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It Still Lives!!  Recent Opinions in Two Willful FBAR Penalty Cases by ROBERT S. HORWITZ

It’s been so long since I have blogged about FBAR cases I almost forgot they even existed.  This is probably the effect of age.  But decisions in two recent cases show that FBAR willful penalty cases are still alive and reflect that courts are not blindly accepting the Government’s “pushing the envelope” theories.  Both cases rejected the Government’s theory that a taxpayer who signs tax return with a Schedule B is automatically “willful.”  Both also give a glimpse at the IRS’s internal decision-making process on whether a willful FBAR penalty should be imposed.

The case that resulted in only one decision, Jones v United States, CV 19-04950 (CD CA May 11, 2020), involves an elderly taxpayer who filed a streamlined disclosure only to end up with penalties assessed against her of $751,685 for 2011 and of $770,255 for 2012 and against her late husband’s estate for 2011 in the amount of $1,890,074.

Margaret Jones was born in Canada in 1928 and her husband, Jeffrey, was born in New Zealand in 1919.  They met and married in Canada and moved to the U.S. in 1954, becoming U.S. citizens in 1969.  Both were high school graduates; neither ever attended college. Jeffrey had four New Zealand bank accounts; Margaret had one New Zealand and two Canadian accounts; they had two joint accounts in New Zealand and two in Canada.  Jeffrey died in 2012.

Although their CPA knew that Mr. and Mrs. Jones were both born overseas and lived in Canada before they moved to the U.S., he never asked them about whether they had any foreign accounts.  He was not familiar with FBAR reporting requirements and never asked any of his clients about foreign assets or advised about foreign banking activities.  He never reviewed Schedule B with the Joneses.  Their returns did not report foreign income and checked “No” to whether they had foreign accounts.

After Jeffrey died, Margaret for the first time learned of his four New Zealand accounts.  In consulting with attorneys about Jeffrey’s estate, she learned for the first time about the need to file FBARs and report foreign income. She filed a timely FBAR for 2012 and in 2014 filed amended returns for 2011 and 2012 reporting previously unreported foreign income.   In 2015, Margaret filed streamlined submissions and paid a miscellaneous penalty of $156,000 based on the highest total balance in her separate accounts and the joint accounts.  The estate tax return filed for her late husband listed his foreign New Zealand accounts.

The revenue agent assigned to review Margaret’s streamlined filing had only three days of training about FBARs, foreign entities, foreign issues and international issues.  The investigation began because the penalty did not include Jeffrey’s four separate accounts.  There were no clear guidelines on filing a streamlined disclosure for a deceased spouse.  Several agents advised the agent auditing Margaret’s streamlined filing  to offer an opportunity to amend her streamlined filing to include Jeffrey’s accounts.  Instead, the revenue agent proposed willful penalty on the ground that Margaret and Jeffrey were “willfully blind.”   The revenue agent’s penalty against Jeffrey’s estate was based on the balance in his accounts as of June 30, 2012.  For Margaret, the revenue agent used 50% of the balance in her separate accounts and the joint accounts and “spread them” between 2011 and 2012.  The total penalty against Margaret was $1,521,000, but half the balance in her account on that date was $1,485,000.

While the Court gave lip service to the cases that had embraced the “constructive knowledge” theory of willfulness, it held that it can be rebutted.  Because there was evidence that Mrs. Jones and her late husband did not know about the need to file FBARs  the Court held there were questions of material fact in dispute:  “Ultimately, willfulness is a finding of fact and the fact that Mrs. Jones signed her return under penalty of perjury is prima facie evidence that she had constructive knowledge of the FBAR requirements.  Such evidence creates a genuine dispute of material fact as to whether she engaged in a willful violation.”

The Court then addressed Mrs. Jones’ argument that the penalty amount was arbitrary and capricious and thus should be set aside.  The Court stated that the penalty amount is reviewed for abuse of discretion under an arbitrary and capricious standard under the Administrative Procedure Act.  Here, the penalty was based on inappropriate data (i.e., the balance on June 30, 2012, to assess penalties for 2011 and 2012) that should not have been used and was therefore “arbitrary and capricious.”  If willfulness is found at trial, the Court stated it would remand the matter to the IRS for a recalculation of the penalty.

