Failing to File FBAR Disclosures Causes Big Problems for Taxpayers

November 18, 2021

For nearly a decade starting in 2012, the Internal Revenue Service has been racking up a string of victories in court cases and getting harsh penalties enforced against taxpayers accused of willful failure to file FinCEN Form 114 (FBARs) disclosing assets held in foreign financial institutions.

Until the Jones case came along, and made them blink.

Willful vs. Non-Willful Violations

At the heart of the Jones case is the concept of willful vs. non-willful violations.

Normally, the IRS can slap a civil penalty on any individual who fails to timely file an FBAR. For non-willful violations, the max penalty $10,000 per violation. But when the failure is willful, the IRS can impose a penalty of up to 50% of the amount the taxpayer failed to disclose on an FBAR, or $100,000 – whichever is higher.

That’s a problem for taxpayers who are targeted for alleged violation of FBAR requirements: The evidentiary burden for government lawyers to establish willfulness has historically been extremely low. Hence the long string of court victories over the years.

Finally, taxpayers won a brief and fleeting victory in the Bedrosian case. In 2008, the IRS initiated an audit of a pharmaceutical executive who had failed to disclose large amounts of money in two Swiss accounts with UBS. Bedrosian cooperated with the audit, and the first auditor ruled that his failure to disclose the accounts was not willful. But when the first auditor left on medical leave, a second auditor ruled that Bedrosian’s failure to file an FBAR were, in fact, willful. This finding triggered possible fines of hundreds of thousands of dollars. Bedrosian appealed to the IRS, lost, and then won his appeal in District Court.

This decision was the first favorable court ruling for a taxpayer on record.

It wasn’t a complete victory. The court also ruled that Bedrosian was likely trying to evade taxes arising from his overseas accounts. The court also ruled that Bedrosian was negligent in his failure to disclose. The Court simply ruled that the Department of Justice had failed to show that Bedrosian engaged in conduct intended to conceal or mislead, or “a conscious effort to avoid learning about reporting requirements.”

The DoJ Proves ‘Reckless Disregard’

Bedrosian’s limited victory against the IRS and the Department of Justice would prove to be short-lived. Justice Department attorneys went to the Third Circuit Court of Appeals for a review of the Circuit Court’s ruling. The Court of Appeals remanded the case back to Circuit Court, ordering the lower court to reconsider, ordering them to use a more objective standard of determining recklessness.

In December of 2020, the Circuit Court finished its deliberation, and issued a new ruling – in favor of the government. In part, the ruling read:

“[T]his Court finds that [the taxpayer’s] actions were willful because he recklessly disregarded the risk that his FBAR was inaccurate. The Court notes that the concept of willfulness encompasses both knowing and reckless conduct. As the Third Circuit emphasized, in the law of taxation, reckless conduct can be violative of IRS statues and/or rules, from an objective point of view, even if not “willful” from a subjective point of view.

This Court, after review of the evidence, concludes that it must use a more expansive concept of willfulness that includes reckless conduct considered from an objective point of view. Accordingly, this Court concludes that [the taxpayer’s] conduct was willful under settled case law.”

Bedrosian was an educated, sophisticated business executive – and this weighed against him at trial: He couldn’t claim ignorance. The Court found that Mr. Bedrosian had a duty to review his previous inaccurate FBAR disclosures, and that if he had, he should have noticed that the account balances were wrong, underreporting his assets by hundreds of thousands of dollars.

With this ruling, the Court imposed a penalty on Mr. Bedrosian of $975,789.19.

The Jones Case

Meanwhile, the Justice Department had been pursuing a case against a New Zealand-born immigrant to California, Jeffrey Jones and his wife, Margaret. Between the two of them, they held eleven separate foreign financial accounts in Canada, where Jeffery had lived for years before immigrating to the U.S. and becoming a citizen, and in New Zealand.

They got into trouble when they did not report their passive income from these foreign accounts on their joint 1040 tax returns for 2011. Furthermore, they checked the “no” box in Schedule B to the Form 1040, indicating they didn’t have any foreign accounts to report. Furthermore, they did not file a 2011 FBAR. They testified they were operating under the mistaken belief that they didn’t have to report those assets until they repatriated them to the United States.

