Claims Court Upholds FBAR Penalty Exceeding Regulatory Cap
In a recent case, the U.S. Court of Federal Claims granted summary judgment in the IRS’s favor and determined that a taxpayer’s failure to file a Report of Foreign Bank and Financial Accounts (FBAR) was willful.
As part of its Kimble v. U.S. decision, the court upheld the IRS’s imposed penalty of $697,229. Importantly, this amount exceeds the $100,000 maximum set out in regulations that haven’t been removed despite a statutory increase in the penalty amount. The court found that the revisions to the statute effectively nullified the contrary regs.
Every U.S. citizen who has a financial interest in, or signature or other authority over, a financial account in a foreign country is required to report the account to the IRS annually. This is done by filing an FBAR. The Secretary of the Treasury may impose a civil monetary penalty on any person who violates this requirement or causes a violation.
The maximum penalty depends on whether the violation was willful or nonwillful. For a willful violation, the maximum penalty is the greater of $100,000 or 50% of the balance in the account at the time of the violation. For a nonwillful violation, the maximum penalty is $10,000.
These penalty amounts reflect a 2004 law change that increased the maximum civil penalties that can be assessed for a willful failure to file an FBAR. Before that change, the maximum penalty was $100,000. Regulations that were put into effect before the statutory increase, however, continue to reflect the former $100,000 maximum (as opposed to the “greater of $100,000 or 50% ...”).
There’s now disagreement among U.S. district courts as to whether the 2004 statutory amendment invalidated the established $100,000 cap. At least one court has held that FBAR penalties can’t exceed the regulatory cap despite the law change.
Facts of the case
The taxpayer in Kimble is a U.S. citizen. Sometime before 1980, her parents opened an investment account at the Union Bank of Switzerland (UBS) and designated her as a joint owner. The taxpayer’s father was Jewish, and members of his family had been killed in the Holocaust. According to the taxpayer, her father’s intent with respect to the UBS account was to provide her with funds in case she needed to escape America. The money in the UBS account was only to be used in an emergency, and its existence was to be kept confidential.
In 1983 or 1984, the taxpayer got married and her father told her husband about the UBS account. The couple had a son in 1985 and told him about the account when he was a teenager. In or around 1998, the couple opened an HSBC bank account in Paris, France, to pay expenses associated with a Paris apartment they owned. Also in 1998, the taxpayer signed two agreements with UBS, one of which directed UBS to physically retain all correspondence about the UBS account at the bank in Switzerland.
During their marriage, the taxpayer’s husband handled the couple’s finances and prepared their joint federal tax returns. He never reported any investment income derived from, or the existence of, the HSBC or UBS accounts. The couple divorced in 2000. The taxpayer didn’t disclose the UBS account in any divorce-related documents, and she became sole owner of the HSBC account at that time.
In 2005, the taxpayer granted her son and mother a general Power of Attorney over the UBS account. She also signed three other documents concerning the UBS account in which she made several inaccurate statements regarding ownership and compliance with U.S. tax law.
She added her son as a co-owner of the UBS account in or around 2008. That same year, the taxpayer learned from a newspaper article that the United States was “putting pressure on UBS to reveal the names of people who had secret accounts in UBS.” She retained counsel to comply with foreign reporting requirements. On June 30, 2008, the balance in the UBS account was $1,365,662, and the balance in the HSBC account was $134,130.
In or around 2010, the taxpayer sold the Paris apartment, closed the HSBC account and deposited the proceeds into the UBS account. She didn’t report any investment income from either account on her original income tax returns from 2004 through 2008 despite having income each year. She also answered a question on those tax returns regarding the existence of reportable foreign financial accounts in the negative for three of those returns and left the question blank on the fourth. The instructions for that question indicated that a “yes” answer would mean that an FBAR should be filed. The taxpayer didn’t file FBARs during these years.
In 2011, as part of her participation in the Offshore Voluntary Disclosure Program (OVDP), in which she enrolled in 2009, the taxpayer filed amended tax returns for 2003 through 2008 reflecting the unreported investment income. On her 2007 amended returns, she also changed her answer to “yes” regarding the existence of a foreign account but left it unchanged on the others.
She negotiated a closing agreement with the IRS in 2012 that required her to pay the tax liability due as well as a $377,309 penalty. But she decided later to withdraw from the OVDP because of the penalty amount and “take her chances.”
The court’s take
The IRS began an examination in 2013 and concluded that the taxpayer’s failure to file an FBAR for 2007 was willful based on various facts, including:
· The value of the UBS account,
· Repeated failures to disclose the accounts and income therefrom,
· Efforts to conceal their existence, and
· Active involvement with the accounts.
The IRS recalculated the total penalty as $697,229 — in other words, 50% of the UBS account balance in 2007 — and assessed the penalty in 2016, which the taxpayer paid in full. She then filed a claim for a refund.
The court concluded that the taxpayer’s 2007 failure to file an FBAR was willful, finding that her actions were voluntary and that she knew of the requirement because of her affirmative answer to the question on her amended 2007 return regarding the existence of foreign reportable accounts.
In so holding, the court rejected the taxpayer’s construction of the term “willfulness” as meaning criminal behavior and requiring more than a simple failure to check a box and file an FBAR. It found that Supreme Court precedent supported treating reckless conduct as “willful” for various purposes.
In addition, the court rejected the taxpayer’s arguments that the IRS had abused its discretion in the amount of the imposed penalty. This included the assertion that the IRS had erroneously concluded that she was the sole beneficiary of the account and that she “actively managed” it. She also claimed that the IRS hadn’t adhered to the $100,000 limit under the regulations, and that the penalty was an “excessive fine” in violation of the Eighth Amendment of the U.S. Constitution.
The court found that the taxpayer’s arguments insufficiently established an abuse of discretion. Specifically, though evidence showed that she wasn’t the sole beneficiary, she had represented in 2005 that she was — and, regardless, she didn’t show that this would make the penalty assessment an abuse of discretion.
The court also found no error in the IRS’s conclusion that she actively managed the account. It noted, for example, that she met with UBS representatives multiple times over the years in both the United States and Switzerland.
Important from a broader perspective, the court found that the $100,000 maximum in the regs was invalid in light of the new statutory maximum. It noted that the IRS has stated in the Internal Revenue Manual that, while its regs hadn’t been revised to reflect the change in the penalty ceiling, the statute raising the maximum was “self-executing and the new penalty ceilings apply.”
If you have a foreign account, follow the rules for FBAR filings carefully. Ask your CPA for assistance in fully understanding and complying with the requirements.