McBride #1 - Court Holds Government Must Prove FBAR Willful Penalty by a Preponderance (11/11/12)

Another court has applied a preponderance of the evidence burden in holding that the Government had established the taxpayer's willfulness for asserting the willful FBAR penalty.  McBride v. United States, 908 F. Supp. 2d 1186 (D. UT 2012), here

Here are the documents, including the Court's Findings of Fact and Conclusions of Law and the related Documents:

1. 20120514McBride-P'sTrialBrief.pdf, here.
2. 20120514McBride-D's Trial Brief.pdf, here.
3. 20120521McBride-Transcript.pdf, here.
4. 20120522McBride-Transcript.pdf, here.
5. 20120724McBride-USPropFoF&Conclusions.pdf, here.
6. 20120822McBride-D Obj re Govt Prop FoF.pdf, here.
7. 20120822McBride-DPropFoF&Conclusions.pdf, here.
8. 20121108McBride-Opinion.pdf, here.

Brief Summary of the Case

Readers will recall that the willful FBAR penalty is the greater of $100,000 or 50% of the amount in the account.  31 USC 5321(a)(5), here.  The penalty in question was the pre-10/23/04 version which provided for the same willful conduct a penalty of $25,000 or the value of the unreported account, not to exceed $100,000.

The McBride facts as found by the Court are ugly for McBride.  I won't recount them in detail, but suffice it to say they involved (i) clear intent to underreport significant amounts of income tax by diverting U.S. income to the offshore accounts, (ii) clear intent to establish the accounts out of the expected line of sight of the IRS with the purpose of furthering the evasion, (iii) information provided to him some of which he read that advised that there were reporting obligations, (iv) answers to the 1040 Schedule B questions of no when the defendant certainly knew he had interests in foreign accounts, (v) lying to the IRS about the offshore actyivity, and (vi) other really bad facts.
Here is a more detailed statement, still summary, the extensive findings:

1. McBride Engaged a financial management firm, Merrill Scott and Associates, which "employed strategies that would allow its clients to avoid or defer the recognition of income for tax purposes  and to shield their assets from the reach of creditors by utilizing." (Par. 10.)
2. "In reality, Merrill Scott's strategies were designed to allow its clients to avoid reporting income and their ownership of assets by having the clients' assets held by nominees holding the legal title of shell corporations and foreign bank accounts." (Par. 11.)
3. "After McBride was given an explanation of Merrill Scott's program, he responded, 'This is tax evasion.'" (Par. 17.)  But he trucked on when the Merrill Scott's representatives said it was legal. (Pars. 18-20.)  [JAT Note: Promoters such as Merrill Scott will say anything to close the deal; there is no indication as to whether McBride believed the representations and plenty of indications that he did not.]
4. McBride chose a plan that "that would move profits [his business] offshore." of his business offshore. (Par. 20.)
5. Merrill Scott provided McBride various pamphlets, including one on offshore strategies that reminded the reader:  "'US citizens are subject to specific US reporting requirements for interests in foreign corporations, trusts and bank accounts. US citizens and others filing Internal Revenue Service returns are not immune from requisite declaration of ownership interests in foreign entities.'"  (Par. 22.)
6. Merrill Scott provided McBride a legal opinion from a related entity that, by the time in question, McBride knew was a related entity.  (Pars. 23-24.)
7. McBride signed a document stating that he had read and understood the marketing materials from Merrill Scott.  (Par. 26.)  [JAT Note:  This is probably a typical promoters CYA document, perhaps required by regulatory authority; who actually reads the complete packages is another question; still, McBride read some of the damning portions, per the findings below.]
8. "McBride testified at trial that he did not read the legal opinion." (Par. 27.)  [JAT Note: The finding is that he testified to that effect, not that the court believed he didn't read it.]
9. McBride stated under penalty of perjury during the case that he had read a document titled Questions and Answers which stated:  "Why not just hide all my assets in a Swiss Account?": "As a U.S. taxpayer, the law requires you to report your financial interest in, or signature authority over, any foreign bank account, securities account, or other financial account. . . . Intentional failure to comply with the foreign account reporting rule is a crime and the IRS has means to discover such unreported assets."  (Pars. 28-29.)
10. McBride never sought or obtained an outside legal opinion or the advice of his accountant and was aware that another accountant expressed concerns.  (Pars. 30-33.)
11. McBride implemented the plan and, in payment sent several checks, one of which had in the memo field: "Bank account offshore." (par. 37-38)
12. McBride received from a business associate an article that "described that holding bank accounts in foreign countries was associated with tax evasion and fraudulent activity."  (Pars. 39-40.)
13. Merrill Scott made available for McBride's strategy three of its offshore shelf, probably shell, companies, each nominally controlled by persons associated with Merrill Scott.  (Par. 45-46.)  McBride understood that these were nominee entities over which he (McBride) had control and in which he had "beneficial ownership."  (Pars. 64-75.)
14. McBride entered agreements with its offshore business suppliers to overpay for product and pass on the overpayment amounts to an offshore entity, thus understating its U.S. profits and underpaying U.S. tax.  (Pars. 48-50.)  The offshore entity deposited the amount in an offshore bank account with the Royal Bank of Scotland in the Bahamas.  (Par. 51-52.)  Other offshore entities and bank accounts were involved.  (Pars. 53-58.)  The accounts held substantial amounts in excess of $100,000 for the years.  (Pars. 57-60.)    "McBride believed and understood Drehpunkt and Lombard to be 'bank accounts.'" (Par. 62.)
15. Ultimately over $2.7 million in overpayments -- referred to as "excess funds" -- were sent to the banks.  (Par. 76.)  About $1.8 million of that total was transferred to Merrill Scott to fund a nominal line of credit to the U.S. company, with the U.S. company treated draws on the line as "loans."  (Par. 77.)  The U.S. company then used much of these "borrowed" funds to "distribute to the owners, including McBride, as nominal "partner draws."  (Par. 84.)
16. McBride also directed the transfer of substantial amounts from the diverted funds to or for his benefit. (Pars. 86-99.)
17. McBride directed employees to appear as nominal beneficial ownership for other offshore accounts and directed the investments made through those accounts.  (Pars. 100-115.)  These accounts held substantial amounts in excess of $100,000.  (Pars. 112-114).
18. McBride became aware no later than early 2001 that Merrill Scott was not legitimate and began pulling his funds out via the line of credit.  (Pars. 116-120.)
19. By the time the 2000 FBAR was due, McBride was aware that he held foreign accounts.  (Par. 121.)
20. McBride never discussed his involvement with his accountant / return preparer and thus never discussed the foreign accounts with him; as a result, the foreign account question on Form 1040 Schedule B was answered "no" and FBARs were not prepared.  (Pars. 122-141.)
21. As noted, McBride never obtained legal or tax professional advice.  (Pars. 142-150)
22. McBride lied to IRS agents in the investigation in order to hide his ownership and financial interest in foreign accounts.  (Par. 153-154.)

Based on the detailed findings of fact, the Court first determined that the Government need prove willfulness only by a preponderance of the evidence rather than by clear and convincing evidence.  Since the Court's recitation of facts was so damning, it is not clear that the Court would have reached a different conclusion even if the burden were clear and convincing.  Nevertheless, here is what the Court said about its holding on the preponderance of the evidence burden:

The statute at issue, 31 U.S.C. § 5321(b)(2), permits the Secretary of Treasury to "commence a civil action to recover a civil penalty assessed under subsection (a) . . . ." The statute does not specify the legal standard to be applied by courts in such an action. The one district court that has directly addressed the question of the burden of proof in a civil FBAR penalty case, United States v. Williams, concluded that the United States' burden of proof was "the preponderance of the evidence" on all questions before the court, including the question of whether the taxpayer's failure to report in that case was "willful." United States v. Williams, No. 1:09-cv-437, 2010 WL 3473311 (E.D. Va. Sep. 1, 2010), rev'd on other grounds, United States v. Williams, No. 10-2230, 2012 WL 2948567 (4th Cir. Jul. 20, 2012). "In enforcement actions brought by the Government in other contexts, . . . the Government is required to prove its case by a preponderance of the evidence on the record established at trial." Id. at *1 (internal citations omitted)). In addition, the district court in Williams held that "[t]he Court's review is 'de novo, and the general rule is that it is a decision based on the merits of the case and not on any record developed at the administrative level.'" Id. (quoting Eren v. Comm'r, 180 F.3d 594 (4th Cir. 1999)).

