Saturday, March 21, 2020

District Court Muddles an FBAR Willful Penalty Case (3/21/20; 3/24/20)

I made a key revision on 3/24/20 at 4:00pm as indicated in red below to state with cites to the statute that the willful FBAR willful penalty limits (greater of $100,000 or 50% of unreported accounts) is a maximum penalty, thus giving the IRS authority to assert lesser FBAR penalty amounts than those maximums.  That reading of the willful penalty was implicit in the  rest of the discussion; I just thought it should be made explicit.  The changed language is marked in red below.

In United States v. Schwarzbaum (S.D. Fla. Dkt. 18-cv-81147, Order dated 3/20/20), here, in an FBAR collection suit, the court:
1. Held that Schwarzbaum was not liable for the FBAR willful penalty for 2006 but held open the possibility that the nonwillful penalty might apply. 
2. Held that Schwarzbaum was liable for the FBAR willful penalty for 2007, 2008 and 2009, but held that the IRS’s method of determining the penalty was arbitrary and capricious because it was not based on the June 30 values in the unreported offshore account, but the Court held that the parties were to confer to “in an effort to resolve the outstanding amount owed.”
The CourtListener docket for the case is here.

JAT Comments:

1.  I will not review the facts leading to the holding but will instead only deal with the legal issues in the opinion that I think are worthy of comment.

2.  On the issue of willfulness, the Court held that Schwarzbaum did not knowingly fail to file the FBAR.  (Slip Op.  15-18.)  The interesting part of that holding is (footnote omitted):
As a preliminary matter, the Court notes that in attempting to satisfy its burden in this case, the USA relies heavily on the notion from case law that a taxpayer is charged with knowledge of the information on a tax return by virtue of signing it under penalties of perjury. See United States v. Doherty, 233 F.3d 1275, 1282 n.10 (11th Cir. 2000) (defendant can be charged with knowledge of the contents of a tax return by signing a fraudulent form); Williams, 489 F. App’x at 659 (taxpayer’s signature is prima facie evidence that he knew the contents of the return and line 7a’s instruction for exceptions and filing requirements for FBAR put taxpayer on inquiry notice of the FBAR requirement); Norman v. United States, 942 F.3d 1111, 1116 (Fed. Cir. 2019) (a taxpayer who signs a return is charged with constructive knowledge of its contents) (citing Greer v. Comm’r of Internal Revenue, 595 F.3d 338, 347 n.4 (6th Cir. 2010); Jarnagin v. United States, 134 Fed. Cl. 368, 378 (Fed. Cl. 2017) (“any individual exercising ordinary business care and prudence would have made inquiry of their accountant about the FBAR filing requirements after having identified the clear error in the response provided to question 7a); McBride, 908 F. Supp. at 1206 (“It is well established that taxpayers are charged with the knowledge, awareness, and responsibility for their tax returns, signed under penalties of perjury, and submitted to the IRS.”).  
However, upon review, the Court agrees with the recent decision in United States v. Flume, No. 5:16-CV-73, 2018 WL 4378161, at *7 (S.D. Tex. Aug. 22, 2018), that the theory of constructive knowledge is unpersuasive in this instance. Imputing constructive knowledge of filing requirements to a taxpayer simply by virtue of having signed a tax return would render the distinction between a non-willful and willful violation in the FBAR context meaningless. Because taxpayers are required to sign their tax returns, a violation of the FBAR filing requirements could never be non-willful. Yet, the statute provides for non-willful penalties. Applying the USA’s suggested reasoning would lead to a draconian result and one that would preclude a consideration of other evidence presented. Accordingly, the USA cannot satisfy its burden of proof in this case on the issue of willfulness simply by relying on the fact that Schwarzbaum signed his tax returns or neglected to review them as thoroughly as he should have.
I have had some skepticism as to whether a no answer or nonanswer to the FBAR question on Schedule B alone should suffice to establish willfulness.  I think that is a circumstance, a very important circumstance, in the mix of all the facts that can weigh toward willfulness.  But, to test, in a case where the Government's entire case was the introduction of proof interest in the foreign accounts and introduction of the return's Schedule B, with the taxpayer introduced nothing (either on motion for summary judgment or at trial),  I would be uncomfortable with a holding that the Schedule B no or nonanswer alone established willfulness.  In Schwarzbaum, of course, there were a lot more surrounding facts.

3.  Although holding Schwarzbaum did not knowingly fail to file, the Court held that he recklessly failed to file and thus was willful for purposes of the FBAR willful penalty for the years 2007-2009.  In so holding the Court accepted the line of cases, the clear trend, permitting recklessness to satisfy the wilfull standard.

