Penalties for Failure to File an FBAR
The Bank Secrecy Act of 1970 authorizes the Department of Treasury to gather information that has “a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings.” 31 U.S.C. § 5311 et seq. Pursuant to this authority, the Department of Treasury has issued regulations requiring each U.S. person “having a financial interest in, or signature or other authority over, a bank, securities or other financial account in a foreign country” to report the relationship to the IRS. 31 C.F.R. § 1010.350(a). If a foreign financial account has a balance exceeding $10,000 during the previous calendar year, the taxpayer must file a Report of Foreign Bank and Financial Accounts (“FBAR”) with the Financial Crimes Enforcement Network, which is a separate agency of the Department of Treasury. Taxpayers must also maintain foreign account records for five years after the due date of an FBAR. 31 C.F.R. § 1010.420.
Failing to comply with the FBAR reporting and recordkeeping requirements may result in civil and criminal penalties depending on the facts and circumstances. For willful violations, the maximum civil penalty is the greater of $100,000 or 50% of the balance in the account at the time of the violation. 31 U.S.C. § 5321(a)(5)(C). Non-willful violations may be subject to a maximum penalty of $10,000. 31 U.S.C. § 5321(a)(5)(B)(i).WILLFULNESS
The severity of an FBAR penalty depends on a taxpayer’s degree of willfulness. The term “willful” has not been clearly defined by statute. However, many federal courts have found that a taxpayer willfully violates 31 U.S. Code § 5314 when he or she knowingly or recklessly fails to file an FBAR. A taxpayer is reckless if he or she clearly should have known that there was a grave risk that the filing requirement was not being met and he or she could have easily found out for certain. The willfulness standard can also be satisfied by evidence of willful blindness, which occurs when a taxpayer deliberately avoids learning about his or her tax obligations. Some courts have imputed constructive knowledge of the FBAR filing requirement on taxpayers as they signed their tax returns under penalty of perjury. There have been and continue to be many lawsuits regarding willfulness. Below are summaries of some of the most notable FBAR cases to date.
Cases in which Courts Found Failure Was Willful
In United States v. Williams, J. Bryan Williams (“Williams”) opened two Swiss bank accounts in the name of a British Corporation. Williams, 489 F. App’x 655 (4th Cir. 2012). Between 1993 and 2000, he deposited more than $7,000,000 into the accounts. He did not report the interest income earned or his interest in the accounts. In 2000, the government became aware of the accounts and requested that the Swiss authorities freeze his accounts. Williams nevertheless completed a tax organizer for that year in which he denied he had an interest in or signature authority over a foreign bank account. He also did not disclose his interest in either account on his FBAR for tax year 2000. Williams was indicted for conspiracy to defraud the IRS and criminal tax evasion. In exchange for a sentence reduction, he allocuted that he knew he was required to report his Swiss accounts during tax years 1993 through 2000, but “chose not to in order to assist in hiding [his] true income from the IRS and evade taxes[.]” Id. The Fourth Circuit stated that Williams exhibited willful blindness by not reading line 7a of Schedule B which asks about a financial interest in or signature authority over any foreign financial accounts and by not paying attention to any of the written words on his tax return. Id. The Fourth Circuit concluded that Williams was at least reckless supporting a willful FBAR penalty.
In United States v. McBride, Jon McBride (“McBride”) sought the services of Merrill Scott and Associates (“Merrill Scott”) “that would result in avoiding or deferring the recognition of $2 million in income that McBride expected to receive.” 908 F. Supp. 2d at 1189-1190. After listening to Merrill Scott employees’ explanation of their services, McBride stated, “This is tax evasion.” Id. at 1190. Merrill Scott responded that its plans were legal and that McBride’s “plan will be one of the cleanest.” Id. McBride stated under penalty of perjury that he read and asked questions from a pamphlet which advised readers to not hide assets in a Swiss account because U.S. taxpayers are required by law to report their financial interests in foreign bank or financial accounts. After retaining the services of Merrill Scott, McBride’s business partner’s accountant sent McBride a letter expressing his concerns regarding Merrill Scott and a newspaper article, which informed readers of the criminal liability of concealing foreign bank accounts. While McBride read the letter and the article, approximately $2.7 million that would have otherwise been his company’s taxable income was directed to various foreign entities and was circulated between them as fictitious loans. Even after the IRS discovered McBride’s complex tax evasion scheme with Merrill Scott, McBride repeatedly lied to the IRS regarding his involvement with Merrill Scott. The Court concluded that “even if McBride were not charged with knowledge of the contents of a tax return by virtue of having signed it, the fact that McBride signed a federal income tax return without having an understanding as to its contents, while simultaneously engaging in transactions with foreign entities designed to avoid or defer tax, constitutes evidence of either willful blindness or recklessness.” Id. at 1212-1213.
