Friday, September 18, 2020

District Court Holds Failure to Properly Report Foreign Accounts on a Fifth Amendment FBAR Is Subject to FBAR Willful Penalty (9/18/20)

In United States v. Bernstein, 2020 U.S. Dist. LEXIS 167278 (E.D. N.Y. 2020), CL here and GS here, the Court granted the Government’s motion for summary judgment determining that the defendants, husband and wife (“Bernsteins”), were each subject to the willful FBAR penalty.  Those interested in the motions (and commotions) can find it in the Court Listener docket entries, here, where the motions are available free.

The key facts are;  For many years prior to 2010, the year for which the willful FBAR penalties were assessed, the Bernsteins had foreign accounts.  For the per-2010 years, they did not file FBARs, answered “no” to the Form 1040 Schedule B question about the foreign accounts, and did not report the income from the foreign accounts.  Over the years, they did not tell their accountant about the foreign accounts because they wanted to keep the accounts secret. That conduct, the Court found on summary judgment, was to cheat on their U.S. taxes.

They had the misfortune of having selected UBS as their foreign bank (although they moved the accounts into a single account at Bank Sal Oppenheim after they realized that UBS was caving to Government pressure as readers of this blog already know).  The following series of events then occurred:

Daniel Bernstein later consulted with a U.S. tax attorney, who told him that it was "nothing serious" because the account held "only a million dollars" and therefore the Government would not likely pursue it. Furthermore, Nemirovski, who consulted with a Swiss attorney, conveyed to Mr. Bernstein that the attorney had assured him that their account information had not been turned over to the IRS. Thus, the Bernsteins decided not to take any action in response to the letter and, specifically, not to participate in the Government's voluntary disclosure program.

In April 2011, the Government advised the Bernsteins that it was auditing their 2007 tax return. By that time, the Bernsteins were aware of publicity about the Government's prosecution of UBS account holders. They returned to the U.S. tax attorney who had told them not to worry two years earlier, but this time he told them, "I can't help you; you need a white-collar criminal attorney." He referred them to Lawrence S. Feld, Esq., who is known for his white-collar practice with a specialty in tax prosecutions, and the Bernsteins retained him.

Attorney Feld effectively disagreed with the prior decision not to participate in the voluntary disclosure program. He found the facts as presented to him "deeply disturbing" and believed that there was a "substantial risk" of criminal prosecution. He advised the Bernsteins to file an FBAR for the 2010 tax year in which they would invoke their privilege against self-incrimination under the Fifth Amendment of the U.S. Constitution. He prepared an addendum to the FBAR describing the basis for the privilege in which the Bernsteins offered to make more detailed disclosures if they received use immunity from criminal prosecution. In addition, the Bernstein's 2010 tax return and Schedule B invoked the Fifth Amendment with regard to any questions about foreign accounts.

Attorney Feld believed that this would protect the Bernsteins from criminal prosecution, although they still might be required "to pay [a] fine." The Bernsteins followed his advice and filed an FBAR for the year 2010 in which they did not provide information about the accounts, instead, in the spaces calling for account information, inserting "Fifth Amendment" in answer to each question. At their depositions, the Bernsteins testified as to their belief, based on the advice from Attorney Feld, that by submitting the FBAR in this manner, they had complied with the disclosure requirements for 2010.

The advice given by Attorney Feld appears to have been sound as there is no suggestion in the record that the Bernsteins are subjects or targets of a criminal investigation. However, in May 2017, the IRS assessed a penalty in the amount of $262,288.50 each for the 2010 tax year. 

The Government brought this collection suit  for the FBAR willful penalties.

Mr. Feld, the attorney advising the Bernsteins to file Fifth Amendment FBARs, is a prominent tax lawyer practicing in the criminal tax arena and is  a co-author of Ian Comisky,  Lawrence Feld,  Steven Harris, Tax Fraud and Evasion (Thomson Reuters), here.

The Court’s reasoning in granting summary judgment is (pardon the long excerpts but the flavor the Court puts in its word is important):

1. The Court rejected the Cheek defense where, for criminal purposes, “[I]f Cheek asserted that he truly believed that the Internal Revenue Code did not purport to treat wages as income, and the jury believed him, the Government would not have carried its burden to prove willfulness, however unreasonable a court might deem such a belief.”  The Bernsteins argued, if they truly believed that Feld’s advice to file a Fifth Amendment FBAR met their obligations to file, then they should not be subject to the willful penalty.  The Court distinguished Cheek as  criminal case and that, for the FBAR penalty, the determination of willfulness is objective rather than subjective and can be based on careless disregard regardless of actual intent.  The Court relied principally on Bedrosian v. United States, 912 F.3d 144 (3d Cir. 2018) regarding the FBAR willful penalty and on Lefcourt v. United States, 125 F.3d 79 (2d Cir. 1997) regarding the currency transaction reporting penalty in § 6060I.  The following from its analysis is illustrative (emphasis supplied):