The preponderance of the evidence standard applied by the district court in Williams is the correct standard. As with Government penalty enforcement and collection cases generally, absent a statute that prescribes the burden of proof, imposition of a higher burden of proof is warranted only where "particularly important individual interests or rights," are at stake. See Herman & MacLean v. Huddleston, 459 U.S. 375, 389 (1983); Grogan v. Garner, 498 U.S. 279, 286 (1991). Because the FBAR penalties at issue in this case only involve money, it does not involve "particularly important individual interests or rights" as that phrase is used in Huddleston and Grogan. In Huddleston, the court of appeals had reversed the district court, stating that the district court's application of the preponderance-of-the-evidence standard in connection with a fraudulent misrepresentation case was incorrect and that a "clear and convincing evidence" standard should have applied in connection with allegations of fraud. 459 U.S. at 379. The Supreme Court reversed, stating that the applicable burden was merely a preponderance of the evidence in cases, even where allegations of fraud were involved, unless "particularly important individual interests or rights are at stake." Id. at 390. 

By contrast, imposition of even severe civil sanctions that do not implicate such interests has been permitted after proof by a preponderance of the evidence. See, e.g., United States v. Regan, 232 U.S. 37, 48-49 (1914) (proof by a preponderance of the evidence suffices in civil suits involving proof of acts that expose a party to a criminal prosecution). 

Id. at 389-90. United States v. Regan held that, at least where the Government is suing to recover a monetary penalty (as is the case here), its suit is a "civil action" to be "conducted and determined according to the same rules and with the same incidents as are other civil actions." 232 U.S. at 46-47. The logic of Huddleston has been applied in the civil tax-penalty area. See, e.g., Mattingly v. United States, 924 F.2d 785, 787 (8th Cir. 1991) ("The standard of proof in these [civil tax violation] cases is usually a preponderance of the evidence, and by statute the burden of proof is often placed on the government."). 

Moreover, the Supreme Court has been unwilling to require that litigants meet a higher burden of proof than the preponderance of the evidence standard where the statute does not specify a higher burden of proof. See Grogan, 498 U.S. at 286 ("The language of [the statute] does not prescribe the standard of proof . . . . This silence is inconsistent with the view that Congress intended to require a special, heightened standard of proof."). With respect to 31 U.S.C. §§ 5314 and 5321, Congress did not specify any special, heightened standard of proof. As a result, there is no reason to deviate from the default burden of proof applicable in civil cases. 

Therefore, the United States bears the burden of proving that McBride willfully failed to file FBARs with respect to the accounts at issue by the preponderance of the evidence.

Summary of Comment on the Case

Practitioners' comments on the case were reported in a Tax Notes Today article.  Jeremiah Coder, District Court Allows Second FBAR Penalty Collection to Proceed, 2012 TNT 219-3 (11/10/12).  Here are some excepts:

Kevin M. Downing of Miller & Chevalier [said]. "As long as the accountant is asking the question, once you don't give those records, you're done. It's a great case," said Downing, a former Department of Justice trial attorney. The civil penalty, which is up to 50 percent of the account balance for every year the offense was committed, is "staggering," he said. 

Brian C. McManus of Latham & Watkins LLP said that while courts have so far agreed that it is permissible to impute knowledge simply by checking the box "no" on Schedule B, those cases thus far have involved other significant facts apart from the Schedule B issue, such as lying to revenue agents or obvious concealment of the account. McBride involved similar bad facts. 

"We'll have to wait and see whether a case comes forward where the person simply didn't know, checked the 'no' box, and there were no other significant facts to demonstrate they were willfully concealing [the account]," McManus said. 

