FBAR penalty litigation — what does case precedence tells us?

Right now, there is still scant FBAR litigation that is helpful to use in any meaningful analysis. The big cases that are out there — they really don’t tell us too much.  As those were for FBAR penalties assessed a long time ago under a different climate. And the underlying facts of each case are likely not to be repeated.  In McBride, the taxpayer actually didn’t control the accounts (but admits he made the mistake of representing himself in the FBAR audit), and the judge, somewhat inexperienced, appeared to have copy and pasted the governments’ brief, likely without much thought. And in Williams, the defendant plead guilty to a criminal charge of tax evasion prior to the imposition of a willful FBAR penalty, so the government has a solid self-admission from the taxpayer that they could use against him (and did). These 2 cases and to a limited extend Zwerner may be a classic example of bad facts making bad law.

The important thing to remember is that unlike an IRS tax debt, the government can not simply issue a few letters and start enforced collections such as IRS levies and liens. But rather, because the authority for assessing willful FBAR penalties comes from the Bank Secrecy Act of 1970 (BSA), FBAR penalties are not taxes (and in fact, have nothing to do with income taxes). Yet, because no other agency has the structure to enforce and examine taxpayers for unfiled FBARs and willful penalty responsibility, this role was assigned to the IRS.
So let me try to rephrase, at some point, in order to put into effect the proposed willful FBAR penalty, the government must prove in a federal district court evidence of willfulness so that it can obtain a judgment that then could be used to collect money against a person. (compare: a judgment is entirely unnecessary for the IRS to collect taxes).  
Before the government has a federal case, its must first follow its administrative rules. It is imperative that you take this administrative portion absolutely serious. if the government does not follow its rules, it *should* lose in federal court. The best type of litigation is the type that never happens. And here, at the administrative level, you have that opportunity. It is critical you present the best possible story to the IRS and the most helpful evidence to demonstrate that you did not possess any willful.

Now, the rules the IRS examiner, or auditor, must follow are located in the Internal Revenue Manual(IRM). In  Section 4.26.16.4.5.3 of the IRM “FBAR Willfulness Penalty – Willfulness,”  we find some relevant criteria:

1. Wilfulness is whether there was a voluntary, intentional violation of a known legal duty

2. A finding of willfulness under the BSA must be supported by evidence of willfulness.

3. The burden of establishing willfulness is on the [IRS].

4. If it is determined that the violation was due to reasonable cause, the willfulness penalty should not be asserted.

5. Willfulness is shown by the person’s knowledge of the reporting requirements and the person’s conscious choice not to comply with the requirements. In the FBAR situation, the only thing that a person need know is that he has a reporting requirement. If a person has that knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR

So the IRS has a problem. How do you prove that someone knew about the FBAR when so much of the tax industry — giants like H&R Block to small CPA firms — well, they did not know about the FBAR (there is actually a good reason it was ignored for years). Also, how do you prove that someone who is from a foreign country knew that the United States, unlike any other country in the world taxes its “persons” on their worldwide income? So it can be argued that failure to report an foreign bank account could not have been willful as a dual US citizen (or even an expat) would have no reason to think the IRS would want their foreign bank information (or retirement, or life insurance) in the first place.

FBAR willful blindness penalties

The tool the IRS has to get around this difficulty is something called willful blindness. “Under the concept of ‘willful blindness,’ willfulness may be attributed to a person who has made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements (yes, you can be assessed an FBAR penalty if you file FBAR but do not maintain records). According to the IRM:
An example that might involve willful blindness would be a person who admits knowledge of and fails to answer a question concerning signature authority at foreign banks on Schedule B of his income tax return. This section of the return refers taxpayers to the instructions for Schedule B that provide further guidance on their responsibilities for reporting foreign bank accounts and discusses the duty to file Form 90-22.1. These resources indicate that the person could have learned of the filing and recordkeeping requirements quite easily. It is reasonable to assume that a person who has foreign bank accounts should read the information specified by the government in tax forms.
Again, I have written why this this Schedule B oversight does not, on its own, constitute willful blindness. Even the IRS agrees, the IRM then states “The mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness.”

Willful FBAR penalty examples

IRM 4.26.16.4.5.3.8 then gives some examples about where willful FBAR penalties should and should not be imposed. The IRM willful FBAR penalty examples are italicized with my commentary,  below each example.

A person admits knowledge of, and fails to answer, a question concerning signature authority over foreign bank accounts on Schedule B of his income tax return. When asked, the person does not provide a reasonable explanation for failing to answer the Schedule B question and for failing to file the FBAR. A determination that the violation was willful likely would be appropriate in this case.

