What 2022 Has Taught Us About FBAR Willfulness

The Bank Secrecy Act requires certain taxpayers to submit timely FBARs to the United States reporting their interests in foreign accounts.  If a taxpayer has an FBAR filing requirement and misses it, the taxpayer can be liable for civil penalties of up to 50% of the account balances or $100,000, if the taxpayer is willful.  On the other hand, if a taxpayer misses the FBAR filing deadline due to non-willfulness, the civil penalties are limited to $10,000 per violation, subject to reasonable cause.

What is the difference between willfulness and non-willfulness?  Good question.  Because the concept of willfulness can include recklessness—and the scope of non-willfulness includes negligence and inadvertence—the line between willful and non-willful is not an easy one to define.  Accordingly, federal courts have been left to grapple with the distinction.

So far in 2022, federal courts have issued five important cases on willfulness.  Each of these is discussed more below.

U.S. v. Schwarzbaum (11th Cir. 2022). 

Brief Facts. 

On January 25, 2022, the Eleventh Circuit Court of Appeals issued its opinion in Schwarzbaum.  In that case, the taxpayer was born in Germany but moved to the United States in the 1990s.  He obtained his Green Card but continued to hold foreign bank accounts in Switzerland and Costa Rica.

Schwarzbaum generally relied on tax professionals to prepare his United States income tax returns.  He argued during the lawsuit against the government that these tax professionals had advised him (incorrectly) that he did not need to report his foreign assets to the IRS unless those assets had some type of U.S. connection.

In 2006, Schwarzbaum’s tax professional prepared and filed an FBAR on his behalf.  In 2007, however, Schwarzbaum chose to go at it alone and prepared and filed his own FBAR.  On the 2007 FBAR, he failed to report all of his foreign accounts.  Schwarzbaum missed his 2008 FBAR but filed an FBAR again in 2009, again not listing all of his foreign accounts.

The IRS later audited his FBAR filings and determined that he should be liable for $13.7 million in willful FBAR penalties.  The district court agreed, at least with respect to his 2007, 2008, and 2009 tax years, and Schwarzbaum appealed.

Court’s Analysis. 

Although Schwarzbaum contended that the district court applied the wrong standard of willfulness—in holding him to a reckless standard—the Eleventh Circuit disagreed with Schwarzbaum.  More specifically, the Eleventh Circuit held that “[w]illful conduct in the FBAR context includes knowing and reckless conduct. . . [and r]eckless conduct is action that objectively entails a high risk of harm, which is the standard the district court applied.”  Given this lower bar to a finding of willfulness, the Eleventh Circuit held that the district court did not err in affirming the willful FBAR penalties against Schwarzbaum because he had reviewed the FBAR instructions for 2007 (in preparing his own FBAR for that year) and failed to report all of his foreign assets for the years at issue even though the instructions told him to do so.

U.S. v. Schik, No. 20-cv-02211 (S.D.N.Y. Mar. 8, 2022).

Brief Facts. 

On March 8, 2022, the Southern District of New York issued its decision in Schik.  Unlike many FBAR cases, the facts in Schik could not be more sympathetic to the taxpayer.  He was close to 100 years old, had an elementary-level education, and was a Holocaust survivor.  When World War II ended, he left a concentration camp and eventually moved to the United States.  In 1957, he became a United States citizen.

After much of his family perished in World War II, Schik gathered their wealth and deposited it into a Swiss bank account.  When Schik made the deposit, he did so on the belief that if another Holocaust occurred, Switzerland would remain neutral, and he would be able to access the funds, i.e., it served as the equivalent of a safety net.  Schik never touched the funds and let a third party manage the investments.  The Swiss bank account eventually grew to $17 million in 2007.

Schik relied extensively on tax professionals to prepare his United States income tax returns.  For the 2007 tax year, his tax preparer never asked Schik whether he had foreign accounts and never provided Schik with a questionnaire.  Schik’s 2007 Schedule B boxes regarding interests in foreign accounts was checked “No”—however, there was evidence that the tax preparer’s software automatically reverted to “No” unless the box was affirmatively checked “Yes.”