4.  The interesting part of the opinion is the Court’s holding the IRS’s calculation of the penalty violated the statute and was arbitrary and capricious and thus the penalty assessment was invalid.  FBAR willful penalty fans (and, with some overlap, readers of this blog) will recall that the IRS had adopted a willful penalty policy as follows (IRM (11-06-2015), Penalty for Willful FBAR Violations - Calculation), here:
After May 12, 2015, in most cases, the total penalty amount for all years under examination will be limited to 50 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination. In such cases, the penalty for each year will be determined by allocating the total penalty amount to all years for which the FBAR violations were willful based upon the ratio of the highest aggregate balance for each year to the total of the highest aggregate balances for all years combined, subject to the maximum penalty limitation in 31 USC 5321(a)(5)(C) for each year.
The Court held that, because the statute tags the penalty amount to the June 30 balance rather than this methodology the assessments were invalid.  (See Slip Op. 22-25.)  Here is the Court’s discussion and resolution of the arguments (Slip Op. 24-25):
Schwarzbaum contends that the IRS failed to exercise its discretion in a reasoned manner in its calculation of the FBAR penalties because its methodology was not based on any year-by-year determination, as required by statute. In response, the USA argues that the penalty calculation was proper because the IRS made a willfulness determination, computed the statutory cap, and then exercised its discretion to mitigate the penalties further in accordance with the IRM. Upon review of the evidence, the Court finds that the base amounts used by the IRS in conducting the penalty calculation were not in accordance with the statute. 
According to the applicable statute, the penalty assessed for a willful violation is the greater of $100,000.00 or “in the case of a violation involving a failure to report the existence of an account or any identifying information required to be provided with respect to an account,” 50% of “the balance in the account at the time of the violation.” 31 U.S.C. § 5321(a)(5)(C)(i), (D)(ii).  
In reaching the penalty amount assessed against Schwarzbaum, the IRS in its correspondence with Schwarzbaum, asserted that it used the balance in each account as of June 30 of each relevant tax year 2006 through 2009 to arrive at a mitigated willful FBAR penalty amount of $35,729,591.00. See Pl.’s Exh. 48. The IRS considered that this amount was excessive, and further reduced the mitigated penalty to $13,729,591.00, which represents the maximum penalty for 2008 divided and spread over the years 2006 through 2009. Id. As a result, the penalty assessed for 2006 was $1,173,778.00,4 and $4,185,271.00 each for tax years 2007 through 2009. Id. However, the evidence adduced at trial conflicts with the IRS’s representation that it utilized the account balances as of June 30 of each tax year. At trial, Anderson testified that he approved the FBAR penalties assessed, which were based on amounts in the penalty calculation worksheet provided by Schwarzbaum during the course of the OVDI proceeding. In connection with his OVDI disclosures, Schwarzbaum reported the highest aggregate balance in each account for each year, not the balance in the account as of June 30 of each year. See Pl.’s Exh. 26; Jt. Exh. 11. As a result, notwithstanding any further mitigation applied by the IRS, the IRS used the incorrect base amounts to calculate the FBAR penalties in this case. The statute is clear that the amount to be assessed is 50% of the balance in the account at the time of the violation. The evidence in this case reflects that the IRS used the highest aggregate balance for each account as reported by Schwarzbaum on his OVDI penalty worksheet, instead of determining the balance in each account at the time of the FBAR violation, as required by statute. As a result, the IRS’s penalty assessments for tax years 2007 through 2009 are not in accordance with law.
Based on that holding, the Court seems to think the Government can just correct the amount(s) of the assessments based on its view of the law.  I question whether the Court’s notion that the amount issue can be corrected now is good.  The holding, as I understand it, is that the assessments were illegal.  Hence, new assessments would be required.  And, the statute of limitations on new assessments has, I suspect, long-since past.  (Perhaps the Court thinks that the IRS could just abate some portion of the assessments to preserve against a statute of limitations argument, but then the IRS may run afoul of some variation of the holding of SEC v. Chenery Corp., 332 U.S. 194 (1947) (Chenery I) that the court will not uphold on bases not asserted by the agency in making the original determination; although Chenery 1 was remanded and a new determination made (SEC v. Chenery Corp., 332 U.S. 194 (1947) (Chenery II)), there appeared to be no statute of limitations problem.)

More importantly, I think the Government had the better part of the argument.  The willful penalty for each year to which it applies "shall not exceed" $100,000 or, if greater, 50% of the amounts in the accounts on the key date (June 30).  See 31 USC § 3521(a)(5)(B)(i) ("shall not exceed") and § 3521(a)(5)(C)(i) for the monetary limits, so the FBAR willful penalty may be less (but not more) than those limits). The IRM formula will result in a penalty in each year of less than the amount it could assess for each year of willful failure to file the FBAR (or complete FBAR).  The IRS has the authority to assert a penalty of less than the high amount and it did so pursuant to the IRM as an alternative to assessing the high FBAR amount for each year (50% of the unreported account amounts on June 30).  I just don’t understand how the Court could have found that to be arbitrary and capricious and thus not in compliance with statute.

And, interestingly, on the Court's reliance on Flume, in a later decision, Flume was held liable for the willful penalty:  Court Finds Taxpayer Willfully Failed to File FBARs (Federal Tax Crimes Blog 6/25/19), here.  The facts in Flume were quite different than in Schwarzbaum, though.

5.  I suppose that, even if the Government ultimately sustains the FBAR willful penalty for 2007-2009, the Court's holding of nonwillfulness for 2006 might mean that the IRS/FinCEN loses the amount of the penalty that was spread to 2006 because the statute of limitations has surely passed to reallocate that amount to another year for which a statute of limitations is opened.  In this regard, I am not sure that the IRS really contemplated that it might lose the willful penalty for some years but not others in the years to which the aggregate FBAR penalty is spread.

6.  I previously reported on an earlier decision in the Schwarzbaum case: Court Rejects Government Summary Judgment Motion in FBAR Willful Penalty Collection Suit (Federal Tax Crimes Blog 8/28/19), here.

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