FBAR “Willfulness” – Fifty Shades of Gray

It’s been awhile since I have blogged about our friend, Mr. FBAR.  For those of you who are not familiar with his nickname, you may know him by his more formal moniker “Report of Foreign Bank and Financial Accounts” (FinCEN Form 114).  He springs from Title 31 of the Bank Secrecy Act (not the Internal Revenue Code). He is an old friend. In fact, he has been around since the 1970’s.

The FBAR must be filed by “US persons” if  (i) the person has an interest in, or signatory authority over, (ii) a foreign (non-US) financial account, and (iii) the aggregate value of all those foreign accounts exceeds $10,000 at any time during the calendar year.

Today’s blog post reviews a more recent case in which we can see the Government flexing its muscles and pushing the FBAR “willful” penalty boundary. The court rejects the IRS’ most egregious argument, but buys in on its other argument.  Let’s have a look at United States v. Schwarzbaum, Case No. 18-cv-81147-BLOOM/Reinhart, 7 (S.D. Fla. March 20 2020)

Background Facts

The taxpayer, Isac Schwarzbaum was born in Germany, obtained a green card in middle age and within 5 years became a US citizen.  The taxpayer’s father was very well off and over the years, transferred $100,000 – $200,000 a year to the taxpayer. In 2001, the father signed over a Swiss account valued at approximately $3 million; another significant gift was made in 2007. During the years in question, 2006-2009, the taxpayer had interests in various Swiss bank accounts and in two bank accounts in Costa Rica.

The taxpayer hired Ms. Doris Shaw to prepare his income tax return in 2006 and told her about the gifts from his father. Shaw advised him that gifts are not reportable unless there is a US connection, which taxpayer understood to mean that a gift was only reportable if it came from a foreign country into the US or went out from the US to a foreign country. It was not clear if Shaw advised taxpayer about foreign account reporting on the FBAR.   Based on Shaw’s advice, the taxpayer incorrectly believed that foreign accounts were only reportable if they had a “US connection” and so, he did not tell her about all of the foreign accounts.  As a result, for 2006, only one Costa Rican account was reported on the FBAR and mentioned on Form 1040, Schedule B.

In 2007-2009, another professional prepared the taxpayer’s returns.  He did not ask about foreign accounts and the taxpayer never mentioned his accounts. As a result, no foreign accounts were reported on the taxpayer’s 2007 Schedule B, nor was a 2007 FBAR prepared for him. The taxpayer, however, did prepare his own 2007 FBAR reporting the Costa Rican account that had been previously reported in 2006.  Similarly, the 2008 income tax return prepared by this same preparer did not report any accounts on the 2008 Schedule B.  Neither the preparer nor the taxpayer prepared a 2008 FBAR.  In 2009, taxpayer claimed  he had told the preparer about the two Costa Rican accounts, yet the Schedule B of his return did not report any foreign accounts. Taxpayer prepared and filed a 2009 FBAR reporting the Costa Rican account and one of his Swiss bank accounts (he included the Swiss account in 2009 because he had made multiple transfers to it from US accounts thus giving the account a “US connection”, which he believed subjected the account to reporting).

In October of 2009, taxpayer received a letter from one of his Swiss banks, UBS, explaining that the IRS had submitted a treaty request to obtain information about the accounts of certain individuals maintained at UBS, and that his account appeared to fit within the scope of the request. In 2011, the taxpayer joined the IRS’ Offshore Voluntary Disclosure Initiative (“OVDI”). He and the IRS agreed to additional income tax, interest, and accuracy-related penalties due as a result of the failure to report interest earned on foreign accounts, which amounts the taxpayer promptly paid. However, he then opted out of OVDI and underwent full examinations leading to the dispute regarding the FBAR “willful” penalty.  (Initially, mitigated “willful” FBAR penalties were assessed for 2006-2009 in the amount $35.4 million. This amount, though mitigated, was deemed excessive, and the IRS later further mitigated the penalties, arriving at a total penalty amount of $13.7 million).

The IRS brought suit in district court to collect the penalties. The taxpayer did not contest he had violated the disclosure and FBAR filing requirements for each of the years. Rather, he argued (among other things) that his violations were not willful and he should therefore not be subject to a willful FBAR penalty.

District Court – A Win and a Loss for Taxpayers Everywhere

The Bank Secrecy Act and relevant Regulations governing the FBAR do not define the term “willful”. The FBAR penalty is a “civil money penalty.” 31 U.S.C. § 5321(a)(5)(A) and we have been seeing the trend in the cases examining “willfulness” in the FBAR context to cover not only “knowing” violations, but violations caused by “willful blindness”, and by “reckless” disregard as well. In a nutshell, “willfulness” in the context of a FBAR violation does not require actual knowledge of the duty to report an interest in a foreign account.

The question is how far can the IRS go in saying a taxpayer willfully violated the FBAR rules? If the taxpayer merely signs his tax return and Schedule B is part of the return, is the act of signing the return along with the Schedule B sufficient to charge the taxpayer with knowledge of the FBAR reporting requirement?  According to the IRS, the answer to that question is “yes”.  The IRS has made this argument before and we see it again in the more recent Schwarzbaum case.

The Win:

In Schwarzbaum, the IRS argued that a taxpayer is charged with knowledge of the information on a tax return by virtue of signing it under penalties of perjury.  Under the IRS view, since the taxpayer filed his income tax returns and FBARs, but these did not fully and properly report his foreign accounts, he knowingly violated the FBAR reporting requirements. Thankfully, the court rejected this argument. If the IRS view were to be accepted, it would render the distinction between “willful” and “nonwillful” penalties absolutely meaningless. Taxpayers are always required to sign their tax returns. If the IRS’ view was accepted, it would follow that a violation of the FBAR filing requirements could never be “nonwillful”, despite the fact that the statute provides for a “nonwillful” penalty.

The Loss:

The court determined that the taxpayer’s failure to report all of his foreign accounts for the years in which he self-prepared his FBARs was “willful” even though he may have misunderstood some of the rules based on advice given to him in an earlier year by his tax return preparer.  The court found that because the taxpayer had reviewed the FBAR instructions the first year he prepared the FBAR, he knew or should have known the FBAR reporting requirements.  The court examined various aspects of the FBAR instructions and found them abundantly clear. The violation of the FBAR requirements for those years was willful because the taxpayer was willfully blind or reckless in violating them.

With this holding, the court fell into step with the current trend, accepting the line of cases that permit recklessness or willful blindness to satisfy the “willful” standard for FBAR violation purposes.

The Takeaway

IRS is becoming more and more aggressive in asserting FBAR penalties and over time we have seen that the courts are making it easier and easier for the IRS to succeed on a “willful” argument.  Taxpayers who have remained tax noncompliant need to take the appropriate action.  What such action may be for different taxpayers will depend entirely on his or her specific facts. Taxpayers should not feel pressured to jump into Voluntary Disclosure, but they cannot sit back and do absolutely nothing. Getting good tax advice from an experienced international US tax advisor is the best place to start; let me know if you need help.

Posted July 16, 2020

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