The IRS examined Schik’s 2007 FBAR year and determined that he should be liable for $9 million of willful FBAR penalties.

Court’s Analysis.

As the government often does in these cases, it moved in Schik for summary judgment on the issue of willfulness.  In layman’s terms, the government argued that no trial was necessary because the undisputable facts showed that Schik was willful as a matter of law.

Similar to Schwarzbaum above, Schik contended that the concept of willfulness should not encompass recklessness.  And similar to Schwarzbaum, the district court disagreed:  “The Court agrees with the decisions of almost every court, including those in this Circuit, that have considered the issue and now holds that a ‘willful violation’ includes reckless violations for purposes of a civil FBAR penalty.”

However, the district court disagreed with the government that it had shown sufficient facts to demonstrate willfulness. Rather, the district court held that summary judgment was not appropriate because Schik had provided competent evidence that he:  (1) did not manage the foreign accounts and account investments; (2) did not know of the requirement to disclose funds; (3) his tax preparer never informed him of the FBAR reporting requirement; and (4) he relied on his tax preparer for his 2007 tax returns and his tax preparer’s software auto-filled the Schedule B questions.

U.S. v. Collins, 36 F.4th 487 (3d Cir. 2022). 

            Brief Facts. 

Collins was issued by the Third Circuit on June 6, 2022.  In that case, the taxpayer was a dual citizen of the United States and Canada.  Since the 1960s, he had worked as a professor in various countries.  While earning funds from his work as a professor, he opened and deposited those funds into various foreign accounts including Switzerland.  By 2007, the balance in his Swiss bank account exceeded $800,000.

Collins attempted to come clean with the IRS by filing under the now-defunct offshore voluntary disclosure program (“OVDP”).  As part of the OVDP, Collins was required to submit amended returns for his 2002 through 2009 tax years.  When his tax professional prepared the returns, Collins learned that he did not owe any federal taxes—rather, capital losses had resulted in refunds being owed to Collins.  On the basis of this advice, Collins opted out of the OVDP.

The IRS later examined Collins’ income tax returns and concluded that he actually owed approximately $72,000 of taxes under the PFIC regime.  Collins quickly paid the additional taxes and penalties that were owed by him to the IRS.

The IRS also examined his FBAR filings and concluded that he was willful for his 2007 tax year.  On this basis, the IRS assessed over $300,000 in willful FBAR penalties against him.  The district court found that Collins was willful, and he appealed to the Third Circuit.

Court’s Analysis. 

Unlike Schwarzbaum, the Third Circuit found that Collins acted intentionally in not filing his FBAR for 2007.  Stated differently, the Third Circuit did not have to reach the decision as to whether Collins was reckless because they believed he acted with a higher intent than reckless.

According to the Third Circuit, evidence that Collins was willful included:  (1) he was a sophisticated taxpayer (a professor); (2) he was aware of the foreign accounts at the time he filed his return and the high balances in the accounts and nevertheless continually checked the Schedule B boxes “No” regarding interests in foreign accounts; (3) he instructed the foreign banks not to send his bank account statements or other mail to him; and (4) he expressed a desire to the bank to discretely transfer funds to the United States for a mortgage application.  Significantly, the Third Circuit disagreed with Collins’ contention that he had shown good faith by entering the OVDP and paying all of the taxes due related to the PFIC taxes.

U.S. v. Katholos, No. 17-cv-531 (W.D.N.Y. Aug. 10, 2022).   

            Brief Facts. 

The Western District of New York issued its decision in Katholos on August 10, 2022.  In that case, the taxpayer was born and grew up in New York.  After completing college, however, she moved to Greece to be with her father.

Katholos and her father traveled to Switzerland to open two Swiss bank accounts.  Both were numbered accounts.  Throughout the years, the Swiss bank accounts advised the Katholos family to move funds to various countries and to set up various foreign entities.  Katholos indicated that she trusted the bank, so she and her family did as they wished.

