Saturday, December 10, 2016

District Court Imposes FBAR Willful Penalty, Holding Reckless Conduct is Willful and Applying Preponderance Standard (12/10/16)

In United States v. Bohanec, 2016 U.S. Dist. LEXIS 170149 (CD CA 2016), here, the Government sued the Bohanecs for judgment for for a single year FBAR penalty.  The Court's Findings of Fact and Conclusions of Law sustain the Government's position.  I include at the bottom of this entry links to other key documents that I downloaded from Pacer.

The facts may be highly summarized as follows:

The Bohanecs were camera dealers in California for many years.  Their camera shop had an exclusive Leica dealership.  Through a relationship with the president of a Leica subsidiary in Canada, Kluck, the Bohanecs earned commissions on sales that were deposited into a UBS account established for them by Kluck.  They amassed substantial amounts in the UBS account.  In 1997, the account had $1,049,900 and, by 12/31/07, the account had $687,600.  The amount in the account on 6/30/08, the filing date for the 2007 FBAR was $643,662.

In addition to the UBS account, the husband had an Austrian account established before he immigrated to the U.S., into which certain deposits were made.  And, they also had an account in Mexico which received transfers from the UBS account to build and maintain a house in Mexico.

After 1998, the Bohanecs stopped filing U.S. income tax returns and did not file until they attempted to join OVDP ini 2010.  The Bohanecs never filed FBARs until they attempted to join OVDP in 2010.

In 2010, the Bohanecs submitted an application to participate in the OVDP.  In the submissions, the Bohanecs only disclosed the UBS account and, further, represented that "original balance and all funds deposited into the [Swiss UBS] account were after-tax earnings from our used camera business."

After preliminary acceptance (acceptance implying that they were not part of UBS's initial disclosures), the Bohanecs submitted six years of delinquent FBARs and delinquent income tax returns (six years were 2003-2008).  The FBARs omitted the Austrian and Mexican accounts.  The delinquent income tax returns omitted income earned by the Bohanecs from camera sale activity on EBay.

The Bohanecs were rejected from OVDP.  The opinion does not state why they were rejected.  Perhaps they were rejected because the IRS became aware of the omissions from the FBAR and the amended income tax returns.  Perhaps by then the IRS had obtained the UBS account documents (either submitted by the Bohanecs or obtained from UBS), showing transfers to the Austrian and/or Mexican accounts.  (If those UBS account documents were submitted by the Bohanecs in the OVDP process, the omission of the other accounts from the FBARs filed in the OVDP process is surprising.)

In 2013, the IRS asserted by notice of deficiency additional tax, failure to file penalties (the regular FTF of 25 percent), and the civil fraud penalty under § 6663.  (It is not clear why the IRS did not assert the fraudulent failure to file penalty in § 6651(f).)  The Bohanecs did not contest the notice and the deficiencies were duly assessed with interest.  Most of the amounts assessed were still outstanding in September 2016 (aggregating $492,163.61).

In this suit, the Government asserts the 50 percent FBAR willful penalty (50 percent of the account balances for reportable accounts on 6/30/08).  The Court in its conclusion states only that the FBAR willful penalty is "the greater of $100,000 or fifty percent of the balance in the foreign accounts on June 30, 2008."  It does not state the amount to which the fifty percent penalty applies.  That may be in the stipulations, though.  The amount of the penalty is not particularly important for present purposes.

