FBAR Willfulness Easier to Prove Under Recent Reyes Second Circuit Decision

Introduction

Under the Bank Secrecy Act (BSA), U.S. persons must generally file annual information returns to report their foreign accounts. Known as FBARs, these returns provide the government with specifics concerning the foreign accounts, such as account numbers and the maximum account balances during the tax year. To ensure compliance, the BSA also imposes significant monetary penalties for late or delinquent FBAR filings. The amount of the penalty depends on the taxpayer’s conduct, broken down into either a willful (highest penalties) or non-willful (reduced penalties) bucket.

For some time, taxpayers have argued that willful FBAR penalties should only be imposed where the taxpayer was aware of the FBAR filing requirement and intentionally failed to file. Conversely, the government has contended that willful conduct encompasses both intentional behavior and recklessness. Thus far, the government has convinced every court of appeals that its definition is correct, including the Second Circuit in its recent decision in U.S. v. Reyes.

Facts in Reyes

Dr. Reyes moved from Nicaragua to the U.S. in 1960, became a U.S. citizen in 1982, and practiced medicine as a surgeon. His wife routinely assisted him with his medical practice.

In 1972, Dr. Reyes’ parents opened a bank account in his name in Nicaragua. They deposited $200,000 and over time the account grew to $2 million. Dr. Reyes later had the funds from the account transferred to a Swiss bank account in which he and his wife both held signature authority.

After many years of not filing FBARs, the IRS discovered the foreign account and sought to impose willful FBAR penalties against the taxpayers for 2010, 2011, and 2012. The agency assessed the willful FBAR penalties and then sought to collect them through litigation in federal district court. To avoid trial on the issue of willfulness, the government moved for summary judgment, citing the following facts:

• The foreign account represented a large part of the taxpayers’ overall wealth (roughly 75% to 90% of their total assets);

• The taxpayers never informed their CPA of the foreign account and never returned their CPA’s questionnaire that asked about the existence of any foreign accounts;

• The taxpayers paid a fee to have the foreign financial institution hold their mail and not deliver it to the U.S.;

• The taxpayers instructed the foreign financial institution not to invest in U.S. securities to avoid U.S. reporting rules;

• The taxpayers never reported their foreign account on Schedule B of their income tax returns;

• The taxpayers used foreign credit cards and funds from the foreign account to pay domestic expenses.

The lower court granted the government’s motion for summary judgment, concluding that these undisputed facts were sufficient, as a matter of law, to find objective recklessness.

The Second Circuit’s Decision

The Second Circuit agreed with the lower court’s decision. In doing so, the Second Circuit joined six of its sister circuits in concluding that willfulness for FBAR penalty purposes includes objective recklessness. In other words, the government can prove willfulness according to a reasonable person standard and does not need to prove the taxpayer’s intent in failing to file an FBAR (a much higher evidentiary hurdle).

In reviewing the undisputed facts, the court reasoned that a reasonable person would have been put on notice of the FBAR reporting requirements when asked by their CPA whether they had foreign accounts through a questionnaire. In addition, such a person would have been alerted to the reporting requirement when the IRS asked about the existence of foreign accounts on Schedule B.

The court further found that there were other indicia of recklessness in that the taxpayers had a large portion of their wealth overseas, used foreign credit cards and funds from the account for domestic expenses, and therefore should have been alerted that funds earned from the account may be subject to U.S. income tax reporting. This was particularly true where the foreign financial institution notified the taxpayers that U.S. tax reporting rules applied if they invested the foreign funds in the account in U.S. securities.

Conclusion

After Reyes, seven circuit courts of appeal have agreed with the government’s position that willfulness includes objective recklessness. Given these decisions, taxpayers should be cautious in attempting to regain compliance with missed FBAR filings. Indeed, many of the IRS compliance initiatives, including the Streamlined Filing Compliance Procedures (SFCP), require taxpayers to certify under penalties of perjury that they were non-willful in missing the filing deadlines for these and other information returns. Taxpayers with questions concerning willfulness should consult with a tax professional knowledgeable on these matters.

For questions concerning this blog post or any other civil or criminal tax related matter, please feel free to contact me at mroberts@meadowscollier.com.