FBAR Penalties: Another Court Holds That FBAR Penalties Can Exceed The Regulatory Ceiling

FBAR Penalties: Another Court Holds That FBAR Penalties Can Exceed The Regulatory Ceiling

The Report of Foreign Bank and Financial Accounts (i.e., the “FBAR”) was for many years confined to the lonely backwaters of Title 31 of the United States Code—the intriguingly-named Bank Secrecy Act.  For years, compliance levels were abysmal.  But penalties were generally not enforced.  To put the situation in perspective, in the course of more than a decade, you could probably have counted the number of penalties assessed against non-compliant account holders on one hand—maybe, just maybe, two hands—at least according to contemporary reports from the Treasury Department to Congress.

But my how the times have changed.  FBAR penalties are most certainly enforced these days.  Some might argue that they are enforced with a vengeance—a vengeance that is disconnected with the purpose behind the FBAR filing requirement.  Truly, the penalties associated with failing to file an FBAR are among the most punitive civil penalties on the books.

The recent Second Circuit decision in United States v. Kahn serves as a reminder of the draconian FBAR penalty structure.  In that decision, the Second Circuit joined the Fourth, Eleventh and Federal Circuit courts in refusing to cap FBAR penalties in accordance with Treasury regulations (from 1987).  Those regulations were on the federal books prior to a major statutory amendment in 2004.  That 2004 amendment increased the statutory “cap” on FBAR penalties to an amount equal to the greater of$100,000 or 50% of the aggregated value of the accounts at the time of the willful failure to file an FBAR.  But the “old” Treasury regulation—which, by the way, has never been amended—still sits on the books and purports to provide a “ceiling” on willful FBAR penalties equal to $100,000.

So the case raises an interesting question: Does an administrative regulation that imposes a penalty that is less than the maximum amount provided by the statute (the statute that the regulation implements) prohibit an administrative agency (here, the IRS) from assessing a penalty that is greater than the regulation’s cap?  It is the agency’s duly-promulgated regulation after all.  And they have only had about 17 years to update it if they wanted to do so.  Perhaps expectations should be properly calibrated….

A Little Background

Willfulness was not in dispute in the case.  Mr. Khan willfully failed a Report of Foreign Bank and Financial Accounts (“FBAR”) for his two foreign bank accounts for 2009.  The IRS assessed a penalty equal to $4,264,728, plus statutory additions and interest, for that failure.

The case put the disconnect between the statute and regulation squarely in play.  On the one hand, Mr. Khan’s estate argued that a 1987 Treasury Department regulation, 31 C.F.R. § 1010.820(g)(2), limits the government’s authority to impose penalties for willful FBAR violations to $100,000 per account.  That is, after all, exactly what the regulation says.  The government, however, argued that the regulation was effectively superseded by a 2004 statutory amendment:  Under 31 U.S.C. § 5321 as amended in 2004, it argued, the maximum penalty for a willful failure to file an FBAR is 50 percent of the aggregate balance in the accounts at the time of that failure.

The upshot?  The Second Circuit rejected the estate’s argument, holding that the penalty limitation provided in the 1987 regulation, which had tracked the penalty provision enacted in a prior version of the statute, was indeed superseded by the 2004 statutory amendment—thereby increasing the maximum penalty.

The Facts

The relevant facts were not in dispute.  Indeed, the parties stipulated to the following basic facts:

  • Harold Kahn … willfully failed to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (“FBAR”) for the 2008 year as required by 31 U.S.C. § 5314 and implementing regulations.
  • The filing due date for the 2008 FBAR was June 30, 2009.
  • The 2008 FBAR should have reported two bank accounts held by Mr. Kahn at Credit Suisse, Switzerland.
  • Each account held over $100,000 and the aggregate value in the two Credit Suisse accounts was $8,529,456, as of June 30, 2009.
  • The Internal Revenue Service assessed a willful penalty for the failure to file the 2008 FBAR in the amount of $4,264,728, which represents 50% of the aggregate account balance as of June 30, 2009, pursuant to 31 U.S.C. § 5321(a)(5).

The FBAR Rules and the Evolution of the FBAR Reporting Requirement

In 1970, Congress enacted the Bank Secrecy Act (“BSA”).  The stated reason: To combat money laundering and other financial crimes in the United States. Pub. L. No. 91-508, 9 202, 84 Stat. 1114 (1970). One of the primary purposes of the BSA was to deter the use of foreign financial accounts to avoid tax obligations. See Id.

