On September 20, 2017, the Eastern District of Pennsylvania issued an important taxpayer-friendly opinion regarding the willfulness standard in FBAR penalty matters. In Bedrosian v. United States, Case No. 2:15-cv-05853-MMB (E.D. Pa., Sept. 20, 2017), the court held that the government had not met its burden in proving that Bedrosian had willfully violated FBAR reporting requirements. This is the first reported decision where a taxpayer has successfully defended against the assessment of the willful penalty in the FBAR context. This opinion could have a major effect on future IRS decisions in the offshore compliance arena and may cause some taxpayers – whether justified or not – to seek a more aggressive approach in addressing prior non-compliance.
Background. The past decade has seen a tremendous increase in offshore tax enforcement. Aside from criminal penalties, the government has used potentially significant foreign bank account reporting (“FBAR”) penalties to coerce taxpayer compliance. In this regard, the Internal Revenue Service (“IRS”) and Department of Justice consistently warned that individuals could be assessed with an annual penalty of up to 50% of unreported foreign accounts if such failures were willful. The combination of criminal exposure and potentially significant civil penalties caused many taxpayers to proactively address non-compliance through newly established IRS programs, such as the Offshore Voluntary Disclosure Program (“OVDP”). These programs were successful in bring tens of thousands of taxpayers back into compliance. The programs also generated tens of billions of dollars in revenue for the government.
At least in the earlier versions of the OVDP, some taxpayers believed that their circumstances may not warrant substantial willful penalties and their exposure was capped at the maximum non-willful FBAR penalty ($10,000 per account per year); however, the holdings in cases like United States v. Williams, 2010 WL 3473311 (E.D. Va., Sept. 1, 2010) and United States v. McBride, 489 F. App’x 665 (4th Cir. 2012) – which were not friendly to taxpayers – forced many taxpayers and their advisors to re-think those positions. At least anecdotally, many taxpayers sought compliance through programs with higher financial burdens as a direct result of the increased risks posed be these cases. The financial trade-off was acceptable because, with near certainty, taxpayers could still address lingering issues for a fraction of the value of their non-compliant foreign assets. On the other hand, to resolve a case on the grounds of non-willfulness or reasonable cause (for a much lower penalty), taxpayers were forced into a much longer ordeal with the IRS and, in many instances, faced financial ruin in a worst case scenario.
Williams and McBride. Both Williams and McBride dealt with the interpretation of the willfulness standard under the civil FBAR penalty statute, 31 U.S.C. § 5314. As statutory penalties for failing to report foreign financial accounts can be many times greater than any other tax or reporting penalties, they are generally the focus (and main concern) of taxpayers when remedying past offshore non-compliance. Unfortunately, for those with offshore accounts, those holdings stemmed from bad facts. For example, in Williams, the defendant specifically acknowledged that he failed to report the existence of Swiss accounts to the government as part of a larger scheme of tax evasion. The acknowledgement was contained within the allocution in his criminal guilty plea. Moreover, in Williams, the defendant continued to provide false FBARs to the government after he was a target of a government investigation. Needless to say, those facts did not help in trying to defend against the government’s assertion that the non-reporting was willful. And, in McBride, the taxpayer specifically sought to avoid taxation through the use of unreported foreign accounts, with the help of a financial management firm. McBride repeatedly lied and refused to produce documents to the IRS when confronted with an investigation. While those facts may have justified a finding of willfulness in both cases, the courts provided additional insight on what else might constitute willfulness. Some of those statements, which were not narrowly drawn to the facts of those cases, led many to believe that the willfulness standard was tantamount to strict liability and could apply to a great range of situations.
In particular, in Williams, the court held that failing to file an FBAR after signing a tax return (which contains reference to the FBAR reporting thresholds) was a “conscious effort to avoid learning” about its requirements. Williams at 659. Attempting to avoid FBAR requirements was deemed akin to willful blindness and was enough to prove willfulness under 31 U.S.C. § 5314. At the least, the court resolved that Williams’ behavior in failing to learning of FBAR requirements was “reckless,” and a willful finding could be made where there was an inference that conduct was meant to conceal or mislead sources of income or other financial information. Id. at 658. Further, the mere signing of the tax return was prima facie evidence that a taxpayer knew of the contents of the return and, by extension, knew of FBAR filing requirements. Id. at 659. It was the latter language that provided taxpayers and practitioners with incredible hesitation in seeking remediation of offshore non-compliance outside of the OVDP – particularly when there was little other guidance to go on. Both taxpayers and practitioners were (and perhaps still are) forced to counsel their clients based on these opinions and the facts from these worse case scenarios; however, as explained below, Bedrosian may cause a taxpayer-friendly shift in this analysis.