Taking it a step even further, we are confronting in the Bernsteins' case the use of off-shore bank accounts in tax havens — not exactly something undertaken by the unsophisticated taxpayer. Taxpayers like the Bernsteins have access to, and in this case they actually used, professional investment and tax advisers to tell them not only the requirements of the law but to help them make decisions on how to comply (or not) with it. Unlike most taxpayers, the Bernsteins were not seeking tax advice for the sole purpose of complying with their annual tax obligations. Rather, their situation was driven by their long history of deception that exposed them to serious criminal liability. There was no "right answer" any tax lawyer could have provided them — at least for tax reporting purposes — absent making a full disclosure.

The Bernsteins' attempts to distinguish Bedrosian and Lefcourt are unpersuasive. As to the former, they emphasize the Third Circuit's focus on recklessness — the taxpayer's failure to review his own tax return, which would have disclosed the non-reporting of his large foreign account — as the equivalent of willfulness. Here, the Bernsteins contend, there was nothing reckless about their reporting in 2010 - they retained a pre-eminent tax attorney and followed his instructions on the best way to proceed to a T.

The Bernsteins' attempt to distinguish Bedrosian makes it worse for them. It is true that the Third Circuit focused on recklessness, but recklessness is a subset of, or an alternative to, willfulness. See Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 57, 127 S. Ct. 2201, 167 L. Ed. 2d 1045 (2007) ("where willfulness is a statutory condition of civil liability, we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well."). The civil law uses it for the same purpose that the criminal law sometimes uses "willful blindness," that is, to prevent an actor from denying the patently obvious. See Viacom Int'l, Inc. v. YouTube, Inc., 676 F.3d 19, 35 (2d Cir. 2012). This means that while a finding of recklessness will usually equate with a finding of willfulness, the converse is not always true. Here, the Bernsteins' very deliberate decision not to disclose the account in 2010 despite having full information and advice of the potential criminal and civil consequences of disclosure versus non-disclosure was not in the least bit reckless. But it was the epitome of willfulness.

As to Lefcourt, the Bernsteins argue that the case involved attorney-client privilege rather the privilege against self-incrimination, and that the former has much more weight in this context. It suffices to note that the Lefcourt firm invoked both their client's Fifth and Sixth Amendment privileges, the attorney-client privilege, and even the ethical rules applicable to attorneys, i.e., the firm took the position that its principal's law license could be at stake. Although the Second Circuit did not expressly rule on any distinction between the attorney-client privilege and these other privileges, it affirmed the grant of summary judgment in favor of the IRS over their assertion.

Once it is determined that the definition of willfulness to be applied in a civil tax penalty case is that described in Bedrosian and Lefcourt, its application here is self-evident. The Bernsteins had a clear choice: disclose the required information and risk a criminal prosecution for earlier years, or abstain from disclosing with a good-faith assertion of their privilege and hope that would eliminate criminal liability and hopefully, perhaps as a matter of negotiation, limit civil liability. They made a good choice; they appear to have avoided criminal liability despite what is almost certainly criminal conduct in prior years. But it was most definitely a voluntary, deliberate, and willful choice.

Moreover, the willfulness inquiry is not limited to their conduct with regard to the 2010 tax year, even though the liability may be. The Bernsteins do not and cannot contend that the historical evidence of their dealings with these accounts is irrelevant or immaterial to the determination of willfulness in 2010 (indeed, the history is in their own Local Rule 56.1 statement). The undisputed facts show deliberate decisions over the course of nearly a decade to park funds overseas at UBS to avoid disclosing them; not telling their accountant about these bank accounts to avoid having to disclose them; falsely answering the question every year for seven years in Schedule B of whether they had off-shore accounts; moving their accounts to a private bank days two days after learning of the UBS-DPA; choosing not to participate in the voluntary disclosure program but instead taking their chances of civil and criminal liability; and then, finally, in 2010, making a limited disclosure that still did not satisfy the requirements of the Bank Secrecy Act but hopefully minimized the impact of their nine year plan of concealment.

That last act in 2010 does not erase the willfulness of their conduct. They didn't have to make an incomplete disclosure. They could have made a full disclosure and still have the ability to negotiate civilly and, if necessary, criminally. But they didn't want to enter those discussions burdened by an express admission of their prior wrongdoing. That was their choice, and no reasonable jury could conclude that it was anything other than willful.

