What is FBAR Litigation?
A recent federal case demonstrates the perils of FBAR litigation and the harsh penalties that apply for a willful failure to file an FBAR (FinCEN Form 114) to report a foreign account. The case involved an IRS civil FBAR penalty assessment of $988,245 for an unreported Canadian financial account. The defendant/taxpayer checked “no” on Schedule B of his federal tax returns during the years at issue, indicating that he did not have a foreign financial account. However, the defendant/taxpayer testified, and the court found, that he did not review the return instructions regarding Schedule B and did not affirmatively mark “no” on the Schedule B. The court, however, remained unsympathetic, and warned that a taxpayer who signs his or her tax returns “will not be heard to claim innocence for not having actually read the return, as he or she is charged with constructive knowledge of its contents.”
The United States government filed the law suit in an effort to collect civil penalties for the taxpayer’s failure to file a Report of Foreign Bank and Financial Accounts (“FBAR“) for the years 2007, 2008, and 2009. The United States alleged that his failure to file the FBAR was willful for the years in question. The defendant admitted that he had failed to file the FBARs, but maintained that the failure was merely negligent and did not rise to the level of a willful violation. Thus, the core issue in the case was whether the taxpayer willfully failed to file an FBAR to report his Canadian accounts for the years 2007, 2008, and 2009.
Below is a summary of the court’s factual findings and the relevant background:
Ott is a United States citizen. He is 56 years old and resides in Redford, Michigan with his wife, Tracey Ott. During trial, Ott testified that he received a high school diploma and has some college education, but he did not finish college.
Ott has worked as a carpenter, sales agent, and the owner and operator of a small business that rents curtains and staging called Show Supplies LLC.
Ott has no training in tax or accounting.
In 1993, Defendant opened two brokerage accounts with McDermid St. Lawrence Ltd. (“McDermid”), a Canadian financial institution, and deposited $50,000 into those accounts.
In 1994, Ott’s Canadian financial advisor, Donna Balaski (“Balaski”), moved brokerage firms from McDermid to Thomson Kernaghan & Co. Ltd. (“Thomson”), a Canadian financial institution. Following his broker, Ott closed his accounts with McDermid and transferred the contents of those accounts into the Thomson accounts.
Between 1993 and 1998, Defendant made additional deposits into the foreign accounts. The additional deposits totaled $71,478.
. . .
Ott has a sister with a Canadian home address. Soon after the . . . accounts were opened, Ott listed his sister’s home address for receipt of mailings and correspondence . . . . At all relevant times, the address associated with the Canadian Accounts was Ott’s sister’s Canadian address.
. . .
Robert C. Weide (“Weide”), Certified Public Accountant (CPA), has been Ott’s accountant for many years and prepared his tax returns during the years at issue.
Weide prepared Ott’s federal tax returns using software licensed by his firm and then transmitted the returns back to him for review and approval.
Weide prepared Ott’s returns based on the materials provided to him by the Otts.
Ott declared on his 2007 tax return that his income was $21,381.
Prior to causing each federal income tax return to be filed, Ott signed his returns, which included the following language: “Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete.”
For each year, the instructions to IRS Form 1040 Schedule B provided that persons who had a foreign account were required to complete Part III of Schedule B to Form 1040, entitled “Foreign Accounts and Trusts.”
For each year, Part III of Schedule B to IRS Form 1040, entitled “Foreign Accounts and Trusts,” asked the filer if he had a financial interest in, or signature authority over, a financial account in a foreign country. The form and instructions also directed the filer to Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (the “FBAR”) and its instructions.
The FBAR is a separate information return that discloses a United States citizen’s interest in a foreign account which holds in excess of $10,000 per year.
Ott testified that he never reviewed the instructions to IRS Form 1040 Schedule B.