United States v. Horowitz involved two highly educated professionals, Peter and Susan Horowitz, who had undisclosed Swiss bank accounts that were opened during their time in Saudi Arabia. No. 19-1280 (4th Cir. Oct. 20, 2020). The Horowitzes moved from the U.S. to Saudi Arabia in the 1980s for Peter’s job. They filed U.S. income tax returns and paid U.S. taxes on income earned in Saudi Arabia with the help of their accountant in the U.S. The Horowitzes initially owned Saudi Arabian bank accounts; however, when a Swiss banker contacted Peter about opening an account, Peter decided to do so because the Saudi Arabian banks did not pay interest. Their Swiss bank account was earning interest income but the Horowitzes did not disclose the account to their accountant. They explained that they had talked to their friends in Saudi Arabia and learned that they did not have to pay taxes in the U.S. on interest income from the Swiss account. When the Horowitzes moved back to the U.S., they stopped receiving bank statements from the Swiss bank because they never updated their address with the bank. Peter still called the bank every year or two to check on the account.
In 2008, Peter came across news articles regarding the Swiss bank’s financial troubles, so he called the bank to inquire about the situation. Upon calling the bank, Peter learned the Swiss bank planned to close the accounts of all Americans. Subsequently, Peter traveled to Switzerland to close the account, which now had a balance of $2 million. Peter opened another account with a different Swiss bank and transferred the money to the new account. This new account was a numbered account, which means a designated number would replace the account holder’s name on any correspondence. Peter also paid for hold mail service asking the bank to keep any correspondence addressed to the Horowitzes. A year later, Peter learned of the Offshore Voluntary Disclosure Program (“OVDP”) and the Horowitzes decided to enter the OVDP. After having filed amended tax returns and paid back taxes, the Horowitzes opted out of the OVDP in 2012, which meant they would face a traditional IRS audit. The IRS determined the Horowitzes had willfully failed to file FBARs and assessed a penalty of close to $750,000. When the Horowitzes refused to pay, the IRS filed suit in District Court, which entered judgment in favor of the IRS. The Horowitzes appealed.
The Fourth Circuit held the Horowitzes should have known that they were not satisfying their FBAR filing requirement and that they could have found out for certain very easily. The Court explained it was reckless for Peter to provide his accountant interest income from their domestic bank accounts and foreign income earned in Saudi Arabia but not even disclose the Swiss bank account to their accountant. The numbered account and hold mail service did not help their case. The Court further explained that Form 1040 specifically asks filers if they had a foreign bank account, and each tax year, the Horowitzes “signed them knowing that they were representing to the IRS, under the penalties of perjury, that the returns were accurate.” Id. at 19.
In Kimble v. United States, Alice Kimble (“Alice”) filed a complaint in the United States Court of Federal Claims for a refund of a $697,229 assessed penalty pursuant to 31 U.S.C. § 5321(a)(5) for the willful failure to file an FBAR. No. 19-1590 (Fed. Cir. 2021). Prior to 1980, Alice’s parents had opened an investment account at UBS as an emergency fund in the event they needed to escape the U.S. as her father’s family did during the Holocaust. Her parents designated Alice as a joint owner and instructed her to never tell anyone about the account. In 1998, Alice and her husband, Michael Kimble (“Michael”) opened a bank account at HSBC in Paris, France. Even though Michael learned about the FBAR reporting requirement in the late 1990s, he “never reported any investment income derived either from the HSBC or UBS accounts,” when preparing their joint tax returns.
