Taxpayer’s Decades-Long FBAR Failures Has Court Considering Contours of ‘Willfulness’ Standard

Violations of the obligation to file a Report of Foreign Bank and Financial Accounts (FBAR) when foreign account balances exceed $10,000 carries harsh penalties. The FBAR penalties are particularly harsh when a taxpayer is convicted of ‘willfully’ violating the rules. In these circumstances, a taxpayer can be on the hook for a penalty that equals the greater of $100,000 or 50% of the account balance. Depending on the exact conduct involved, additional penalties potentially including a prison sentence may be appropriate.

However, the penalties attached to FBAR weren’t always quite so severe. In fact, for the first several decades of the obligations existence, the law did not provide a penalty for non-willful violations. Furthermore, penalties for willful violations were capped at $100,000. In 2004, the law was amended and penalties were introduced for even accidental violations of the law. Furthermore, for willful violations, the $100,000 penalty ceiling was essentially transformed into a penalty floor.

However, due to the lack of a penalty for accidental noncompliance, limited penalties for willful noncompliance, and a lack of enforcement a significant number of taxpayers neglected this obligation for decades. Some continued to neglect their duty to disclose foreign accounts even after the new FBAR. For many taxpayers, this is a recipe for a tax enforcement action that could produce huge fines and penalties.

From a $100 Deposit in a Swiss Bank Account in the 1970s to an FBAR Fine of Nearly $1 Million

During the 1970s, Arthur Bedrosian opened a Swiss bank account with a $100 deposit while on a business trip. By the mid-2000s, this sum had increased significantly and Bedrosian had also opened a second Swiss account by this time. When Bedrosian finally attempted to take some corrective action in 2007, one foreign account had a balance of $240,000 while the second foreign account had a balance of $2.3 million. In all, Bedrosian had roughly $2.5 million in undisclosed foreign assets when he finally made a partial disclosure in 2007.

Why Didn’t the Taxpayer Fix FBAR Mistakes Sooner?

Bedrosian claims that he never told his original accountant about his foreign accounts because “the accountant never asked.” However, at some point in the 1990s, Bedrosian claims that he did disclose the accounts. While the accountant is now deceased, Bedrosian claims that the accountant told him to take no action because “the damage was already done.”

After the accountant passed away, Bedrosian sought out advice from a new accountant. It was this accountant that encouraged Bedrosian to make his 2007 partial disclosure. While his disclosure failed to include income, he did disclose the foreign account containing $240,000.

In 2008, Bedrosian engaged in a series of transactions. He first asked his Swiss bank to close one of his accounts and transfer the assets to a new Swiss bank account at a different bank. At the end of 2008, he asked the original Swiss bank to close the remaining account. He asked the bank to transfer these funds to a U.S. account.

Major Mistakes in August and September 2010 Regarding an OVDP Filing May Have Put the Taxpayer on the IRS’s Radar

In August and September 2010, the taxpayer apparently decided that his situation could not continue and sought to address his past noncompliance. Unfortunately, the taxpayer’s approach to the issue was rather confused and likely had the effect of providing the U.S. government with evidence to support a tax enforcement action.

In August 2010, Bedrosian filed an amended 2007 income tax return and FBAR. This amended tax return reported approximately $220,000 in income from the Swiss accounts. The amended FBAR also included the second account that was not included in the original filing. The next month, Bedrosian attempted to file for relief through the Offshore Voluntary Disclosure Program (OVDP).

What transpired next is not clear. Bedrosian claims that an IRS agent told him to “opt-out of OVDP.” The government claims that Bedrosian did file an application to enter the program, but his application was rejected. In any case, if relief through OVDP was available, the taxpayer seems to have botched the filing. It is also possible that the IRS agent was advising Bedrosian to “opt-out” because an OVDP filing was inappropriate due to past acts or filings. A tax lawyer can help make this determination before a taxpayer hands potentially damaging documents over to the IRS.

Taxpayer Faces Nearly $1 Million in Fines

In July 2013, the IRS finally ordered a penalty against the taxpayer for his FBAR failures. The IRS sought a penalty of $975,789.17 for the taxpayer’s failure to comply with FBAR rules and regulations. This FBAR penalty signified that the government believed that Bedrosian has willfully violated the tax rules. However, what exactly constitutes willfulness — and thus what exactly the government must prove — was raised as an issue in a lawsuit filed by Bedrosian.

The Taxpayer Raises Questions Regarding the Definition of Willfulness in Civil FBAR Proceedings

The IRS and the taxpayer agree that the only issue in this proceeding is the applicable willfulness standard.

Bedrosian asserts that the government is obligated to utilize the same standard for willfulness in the civil context as it would in a criminal context. This means that the government would need to prove that a taxpayer engaged in a voluntary, intentional violation of a known legal duty for a willfulness penalty to be appropriate. However, the court has shown a general disapproval with this line of reasoning. Rather, the court seems to suggest that recent court decisions have established reckless actions as falling within the definition of ‘willfulness’ for civil purposes. If recklessness were included in the civil definition of willfulness, it would greatly expand the body of taxpayers likely to face a willfulness penalty.

Botched OVDP Filings, Institutional Reporting Means that No Account Can be Truly Secret

Once a taxpayer fails to comply with FBAR or another offshore account reporting duty, he or she is placed in a precarious position. That is, a continuing failure to report the account may compound past liability for noncompliance. Furthermore, if the taxpayer engages in additional actions to conceal the accounts, such as failing to report foreign accounts and income on future tax returns, he or she is likely to create new liability for tax violations and crimes. Thus a taxpayer may be motivated to seek relief through OVDP. However, as this matter illustrates, making a botched disclosure can simply mean that you have handed over highly damaging relevant documents to the government.

Taxpayers should also be spurred into action because of the global web of institutional disclosures authorized and enforced through international governmental agreements (IGAs). These IGAs can provide for the automatic reciprocal sharing of tax and financial data between the United States and foreign nations. Since foreign financial intuitions are subject to a potential withholding penalty of up to 30 percent for noncompliance, they are likely to turn over the data. Therefore, no taxpayer can rely on an account remaining secret but attempts to address the problem singlehandedly can, unfortunately, result in extremely damaging errors.

Concerned about FBAR Failures?

If you are worried about potentially costly mistakes regarding FBAR or any other tax obligation, the lawyers of the Tax Law Offices of David W. Klasing may be able to help. We can help you address FBAR concerns before they turn into potentially huge fines and penalties. Furthermore, our meticulous and process-oriented approach decreases the likelihood that mistakes or errors will be made when seeking relief through OVDP. To schedule a confidential reduced rate consultation, please call 800-681-1295 today.