Speaking on his own behalf, John McDougal, special trial attorney and division counsel, IRS Small Business and Self-Employed Division, said, "I don't think that just checking the box 'no' on the tax return in and of itself is enough to justify a willful penalty," adding that the context in which the box was checked must be considered. 

Practitioners must look at the language of the court cases in light of the facts being considered, McDougal said. "I can envision a lot of cases where the accountant was poorly advising the taxpayer and there is a reason the box is checked no," he said. However, the McBride and Williams courts articulate that in the absence of those reasons, they will infer knowledge from a signature on the return, he said.

Besides the quotes here are some other points reported in the TNT article:

1. McDougal reported that the IRS does not typically assert a penalty for failure to file the FBAR and for failure to keep the required records.
2. McDougal reported that the IRS has good basis for avoiding the Fifth Amendment claim based on Fisher's foregone conclusion rather than the required records doctrine.
3. Caroline D. Caraolo reported that some taxpayers opting out get favroable results based on reasonable cause.

JAT Analysis of the case

1. Given the facts as found by the Court, I am not sure that the burden of proof -- more precisely, the burden of persuasion, but I use burden of proof here -- holding is a holding in the case or is dictum.  The facts found by the court are so damning,  that I find it hard to believe that the Court would have reached a different conclusion if it had applied the "clear and convincing" standard.  This analysis is similar to preponderance of the evidence cases where the burden of persuasion affects a fact finding only when the trier is in a state of equipoise.  For this reason, the Tax Court and other courts may discuss disputed allocation of the burden of proof when applying the preponderance of the evidence standard but then conclude that the burden of proof is irrelevant because it finds the fact by a preponderance of the evidence.  See e.g., Estate of Jorgensen v. Commissioner, 2011 U.S. App. LEXIS 9203 (9th Cir. 2011) (“When, as here, the tax court decides the case based on the preponderance of the evidence and without regard to presumptions of correctness, § 7491's burden-shifting is simply not relevant”).   So, too, if the Court  in McBride had said that, regardless of which standard applied, it would still find that the Government had established McBride's willfulness, then its holding that the preponderance standard applied would be dictum.  I think that may be where the Court was.  I do note, however, that there is at least the possibility that the Court would have held for the taxpayer under the "clear and convincing" standard and thus the holding as to preponderance of the evidence may be a holding of the court rather than dictum.  It appears that, immediately after the hearing, the Court made a preliminary finding that the Government had not established willfulness, but did not state which standard it applied in making that preliminary finding.  See Docket entry 97 which says as follows:

Record reviewed as to financial interest of the defendant. Argument heard. Court made findings on the record and found that Mr. McBride had financial interests and control of accounts.
Further review of the record as to willful blindness. Argument heard. Court made findings on the record and preliminarily finds against the government.
Government to prepare findings of facts and conclusions of law that are relevant to control of the authority and willfulness. Government to include a discussion of cases and facts to which granted willfulness. Government to submit within 60 days. Once submitted, defense will have 30 days to respond.

2. Two district courts have now applied the preponderance of the evidence standard.  In the prior case (Williams), the parties and the Court of Appeals did not address the proper standard.  So, at this time, it is only the holding of two district courts.  And, for the reasons noted above, I am not sure that, since the facts against the defendants in the cases were so bad, the holdings are not dictum.

3. I am not sure that the two district court opinions properly resolve the issue of the proper burden of proof.  In my further discussion, I focus on the McBride resolution since it is the latest to synthesize the analysis in support of the preponderance standard.  Also, I can just summarize my position.

