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Ninth Circuit Holds Reckless Is Not Willful for Purposes of Preparer Penalty and Further Musings on the FBAR Willful Penalty by ROBERT HORWITZ

Internal Revenue Code § 6694 imposes a penalty on return preparers who understate a taxpayer’s tax liability.  The amount of the penalty is $1,000 per return if the understatement is due to an “unreasonable” position.  § 6694(a)(1).  Under § 6694(b)(1), the amount is the greater of $5,000 or 75% of the income derived by the preparer from preparing the return if the understatement is due to

  • “a willful attempt” to understate the tax liability on the return, § 6694 (b)(2)(A), or
  • “reckless or intentional disregard” of tax “rules and regulations’.’§ 6694 (b)(2) (B).
    In Rodgers v. United States, Docket No. 18-55009 (June 21, 2019), the Ninth Circuit held that “willful” under (b)(2)(A) does not include reckless conduct.  Instead, it requires “a conscious act or omission made in the knowledge that a duty is therefore not being met.” It reversed the district court’s determination that 5 corporate returns prepared by Rodgers willfully understated tax because the district court defined willful as including reckless disregard-

The Rodgers decision is “not for publication” and thus may not be cited as precedent under Ninth Circuit Rule 36-3.  It also does not discuss the facts in the case.  The district court’s 33-page Findings of Fact and Conclusions of Law fill in the details.  Rodgers is a tax attorney and certified public accountant who prepares tax returns.  He prepared returns for two individuals and three related corporations.  These returns substantially understated tax due to numerous errors.  Determining that the understatements were due to Rodgers’ willful or reckless acts and omissions, the IRS assessed fourteen penalties against him under §6694(b).  Rodgers paid part of the penalties and sued for a refund of the amounts paid and the abatement of the remainder.  The Government answered and counterclaimed for the balance owed.  Prior to trial, the Government conceded five of the penalties.  The district court was left to decide whether Rodgers was liable for penalties assessed with respect to the 2009 and 2010 returns prepared for each of the two individual clients and two of the corporate clients and the 2009 return for a third corporate client.

In its conclusions of law, the district court cited Safeco Ins. Co. v. Burr, 551 U.S. 47 (2007), for the proposition that “where willfulness is a statutory construct of civil liability, we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well.”  The district court then held, as to the returns for each of the five taxpayers, that Rodgers “willfully” understated tax, listing for each return the numerous errors they contained.  The only difference between the district court’s discussion of Rodgers’ willfulness in preparing the individual returns and its discussion concerning the corporate returns is that with respect to the former the district court found that Rodgers had knowledge of specific provisions of the Internal Revenue Code but failed to apply them while in the case of the corporate returns the district court determined that Rodgers “knew of the operation” of the three corporations and failed to follow his office’s standard practice in preparing their returns.  The district court concluded by finding that Rodgers “willfully and recklessly” prepared the nine returns in question and was, therefore, liable for penalties under § 6694(b).

In support of its decision, the Ninth Circuit relied on its prior decision in Ritchey v IRS, 9 F3d 1407 (9th Cir. 1993), and “noted further” that “willful” in § 6694(b) has the same meaning as the definition used in § 7206.  According to the Ninth Circuit, under United States v. Bishop, 412 US 346 (1973), this “does not include recklessness.”  In Bishop, the Supreme Court held that “willful” for purposes of § 7207, a misdemeanor, has the same meaning as for purposes of § 7206(1):

The Court, in fact, has recognized that the word “willfully” in these statutes [the criminal tax provisions of the Internal Revenue Code] generally connotes a voluntary, intentional violation of a known legal duty.

412 US at 360.

The Richey case relied on in Rodgers was a § 6694(b) penalty case involving a return preparer previously convicted of aiding and abetting in the preparation of false and fraudulent returns in violation of § 7206(2).  The Government moved prior to trial for partial summary judgment on the ground that the conviction collaterally estopped Richey from asserting he was not willful.  The district court denied the motion and the jury returned a verdict in favor of Richey.  The Ninth Circuit reversed, noting that the issue was the same in both the criminal case and the civil penalty case: whether Richey acted willfully.  The Ninth Circuit held that the district court erred in denying the Government’s motion:

Furthermore, the term “willful” has the same meaning under both sections 7206 and 6694. Willfulness under section 7206 “simply means a voluntary, intentional violation of a known legal duty.”  United States v. Pomponio, 429 U.S. 10, 12, 97 S.Ct. 22, 23-24, 50 L.Ed.2d 12 (1976). Similarly, under section 6694(b) willfulness “merely requires a conscious act or omission made in the knowledge that a duty is therefore not being met.” Pickering v. United States, 691 F.2d 853, 855 (8th Cir.1982).