In 2008, Alice learned that the U.S. government issued a John Doe Summons to UBS requesting names of U.S. taxpayers who may be using their accounts to evade U.S. taxes. Therefore, Alice entered into the Offshore Voluntary Disclosure Program (“OVDP”) in 2009. Shortly thereafter, Alice signed a document allowing UBS to comply with the deferred prosecution agreement it entered into with the U.S., which required it to provide the IRS information of its clients who were U.S. citizens. As part of her participation in OVDP, she amended her tax returns. She, however, failed to answer affirmatively that she has an interest in a foreign bank account even though she disclosed the income earned in her HSBC and UBS accounts. The Closing Agreement stated Alice would pay the tax liability due and a miscellaneous penalty of $377,309, however, Alice decided to withdraw from OVDP because the penalty was excessive. She was subsequently examined by the IRS who determined her failure to file an FBAR for tax year 2007 was willful, and therefore, imposed a penalty of 10 percent of the maximum balance of the HSBC account and 50 perfect of the maximum value of the UBS account, for a total penalty amount of $697,229. Alice paid the assessed penalty in full and filed a complaint for a refund in the United States Court of Federal Claims. The court explained that because Alice did not review her tax returns for accuracy and because she did not answer affirmatively that she had an interest in a foreign bank account on her 2007 Schedule B, she “exhibited a ‘reckless disregard’ of the legal duty under federal tax law to report foreign bank accounts to the IRS by filing a [sic] FBAR.”
There was a myriad of other facts in this case that supported the IRS’ position that Alice was willful. For example, Alice paid UBS for hold mail service. She and Michael also met with UBS representatives on numerous occasions. Furthermore, the offshore income she failed to disclose was 52 percent of her overall earnings in 2007. The court, however, concluded that Alice’s failure to review her returns and answer affirmatively to Question 7(a) on Schedule B was sufficient for a finding of willfulness.
The Williams, McBride, and Horowitz courts imputed constructive knowledge of the FBAR filing requirement on the taxpayers as they signed their tax returns under penalties of perjury. Many other courts have followed suit. The District Court in United States v. Flume, however, rejected the constructive knowledge theory and stated that “[t]he constructive knowledge theory is unpersuasive.” Flume, No. 5:16-CV-73 (D.C. S.D. Tex. June 11, 2019) at *11 (citing Flume, 2018 WL 4378161, at *7). The District Court explained that the theory would render the distinction between willful and non-willful meaningless. “If every taxpayer, merely by signing a tax return, is presumed to know the need to file an FBAR, it is difficult to conceive of how a violation could be non-willful.” Flume, 2018 WL 4378161, at *7. The Flume Court further stated, “there is no policy need to treat constructive knowledge as a substitute for actual knowledge.” Id. Although constructive knowledge was not imputed in Flume, the Court held Flume’s conduct to be willful because his testimony was not credible, his finances appeared to be structured in ways to evade taxes, his tax preparer reminded him every year of the FBAR reporting requirement, and he had disclosed one of his accounts on Schedule B, but not the other.
Case in which Court Found Failure Was Non-Willful
In 1973, Arthur Bedrosian (“Bedrosian”), a successful and financially literate businessman, opened a Swiss bank account in order to have access to funds while traveling abroad for his job. Bedrosian, No. 2:15-cv-5853 (E.D. Pa. 2017). Over time, he began using the account as a savings account. He did not actively manage the account but was kept informed of its activities mostly during his annual meetings with the Swiss bank representatives. In 1993 and 2004, he requested that the bank stop sending him written communication regarding the account. In 2005, the bank lent Bedrosian money and converted his savings account into an investment account, which resulted in the creation of a second account.