Again, answers that could likely avoid a willful FBAR penalty are that the software defaulted to “no,” or that the taxpayer had no idea, that unlike every other country,  their foreign income was taxable and thus had no reason to examine Schedule B, or even think there was any place on a tax return to put foreign income. A bad strategy is offering no explanation. Even though the IRS has the burden of proof, we can see in this example they are instructed to use your silence against you. 

A person files the FBAR, but omits one of three foreign bank accounts. The person had closed the omitted account at the time of filing the FBAR. The person explains that the omission was due to unintentional oversight. During the examination, the person provides all information requested with respect to the omitted account. The information provided does not disclose anything suspicious about the account, and the person reported all income associated with the account on his tax return. The willfulness penalty should not apply absent other evidence that may indicate willfulness.

In this example, don’t you notice something strange? The unreported bank account had no unreported income. Yet still, if there were evidence that the failure to file an FBAR was suspicious, the examiner is instructed that they can look to assess willful FBAR penalties! Does this seem completely insane? Well, actually this part isn’t the insane part. Remember, the Bank Secrecy Act of 1970 was passed to deter international crime syndicates from using international banking as havens to keep their money and transfers safe from the prying eye of the US Treasury. So in fact, a penalty imposed where an account was used for criminal purposes but had no unreported income, well a penalty in that case would be more in line with the actual intent of  FBAR.

FBAR penalties were never intended as a tool to punish people for mere tax evasion. There were already criminal tax evasion and civil fraud penalties at the time the Bank Secrecy Act of 1970 was passed. Assessing FBAR penalties for those who did not report all of their worldwide income is a brilliant sleight of hand by the IRS to take a power Congress never really intended them to have. And we really can’t count on the federal courts to limit agency power to the legislative intent of the bill, right? Federal Courts routinely give statutes an interpretation that gives government the most power, even when those words aren’t there or are completely contradicted by the actual statute itself.

A person filed the FBAR in earlier years but failed to file the FBAR in subsequent years when required to do so. When asked, the person does not provide a reasonable explanation for failing to file the FBAR. In addition, the person may have failed to report income associated with foreign bank accounts for the years that FBARs were not filed. As with example a. above, a determination that the violation was willful likely would be appropriate in this case.

Sometimes you need to be absolutely sure that you have not overlooked any positive aspects to your reason you did not file. In this case, even a plausible reason is better than no reason. A plausible reason while it may not avoid all FBAR penalties, you may be assessed with a less serious, and far smaller non-willful penalties or some sort of other FBAR penalty mitigation may apply. Again, the IRS will have to sue you in court to collect FBAR fines. So do you think there might be room for negotiation?

A person received a warning letter informing him of the FBAR filing requirement, but the person continues to fail to file the FBAR in subsequent years. When asked, the person does not provide a reasonable explanation for failing to file the FBAR. In addition, the person may have failed to report income associated with the foreign bank accounts. As with examples a. and c. above, a determination that the violation was willful likely would be appropriate in this case.

This is a very difficult, but not impossible, set of facts to overcome. As with our FBAR audit and OVDP opt-out clients, an FBAR warning letter is actually the result we hope to obtain. But after this FBAR warning letter is issued, it is safe to say that you are now aware that you have an obligation to report your foreign bank accounts and your worldwide income.

But one example I can think of is this. Suppose you do know you do need to report your foreign bank accounts and started to report them all.  But later, you move to London. There, you buy a life insurance policy and your employer sets up a retirement account for you.  And now, while you are reporting your foreign bank accounts properly,  didn’t know you needed to report your foreign life insurance, and that in fact, your foreign life insurance is not considered to be a US life insurance policy, but a mere investment vehicles for which you need to pay excise tax on the premiums and income the policy earned (yes this is true). And as to your employer retirement fund, that probably needs to be reported on your FBAR (even if gains are deferred, per the US-UK tax treaty).

The most important consideration about fighting willful FBAR penalties? Don’t give up hope

No doubt, the way the IRM is written and the way that many court decisions have gone, many people who have unreported FBARs are absolutely scared that the worst possible thing will happen — that they will be assessed willful FBAR penalties whether in an OVDP opt-out or civil examination. And during this intimation-induced panic, they fail to mount a defense to properly document and argue why they were not willful. Something we have always learned is to never give up hope. IRS agents do their best to follow the IRM, and not appreciating the constraints they operate under leads people to bungle a case that was winnable. Tree, not every case can be 100% winnable, but every bad set of facts can be made better.

 http://www.irsmedic.com/2014/09/11/willful-fbar-penalties-happen-avoid/