4. The principal authority authority is Herman & Maclean v. Huddleston, 459 U.S. 375 (1983).  The Supreme Court held that the Securities 10(b)  fraud action required proof only by a preponderance.  The Supreme Court noted that there was a traditional common law requirement that fraud be proved by clear and convincing evidence but found that the "antifraud provisions of the securities laws are not coextensive with common law doctrines of fraud."  (p. 388.)  The Court noted that, where Congress has not spoken, the courts assign the burden based on balancing of interests.   The Court said (footnote omitted):

[W]e have required proof by clear and convincing evidence where particularly important individual interests or rights are at stake. See, e. g., Santosky v. Kramer, 455 U.S. 745 (1982) (proceeding to terminate parental rights); Addington v. Texas, supra (involuntary commitment proceeding); Woodby v. INS, 385 U.S. 276, 285-286 (1966) (deportation). By contrast, imposition of even severe civil sanctions that do not implicate such interests has been permitted after proof by a preponderance of the evidence. See, e. g., United States v. Regan, 232 U.S. 37, 48-49 (1914) (proof by a preponderance of the evidence suffices in civil suits involving proof of acts that expose a party to a criminal prosecution).
Thus, in interpreting a statutory provision in Steadman v. SEC, supra, we upheld use of the preponderance standard in SEC administrative proceedings concerning alleged violations of the antifraud provisions. The sanctions imposed in the proceedings included an order permanently barring an individual from practicing his profession. And in SEC v. C. M. Joiner Leasing Corp., 320 U.S., at 355, we held that a preponderance of the evidence suffices to establish fraud under § 17(a) of the 1933 Act.
A preponderance-of-the-evidence standard allows both parties to "share the risk of error in roughly equal fashion." Addington v. Texas, supra, at 423. Any other standard expresses a preference for one side's interests. The balance of interests in this case warrants use of the preponderance standard. On the one hand, the defendants face the risk of opprobrium that may result from a finding of fraudulent conduct, but this risk is identical to that in an action under § 17(a), which is governed by the preponderance-of-the-evidence standard. The interests of defendants in a securities case do not differ qualitatively from the interests of defendants sued for violations of other federal statutes such as the antitrust or civil rights laws, for which proof by a preponderance of the evidence suffices. On the other hand, the interests of plaintiffs in such suits are significant. Defrauded investors are among the very individuals Congress sought to protect in the securities laws. If they prove that it is more likely than not that they were defrauded, they should recover.

I think the FBAR situation is materially different from the securities context in Huddleston and the cases on which Huddleston relies.  Rather, I would look to a more directly relevant context than the ones used by the McBride Court.

5. Willfulness, the standard involved here, is a common standard used both in the FBAR / BSA context and in the tax law in both criminal and civil contexts to mean the intentional violation of a known legal duty.  See Ratzlaf v. United States, 510 U.S. 135, 136-37 (1994).   IRM 4.26.16.4.5.2 (5-05-2008), titled FBAR Willfulness Penalty - Application, provides:  "The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty."  This is the so-called Cheek test for criminal prosecution.  The civil tax analog to the criminal test is "fraud," for which a 75% civil penalty is provided.  The following is from the most recent draft of my Tax Procedure book (footnotes omitted):

The statute does not define fraud, but it may be viewed as the civil counterpart of criminal tax evasion in § 7201. The courts dealing with the civil fraud penalty do not usually state the standard as the crisp elements in § 7201 – affirmative act, tax due and owning and willfulness (the standard Cheek formulation being “intentional violation of a known legal duty”).    Those courts do, however use words that, in my view, say the same thing.  For examples, in civil fraud cases, courts had stated: (i)  “Fraud is the intentional commission of an act or acts for the specific purpose of evading tax believed to be due and owing;” and (ii) fraud requires that “the taxpayer have intended to evade taxes known to be due and owing by conduct intended to conceal, mislead or otherwise prevent the collection of taxes and that is an underpayment.”  In making the determination, as with criminal cases, courts will often look to certain common patterns indicating fraud – referred to as badges of fraud, such as unreported income, failure to keep adequate books, dealing in cash, etc.  The key differences between the two is that § 6663 is a civil penalty and different burdens of proof apply as I note later. 

