How has the FBAR willfulness penalty structure changed in light of the recent Fourth Circuit decision in Williams?

Date: 01/02/13

Topic: Foreign Accounts

The Williams Decision: Willfulness in the FBAR Penalty Scheme

A distillation of the Williams decision, or rather, series of decisions potentially introduces a new lower standard for penalizing taxpayers with unreported foreign accounts. Foreign account reporting legislation and regulations require the filing of an annual FBAR. The governing law under which Williams was decided asserts that the government could assess a civil penalty against taxpayers only where it could demonstrate that they “willfully” violated the FBAR rules. If the government manages to satisfy this high evidentiary standard, it is authorized to assert civil FBAR penalties ranging from $25,000 to $100,000 (or 50% of the account balance), depending on the highest balance of the unreported foreign financial account(s).

FACTS

In United States v. Williams, the taxpayer was a sophisticated international businessperson that began looking into strategic opportunities in the former Soviet Union. In doing so, he opened two accounts at Credit Agricole Indosuez, S.A. (then known as Banque Indosuez) in the name of ALQI Holdings, Ltd. (ALQI), a British Virgin Islands corporation controlled by the taxpayer. Over an eight-year period from 1993 to 2000 more than $7 million was deposited into the accounts from services rendered under the ALQI banner. However, the taxpayer failed to 1) report all income deposited into or generated by the account on his income tax return, 2) check the “yes” box in Part III of Form 1040, Schedule B (“Foreign Accounts and Trusts”), and 3) file an FBAR with Treasury by June 30 of the relevant year. As a result, Swiss authorities at the behest of their United States counterparts froze the accounts.

The IRS pursued criminal charges and in 2003 the taxpayer pled guilty to one count of criminal tax evasion and one count of criminal conspiracy to defraud the U.S. government. He declared, “I knew that most of the funds deposited into the ALQI accounts and all of the interest income were taxable to me. However, [on] the calendar year returns ’93 through 2000, I chose not to report the income to the Internal Revenue Service in order to evade substantial taxes owed thereon, until I filed my 2001 tax return…I also knew that I had the obligation to report to the IRS and/or the Department of the Treasury the existence of the Swiss accounts, but for the calendar year tax returns 1993 through 2000, I chose not to in order to assist in hiding my true income from the IRS and evade taxes thereon.”

Approximately one year later the IRS initiated a civil examination. When the assigned revenue agent asked the taxpayer to file an FBAR for 2000, he indicated that was the first time he learned of the FBAR requirement. A maximum penalty of $100,000 for each account was subsequently levied for “willfully” violating the filing requirement twice. The taxpayer opposed the penalty stating he had not “willfully” violated the law.

WILLIAMS II

The government filed a complaint in district court in April 2009 “for the purpose of collection of outstanding civil penalties.” Referring to his earlier guilty plea back in 2003, the government maintained that the taxpayer already had admitted in the criminal trial that he knew he had an obligation to report the existence of the Swiss accounts, he knew that the foreign source income deposited into and generated by the accounts constituted taxable income to him, and he knew that he was conspiring with others to escape detection by the IRS. Thus, reasoned the government, the taxpayer acted “willfully” in not filing the FBAR. The District court entered a favorable judgment for the taxpayer citing the government’s unsatisfactory distinction between merely failing to disclose and “willfully” failing to disclose. Moreover, the Court asserted that the broad based plea in the criminal context does not necessarily support the civil equivalent.

WILLIAMS III-THE APPEAL

Discontented with the result, the government appealed the decision. It maintained that where willfulness is a condition of civil liability:

  1. The concept of willfulness is broad enough to cover both reckless and knowing violations
  2. It is not necessary to prove that a taxpayer had an improper motive or bad purpose to show willfulness, and
  3. Evidence of a taxpayer’s actions to conceal income, in conjunction with the taxpayer’s failure to seek information about foreign account reporting requirements, suffices to show willfulness.

The Fourth Circuit unequivocally stated “the evidence as a whole leaves us with a definite and firm conviction that the district court clearly erred in finding that [the taxpayer] did not willfully violate [the FBAR rules for 2000].” In this regard the court discussed the proper legal standard to be applied. The court declared that 1) willfulness can be inferred from taxpayer conduct designed to conceal financial information, and 2) willfulness also can be inferred from a taxpayer’s conscious effort to avoid learning about reporting requirements, i.e., “willful blindness” exists where a taxpayer knew of a high probability of a tax liability yet intentionally avoided the pertinent facts. Furthermore, where willfulness is a condition for civil liability, the court of appeals specified that this covers both knowing and reckless violations of a standard.

IMPORTANCE

Williams is the first case in which the courts have interpreted the concept of “willfulness” in a civil FBAR context. Interestingly, the court applied a much lower standard than that previously indicated by the IRS, which in its own Internal Revenue Manual describes the test being “whether there was a voluntary, intentional violation of a known legal duty.”

The question for taxpayers and their advisors is whether this decision institutes a standard whereby the government can establish willfulness by showing that the taxpayer was merely reckless and the taxpayer’s motive for not filing an FBAR is irrelevant or this is merely and aberration based on the particular facts of the case? In either case, it is clear that FBAR compliance and international tax enforcement issues are on the continual rise and it is worth paying close attention to ensure one does not find him or herself on the wrong side of an IRS Criminal Investigation.

If you have unreported foreign accounts and fear that the IRS may soon learn of your activities the Tax Law Offices of David W. Klasing can help you get back into compliance and avoid the impending wrath of the IRS and state taxing authorities. The first step is to determine how severe a problem you have. It could be as simple as filing the missing FBARs and requesting penalty abatement for reasonable cause where all of the foreign income has been duly reported. Or as involved as filing 8 years of amended returns to report the foreign income, 8 years of FBAR’s and then guiding you through making a Voluntary Disclosure to the criminal investigations division of the IRS.