From 1972 until 2006, Bedrosian’s accountant, Seymour Handelman (“Handelman”) prepared Bedrosian’s income tax returns. “Bedrosian did not tell Handelman about his Swiss account until some point in the mid-1990s, at which time Handelman advised him that he had been breaking the law every year that he did not report the account on his tax return.” Id. at *2. Handelman then advised Bedrosian that he could not unbreak the law so he should take no action. In 2008, Bedrosian’s new accountant filed his 2007 tax return disclosing his interest in a Swiss bank account on Schedule B. He also filed an FBAR for the first time in which he reported one of his two Swiss accounts. As Bedrosian became more aware of the FBAR reporting requirements, he sought the advice of his attorney to rectify the issue before learning that the government began an investigation on him. On the advice of his lawyers, Bedrosian amended his returns and paid taxes on the gains from his Swiss accounts. In 2011, the IRS notified Bedrosian that it would audit him.
The District Court found that Bedrosian may have been negligent but was not willful in failing to report his second Swiss account, which contained approximately $2 million. The Court explained that while Bedrosian should have been more careful in reviewing his 2007 tax returns, none of the evidence “indicate[s] ‘conduct meant to conceal or mislead’ or a ‘conscious effort to avoid learning about reporting requirements.’” Id. at *14. The Court further stated that “the facts show that he did check the box indicating he had a foreign account on his 2007 tax return, he did identify Switzerland as the country in which the account was located, and he did file an FBAR for 2007 stating he had assets in a foreign account. . . . Furthermore, he approached his personal lawyer and retained an accounting firm to file amended returns and rectify the issue prior to learning that the government was investigating him and prior to learning that UBS was turning his information over to the IRS.” Id. The Court, therefore, concluded that Bedrosian’s conduct was not willful. To this day, this appears to be the only case in which the IRS did not prevail on its willful FBAR penalty claim. This may not be the case for much longer because the Third Circuit Court of Appeals remanded the case back to the District Court to consider whether Bedrosian’s conduct satisfies the objective recklessness standard. The Third Circuit ruled that the District Court’s “discussion and distinction of prior FBAR cases imply the ultimate determination of non-willfulness was based on findings related to Bedrosian’s subjective motivations and overall ‘egregiousness’ of his conduct, which are not required to establish willfulness in this context.” Bedrosian, 912 F.3d 144, 153 (3d Cir. 2018).CIVIL FBAR PENALTIES
Pursuant to 31 U.S.C. § 5321(a)(5)(A), “[t]he Secretary of the Treasury may impose a civil or money penalty” on anyone who violates the FBAR reporting requirements. In 2004, Congress amended § 5321 to include a provision providing a non-willful penalty of $10,000. According to Internal Revenue Manual § 4.26.16-1, non-willful FBAR penalties cannot exceed $10,000 per account, per year unless managerial approval is obtained. Furthermore, the aggregate amount of non-willful FBAR penalties cannot exceed 50% of the highest aggregate balance of the accounts during the year at issue. No penalty will be imposed if the “violation was due to reasonable cause, and the amount of the transaction or the balance in the account at the time of the transaction was properly reported.” 31 U.S.C. § 5321(a)(5)(B)(ii). The statute of limitations for FBAR cases expires six years after the due date of the FBAR.
The 2004 amendment to § 5321 also increased the maximum willful penalty to the greater of $100,000 or 50% of the highest balance in the undisclosed foreign account. Based on this provision, the IRS has imposed willful FBAR penalties equal to 50% of the highest aggregate balance of the account. However, Treasury Regulation 31 C.F.R. § 1010.820(g) states that a civil penalty for a failure to report a foreign financial account is “not to exceed the greater of the amount (not to exceed $100,000) equal to the balance in the account at the time of the violation, or $25,000.” 31 C.F.R. § 1010.820(g). In justifying a penalty of 50 % of the balance in the foreign account, the IRS argues that § 1010.820 is inconsistent with the § 5321 amendments of 2004, and therefore, § 1010.820 is invalId. The courts have been split on this issue.