Section 6663, although having the same substantive test as criminal tax evasion, is remedial rather than punitive.  Helvering v. Mitchell, 303 U.S. 391, 401 (1938); cf.  Reiserer v. United States, 478 F.3d 1160 (9th Cir. 2007).  The IRS nevertheless must prove fraud.  Section 7454(a), here, imposes that burden explicitly in Tax Court cases, but Section 7454(a) applies only to Tax Court cases.  There is no statute assigning the burden in other forums, such as the district court or the Court of Federal Claims in refund suits.  But the law is settled that the IRS bears the burden in those fora.  Paddock v. United States, 280 F.2d 563 (2d Cir. 1960);  see also Leo P. Martinez, Tax Collection and Populist Rhetoric: Shifting the Burden of Proof in Tax Cases, 39 Hastings L.J. 239, 263-264 (1988) (citing Paddock and Carter v. Campbell, 264 F.2d 930, 937-38 (5th Cir. 1959); Trainer v. United States, 145 F. Supp. 786, 787 (E.D. Pa. 1956); see Lee v. United States, 466 F.2d 11, 14 (5th Cir. 1972)).  And, not only does the IRS bear the burden, it bears the burden by clear and convincing evidence even without a statutory prescription that it do so.  See Tax Court Rule 142(b), here; but adopted in other judicial for a (e.g., Gaughen v. United States, 2012 U.S. Dist. LEXIS 11662, 5-6 (M.D. Pa. 2012)).  So the more direct analogous authority is, I submit, this one.

Readers must remember that this is only my opinion.  It is not even a minority opinion.

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By the way, I highly recommend the Paddock decision, here, written by Judge Friendly, one of the leading jurists of all time.

[Since posting the recommendation on Judge Friendly's Paddock decision, I learned of a special Program at Harvard Law School on Judge Friendly's legacy.  The program is called "Henry Friendly, Greatest Judge of His Era: A Discussion of His Legacy."  The program information may be viewed here.]

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Finally, I do note that the Court's discussion of the burden of proof issue was lifted verbatim from the Government's Proposed Findings of Fact and Conclusions of Law, subject to only a couple of minor introductory deletions ("However" and "Moreover").  The same language was included in the Government's opening brief filed earlier, except that it included the following two paragraphs that were omitted from the Government's Proposed Findings of Fact and Conclusions of Law (the latter of which were essentially cut and pasted into the Court's opinion).  The first paragraph is redundant which is perhaps why the Government omitted it from the Proposed Findings of Fact and Conclusions of Law; the second paragraph is more certain and it is not clear why the Government omitted it from the Findings of Fact and Conclusions of Law (which means that the Court omitted it also):

The logic of Huddleston and Grogan, and the logic applied by the Williams court, should be applied in this FBAR penalty context. The preponderance of the evidence standard should be applied here because there is no statutory language to the contrary, and this suit is merely for the recovery of money and thus does not implicate any of the individual rights referred to by the Supreme Court in Huddleston and Grogan. Therefore, the United States bears the burden of proving that McBride willfully failed to file FBARs with respect to the accounts at issue by the preponderance of the evidence adduced at trial. 

Though McBride may attempt to assert that the applicable burden of proof with respect to the issue of willfulness is the “clear and  convincing standard,” that assertion is wrong and unsupported by any law. Moreover, McBride may not cite to Internal Revenue Service Legal Memorandum No. 200603026 (Sept. 1, 2005) as his counsel indicated he might at the Final Pretrial Conference before this Court on May 10, 2012. 26 U.S.C. § 6110 specifically prohibits Chief Counsel Advice memoranda like the one mentioned by counsel for McBride from being either used or cited as precedent. 3 Therefore, that memorandum has no controlling effect, and moreover should not have any persuasive value because the memorandum cites no legal authority that is inconsistent with the above analysis. Therefore, that IRS Legal Memorandum should  [*9]  have no effect on this Court’s determination of the applicable burden of proof on any issue at trial. 

   n3 26 U.S.C. § 6110(i) states, in relevant part, “Unless the Secretary otherwise establishes by regulations, a written determination may not be used or cited as precedent.” 26 U.S.C. § 6110(i)(3). 

For my earlier blogs on the FBAR willfulness penalty burden of proof issue, see:

1. Burden of Proof for Willfulness in FBAR Violations (Federal Tax Crimes Blog 9/6/11), here.
2. Burden on Government to Prove Willfulness in FBAR Matters (Federal Tax Crimes Blog 6/8/12), here.