Their accountant at that time testified that he didn’t ask them about any Canadian accounts, and at any rate, didn’t realize it would be an issue, because despite having worked with the Joneses for 25 years, he had no other clients with international tax issues. He also admitted to not reviewing the Schedule B with his clients. And the Joneses, naturally, raised the reasonably reliance defense. They aren’t tax professionals. They were relying on the expertise of their tax advisor in filing the returns.

The problem with that argument: They apparently didn’t even tell their accountant about their foreign accounts at all. So their accountant didn’t get a chance to advise them about their FBAR requirement. And the DoJ asserted that the Joneses should have known that they had to disclose it, and received constructive notice about their responsibility when they signed Schedule B.

The Government Goes After a 90 Year-Old Widow

Alex died at age 93, with the matter still unresolved – and leaving his elderly widow as executor of his estate to clean up the mess. When she became aware of the FBAR problem and her duties as executor of her late husband’s estate, she was, indeed, proactive about rectifying the matter. For example, she disclosed the foreign accounts on Form 706, filed a correct FBAR in 2012, she hired an attorney, applied for the Streamlined Domestic Offshore Procedures (SDOP), and paid the offshore penalty.

The Justice Department rejected Margaret’s claim of non-willfulness, and went after the max penalty against a 90-year-old woman and her late husband’s estate.

The Justice Department was unmoved. In fact, they tried to use the fact that Margaret filed a correct FBAR as evidence that she must have known about her responsibility to file the prior one. Effectively, they attempted to use her later compliance as evidence against her.

This time, the Circuit Court rejected several of the governments’ arguments. They ruled that signing an erroneous tax return cannot by itself establish “willfulness.”

Furthermore, the Department of Justice claimed that reasonable reliance on a tax professional’s advice was not a defense against a willfulness accusation. The Circuit Court rejected this argument, too.

Finally, the Circuit Court ruled that they would not grant summary judgment on the government’s claims, because several the governments’ claims were findings of fact that would have to happen at trial.

That set the Department of Justice on its heels: They apparently felt they faced an uphill battle in pursuing a 90-year-old widow in failing health in the attempt to fine her hundreds of thousands of dollars. If the case went against them, it would disrupt a long string of very pro-government precedents, and possibly make it more difficult for the government to pursue much more egregious cases in the future.

So, shortly before the case went to trial the government punted, and settled with Ms. Jones out of court.

Takeaways

Taxpayers should take a number of lessons from these two cases, and the related case law:

First, understand that an ounce of prevention is worth a pound of cure. The IRS and DOJ are serious about enforcing FBAR requirements and continue to aggressively pursue violators. Taxpayers with overseas accounts and their advisors should be careful to disclose all foreign assets in FBAR filings.

Second, the government has a very low standard of proof when it comes to establishing willfulness. They only need to demonstrate it by a preponderance of the evidence. The evidence doesn’t have to be ‘clear and convincing,’ and certainly doesn’t have to establish it ‘beyond reasonable doubt.’ If the government is determined to show your failure to comply with FBAR and other such requirements is ‘willful,’ it is extremely difficult under current case law for taxpayers to mount an effective defense.

It might have gotten much easier, had the Jones case gone to trial, and the Joneses prevailed. That would have established a much more taxpayer-friendly precedent. But by settling, the government was able to keep that case off the stare decisis record.

Third, experience matters. International tax compliance is a specialized field. Not all tax professionals have expertise in these matters – even after many years of experience working with an overwhelmingly U.S.-based client base. If you have international connections, do business overseas, or still have foreign accounts, it’s critical that you seek the services of tax professionals with specific and proven expertise in these matters. It shouldn’t be a sideline: International tax compliance should be a key focus of your tax professional’s practice.

Had the Jones’ accountant had more experience with FBAR compliance, he might have known to do more digging and learn about the Jones’ overseas accounts – and saved until legal fees, fines, and stress.

About AbitOs
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If you would like to benefit from our expertise in these areas, or if you have further questions on this Alert, we encourage you to contact us.