Lowering the Bar for Willfulness for FBAR Penalties

Lowering the Bar for Willfulness for FBAR Penalties

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The IRS has authority to assert FBAR civil penalties.  Before delving into the FBAR abyss, this is a good time to debunk some FBAR myths.  First, there is no such thing as an FBAR penalty within the Offshore Voluntary Disclosure Program (OVDP).  The FBAR penalty exists only outside of the OVDP framework.  However, there is a penalty within the OVDP that is often considered to be the equivalent of the FBAR penalty.  That penalty is commonly referred to as the offshore penalty.  Generally, it is 27.5% of the highest aggregate balance of all foreign accounts during the disclosure period.

Second, contrary to popular belief, an FBAR violation doesn’t automatically mean that a penalty will be asserted.  Examiners are expected to exercise discretion, taking into account the facts and circumstances of each case, in determining whether a penalty should be asserted at all.  For example, the examiner may determine that the facts do not justify asserting a penalty.  In that case, the examiner will issue an FBAR warning letter, Letter 3800.

According to IRM 4.26.16.4, the sole purpose of the FBAR penalty is to promote compliance with the FBAR reporting and recordkeeping requirements.  In exercising their discretion, examiners should consider whether issuing a warning letter and securing delinquent FBARs, rather than asserting a penalty, will achieve the desired result of improving compliance in the future.

To the extent that a penalty is warranted, there are two types: non-willful and willful.  Both types have varying upper limits, but no floor.  The first type is the nonwillful FBAR penalty.  The maximum nonwillful FBAR penalty is $ 10,000.  And the second type is the willful FBAR penalty.  The maximum willful FBAR penalty is the greater of (a) $ 100,000 or (b) 50% of the total balance of the foreign account.

To the extent that the IRS attempts to assert a willful FBAR penalty, it has the burden of proving willfulness.  Willfulness has been defined by courts as “an intentional violation of a known legal duty.”

While the standard for proving willfulness in the context of a criminal tax case is relatively clear, just the opposite is true in the context of asserting a civil FBAR penalty.  According to the IRM, the only thing that a person need know is that he has a reporting requirement.  And if a person has that requisite knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR.  The latter is referred to in legal circles as the theory of “willful blindness.”

The fact that willful blindness can be used to circumvent what is otherwise the “gold standard” for proving intent in the criminal arena – i.e., a specific intent to violate a known legal duty – might be bad enough.  But it only gets worse.  In one fell swoop, the fourth circuit court of appeals, which is one of eleven in the United States and ranks right below the United States Supreme Court, lowered the burden of proof needed to show that the failure to file an FBAR was intentional.  For this reason, J. Bryan Williams is a name that U.S. persons with undisclosed foreign bank accounts may come to dread.

Williams, a US citizen, deposited $ 7 million in Swiss bank accounts from 1993 to 2000 without disclosing the money to the Internal Revenue Service.  He was indicted for tax evasion and in 2003, he pleaded guilty.  In 2007, Williams filed FBARs for each of the years in which he held the accounts.

In 2009, Williams became the target of a rare civil suit initiated by the IRS.  In that suit, the IRS sought to impose a $200,000 penalty for willfully failing to file a Report of Foreign Bank and Financial Accounts (Treasury Department Form 90-22.1), on Williams’ two Swiss accounts.  This form is commonly known as the FBAR.

The district court ruled in favor of Williams.  But the Fourth Circuit Court of Appeals reversed.  By holding that the IRS lacked evidence to prove Williams’ willful violation of the FBAR filing requirement, the district court ruling gave hope to FBAR non-filers.  Specifically, the court rejected the government’s arguments that Williams was liable for FBAR penalties because he failed to list income from his Swiss account on his 2000 tax return and had checked “No” in Schedule B, the section which asks the filer if he has any financial accounts in another country.

The court reasoned that Williams’ failure to disclose the accounts “was not an act undertaken intentionally or in deliberate disregard for the law, but instead constituted an understandable omission given the context in which it occurred.”  And what was the context in which this failure to disclose occurred?  Mr. Williams admitted to never reviewing his tax return, much less looking at the FBAR.  Because it is impossible to intentionally violate a duty that one did not know to exist, Mr. Williams could not have intentionally failed to disclose the accounts on his returns.

This holding had been widely accepted to be the standard for willfulness.  But that was all about to change.  In reversing, the Fourth Circuit Court of Appeals reasoned that Williams made a “conscious effort to avoid learning about reporting requirements.”

While the majority could have rested there and concluded that the record established willful blindness and reversed on that basis alone, they decided to go one step further.  That one step sent shock waves through all the circuits, creating a firestorm of opposition amongst critics.  The majority held that Williams’ signature on his tax return was “prima facie evidence that he knew the contents of the return,” even though Williams denied ever reviewing it.

The majority found that the instructions in Schedule B, which refers to the FBAR, put Williams and every other taxpayer on “inquiry notice” of the filing requirement.  What does this mean?  Very simply that a taxpayer is presumed to be cognizant of the FBAR requirement simply by signing the tax return.

The practical effect of this opinion is nothing short of mind blowing.  First, instead of having to prove a specific intent to “violate a known legal duty,” which other tax cases have upheld as the standard for willfulness, the opinion suggests that a taxpayer’s presumed understanding of the FBAR requirement may be enough to make him liable for penalties for willful violations.  In other words, whether a person actually knew about the FBAR reporting requirements is meaningless.