The second case is United States v. Schwarzbaum, Case No. 18-cv-81147 (SD FL March 20, 2020, and May 18, 2020).  The first decision in that case dealt with whether the Mr. Schwarzbaum was willful; the second decision dealt with the amount of the penalty and whether it violated the excessive fines clause of the Eighth Amendment.

Mr. Schwarzbaum was born in Germany, had lived in a number of countries and spoke six languages.  His father had built a successful textile business and had invested in real estate.  He became a U.S. citizen in 2000, spent part of each year from 1993 to 2010 in Costa Rica, Switzerland and the U.S. and lived in Switzerland full time from 2010-2016.  Since 2016 he has lived in the U.S.

Mr. Schwarzbaum’s father supported him until he was 45, when his father signed over a Swiss account to him with $3 million.  He invested the funds conservatively like his father had.  His father died in 2009, leaving to him other offshore accounts.  Mr. Schwartzbaum let the bankers invest the money for him.  Between the years in issue, 2006 through 2009, Mr. Schwarzman had 11 Swiss bank accounts.

Mr. Schwartzbaum used accountants to prepare his U.S. tax returns.  In 2001, he told his CPA that he had received a substantial gift from his father in Europe.  The CPA told him that there was no U.S. tax reporting requirement for foreign gifts.  The CPA never told Mr. Schwarzman about the need to report income from foreign assets and he never asked the CPA about whether he had to do so.

By 2006, Mr. Schwartzbaum was using a different CPA.  He told her he had received money from family in Switzerland.  She told him that there was no need to report gifts to the IRS unless there was “a U.S. connection.”

At trial, Mr. Schwartzbaum testified that based on his experience in other countries, he believed that taxation is based on residency and not citizenship.  Between 2006 and 2009, he had an account in Costa Rica that he transferred money to from the U.S. He filed FBARs for 2006 through 2009 that reported the Costa Rican account because it had a “U.S. connection.”  In 2009 he transferred funds from the U.S. to his largest Swiss account.  He reported that account on his 2009 FBAR, but not any of his other Swiss accounts.  He also reported a $5.05 million gift from his father in 2007 because the funds were wired to the U.S.

In October 2009, Mr. Schwartzbaum received a letter from UBS; he consulted his Swiss lawyer, who told him not to do anything.  He did not consult any American lawyer or accountant.  Ultimately, he participated in the OVDI, but opted out. Initially, after interviewing Mr. Schwartzbaum, the agent to whom the case was assigned and his manager believed that only non-willful FBAR penalties should be assessed.  The Offshore Technical Advisor convinced them that there were sufficient indicia of willfulness and that FBAR willful penalties should be assessed.  The maximum potential penalties that could be asserted against Mr. Schwartzbaum was $35.4 million, but the IRS mitigated the amount to $13.729 million, the penalty for the year with the largest balance, and spread it out over 2006, 2007, 2008 and 2009.

Beginning its analysis, the district court stated that for purposes of a civil penalty, willfulness includes both knowing and reckless conduct and willful blindness but rejected the Government’s argument that a taxpayer has constructive knowledge of the FBAR filing requirements based on signing a tax return.

Turning to whether there was reckless conduct or willful blindness, the district court rejected the Government’s arguments that Mr. Schwartzbaum was willfully blind because he opened Swiss accounts with instructions to “hold” mail and did not respond to the UBS letter, since he was directed to sign the “hold instructions” by Swiss bankers and didn’t respond to the letter based on his Swiss attorney’s advice.

Mr. Schwarzbaum was not out of the woods yet.  Based on his FBAR filings for 2006-2009, the district court held that he was willfully blind for 2007, 2008 and 2009 but not for 2006.  While his English was limited in these years, he never asked anyone to translate the FBAR form or instructions for him.  These instructions were unequivocal that a U.S. person, which he was, was obligated to report all foreign financial accounts, regardless of whether there was a “U.S. connection.”  After reviewing the FBAR instructions for 2007, Mr. Schwarzbaum was or should have been aware “of a high probability of tax liability with respect to his unreported accounts” and took no steps to learn about what his filing and tax obligations were.  Thus, he met the willful blindness standard.