Neither Richey nor Rodgers articulates why the definition of “willful” for criminal tax purposes means the same for civil tax penalties.  In the context of the trust fund recovery penalty under § 6672, the Ninth Circuit has held that reckless disregard is sufficient to support a finding of willfulness, Phillips v United States, 73 F3d 939 (9thCir. 1996); Leuschner v United States, 336 F2d 246 (9th Cir. 1964), even though criminal liability for failing to collect, account for or pay over withholding tax requires a finding of a “voluntary and intentional violation.”  United States v Easterday, 564 F3d 1004, 1006 (9th Cir. 2009); United States v. Gilbert, 266 F3d 1180, 1185 (9th Cir. 2001).

If the Ninth Circuit is of the opinion that, where criminal and civil liability for the same action require a finding of willful action or omission, the same definition of willful should be used, then the definition of “willful” articulated by the Supreme Court in Ratzlaff v United States, 510 US 135 (1994), involving a criminal violation of the structuring provisions of the Bank Secrecy Act, should apply to the parallel civil penalties contained in 31 USC § 5321, including the FBAR willful penalty.  The definition of “willful” articulated by the Supreme Court in Ratzlaff required the Government to prove that the defendant’s actions were voluntary and that the defendant knew his actions violated the law.  The only published appellate decision on the question of what constitutes willfulness for purposes of the civil FBAR penalty is Bedrosian v United States, 912 F. 3d 144 (3d Cir. 2018) (holding that willfulness for purposes of the FBAR civil penalty encompasses both knowing and reckless violations).  In a brief recently filed with the Fourth Circuit, the defendants in United States v. Horowitz urge the appellate court to apply the Ratzlaff standard and require a showing of actual knowledge to impose the willful FBAR penalty.

In a blog posted on January 2, 2019, I wrote about the district court’s decision in United States v. Flume, 122 AFTR 2d 2018-5641 (SD TX 2018), where the court denied the Government’s motion for summary judgment in an FBAR willful penalty case, specifically rejecting the theory that a taxpayer is deemed to have known of the FBAR requirement if he signed a tax return that checked the box “no” to the question of whether he had offshore accounts.  Flume’s victory was short lived.  On June 11, 2019, the district court issued an opinion holding that Flume was liable for the willful FBAR penalty.  123 AFTR 2d 2019-2211 (SD TX 2019).

In its opinion, the district court stated that willful for purposes of the FBAR penalty includes a knowing or reckless failure to file.  It found that Flume knew about the FBAR requirement but intentionally did not file reports listing his UBS accounts.  At trial, Flume’s two return preparers for 1999 through 2010 both testified that Flume told them about Mexican bank accounts but never told them about his UBS accounts, that they had never seen the general ledger for his business listing the UBS accounts, and that they sent him each year a form letter reminding him of his obligation to report all foreign bank accounts and financial interests.  The district court further found Flume’s testimony “not credible,” and full of “numerous indicia of dishonesty,” due, among other things, to the many contradictions in his testimony, the discrepancy between his testimony about when and how he learned of the FBAR requirement in a Tax Court case, in his deposition and at trial, and his explanation of why he understated the value of his UBS accounts in delinquent FBARs.  The court ended its opinion with the continued affirmance of its determination that “‘the constructive-knowledge theory is unpersuasive’ as a justification for penalties based on knowing conduct.”

We still have a long way to go before the willfulness standard for the FBAR willful penalty is resolved.   Besides the Horowitz case pending before the Fourth Circuit, there is the Kimble case pending before the Federal Circuit challenging a Federal Claims Court decision holding that constructive knowledge is sufficient to establish willfulness and rejecting the argument that the FBAR regulation caps the maximum willful penalty at $100,000.  So stay tuned.

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.

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