Katholos used a family CPA to prepare her 2007 tax return.  On her 2007 Schedule B, she checked the box “No” regarding interests in foreign accounts.  However, she contended that she never reviewed the return or spoke to the CPA.  Neither her nor her CPA filed a 2007 FBAR.

Katholos attempted to make an OVDP submission but was denied.  The IRS later initiated an examination of Katholos and determined that she should be liable for willful FBAR penalties of approximately $4 million for her 2007 tax year.

Court’s Analysis. 

Similar to Schik, the government moved for summary judgment on the issue of willfulness.  In their motion, the government argued that Katholos was reckless because:  (1) the accounts were numbered accounts; (2) she signed documents with the foreign bank indicating she was not a United States citizen; (3) she did not review her 2007 tax return with her CPA; and (4) mail was held by the foreign bank and not delivered to Katholos or her family.

Katholos disagreed with the government that there were sufficient facts to demonstrate willfulness.  In response to the government’s motion for summary judgment, Katholos argued, among other things:  (1) all decisions regarding the foreign bank were made by her father and not her; (2) she actually provided her United States passport to the foreign bank when opening the foreign accounts; (3) she tried to regain compliance with the tax laws by filing an OVDP.

The district court agreed with Katholos and found that summary judgment was not appropriate because there were sufficient facts in dispute that created a triable issue on recklessness.

Bedrosian v. U.S., 42 F.4th 174 (3d Cir. 2022). 

Brief Facts. 

The Third Circuit released its decision in Bedrosian on July 22, 2022.  The Bedrosian case has been going on for quite some time and has been the topic of prior articles by our firm.  You can find some of those here and here.

In this case, Bedrosian held two foreign bank accounts.  He failed to disclose his foreign accounts to the IRS, even though there was evidence an accountant had told him years earlier that he “was breaking the law by failing to report.”  Bedrosian later disclosed the foreign accounts but omitted one of the accounts in Switzerland.  The IRS examined his FBAR filings and assessed a willful FBAR penalty of approximately $975,000.

Bedrosian prevailed at first in the district court.  Specifically, that court concluded he had been only negligent in omitting the foreign account.  However, on appeal, the Third Circuit reversed the district court’s decision, indicating that the district court had misinterpreted the reckless standard.  On remand, the district court agreed with the government and held against Bedrosian.  He appealed.

Court’s Analysis. 

The Third Circuit upheld the district court’s conclusion that Bedrosian was reckless.  Specifically, they found the following evidence sufficient to support a reckless finding:  (1) Bedrosian only cooperated with the IRS after he learned that the IRS would have his information; (2) after he filed his 2007 FBAR, he sent letters to the Swiss bank accounts directing the closure of two accounts (even though he only disclosed one account); (3) he had “mail holds” on his foreign accounts; and (4) he admitted that he was aware of the significant amount of money he held in his foreign bank accounts.

Parting Thoughts. 

Although every case stands on its own facts and circumstances, the cases above are helpful to tax professionals and taxpayers alike in determining what is non-willful and what crosses into the territory of willfulness.  Bad facts showing willfulness include:  (1) numbered accounts; (2) mail holds; (3) checking Schedule B boxes “No” regarding foreign accounts and requirements to file FBARs; and (4) having a general awareness of the FBAR and its filing requirements in prior years.  Good facts showing non-willfulness include:  (1) being not well educated and/or well-versed in federal income tax laws; (2) good explanations for why the Schedule B boxes were checked “No”; (3) not managing the foreign accounts or investment decisions related to the foreign accounts; and (4) good-faith reliance on tax professionals to prepare United States tax returns.  Taxpayers who have not complied with their prior year FBAR reporting should bear these facts in mind in determining the best strategy to regain compliance with the FBAR reporting rules.  See here and here.

Have a question? Contact Matthew Roberts, Freeman Law.

 

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