We have another important FBAR case, US v Katholos No17cv531 WDNY Aug 10 2022. Ms Katholos was first introduced to my readers in 2018 (blog post here). An update on Katholos was posted just last week detailing a court’s clarification, perhaps an expansion, of the definition of “financial interest” in an account requiring FBAR reporting. Today’s post examines how far the Internal Revenue Service (IRS) will go to assert a civil “willful” FBAR penalty. Thankfully, the court did not buy it and has determined that the issue of “willfulness” should be determined at trial.
The Katholos case has now been dragging on for four years, undoubtedly with mounting legal costs and emotional turmoil. Sadly, the FBAR saga for Marika Katholos continues. The United States government is seeking judgment against Ms. Katholos for an outstanding civil “willful” FBAR penalty (over $4.47 million) “for her failure to report timely her financial interest in, or signature or other authority over, a foreign financial account during the 2007 calendar year.” The District Court refused to grant the government a “summary judgment” for a civil FBAR willful penalty.
For those who do not understand legal mumbo jumbo, let’s explain “summary judgment”. A summary judgment is requested when one party (here, the US Government) believes that there are no important facts that can reasonably be disputed, and that in light of those undisputed facts, it is entitled to a judgment by the court under the applicable law without any need for a trial. Summary judgment would be appropriate if the Government could show that there is no genuine dispute as to any material fact. Essentially in this case, the IRS took the position that the facts clearly established Ms. Katholos’ failure to file a 2007 FBAR reporting certain Swiss accounts was “willful” and therefore, the penalty should apply without any need for trial.
What is Needed for FBAR Civil “Willfulness”?
The court disagreed and held that summary judgment was not appropriate . There were sufficient facts in dispute so as to create a triable issue. This is a good decision for taxpayers – it indicates that while the courts are giving IRS plenty of room with the definition “willfulness” in the civil FBAR penalty arena, the courts are not permitting IRS leeway in proving “willfulness” when the facts can reasonably be disputed. Readers should be reminded that the trend of the courts is to give the IRS wide berth in the meaning of civil “willfulness” for FBAR purposes.
No bad intent is required –in the civil context, “willful blindness” and “recklessness” suffice to support a finding of “willfulness”. These concepts encompass objective standards. “Willful blindness” is a form of “deliberate ignorance” and involves the concept that an individual could readily obtain information, which if they did, would inform them that their actions or inactions could be in violation of a law. An individual can be “reckless” if the action or inaction involves an “unjustifiably high risk of harm that is either known or so obvious that it should be known.”
A brief overview of the Katholos facts follows below.
Background of the Katholos Case
Ms. Katholos is a US citizen and has been living in Greece as a homemaker since 1994 with her non-US husband, 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 UBS bank in Switzerland in 1998. Ms. Katholos’ father apparently took the lead with regard to the accounts. He was a Greek immigrant and could not speak or write English very well; he had achieved only a second grade education but did very well financially with a contracting business in New York.
Later, in 2005, a Lichtenstein family foundation (“Foundation”) and a Hong Kong company were created at the advice and prompting of the UBS Swiss bankers, in part, to facilitate making certain investments. Swiss accounts were established at UBS for each of the Foundation and the Hong Kong company. Ms. Katholos was listed as one of the beneficial owners of the assets in the Swiss account that was opened for the Foundation and as a beneficial owner of the Swiss account opened for the Hong Kong company.
The Government states that, when opening these accounts, Katholos signed a document indicating that she was not a US citizen and did not have dual citizenship. Ms. Katholos states that she presented her United States and Greek passports to UBS bankers, and that her Greek passport indicates that her place of birth is the United States. She explained that she would “just sign” forms because she and her father trusted UBS. Ms. Katholos maintained communication with UBS bankers regarding investment strategies, performance of the accounts, and instructions on how to invest better but it appears undisputed that Ms. Katholos communicated with UBS on her father’s behalf.
At various times in 2007, Ms. Katholos sent a total of 3 requests to UBS to transfer funds from the Swiss bank account of the Hong Kong company, for example, to her personal account in Greece, or on her behalf to other parties.
For decades, the Katholos family used the same certified public accountant to prepare their federal income tax returns. The Government and Ms. Katholos dispute certain things. The Government contends that the CPA prepared an individual income tax return for Ms. Katholos in 2007, but she contends she is unaware of who prepared the return and that she never spoke to the CPA about the preparation of her returns from 2005 to 2007, and she never reviewed, signed, or filed those returns.
On her individual tax return for 2007, questions relating to interest in or signature authority over foreign accounts and trusts were answered “no”. Ms. Katholos did not file an FBAR for 2007, the year in issue.
Ms. Katholos attempted to make an OVDP submission but this was denied, likely on grounds it was not “timely” (i.e., that the government had already obtained information about her and her accounts from UBS).
Was Ms. Katholos “Willful”?
The Government argued that the evidence established, as a matter of law, “key indicia of willfulness, including a pattern of concealment and a reckless indifference toward [Ms. Katholos’s] obligations with respect to reporting foreign accounts to the IRS.”. The government pointed out such things as the fact that entities were used in the structure, some accounts were Swiss “numbered”” accounts, hold mail orders were given to the bank, and argued that she attempted to hide her US citizenship from UBS. Ms. Katholos argued that the facts were subject to interpretation and that the Government had improperly drawn inferences in its favor. Ms. Katholos argued that “the use of entities, numbered accounts, and ‘hold mail’ cannot be viewed in [a] vacuum when considering willfulness.” She asserted that she was just a means of communication because of her father’s language barrier and that all of these facts were decisions made by her father whose intent cannot be imputed to her. She also notes that she provided UBS with her United States passport.
The court agreed with Ms. Katholos – willfulness is a matter for the factfinder. Quoting other judicial precedent, the court stated that summary judgment is not appropriate: “[i]f reasonable minds could differ as to the import of the evidence”….. “A jury could . . . conclude that [Katholos’s conduct] reveal[s] willful blindness, or establishes] a pattern of conduct so unreasonable as to constitute reckless disregard. Still,… a reasonable jury [could] conclude otherwise. And that is enough to make summary judgment on the issue of willfulness inappropriate.”
IRS is still waging war on unreported offshore accounts and assets. The Katholos case involved very early days in the FBAR enforcement crusade (the year was 2007). Given this, one might expect a certain degree of leniency from the IRS. The IRS view was that Ms. Katholos was “willful” despite a fairly unique set of facts. It is unlikely that today, the government will seek anything less than “willful” FBAR penalties for violations if it is given any ammunition to do so.
Taxpayers must not just blithely sign a tax return. It is foolhardy to think that because one has had a professional prepare tax returns that this will offer protection from penalties. Reliance on the tax professional is no guarantee of protection.
Even if no tax may be owed with respect to offshore accounts, expect an FBAR failure to result in astronomical penalties. Establishing “nonwillfulness” is getting harder and harder to achieve and the IRS is apparently looking back at old submissions made by taxpayers into the “Streamlined” and delinquent FBAR or foreign information return procedures.
I am happy to assist with your tax and FBAR noncompliance concerns.
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Posted October 13, 2022
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