Sunday, July 15, 2018

Government Pushes the Envelope on the Meaning of Willfulness in FBAR Willful Civil Penalty (7/15/18)

A colleague called my attention to the Government's motion and brief for summary judgment in Kimble v. United States (CFC Dkt. no. 17-421 T), here.  The case is an FBAR willful civil penalty refund suit.  In the brief, the Government makes bold claims about the standard for what it must prove to establish a persons liability for the FBAR willful civil penalty.  The docket entries are here.  Mrs. Kimble has not yet filed a response.  I offer the following based on the Government's brief.

I start with the statute.  Section 5321(a)(5)(C) authorizes the civil FBAR willful penalty as follows against "any person willfully violating, or willfully causing any violation of, any provision of section 5314."  The latter section is the section imposing the requirement to file an FBAR.

Often where there is a significant civil penalty, there is a corresponding criminal penalty.  (See e.g., the income tax civil fraud penalty in § 6663 and the criminal tax evasion penalty in § 7201, imposing parallel penalties with the only material difference being the level of proof required (clear and convincing in the civil fraud instance and beyond a reasonable doubt in the criminal instance).)  Similarly, there is also a criminal penalty in 31 USC § 5322(a) imposed on "A person willfully violating this subchapter or a regulation prescribed or order issued under this subchapter."

Two things to observe about the criminal FBAR penalty.  First, the penalty is stated in the same words and cut from the same cloth.  By contrast the civil fraud income tax penalty is worded differently and interpreted the same as the criminal penalty for tax evasion. Second, the criminal penalty for tax evasion requires proof beyond a reasonable doubt, but the civil penalty requires proof by clear and convincing evidence.

The consensus of the decided cases for the civil FBAR willfulness penalty hold that the FBAR willful civil penalty requires that the government prove willfulness only by a preponderance of the evidence.  I think that holding is wrong, as I have previously asserted on this blog, but do not address that issue here.

What I want to address is the meaning of willfulness.  In Ratzlaf v. United States, 510 U.S. 135 (1994), the Supreme Court held that the same standard of willfulness applies to the FBAR criminal penalty as applies in federal tax crimes requiring willfulness -- "`voluntary, intentional violation of a known legal duty'" Cheek v. United States, 498 U.S. 192, 201 (1991) (a tax case).  Since the Supreme Court calibrated the definition of willfulness for FBAR criminal purposes to the definition of willfulness for criminal tax purposes, I have found the following explanation from Bryan v. United States, 524 U.S. 184 (1998) to be helpful:
The word “willfully” is sometimes said to be “a word of many meanings” whose construction is often dependent on the context in which it appears.  See, e.g., Spies v. United States, 317 U.S. 492, 497 (1943).  Most obviously it differentiates between deliberate and unwitting conduct, but in the criminal law it also typically refers to a culpable state of mind.  As we explained in United States v. Murdock, 290 U.S. 389 (1933), a variety of phrases have been used to describe that concept.  As a general matter, when used in the criminal context, a “willful” act is one undertaken with a “bad purpose.”  In other words, in order to establish a “willful” violation of a statute, “the Government must prove that the defendant acted with knowledge that his conduct was unlawful.” Ratzlaf v. United States, 510 U.S. 135, 137 (1994). 
* * * * 
In certain cases involving willful violations of the tax laws, we have concluded that the jury must find that the defendant was aware of the specific provision of the tax code that he was charged with violating.  See, e.g., Cheek v. United States, 498 U.S. 192 (1991).  Similarly, in order to satisfy a willful violation in Ratzlaf, we concluded that the jury had to find that the defendant knew that his structuring of cash transactions to avoid a reporting requirement was unlawful.  See 510 U.S. at 138, 149.  Those cases, however, are readily distinguishable.  Both the tax cases and Ratzlaf involved highly technical statutes that presented the danger of ensnaring individuals engaged in apparently innocent conduct.  As a result, we held that these statutes “carve out an exception to the traditional rule” that ignorance of the law is no excuse and require that the defendant have knowledge of the law.  The danger of convicting individuals engaged in apparently innocent activity that motivated our decisions in the tax cases and Ratzlaf is not present here because the jury found that this petitioner knew that his conduct was unlawful.
With that background of what the term willfully means in the parallel criminal FBAR penalty statute, let's turn to willfully in the civil FBAR willful penalty statute.

The Government argues in Kimble that a substantially more relaxed definition of willfulness applies (and it is not just about the burden of proof).  Here is the argument (p. 3 and 17-18; bold face supplied by JAT):
A taxpayer failing to file a timely FBAR acts willfully, and is subject to a penalty under 31 U.S.C. § 5321(a)(5)(C), if he or she (1) failed to file the report voluntarily, and not accidentally; (2) was willfully blind to the legal obligation and to the facts giving rise to the obligation; or (3) recklessly disregarded the legal duty to file the report. 
* * * * 
The text of the statute does not define the term "willful" or "willfully." 31 U.S.C. § 5321(a)(5). When interpreting the term in other contexts, the Supreme Court has held that "'willfully' is a word of many meanings whose construction is often dependent on the context in which it appears." Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 57 (2007). Courts have outlined three standards for willfulness in the FBAR context. These standards are in the alternative, that is, if the taxpayer's situation meets even one of them, willfulness would be established. The standards are: (1) failing to comply with a legal duty voluntarily rather than accidentally; (2) willful blindness to a legal duty and the attendant facts; and (3) reckless disregard of a legal duty.
The first articulation in subparagraph (1) seems to be the Cheek standard, stated less stringently than the Supreme Court stated it in Cheek.  If the person failed to comply with the legal duty voluntarily, he or she per must have known the law in order to voluntarily not comply with it and intended to violate it.  I think a better statement would be as stated in IRM (11-06-2015) Willful FBAR Violations - Defining Willfulness ("The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty.")  That is the Cheek standard.