2, The Court then continues with a discussion of a possible adverse inference from the Fifth Amendment if the case went to trial, but did not resolve the issue by concluding:

But I see no reason to have to determine whether or what kind of consequences should flow from the particular statements in the Bernsteins' 2010 FBAR. As the preceding discussion shows, in concluding that no reasonable jury could find anything other than that the Bernsteins' willfully failed to comply with the statute, I did not draw an adverse inference against them or indeed rely on their assertion of privilege in any way. The statute and regulations say that the Bernsteins must provide certain information to the Government every year. They chose not to provide it and now must face the music from their non-compliant filing. n4 The reason they chose not to provide it is immaterial to the analysis. See Lefcourt, 125 F.3d at 83.
   n4"A party who asserts the privilege against self-incrimination must bear the consequences of lack of evidence and the claim of privilege will not prevent an adverse finding or even summary judgment if the litigant does not present sufficient evidence to satisfy the usual evidentiary burdens in the litigation." 4003-4005 5th Ave., 55 F.3d at 83 (internal quotation marks and citation omitted). In our case, the only reason the Bernsteins could not fully comply with their disclosure requirements was because they did not want to reveal prior unlawful activity. This does not excuse their non-disclosure. See United States v. Stirling, 571 F.2d 708, 728 (2d Cir. 1978) ("Appellants chose to engage in lawful activity in an unlawful manner. That unlawfulness cannot now be used to excuse them from regulatory disclosure requirements, even though such disclosures could lead to criminal prosecution under other statutory schemes.").

It is often useful on summary judgment motions to envision what would happen if the motion was denied and the case went to trial. Here, the jury would receive evidence of all of the Bernsteins' dubious conduct between 2002 and 2009 described above. See Fed. R. Evid. 401, 404(b). It would then be apprised of their 2010 FBAR and the invocation of their privilege. If I went the Bernsteins' preferred direction (instead of instructing the jury that it could draw an adverse inference against the Bernsteins by reason of their invocation of the privilege, which I might or might not do), I would then instruct the jury, in substance, that "you may not consider the Bernsteins' invocation of their Fifth Amendment privilege in determining whether they acted willfully. That is not a bad act. They had a right to assert their privilege. You must only determine whether they willfully failed to disclose information that is required by law." Based on the definition of "willfulness" set forth above, I only see one answer to that question.

This is not semantics. It is the difference between using the privilege as a shield against criminal liability as opposed to a sword to cut off civil liability, in effect, a tax-planning device. It would be all too easy for tax cheats, once caught or on the verge of getting caught, to invoke their Fifth Amendment and avoid civil tax penalties. That result would be unacceptable and there is no precedent for it.

The privilege against self-incrimination is important, but it is not impenetrable. It admits to waiver and exceptions even in the criminal context, just like common law privileges. When moved into the civil context, its importance often diminishes, and as shown above, there is no blanket prohibition against giving it adverse effects. But one thing it is not in the civil context is the equivalent of an outright acknowledgement of the facts. It is also not a substitute for compliance with law.

JAT Comments:

1. I infer that the reason the IRS assessed the willful FBAR penalty for only 2010 is that the statute of limitations may have expired on the earlier years.  The audit started in 2011 for the tax year 2007.  And, I infer that the audit started prior to the 2010 FBAR filing date, June 30, 2011.  At that time, the FBAR statute of limitations for the years 2004-2009 were open, although given the time for audits some of the earlier years usually drop off but for all of the years prior to 2010 to drop off seems odd.  Remember that under the IRS practice, it first calculates the high amount in the accounts for the willful years that are still open, calculates an aggregate penalty of 50% of that high amount, and allocates that aggregate penalty among the open years.  In any event, if the 2010 year were the high amount and the account on June 30, 2010 had at least the high amount, the 2010 year could absorb the penalty under the IRS calculations.

2. It was also not clear to me if the IRS applied an aggregate 50% penalty and split that amount between the Bernsteins.  In theory, the IRS could assess 50% against each which would be 100%, a pretty stiff penalty.  However, my experience is that, so long as the IRS gets 50%, it is happy.  And there is something in the opinion that indicates that the penalty was 50% in the aggregate.

3.    Referring to the bold face, it appears that Mr. Feld did a good job.  When the Bernsteins brought the matter to him, basically what he could do was damage control.  They no longer qualified for OVDP which would have both eliminated the criminal risk and the civil penalty amount.  The main focus for Mr. Feld was to mitigate, if possible, the criminal risk.  While it is not clear why the Government did not pursue criminal prosecution, the Court at least felt that the Fifth Amendment FBAR might have avoided the criminal risk.

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