Bedrosian: A Renewed Focus on the Facts. In Bedrosian, the taxpayer sought a refund from the United States of a payment for an alleged “willful” violation of the FBAR reporting requirements. (The United States counterclaimed for additional funds relating to the willful civil FBAR penalty.) Like Williams and McBride before, the taxpayer had placed significant funds in at least one Swiss account. Bedrosian was aware of at least one of the foreign financial accounts. Although initially unaware of the reporting requirements, Bedrosian learned of the requirement to file FBARs in the 1990s and, based on advice from his accountant, decided not to address the issue or file FBARs going forward. When Bedrosian began using a new accountant in 2007, his new accountant correctly completed the Schedule B (i.e., affirmatively reporting the foreign account on his income tax return) and filed an FBAR on Bedrosian’s behalf; however, the FBAR apparently only reflected one of the two foreign financial accounts that should have been reported on the FBAR for 2007. Bedrosian stated that he did not inform his new accountant of the accounts, did not know how his accountant knew of the foreign accounts, and merely signed the tax return. Thereafter, Bedrosian developed further awareness of the ramifications for failing to report the foreign accounts on FBARs. He engaged tax counsel to amend his tax returns and paid additional taxes relating to those financial accounts. Thereafter, the IRS initiated an audit and began the process of assessing Bedrosian with applicable FBAR penalties. Bedrosian cooperated with the IRS during the audit. The case focused on the applicability of the willful FBAR penalty for the account – the more significant of the two accounts – that went unreported on his FBAR for 2007.
At trial, the court stated that the government bore the burden of proving each element of the civil FBAR penalty by a preponderance of the evidence, including whether Bedrosian was willful in not reporting the foreign accounts. It was the willful element that constituted a bulk of the court’s legal analysis in Bedrosian. At the outset, the court held that willfulness can be established where one “knowingly or recklessly fails to file an FBAR” and does not require a showing of “improper motive or bad purpose.” The court agreed with the analyses in Williams and McBride wherein willful blindness, reckless disregard, or an “inference…to conceal or mislead sources of income or other financial information” could satisfy the standard.
Though the court largely agreed with the analytical framework set forth in the earlier opinions, it diverged in its analysis due to the more taxpayer-friendly facts in the case. The court reiterated that willfulness was a “question of fact” and was based upon the defendant’s “state of mind, knowledge, intent and belief regarding the propriety of their actions.” Even after acknowledging that Bedrosian was a sophisticated businessman who had knowingly failed to comply with tax laws, the court held that the government had not met its burden in proving willfulness as to FBAR violations. In so concluding, the court found that Bedrosian’s failure to report one account on the FBAR filed for 2007 was, at most, negligent. Even though Bedrosian could have easily discovered its existence and included it on the FBAR, the failure was significantly different than that in Williams and McBride. The court noted that, in those other cases, both defendants had significant holdings in foreign financial accounts and both had admitted, in a criminal context, to using the unreported accounts as part of larger tax evasion schemes. In Bedrosian, the government had only established that (1) the FBARs were inaccurate, (2) Bedrosian may have learned of the existence of the unreported account, (3) he was a sophisticated businessman, and (4) he was told that he was “breaking the law” by his accountant. According to the court, whereas the criminal convictions in Williams and McBride showed intent, in Bedrosian, the government’s case merely established that Bedrosian employed a lack of attention – not a conscious effort to conceal or mislead.
Moving Forward. While Bedrosian is undoubtedly a win for taxpayers, only time will tell show the magnitude of its effect. Williams and McBride still support a standard close to strict liability in the FBAR area. Moreover, it is not clear whether an inaccurate Schedule B (i.e., failing to report foreign accounts on a tax return), may be enough to establish willfulness. (It is important to note that, in Bedrosian, the Schedule B was accurate and only the FBAR was inaccurate.) If faced with a similar scenario in the future, it is likely that the government will spend more effort developing facts regarding the taxpayer’s specific intent to report a foreign financial account. It is thus important for other taxpayers to carefully develop the facts underlying the failure to report before deciding how to address the issue. Taxpayers must be prepared to refute any number of arguments that could be made by the government to show that non-compliance was intentional, reckless, or the result of willful blindness.
Regardless of its effect on the law, if any, Bedrosian will likely persuade a subset of taxpayers to either avoid the OVDP altogether (and opt instead for the Streamlined Filing Compliance Procedures) or may cause some taxpayers to “opt out” of the OVDP. Cases like Bedrosian, and perhaps others working their way through the legal system, may cause the IRS to re-evaluate its litigation positions and penalty policy in this area. Until more firm guidance is available, taxpayers should look to Bedrosian as a beacon of hope and should certainly provide it as a cautionary example for the government – one that too frequently believes all FBAR violations are willful in nature. Still, taxpayers need to tread lightly when dealing with significant offshore non-compliance. Advisors should be careful not to overstate the importance of the findings in Bedrosian. With many instances of non-compliance still yet to be discovered, the government will likely continue to emphasize enforcement in this area and will likely not be dissuaded by this recent decision. Seeking certain resolution in the OVDP will still benefit many taxpayers faced with similar circumstances and potentially calamitous FBAR penalties.
These descriptions are intended for informational purposes only and should not be taken as legal advice on any particular set of facts or circumstances. If you have unreported foreign income, assets, or financial accounts, you should consult a tax professional. Each of the compliance initiatives described above have specific eligibility and procedural requirements that require strict adherence. Failure to comply with these requirements may result in dire civil and criminal consequences. Rosenberg Martin Greenberg, LLP is experienced in all aspects of federal and state tax laws, including foreign bank account reporting, foreign tax treaties, tax provisions affecting foreign investment and foreign residents, offshore tax compliance initiatives, and more. Please contact Brandon Mourges at 410.951.1149 or firstname.lastname@example.org for a free consultation.