In spinning its argument under this standard, the Government asserts (p. 19):  "By virtue of her having signed her federal income tax return, Mrs. Kimble is charged with knowledge of the FBAR reporting requirement."  Note that she is "charged with knowledge" under this argument, not that she knew and made a voluntary choice to violate the duty.  From that leap, the Government argues that the defendant is charged with (i) knowledge of the contents of a return he or she signs and (ii) in part here relevant, of the foreign account question and the reference to the FBAR filing requirement.  From that deemed / "charged with" knowledge (not actual knowledge), the person signing a return with the question marked "no" then met the requirement of (1) that he or she must have made a voluntary choice to not file the FBAR.

In my mind, this is bizarre stuff and would be almost laughable except that the Government makes the arguments and spins the cases as supporting the argument.  And the argument finds traction in the courts.  Can it be the law that for all civil penalty purposes, the taxpayer is charged with knowledge of the law and intent to violate it as to whatever he or she could have discovered had he or she studied the return before signing it?  Think civil fraud penalty case arising from a foreign account.  Is the defendant liable for the civil fraud penalty simply upon proof of knowledge of the foreign account and signing a return where the foreign account question was answered no or not answered at all (the instructions are the same and could  have been discovered had he or she read the return and its attachments, including Schedules)?

In further explanation, the Government argues (p. 21) in a heading that "Mrs. Kimble had knowledge of her obligation to file the FBAR, and failed to do so."  But, then it opens the argument with "Mrs. Kimble had constructive knowledge of the FBAR requirement, because she signed her original 2007 tax return, which included the question on foreign bank accounts on Schedule B."  Well, which is it guys -- knowledge or constructive knowledge?  And then the rest of the section merely recounts circumstantial evidence from which a trier of fact might find knowledge (not must find knowledge).

The other two articulations (2) and (3) are more troublesome.  The second (the willful blindness) articulation is suspect to me.  I have written often on the use of willful blindness in criminal cases where the Cheek standard applies.  Basically, I don't think that willful blindness is a substitute for the specific intent required by Cheek but is only a factor the jury may consider along with all other factors in the case to make the finding that the defendant willfully violated the statute.  In other words, for example, in a criminal tax case, the judge could not submit a special interrogatory to the jury as to whether it finds that the defendant willfully blinded himself to the law and then, if the jury answered the question "yes," convict the jury of the tax crime without the jury making any determination as to whether the defendant had the specific intent to violate a known legal duty.  I think that same analysis should apply in a civil context where the relevant standard is the Cheek standard (as the Government states in (1)).  So, while the judge or jury may in a civil case consider willful blindness, I think the judge or jury still has to make the finding of intent to violate a known legal duty and willful blindness should not alone suffice to meet that standard.

Apparently recognizing that its "constructive knowledge" argument is weak, the Government leans heavily on willful blindness in (2) to distract from the deficiency.  I have nothing more to say on that.

The (3) articulation is even more troubling because of the way the Government further explains it in the brief.  Reckless disregard is not a specific intent to violate a known legal duty.  The government simply regurgitates the same facts in argument that "Reckless Disregard: Mrs. Kimble recklessly disregarded her duty to file a 2007 FBAR."

I presume that Mrs. Kimble will file a response with appropriate summary judgment evidence keeping the real issue in play -- whether she, in the Government's own words, "fail[ed] to comply with a legal duty voluntarily rather than accidentally."  Or in the language of Cheek, intended to violate a known legal duty.

I think the Government keeps pressing the envelope on the FBAR civil willful penalty willfulness standard and, finding willingness -- not same as willfulness -- in the courts, just pressing far beyond where the Government could have credibly made the case from the beginning.  Keep in mind that in the first pronouncement by the IRS in an internal guidance document, the IRS attorney determined that the Cheek willfulness standard applied and concluded that the clear and convincing evidence standard applied to the civil FBAR willful penalty.  And the IRS continues to claim the Cheek standard in the IRM (see above) while eroding its meaning.

Additional comments:

1. If inquiry is beyond what the person knew and is properly into what the person should have known, then shouldn't the judge permit some type of expert testimony as to public state of play of the FBAR matters in assessing what the person should have known.  See United States v. Garrity, 2018 U.S. Dist. LEXIS 91665 (D. Conn. 2018), discussed in Court Rejects Defense Expert Testimony as to State of Law and Duty in Government FBAR Willful Penalty Case (Federal Tax Crimes Blog 6/3/2018), here.

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