The Willful FBAR Penalty: Bedrosian and New Insights
The Third Circuit Court of Appeals recently issued its much-anticipated decision in Bedrosian v. United States. The opinion reviewed a lower court’s decision refusing to apply the willful FBAR penalty. See our prior post on the case here. The appellate court’s decision ultimately remanded the case back to the lower court for further analysis.
The FBAR Reporting Requirement:
Congress passed the Bank Secrecy Act of 1970 to require certain reports and records that may be useful in “criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities . . . .” 31 U.S.C. § 5311. One provision of the Act, 31 U.S.C. § 5314, instructs the Secretary of the Treasury to prescribe rules that require persons to file an annual report identifying certain transactions or relations with foreign financial agencies. The Secretary of the Treasury has implemented this statute through various regulations, including 31 C.F.R. § 1010.350, which specifies that certain United States persons must annually file a Report with the IRS for foreign accounts exceeding $10,000 in the prior calendar year. 31 C.F.R. § 1010.306(c). The authority to enforce the FBAR requirement has been delegated to the Commissioner of Internal Revenue. Id. § 1010.810(g); see also Internal Revenue Manual § 4.26.1, Ex. 4.26.1-3 (U.S. Dep’t of Treasury Memorandum of Agreement and Delegation of Authority for Enforcement of FBAR Requirements).
The Jurisdictional Question
The Bedrosian court’s analysis raises an interesting jurisdictional question—a question that was not raised by either of the parties. It asks whether a party can gain access to a federal district court to challenge an FBAR penalty assessment by paying part—but not all—of that penalty and suing to recover that payment. Generally, under the Supreme Court’s decision in Flora and in the context of a suit for a refund of taxes, a taxpayer must pay the entire assessment before bringing a suit for a refund. Practitioners and the government have basically worked under the assumption that this restriction does not apply to FBAR penalties, largely because they are imposed under Title 31 of the US Code, not the Tax Code, which is codified in Title 26. Here is a brief summary excerpt of the court’s analysis:
The jurisdictional inquiry in this case is a matter of first impression. Unlike most cases involving the IRS’s assessment of a civil FBAR penalty, in which the IRS files suit to recover the penalty, this case began when Bedrosian paid one percent of the assessed penalty and then filed a complaint in the District Court seeking to recover his partial payment. The Government did not challenge that Court’s jurisdiction over Bedrosian’s claim; as noted, it instead answered the complaint and filed a counterclaim seeking the full penalty amount.
The parties contend the District Court had jurisdiction over Bedrosian’s claim under the so-called Little Tucker Act, 28 U.S.C. § 1346(a)(2), which provides district courts with original jurisdiction, concurrent with the U.S. Court of Federal Claims, over certain claims against the United States not exceeding $10,000 in amount, including certain claims “founded . . . upon the Constitution . . . or [an] Act of Congress.” The parties contend Bedrosian’s claim qualified for jurisdiction under the Little Tucker Act because it did not exceed $10,000 in amount (Bedrosian’s initial claim seeking to recover his partial payment of $9,757.89) and was founded on the FBAR statute, 31 U.S.C. §§ 5314 & 5321.
We decline to hold that Bedrosian’s initial claim against the Government gains jurisdiction under the Little Tucker Act. A claim may qualify only if it does not fall within the scope of the so-called tax refund statute, 28 U.S.C. § 1346(a)(1). See id. § 1346(a)(2) (applying to claims “other” than those within 28 U.S.C. § 1346(a)(1)). The tax refund statute encompasses, among other things, claims to seek recovery of any “penalty” that is wrongfully collected “under the internal-revenue laws.” Id. § 1346(a)(1). The parties concede that a civil penalty under the FBAR statute is a “penalty” under § 1346(a)(1), but they contend it was not assessed “under the internal-revenue laws” because the FBAR statute, 31 U.S.C. §§ 5314 & 5321, is in Title 31 of the U.S. Code, not Title 26 (the Internal Revenue Code). We are skeptical of this argument’s elevation of form over substance, and, for reasons stated in the margin, we are inclined to believe that Bedrosian’s initial claim did not qualify for district court jurisdiction at all.