The BSA required that private individuals report their relationships with foreign financial institutions. Id. § 241 (codified as amended at 31 U.S.C. § 5314). Congress vested the Secretary of the Treasury (“the Secretary”) with the authority to prescribe the FBAR form and authorized the Secretary to promulgate regulations necessary to implement and enforce this reporting requirement. See Id. § 242.

In 1972, the Secretary promulgated regulations implementing the FBAR requirement. 37 Fed. Reg. 6912 (codified as amended at 31 C.F.R. Ch. X) (Apr. 5, 1972). Those required that each person with an interest in a bank account in a foreign country report the relationship on his or her federal income tax return for each year in which the relationship exists. Id. at 6913 (codified as amended at 31 C.F.R. 5 1010.350). The form the Secretary prescribed has come to be known as an FBAR, and failure to file it can result in monetary penalties.

As money laundering became an ever-larger problem, Congress passed the Money Laundering Control Act of 1986 (“the MLCA”). Pub. L. No. 99-570, Subtit. H, 100 Stat. 3207 (Oct. 27, 1986). Through the MLCA, Congress increased both the civil and criminal penalties associated with money laundering and related violations of the BSA. Most notably for our purposes, Congress added a new civil money penalty—a penalty for a willful failure to file an FBAR.

The maximum penalty was set at “the greater of” $25,000 or “an amount (not to exceed $100,000) equal to the balance in the account at the time of the violation.” 31 U.S.C. § 5321(a)(5)(B)(ii)(I)-(II) (1988) (the “1986 Statute”). In 1987, the Secretary promulgated the 1987 Regulation.  That regulation is currently located at 31 C.F.R. § 1010.820(g), (which I affectionately referred to as the “lonely backwaters of Title 31” above).  That regulation repeated almost verbatim the language of the new civil penalty provision in 31 U.S.C. § 5321(a)(5).

The revised FBAR penalty regulation read as follows:

((g))  For any willful violation committed after October 27 1986, of any requirement of [§ 1010.350, § 1010.360 or § 1010.420], the Secretary may assess upon any person, a civil penalty:

((2))  In the case of a violation of [§ 1010.350 or § 1010.4201 involving a failure to report the existence of an account or any identifying information required to be provided with respect to such account, a civil penalty 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.

Id. at 11446 (codified as amended at 31 C.F.R. § 1010.820(g)).

Following the terrorist attacks of 9/11, Congress began to debate legislative changes of its own. Both chambers of Congress contemplated amendments to the FBAR penalty statute. Notably, though, while one chamber of Congress proposed substantially raising the penalty ceiling, the other proposed retaining the original caps. Congress ultimately elected to increase the penalties and, in 2004, amended the FBAR penalty statute to increase the prior-law penalty for willful behavior.

As a result, the 2004 Statute increased the civil penalty for willful behavior to its present level, making the maximum penalty for failure to file an FBAR the greater of $100,000 or 50 percent of the aggregate balance in the accounts at the time of the violation.  31 U.S.C. § 5321(a)(5)(C)(i).

The regulations, however, were not updated or amended to reflect the statutory changes.  They continued to require that each person holding a foreign bank account file an FBAR for each year in which he or she holds such an account. 31 C.F.R. § 103.24 (2009) (codified as amended at 31 C.F.R. § 1010.250).  And a failure to do so, under those regulations, could result in “a civil penalty 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.”

That is where the legislative evolution stood at the relevant point in time for Kahn 

The Issue

So back to the issue.  The government, in Kahn, maintained that the 2004 Statute, 31 U.S.C. § 5321(a)(5)(C)—providing that the maximum assessable penalty was the greater of $100,000 or 50 percent of the aggregate account balance at the time of the violation—should be applied.  That amount was $4,264,728.  The Estate, on the other hand, contended that the penalty was necessarily limited to $100,000 per account (for a total of $200,000) under 31 C.F.R. § 1010.820(g)(2)—the 1987 Regulation.