Mr. Schwarzbaum challenged the amounts assessed under the Administrative Procedure Act.  The IRS used the high account balance as shown on Mr. Schwarzbaum’s OVDI worksheet and not the balances as of June 30 of the year following the year for which the report was filed.  Thus, the penalties were not assessed according to law.  The court ordered supplemental briefing on the amount of the penalties and whether the Eighth Amendment prohibition against excessive fines applied.

In its second order, dated May 18, 2020, the district court fixed the total penalties for 2007, 2008 and 2009 at $12,907,952.  The court rejected Mr. Schwarzbaum’s arguments that a) no penalty should apply since the IRS did not follow the law in determining the penalty amount; b) that the case should be remanded to the IRS for further proceedings, with the IRS being time-barred from assessing penalties since that argument was not properly raised; c) that the penalties were invalid, since the court had already determined that Mr. Schwarzbaum was liable for willful penalties and had ordered supplemental briefing as to the amount, which the Government did; and d) that the FBAR penalty should be capped at $100,000 per tax year, since this was contrary to the statutory language.

The district court also rejected the Government’s argument that it should sustain the full amount of the proposed penalties, $13,729,591, since that amount was below the statutory maximum for 2007, 2008 and 2009.  The court rejected this argument, finding it was not “harmless error.”  Based on the balance in each account the district court determined that the penalties were $4,498,486 for 2007, $4,212,871 for 2008 and $4,196,595 for 2009.  In its analysis, the district court relied on charts prepared by the Government that listed the balance in each account as of June 30 of the year following the year for which the report was required and determined a penalty amount based on 50% of the balance in each account and, in some instances where the account balance was unknown or below $100,000 fixed the penalty at $100,000.

Which takes us to the last and perhaps the most important part of the opinion: the court’s evaluation of the Excessive Fines argument.  The court held that FBAR penalties do not violate the Eight Amendment Excessive Fines provision because they did not serve primarily punitive, retributive or deterrent purposes but were primarily remedial.  The court termed the FBAR penalty a “tax penalty” and noted that tax penalties have traditionally considered remedial.  The court also said that treating FBAR penalties as outside the purview of the Eight Amendment was consistent with the purpose of the FBAR, which “is to identify persons who may be using foreign financial accounts to circumvent United States laws and to identify and trace funds used for illicit purposes to identify unreported income maintained or generated abroad.”  Further, 31 USC sec. 5321 is entitled “Civil penalties.”  The court concluded that FBAR civil penalties are not subject to the Eighth Amendment.  I found the court’s analysis of the applicability of the Eighth Amendment unsatisfactory.  FBAR penalties are not “tax penalties” and the purpose of the BSA was in part aimed at detecting and deterring criminal conduct. My guess is this issue is heading to an appellate court.  While there may not be definitive law yet, most court’s that have dealt with the issue have agreed the Excessive Fines clause would apply to an FBAR penalty.[1]

Some take aways: first, while the Government continues to push the claim that a person who signs a tax return is automatically deemed to know of the FBAR reporting requirements, some district courts are pushing back; second, the IRS’s default position is when in doubt, assess the FBAR willful penalty; third, the Government will go through each account to determine not only non-willful penalties but also willful penalties.  Thus, if a taxpayer had several accounts, the willful penalty may be based on 50% of the balance in accounts with over $100,000 and $100,000 if the account had a balance of $100,000 or less.

Of overriding importance is that maybe— and just maybe—these decisions will cause IRS and DOJ Tax to recognize that they are dealing with penalties and penalties have a purpose.  When they are applied in a manner which undercuts the credibility of the tax administrator by pushing the envelope at every corner, they not only lose their effectiveness but also undermine the fairness of tax enforcement.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

[1] See Steven Toscher and Michel R. Stein, “The Eight Amendment Limits on FBAR Penalties—Common Sense Limitations Becomes a Legal Reality,” Journal of Tax Practice & Procedure, June-July 2018, 39.

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