Second, it gives a major boost to the IRS’s current intensive pursuit of overseas tax evasion.  How?  By making it easier for the IRS to prove willfulness in the context of a willful FBAR penalty.  Very simply, the IRS now has enormous leverage to collect the hefty penalties that accompany the willful FBAR penalty.  Indeed, the civil penalty for willfully failing to file an FBAR may reach $100,000, or 50% of the value of the offshore account, whichever is greater.  As one expert observed, “This case is likely to be the start of a wave of FBAR audits for the IRS because of the sheer sums the IRS stands to collect by ramping up civil FBAR enforcement.”

While Williams might strike fear in the hearts of even the bravest taxpayers, taxpayers can take some relief in the following.  First, the case was a gross example of offshore tax evasion.  Not only did Mr. Williams fail to disclose his Swiss accounts on his tax returns, but he also denied having overseas assets to his accountant and attorney.  Indeed, this was the equivalent of waiving a red flag in front of a bull.

Second, Williams is an unpublished opinion.  Therefore, it is not binding precedent on federal courts in the fourth circuit, much less any of its sister circuits.  And third, if the IRM is any indication, it appears that the official position of the IRS is to interpret the meaning of willfulness in accordance with the heightened definition (i.e., an intentional violation of a known legal duty).  However, a word of caution is in order.  As one expert said, “The IRS would be crazy not to use this ruling to its advantage.  There is simply too much money at stake.”

Balancing the carrot of voluntary disclosure with the stick of criminal prosecution and willful FBAR penalties requires the IRS to walk a fine line.  Indeed, the more they enforce FBARs, the more the IRS risks driving people away, as opposed to bringing people in under the tent of the voluntary disclosure program.  If recent cases are any indication, it appears that the IRS cares little about the impact that its heavy-handed approach to enforcing FBARs has on the willingness of those with undisclosed foreign accounts to make voluntary disclosures.

The IRS has shown that it will not hesitate to seek maximum willful FBAR penalties.  For example, in July 2012, two former UBS clients were ordered to pay $ 2.5 million in civil penalties for willfully failing to file FBARs on millions of dollars they held in offshore accounts that were located in bank secrecy havens.

The following examples illustrate situations in which willfulness may exist:

  • Jill has a foreign bank account. She admits knowledge of, but fails to answer the question on Schedule B of her return concerning whether she has an interest in a foreign account. When asked, Jill does not have a reasonable explanation for failing to answer the question and for failing to file the FBAR. A determination that the violation was willful would be appropriate.

 

  • Jack has a foreign bank account that he has failed to disclose. He received a warning letter informing him of the FBAR filing requirement. Notwithstanding that, he continues to fail to file the FBAR in subsequent years. When asked, Jack does not provide a reasonable explanation for failing to file the FBAR. To make matters worse, Jack fails to report income associated with the foreign account. A determination that the violation was willful would be appropriate.

 

  • Tom is a U.S. citizen. He has a foreign bank account with Credit Suisse. Tom files an FBAR in earlier years. However, he fails to file one in subsequent years, despite having an obligation to do so. When asked to explain why he didn’t file an FBAR in subsequent years, Tom does not have a reasonable explanation. Further compounding Tom’s problem is the fact that he failed to report a substantial amount of interest associated with that same account during the years that he failed to file the FBAR.

The following example illustrates a situation where willfulness does not exist:

Fred is a U.S. citizen.  He has three foreign bank accounts with Credit Suisse.  Fred files an FBAR in 2007, but omits one of these accounts.  He closed the omitted account just a few weeks before June 30, 2008, the date that he filed his FBAR for tax year 2007.  However, Fred reported all income associated with the omitted account on his 2007 tax return.

When asked why he didn’t disclose the omitted account, Fred explains that it was due to unintentional oversight.  During a subsequent examination, Fred provides all of the information requested pertaining to the omitted account.  None of the information discloses anything suspicious about the account.

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6 Comments

  1. Pramod Ahuja
    2014-05-14 11:56:19

    just checking if there is any consistency on the part of the IRS to enforce - it seems that different handling offices are doing their own thing

  2. mjdeblis
    2014-05-14 20:22:48

    You hit the nail right on the head. The only thing that is consistent is the inconsistent enforcement of this penalty from office to office.

  3. Catherine Rude
    2014-05-14 21:56:35

    The issue is being coordinated at the IRS Appeals level out of the Dallas, Texas Appeals Office.

    1. mjdeblis
      2014-05-14 22:19:42

      Thanks for the heads up. I appreciate it.

  4. Ted L
    2014-05-15 18:44:54

    The inconsistency in enforcement/penalties by the IRS is a mere matching of the same inconsistencies in all courts of law. perhaps not right, but just as prosecutors and judges have a wide variety of views/opinions, if that's the proper term, so do members of any organization including the IRS. To restate, perhaps not "right", but a fact of life, weather we like it or not. And to repeat the old adage, "Ask two lawyers, get three opinions." LOL

    1. mjdeblis
      2014-05-16 17:10:39

      Excellent comment. I couldn't agree more.

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