Ott did not file an FBAR reporting the Canadian Accounts for the 2007 calendar year on or before June 30, 2008. Ott did not file an FBAR reporting the Canadian Accounts for the 2008 calendar year on or before June 30, 2009. Ott did not file an FBAR reporting the Canadian Accounts for the 2009 calendar year on or before June 30, 2010. Ott timely filed FBARs for the 2010 year.
The court specifically noted that the defendant did not affirmatively check “no” on Schedule B. Instead, the court pointed out that the tax software used by the taxpayer’s accountant defaulted to checking “no” on Schedule B:
In the preparation of the tax returns for the years at issue, Weide did not affirmatively check the “No” box on the Schedule B regarding Ott’s ownership in foreign accounts. Instead, the accounting software Weide used defaulted to check the “No” box on Schedule B.
Prior to October 2010, Ott did not ask Weide if he was required to report the income from his Canadian Accounts on his tax returns.
Against this background, the IRS assessed penalties against the taxpayer under 31 U.S.C. § 5321 for willful failure to report the Canadian Accounts on an FBAR for 2007, 2008, and 2009. Specifically, the IRS assessed a total civil penalty of $988,245.
The Parties’ Positions
The Government contended that the taxpayer had “constructive knowledge” of his reporting obligations because he signed tax returns that included a reference to the FBAR within the Schedule B form. The Government also argued that the taxpayer engaged in an act of concealment by naming his sister’s Canadian address on the accounts. Finally, the Government argued that because the foreign account balances represented an overwhelming proportion of the taxpayer’s total income, this demonstrated that he recklessly, and therefore willfully, failed to file FBARs for the years in question.
The taxpayer, however, argued that his signature on his tax returns, along with the absence of any deliberate acts of concealment, demonstrated that there was no willful failure to file the FBARs, and that he was at most negligent, which gives rise to a much lower penalty.
The Standard of Proof in FBAR Suits Generally
Generally, suits to recover a monetary penalty require the government to prove its case by a preponderance of the evidence. Courts have generally applied this standard of proof in civil cases involving failures to report FBARs. See, e.g., United States v. Garrity, 304 F. Supp. 3d 267, 270 (D. Conn. 2018) (“. . . every court that has answered the question before me has held that the preponderance of the evidence standard governs suits by the government to recover civil FBAR penalties.”) (citing Bedrosian v. United States, No. CV 15-5853, 2017 WL 3887520, at *1 (E.D. Pa. Sept. 5, 2017)) (additional citations omitted).
As a result, the Ott court determined that the government bore the burden to prove that the taxpayer willfully failed to file FBARs by a preponderance of the evidence.
Mere “Recklessness” Equals Willfulness
As have several other courts, the Ott court found that in the context of FBAR penalties, an objectively reckless violation is sufficient to support a finding of “willfulness.” The court’s analysis on the issue is set forth below:
The Supreme Court has distinguished between civil and criminal recklessness, holding that “where willfulness is a statutory condition of civil liability, we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well.” Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 57 (2007). Willful action includes “conduct marked by careless disregard whether or not one has the right so to act.” Id. (citing United States v. Murdock, 290 U.S. 389, 395 (1933)) (internal citations omitted). Civil recklessness is analyzed under an objective standard, with conduct “entailing an unjustifiably high risk of harm that is either known or so obvious that it should be known.” Id. (citing Farmer v. Brennan, 511 U.S. 825, 836 (1994)). This is distinguishable from criminal recklessness, which “requires subjective knowledge on the part of the offender.” Id. at n.18. A taxpayer may act recklessly in regard to IRS filing requirements when he “(1) clearly ought to have known that (2) there was a grave risk that the filing requirement was not being met and if (3) he was in a position to find out for certain very easily.” Bedrosian v. United States of Am., Dep’t of the Treasury, Internal Revenue Serv., 912 F.3d 144, 153 (3d Cir. 2018) (internal citations omitted) (internal quotations omitted).
The “Willful Blindness” Doctrine Applies
A number of courts have been willing to apply a “willful blindness” theory in determining whether a taxpayer willfully failed to file an FBAR.