The court ended this analysis with a curious and extensive footnote (footnote 1):
The parties’ argument that Bedrosian’s claim is not within the tax refund statute is premised on the notion that the phrase “internal-revenue laws” in 28 U.S.C. § 1346(a)(1) refers only to laws codified in Title 26 of the U.S. Code. But that argument does not follow the statutory history of the tax refund statute, which suggests that “internal-revenue laws” are defined by their function and not their placement in the U.S. Code. See Wyodak Res. Dev. Corp. v. United States, 637 F.3d 1127, 1134 (10th Cir. 2011). The argument also ignores the Tax Court’s rejection of the proposition that “internal revenue laws are limited to laws codified in [T]itle 26.” See Whistleblower 21276–13W v. Comm’r, 147 T.C. 121, 130 & n.13 (2016) (noting that “the IRS itself acknowledges that tax laws may be found outside title 26”). We also observe, by analogy, that claims brought by taxpayers to recover penalties assessed under 26 U.S.C. § 6038(b) for failing to report holdings of foreign companies—a statute nearly identical to the FBAR statute, except addressing foreign business holdings rather than foreign bank accounts—are brought under the tax refund statute, 28 U.S.C. § 1346(a)(1). See Dewees v. United States, 2017 WL 8185850, at *1 (Fed. Cir. Nov. 3, 2017). Also, allowing a taxpayer to seek recovery of a FBAR penalty under the Little Tucker Act permits that person to seek a ruling on that penalty in federal district court without first paying the entire penalty, as Bedrosian did here by paying just under the $10,000 Little Tucker Act threshold. This violates a first principle of tax litigation in federal district court—“pay first and litigate later.” Flora v. United States, 362 U.S. 145, 164 (1960). We are inclined to believe the initial claim of Bedrosian was within the scope of 28 U.S.C. § 1346(a)(1) and thus did not supply the District Court with jurisdiction at all because he did not pay the full penalty before filing suit, as would be required to establish jurisdiction under subsection (a)(1). See Flora, 362 U.S. at 176–77. But given the procedural posture of this case, we leave a definitive holding on this issue for another day.
The circuit court found that it was ultimately not necessary to address the jurisdictional question because, in any event, jurisdiction was granted by the government’s counterclaim.
The Willfulness Penalty and Standard
Aside from the interesting jurisdictional questions, the Third Circuit’s opinion addressed whether the district court analyzed the “willfulness” question under the correct legal standard. Interestingly, it found that the district court had indeed adopted the correct standard, but then remanded the case back down, determining that it was unclear whether the court had actually applied that standard. It found that while the district court had invoked the proper standard—that is, that a willful violation occurs where a defendant knowingly or recklessly fails to file an FBAR—its analysis, in the court’s opinion, seemed to focus too much on the subjective motivations of the defendant, rather than on whether he had violated a more objective standard of conduct.
The appellate court’s analysis provided the following background on the proper standard for assessing a willful FBAR penalty:
In assessing the inquiry performed by the District Court, we first consider its holding that the proper standard for willfulness is “the one used in other civil contexts—that is, a defendant has willfully violated [31 U.S.C. § 5314] when he either knowingly or recklessly fails to file [a] FBAR.” (Op. at 7.) We agree. Though “willfulness” may have many meanings, general consensus among courts is that, in the civil context, the term “often denotes that which is intentional, or knowing, or voluntary, as distinguished from accidental, and that it is employed to characterize conduct marked by careless disregard whether or not one has the right so to act.” Wehr v. Burroughs Corp., 619 F.2d 276, 281 (3d Cir. 1980) (quoting United States v. Illinois Central R.R., 303 U.S. 239, 242–43 (1938)) (internal quotation marks omitted). In particular, where “willfulness” is an element of civil liability, “we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well.” Fuges v. Sw. Fin. Servs., Ltd., 707 F.3d 241, 248 (3d Cir. 2012) (quoting Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 57 (2007)). We thus join our District Court colleague in holding that the usual civil standard of willfulness applies for civil penalties under the FBAR statute.
This holds true as well for recklessness in the context of a civil FBAR penalty. That is, a person commits a reckless violation of the FBAR statute by engaging in conduct that violates “an objective standard: action entailing ‘an unjustifiably high risk of harm that is either known or so obvious that it should be known.’” Safeco, 551 U.S. at 68 (quoting Farmer v. Brennan, 511 U.S. 825, 836 (1994)). This holding is in line with other courts that have addressed civil FBAR penalties, see, e.g., United States v. Williams, 489 F. App’x 655, 658 (4th Cir. 2012), as well as our prior cases addressing civil penalties assessed by the IRS under the tax laws, see, e.g., United States v. Carrigan, 31 F.3d 130, 134 (3d Cir. 1994). With respect to IRS filings in particular, a person “recklessly” fails to comply with an IRS filing requirement when he or she “(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 [or she] was in a position to find out for certain very easily.” Id. (quoting United States v. Vespe, 868 F.2d 1328, 1335 (3d Cir. 1989) (internal quotation omitted)).
Stay tuned, as Freeman Law will continue its in-depth coverage of the Bedrosian case.
For other FBAR penalty resources, try our other posts, including: