IRS Required to Return FBAR “Penalty:” Penalty was “Illegally Exacted”

In Bank Secrecy Act, FBAR, White Collar, Willfulness by Jason FreemanLeave a Comment

The much-anticipated decision in Bedrosian v. United States was released on Wednesday of this week, and it did not fail to disappoint—unless, of course, you find yourself on the latter side of the “v” in the case caption.  The case presented a fundamental FBAR issue: was Bedrosian’s failure to report his foreign account “willful?”  If it was, he would have been subject to a penalty of more than $1 million.  If not, he could keep the money.  It was, quite literally, the million-dollar question.  To save the suspense, I’ll cut to the chase: the district court ultimately held that the failure was not willful.  The court ordered the government to repay the “illegal exaction” back to Bedrosian.  The decision is remarkable, as it was the first in a line of recent FBAR willfulness cases to reach this conclusion.

The case arose in a common procedural posture: Bedrosian initiated a refund suit, seeking a refund of the $9,757.89 that he paid to the government for what the government alleged was a “willful” failure to report a foreign account. The government counterclaimed against Bedrosian for $1,007,345.48—the full amount of the “willful” penalty that it had assessed.

The background is not particularly remarkable for this context, even in excerpted form:

Bedrosian is a successful businessman who . . .  spent his career in the pharmaceutical industry, rising in the ranks to the position . . . [of] Chief Executive Officer at Lannett Company, Inc., a manufacturer and distributor of generic medications. In the early 1970s, when he was just getting started in the industry, Bedrosian held a position with Zenith Labs that required a significant amount of international travel. Rather than rely solely on traveler’s checks to make purchases abroad, in or about 1973 he decided to open a savings account with Swiss Credit Corporation in Switzerland. . . . Bedrosian initially used the account in order to have access to funds while traveling abroad but, as the years went on, he began to use it more as a savings account. . . . . In 2008, UBS informed him that he had sixty days within which to repay the loan, close his accounts, and transfer all assets therein to another bank.  Bedrosian moved the funds to a different Swiss bank called Hyposwiss.

. . .

 

Bedrosian also filed a Report of Foreign Bank and Financial Accounts (“FBAR”) for the first time in which he reported the existence of one of his two UBS accounts.  The FBAR only listed his UBS account ending in 5316, which had assets totaling approximately $240,000, and did not report the account ending in 6167, which had assets totaling approximately $2 million.

The issue in the case was whether Bedrosian’s failure to report the second account constituted a “willful” failure to report.

As background, the FBAR reporting obligation stems from the Bank Secrecy Act (“BSA”).  Congress passed the BSA in 1970 in an effort to remedy the “unavailability of foreign and domestic bank records of customers thought to be engaged in activities entailing criminal or civil liability.” California Bankers Ass’n v. Schultz, 416 U.S. 21, 26 (1974). The BSA was intended to “require the maintenance of records, and the making of certain reports, which ‘have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings.’” Id. (quoting 31 U.S.C. § 5311).

One such reporting requirement is the FBAR.  Section 5314(a) and its regulations require that all United States citizens report any “financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country.” 31 C.F.R. § 1010.350(a); 31 U.S.C. § 5314(a).  Such an interest is reported on the FBAR (now also known as FinCEN Form 114).  A failure to timely file an FBAR is subject to a penalty that varies in amount depending on the taxpayer’s level of culpability. 31 C.F.R. § 1010.306(c); 31 U.S.C. § 5321(a)(5).  A non-willful failure to file an FBAR is subject to a penalty not to exceed $10,000.  A willful violation, on the other hand, is subject to a statutory penalty equal to the greater of $100,000 or fifty percent of the balance in the account at the time of the violation. 31 U.S.C. § 5321(a)(5)(B)(i), (a)(5)(C).

In Bedrosian, both parties conceded that the account at issue had not been included on the FBAR.  The only question was whether the failure to report the account was “willful.”  The court, citing several prior FBAR cases, held that the willful-intent standard is satisfied by a finding that the defendant “knowingly or recklessly violated the statute.” The government, in other words, is not required to prove an improper motive or bad purpose. This definition contrasted sharply with the definition that the taxpayer urged the court to adopt: the same standard used in the criminal context, which requires that the government prove that the failure amounted to a voluntary, intentional violation of a known legal duty. See Cheek v. United States, 498 U.S. 192, 201 (1991).  See our prior post on the so-called Cheek defense at The Cheek Defense to Federal Tax Crimes.  The court’s rejection of this heightened standard was, however, consistent with recent cases in this area.  E.g., United States v. Williams, No. 09-437, 2010 WL 3473311, at *1 (E.D. Va. Sept. 1, 2010), rev’d on other grounds, United States v. Williams, 489 F. App’x 655 (4th Cir. 2012); United States v. McBride, 908 F. Supp. 2d 1186, 1201 (D. Utah 2012).

As the court held, “[t]he government bears the burden of proving each element of its claim for a civil FBAR penalty by a preponderance of the evidence, including the key question . . . of whether an individual’s failure to report was ‘willful.’”  But the court also reinforced the fact that “willfulness” encompasses “willful blindness” (as well as, for that matter, reckless violations):

To further elucidate the definition of “willfulness” in this context, we note that acting with “willful blindness” to the obvious or known consequences of one’s actions will satisfy the standard. Willful blindness is established when an individual “takes deliberate actions to avoid confirming a high probability of wrongdoing and [when he] can almost be said to have actually known the critical facts.” In the tax reporting context, the government can show willful blindness by evidence that the taxpayer made a “conscious effort to avoid learning about reporting requirements.”

The incorporation of the willful blindness doctrine into the definition of “willfulness” is a trend that continues to expand the scope of what constitutes a “willful” violation.  That expansion gives the government a significant tool to argue willfulness in many contexts.

Ultimately, the punchline is that the district court distinguished the facts in Bedrosian from those of other recent FBAR cases finding willfulness.  The case thus breaths some hope into this corner of the law for taxpayers currently fighting FBAR penalties.  In my estimation, the government is likely (if not certain) to appeal the decision.  And, in negotiating FBAR resolutions, it may very well take the position that the case is an outlier or argue that it should be entitled to little weight.  But make no mistake: the case is significant and marks an important decision in the FBAR context that taxpayers and the defense bar should read carefully—and, perhaps, cite liberally.

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