In United States v. Colliot, No. 1:16-cv-01281 (W.D. Tex. 2018), the Court agreed with the taxpayer that “the IRS cannot assess penalties in excess of the threshold set by 31 C.F.R. § 1010.820.” The Court reasoned that “§ 5321(a)(5) vests the Secretary of the Treasury with discretion to determine the amount of the penalty assessed so long as that penalty does not exceed the ceiling set by § 5321(a)(5)(C).” The Court further explained, “§ 1010.820—a regulation validly issued by the Treasury via notice-and-comment rulemaking—purports to cabin that discretion by capping penalties at $100,000.” Id. at 5. The Court concluded, therefore, the IRS cannot assess a willful FBAR penalty of more than $100,000 as it violates the regulation. The Court did not, however, rule on what relief should be afforded to the taxpayer and ordered the parties to provide additional briefing.
Another District Court also rejected the IRS’ contention that “the different penalty caps in 31 U.S.C. § 5321 and 31 C.F.R. § 1010.820(g) demonstrates an inconsistency such that the statute trumps the regulation.” United States v. Wadhan, 325 F. Supp. 3d 1136, 1139 (2018). The Court stated that the statute and regulation are not inconsistent, because “compliance with the lower cap set in 31 C.F.R. § 1010.820(g) also complies with 31 U.S.C. § 5321.” Id. The Court further explained that the “simple and straightforward interpretation that gives coherent meaning to both the statute and the regulation [is that] in the exercise of statutory discretion, the Secretary limited the penalties that the IRS could impose to $100,000.” Id. The Court inferred from the inflation adjustments made to the maximum FBAR penalty by the Secretary of Treasury that “the Secretary was aware of the penalties available under 31 U.S.C. § 5321(a)(5)(C) and elected to continue to limit the IRS’ authority to impose penalties to $100,000 as specified in 31 C.F.R. § 1010820.” Id. at 1140.
The Court of Federal Claims disagreed with Colliot in Norman v. United States, and stated that “the amendment did not merely allow for a higher ‘ceiling’ on penalties while allowing the Treasury Secretary to regulate under that ceiling at his discretion.” Norman, No. 1:15-cv-00872 (Fed. Cl. 2018) at *8. The Court explained that because the amended statute states “the maximum penalty ‘shall be increased’ to the greater of $100,000 or 50 percent of the account[,] . . . Congress raised the new ceiling itself, and in so doing, removed the Treasury Secretary’s discretion to regulate any other maximum.” Id. The United States Court of Appeals for the Federal Circuit affirmed stating, “because the statute is unambiguous, we ‘must give effect to the unambiguously expressed intent of Congress.’” Id. at 11.
The Court of Federal Claims rejected Colliot again in Kimble v. United States explaining that “the [§ 5321 amendments of 2004] replaced the prior penalty for willful violations of federal tax law in 31 U.S.C. § 5321(a)(5) (2003), thereby nullifying any inconsistent regulations governing the pre-2004 statute.” No. 1:17-cv-00421 (Fed. Cl. 2018) at *21. The Court stated that Colliot’s reasoning “conflicts with the decision of the United States Court of Appeals for the Federal Circuit in Barseback Kraft AB v. United States, 121 F.3d 1475 (Fed. Cir. 1997).” In Barseback, plaintiffs sued to enforce contracts to obtain uranium enrichment services from the Department of Energy (“DOE”). Kimble, No. 1:17-cv-00421 (Fed. Cl. 2018) at *21. The contracts stated prices would be set according to the DOE’s policy. Id. “After the parties executed the contracts, Congress enacted legislation that transferred responsibility for administering uranium sales to a new federal agency, and ‘changed the government’s pricing strategy.’” Id. Plaintiffs argued that the parties should be bound by the DOE’s pricing policy and not the new policy. The Court of Appeals for the Federal Circuit held that there was no valid DOE pricing policy “because Congress had stripped it of its authority to sell uranium enrichment services.” Id. “‘The fact that DOE’s [pricing regulations] had not been formally withdrawn from the Code of Federal Regulations [did] not save them from invalidity.’” Id. The United States Court of Appeals for the Federal Circuit affirmed the Court of Federal Claims’ holding as it did in Norman. More and more courts since Kimble have held that the higher penalty limit pursuant to § 5321(a)(5)(A) applies.
