FBAR back then.  Frankly, I think IRS may be looking at Kotholos with that wonderful 20/20 hindsight.

It will be interesting to see if the court upholds a finding of “willfulness” on the Kotholos facts, which are so very different from those in Kimble. One thing is abundantly clear, the IRS is becoming more and more aggressive in what it considers “willful” behavior when it comes to FBAR filings.  Let’s see how far the IRS will get in taking its FBAR crusade to even higher levels.

Published September 2, 2018

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2 thoughts on “Kotholos – New Case Shows IRS Aggression in Asserting FBAR “Willful” Penalty

  1. Well, the very existence of this case proves the need to renounce U.S. citizenship “quick time” (if you don’t live in the USA).

    Undoubtedly, some will try to portray this as evidence of the IRS specifically going after “Americans Abroad” for FBAR penalties. As horrible as this is, I don’t interpret it that way.

    Here is why …

    1. The accounts were with UBS which was the bank in the “Eye Of The Storm”

    2. The accounts were in a country that was different from where she lived (Greece).

    3. If Switzerland isn’t bad enough we have Hong Kong and Lichtenstein.

    4. The accounts balances were high enough to provide a good IRS penalty base.

    Given these circumstances I doubt the IRS would care where the “taxpayer” was located.

    I strongly recommend that you read the Taxpayer’s reply (linked from the article). In addition to focusing on the lack of evidence of willfulness, it describes how the government failed to follow its own internal procedures for assessing these penalties, which is significant.

    Finally, as the post describes, I am struck by three things:

    1. The extent to which she was not properly educated on how the Internal Revenue Code applied to her while living outside the United States.

    2. Her use of a U.S. based tax preparer (who in 2007) probably have had little of no knowledge of these issues

    3. The lack of financial sophistication in her family.

    These are people who worked hard for their money and were simply trying to manage the fruits of their labor. They were not people who were trying to cheat the IRS (whether they owed any U.S. taxes or not).

    An FBAR penalty may or may not be appropriate. But the “willful” penalty is arbitrary, capricious and unjust.

    This reminds me very much of Marie Curran’s “Adventures In FBAR”. For those who haven’t heard of Ms. Curran (even the trial judge disagreed with her prosecution), you will find her story here:

    https://www.forbes.com/sites/robertwood/2013/01/08/florida-widow-guilty-21m-penalty-for-inherited-swiss-liechtenstein-accounts/#402b2e7722da

    In closing …

    This is happening to a housewife in Greece who actually tried to disclose the accounts to the IRS. Looks like the “FBAR Fundraiser” is alive and well.

    Liked by 1 person

  2. The Taxpayer’s “Answer” to the Government’s complaint is dated August 11, 2017. A significant part of the Answer focuses on the assertion that the Government’s complaint provides no evidence of “willfulness”. Yet, the “letters rogatory”, sent to the courts in Lichtenstein and Greece – which are an attempt to find evidence of “willfulness” – are dated August 28, 2018. Does this suggest that the Government asserted the “willful” FBAR penalty prior to having direct evidence of “willfulness”?

    I don’t know the rules of Civil Procedure for this court, but at first blush, It would seem that the court is “bending over backwards” to help the government prove willfulness by sending the information requests to Lichtenstein and Greece.

    Also of interest is the fact that the Government’s complaint demands a jury trial. What wold a jury in upstate New York think of an immigrant family, that “made good” and returned to live in Greece?

    Liked by 1 person

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