While the court noted that there is no clear consensus about the willful blindness definition in civil tax liability suits, it found that “willful blindness may be proven by objective recklessness in the civil FBAR context.”
It should be noted, however, that courts have applied widely varying definitions of “willful blindness” depending on the type of litigation. See, e.g., Glob.-Tech Appliances, Inc. v. SEB S.A., 563 U.S. 754, 768 (2011) (holding that for patent infringement civil lawsuits under 35 U.S.C. § 271(b), the willful blindness standard embraces the definition in criminal law, where it can almost be said that the defendant has actual knowledge of the wrongdoing) (emphasis added); U.S. v. Poole, 640 F.3d 114, 122 (4th Cir. 2011) (finding willful blindness in a criminal tax prosecution when a defendant “was subjectively aware of a high probability of the existence of a tax liability and purposely avoided learning the facts pointing to such liability . . .”); In re Aimster Copyright Litig., 334 F.3d 643, 650 (7th Cir. 2003) (holding that “willful blindness is knowledge, in copyright law . . .”).
Failing to Read Your Tax Return is Not a Defense
The court refused to find that failing to read one’s tax return is a defense to willfulness. Instead, the court found that a taxpayer who fails to read his return, or a portion of his return, acts in an objectively reckless manner. Reckless conduct, the court held, is sufficient to demonstrate a willful violation. As the court reasoned:
Generally, a taxpayer who signs his or her tax returns “will not be heard to claim innocence for not having actually read the return, as he or she is charged with constructive knowledge of its contents.” Greer v. Comm’r, 595 F.3d 338, 347 n.4 (6th Cir. 2010) (internal citations omitted). The Sixth Circuit held that “[i]t is reasonable to assume that a person who has foreign bank accounts would read the information specified by the government in tax forms,” including the Schedule B language referring the taxpayer to FBAR filing requirements. U.S. v. Sturman, 951 F. 2d 1466, 1477 (6th Cir. 1991). The Sixth Circuit also found that in the criminal context, the mere signing of a return does not prove subjective knowledge, and therefore willful blindness, of the FBAR filing requirement. U.S. v. Mohney, 949 F. 2d 1397, 1407 (6th Cir. 1991). This burden is met in civil cases, however, if the defendant’s conduct and failure to report meets an objective recklessness standard. Safeco Ins., 551 U.S. at 57.
Ott signed a return each year, under penalty of perjury—regardless of whether he actually read the return—certifying that he did not have an interest in foreign accounts. Accordingly, constructive knowledge of the requirement to file the FBAR is imputed to Ott, supporting a finding of willfulness here. See id. at 1208.
Relying on Non-Experts or Advice that is “Too Good to Be True” is not a Defense
The court found that the taxpayer’s reliance on advice from non-experts that the accounts were not required to be reported was reckless. The court also indicated that relying upon advice that is “too good to be true” may give rise to exposure to penalties:
Willfulness may be found “if the individual recklessly ignores the risk that conduct is illegal by failing to investigate whether the conduct is legal.” McBride, 908 F. Supp. 2d at 1209. “Taxpayers have long been cautioned that they have a responsibility to investigate claims when they are likely too good to be true.” Id. (citing Pasternak v. Comm’r, 990 F. 2d 893, 903 (6th Cir. 1993)) (internal quotations omitted). A taxpayer recklessly abdicates that responsibility, for example, when he fails to consult with his accountant about foreign account reporting requirements. See, e.g., McBride 908 F. Supp. 2d at 1210; Sorenson v. United States, 521 F.2d 325, 329 (9th Cir. 1975); Horowitz, 361 F. Supp. 3d at 513.
Overall, the Ott case represents a government victory and a reminder that many courts have found that the willfulness standard can be satisfied by mere reckless conduct and constructive knowledge.
For U.S. persons facing FBAR penalties, contact our attorneys at Freeman Law at (214) 984-3410 or contact us online for a consultation. Our attorneys are experienced in FBAR defense representation and international tax penalties.
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