It is important to note that while the pre-2004 statutory limitation is favorable, the IRS has discretion in assessing FBAR penalties, and may not necessarily take the aggressive position of assessing the maximum amount prescribed by the regulation. I.R.M. 4.26.16. For example, in Colliot, the Government filed an additional memorandum showing that it could have assessed a larger aggregate FBAR penalty against the taxpayer than what it actually imposed, if the Government had assessed the maximum penalties allowed under the Court’s holding. Therefore, the IRS could potentially assess lower penalties than either maximum limitation.CRIMINAL FBAR PENALTIES
Criminal penalties for willfully failing to file an FBAR may result in a fine of at most $250,000 and/or 5 years of imprisonment. 31 U.S.C. § 5322(a). If a taxpayer willfully fails to file an FBAR while violating another law of the U.S. or as a part of a pattern of any illegal activity involving more than $100,000 in a 12-month period, such taxpayer may be fined at most $500,000 and/or imprisoned for at most 10 years. 31 U.S.C. § 5322(b).FIFTH AMENDMENT FBAR
Taxpayers who are facing potential criminal prosecution and who are not eligible for the Offshore Voluntary Disclosure Program (“OVDP”) may want to consider filing a Fifth Amendment FBAR, in which a taxpayer asserts his or her privilege against self-incrimination. In this type of FBAR, a taxpayer may also request immunity from criminal prosecution in exchange for more detailed information. A Fifth Amendment FBAR should be filed in conjunction with an individual income tax return and Schedule B invoking the privilege against self-incrimination with respect to any questions about foreign financial accounts. This may provide protection against criminal liability, although it would not bar the imposition of financial penalties.
This is the option Daniel and Yana Bernstein chose when the IRS contacted them regarding auditing their 2007 tax return. Mem. Decision and Order Mot. for Summary Judgment, U.S. v. Bernstein, Case No. 19-cv-2912 (E.D.N.Y. 2020). The Bernsteins had a Swiss bank account at UBS which was opened with the help of their financial advisor. Their financial advisor and Daniel told UBS to never contact the Bernsteins regarding the account. The Bernsteins did not tell their accountant about the Swiss bank account because they wanted it to remain a secret. In 2009, when news broke that UBS entered into a deferred prosecution agreement with the U.S. Department of Justice, Daniel Bernstein opened another Swiss account at Bank Sal and transferred the funds from their UBS account, which totaled about $1 million, to this newly created account. A few months later, UBS contacted the Bernsteins notifying them that the U.S. Government was seeking information about their account and recommended they participate in the OVDP, which they did not do. Two years later, the Bernsteins received a notification from the IRS stating it would be examining their 2007 tax return.
The Bernsteins met with a tax attorney who advised the Bernsteins to invoke their privilege against self-incrimination in their 2010 FBAR. The attorney prepared an addendum to the FBAR explaining the Bernsteins’ Fifth Amendment right and stating the Bernsteins may provide more information if they receive immunity from criminal prosecution. The Bernsteins also invoked their privilege against self-incrimination in their 2010 tax return and Schedule B. The Bernsteins were not criminally prosecuted, however, the IRS assessed a penalty of $524,577 for their willful failure to file a complete FBAR for tax year 2010. When the Bernsteins refused to pay, the IRS filed suit in District Court.
The District Court held that whether a taxpayer was willful in filing an incomplete FBAR is an objective, not subjective, inquiry. Therefore, the reason the Bernsteins did not disclose their foreign account to the IRS is immaterial. The Court explained the Bernsteins made a good choice by invoking their privilege in their 2010 FBAR, because they avoided criminal liability. The Court, however, sustained the 50% willful FBAR penalty against the Bernsteins because they took deliberate actions to hide the Swiss account from the Government.
Due to the severe civil and criminal penalties that may be imposed for a failure to file an FBAR, you may want to consult a tax attorney experienced in FBAR issues. Pedram Ben-Cohen represents many taxpayers concerning their foreign financial assets. He is not only an attorney and CPA, but also a Board Certified Taxation Law Specialist. If you would like us to advise you on your options, please call us at (310) 272-7600 or complete our online form.