The Analysis

The regulation states that the Secretary ”may assess … a civil penalty” on any person who willfully violates the FBAR requirement, 31 C.F.R. § 1010.820(g) (emphasis added).  The estate maintained that this provision is not inconsistent with the 2004 statutory language. The court, however, noted that while the regulation states that the Secretary may impose such a penalty only up to a maximum of $25,000, the statute provides that the maximum “’shall be increased to the greater of (I) $100,000, or (II) 50 percent’” of the unreported aggregate balance. The court reasoned that the use of the mandatory “shall be” phrase “shows that Congress did not intend to delegate the determination of the maximum penalty to the Secretary.” The court stated that:

[t]he Secretary may, on a case-by-case basis, impose penalties below the statutory maximum. But he cannot effectively abrogate the statute and the maximum penalty specifically set by Congress by promulgating (or failing to repeal) a regulation providing a different penalty ceiling.

Id. (emphasis added).

Drawing on the district court’s analysis, the Second Circuit concluded that the 1987 Regulation and the 2004 Statute are not “harmonious,” citing to several authorities in support of its position.  Norman v. United States, 942 F.3d 1111, 1117-18 [124 AFTR 2d 2019-6595] (Fed. Cir. 2019) (”Norman“); United States v. Horowitz, 978 F.3d 80, 90-91 [126 AFTR 2d 2020-6551] (4th Cir. 2020) (” Horowitz “); United States v. Rum, 995 F.3d 882, 892 [127 AFTR 2d 2021-1761] (11th Cir. 2021) (”Rum“).  Thus, the Second Circuit found that:

“when Congress enacted the 2004 Statute stating that the maximum penalty “shall be increased,” any continued adherence to the 1987 Regulation contravened both the plain language of the statute and the “manifest congressional design,” id. , embodied in the 2004 Statute. As the Court of Appeals for the Federal Circuit in Norman stated in rejecting an attempt to have the 1987 Regulation’s penalty limitation applied instead of the maximum provided by the 2004 Statute,”

[i]t is well-settled that subsequently enacted or amended statutes supersede prior inconsistent regulations…. A regulation that contravenes a statute is invalid…. A regulation cannot override a clearly stated statutory requirement…. It is well-settled that when a regulation conflicts with a subsequently enacted statute, the statute controls and voids that regulation…. Ms. Norman’s position to the contrary would inappropriately prevent all newly created or amended statutes from taking effect until all inconsistent regulations are amended or repealed.

Norman, 942 F.3d at 1118 (internal quotation marks omitted (emphases ours)); seee.g.Rum, 995 F.3d at 892 (“The plain text of § 5321(a)(5)(C) makes it clear that a willful penalty may exceed $100,000 because it states that the maximum penalty ‘shall be … the greater of (I) $100,000, or (II) 50 percent of’ … the balance of the account. The regulation was promulgated in 1987 and mirrored the language of the statute at that time but was never updated. ‘[T]he statute’s language is hardly consistent with an intent by Congress to allow the Secretary to impose a lower maximum penalty by regulation; rather, Congress itself set a specific maximum penalty for a willful violation.’” (quoting Horowitz, 978 F.3d at 91 (emphases ours)); Horowitz, 978 F.3d at 91 (“[T]he 1987 regulation on which the Horowitzes rely was abrogated by Congress’s 2004 amendment to the statute and therefore is no longer valid.”).

Where do we go from here?

The Second Circuit’s decision continues a trend of decisions from federal courts addressing this particular issue.  But do I think it’s correct?  No.  In my opinion, several courts that have addressed this (and, frankly, a number of other FBAR issues) have invited, and contributed to, an echo chamber, repeatedly parrotting back faulty, superficial reasoning that—if we’re being brutally honest—sure looks result-driven.  But courts, in my humble opinion, should be more concerned with being right than consistent.  If courts are going to stop holding the IRS to its words (the words of its regulations), then what value and role do regulations serve?  And what is an average citizen to think about the meaning, validity, or need to comply with those words?  After all, the Treasury has had 17 years and counting to amend the regulation.

Have a question on FBAR? Contact Jason Freeman, Freeman Law, Texas.

Mr. Freeman is the founding and managing member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney. Mr. Freeman has been recognized multiple times by D Magazine, a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service.
He was honored by the American Bar Association, receiving its “On the Rise – Top 40 Young Lawyers” in America award, and recognized as a Top 100 Up-And-Coming Attorney in Texas. He was also named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas” by AI.

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