The key conclusions for present purposes are relatively short, so I include them all:
77. The only dispute in this matter is whether the Bohanecs' failure to timely file an FBAR disclosing their financial interest in their foreign accounts for 2007 was willful. 
78. Section 5321 (a)(5) of Title 31 does not define willfulness. 31 U.S.C. § 5321(a)(5). 
79. The Supreme Court has explained that "willfully is a word of many meanings whose construction is often dependent on the context in which it appears." Safeco Ins. Co. of America v. Burr, 551 U.S. 47, 57 (2007) (internal quotations and citation omitted). 
80. Although Defendants assert that "willfulness" encompasses only intentional violations of known legal duties, and not reckless disregard of statutory duties, no court has adopted that principle in a civil tax matter. The only cases Defendants cite to support their argument that "willful" means that a defendant must have knowledge and specific intent are criminal cases. See Ratzlaf v. United States, 510 U.S. 135 (1994) (structuring); United States v. Eisenstein, 731 F.2d 1540 (11th Cir. 1984) (felonious failure to file currency transaction reports). 
81. Where willfulness is an element of civil liability, the Supreme Court generally understands the term as covering "not only knowing violations of a standard, but reckless ones as well." Safeco, 551 U.S. at 57. 
82. "Recklessness" is an objective standard that looks to whether conduct entails "an unjustifiably high risk of harm that is either known or so obvious that it should be known." Safeco, 551 U.S. at 68 (internal quotation marks and citation omitted). 
83. Several other courts, citing Safeco, have held that "willfulness" under 31 U.S.C. § 5321 includes reckless disregard of a statutory duty. See United States v Williams, 489 Fed.Appx. 655, 658 (4th Cir. 2012); United States v. Bussell, No. CV 15-02034 SJO(VBKx), 2015 WL 9957826 at *5 (C.D. Cal. Dec. 8, 2015); see also United States v. McBride, 908 F.Supp. 2d 1186, 1204, 1209 (D. Utah 2012). 
84. Defendants argue that the Chief Counsel of the Internal Revenue Service has opined, prior to Safeco, that the willfulness standard for purposes of 31 U.S.C. § 5321 is the same as the criminal standard. IRS CCA 200603026. Chief Counsel Advice, however, may not be used or cited as precedent. 26 U.S.C. § 6110(k)(3); see also Elbaz v. Commissioner of Internal Revenue, T.C. Memo. 2015-49, 2015 WL 1197533 at *3 (T.C. 2015). 
85. The Internal Revenue Manual's interpretation of "willfulness" for purposes of 31 U.S.C. § 5321, cited by Defendants, does not have the force of law, and is not relevant here. See Fargo v. Commissioner of Internal Revenue, 447 F.3d 706, 713 (9th Cir. 2006); Kimdun Inc. v. United States, No. 16-cv-01500-CAS(RAOx), 2016 WL 4408816 at * 8 (C.D. Cal. Aug. 15 2016). 
86. The Supreme Court has held that a heightened, clear and convincing burden of proof applies in civil matters "where particularly important individual [*14]  interests or rights are at stake." Herman & MacLean v. Huddleston, 459 U.S. 375, 389 (1983). Such interests include parental rights, involuntary commitment, and deportation. Id. The lower, more generally applicable preponderance of the evidence standard applies, however, where "even severe civil sanctions that do not implicate such interests" are contemplated. Id. at 390; see also Grogan v. Garner, 498 U.S. 279, 286 (1991). The monetary sanctions at issue here do not rise to the level of "particularly important individual interests or rights." Accordingly, the preponderance of the evidence standard applies. See also McBride, 908 F.Supp.2d at 1214. 
87. The government has proved by a preponderance of the evidence that Defendants were at least recklessly indifferent to a statutory duty for the following reasons:
a. Defendants were reasonably sophisticated businesspeople. For a time, Defendants' camera shop was the only exclusive Leica dealer in the world. The deals Defendants negotiated with Leica's U.S. distributor were so favorable as to motivate other Leica retailers to protest. Defendants were able to circumvent Leica's supply restrictions by entering into an international agreement with Leitz Canada. Defendants had a worldwide reputation and sold and shipped to customers around the world. Defendants knew that they had to pay taxes if they earned money, and that they had to file tax returns. Defendants always used a tax preparer to prepare the camera shop's tax returns. Defendant August Bohanec was sufficiently sophisticated to obtain two patents without assistance. Defendants also managed the construction of a home along the coast of Mexico, including the hiring of a contractor and the opening of a Mexican bank account. 
b. Defendants were at least reckless, if not willfully blind, in their conduct with respect to their Swiss UBS account and their reporting obligations regarding the account. n2 Defendants never provided UBS with their home address, and never told anyone other than their children of the existence of the UBS account, including the tax preparers Defendants hired to help them file tax returns. Defendants never asked a lawyer, accountant, or banker about requirements regarding the UBS account, and never used a bookkeeper or kept any books once the UBS account was opened.
   n2 See McBride, 908 F.Supp.2d at 1205 ("Where a taxpayer makes a conscious effort to avoid learning about reporting requirements, evidence of such willful blindness is a sufficient basis to establish willfulness.") (internal quotation marks and citation omitted). 
c. Defendants' representations that they were unaware of or did not understand their obligations, and deferred entirely to Kluck, are not credible. Part III of Schedule B of Defendants' 1998 tax return put them on notice that they needed to file an FBAR. Defendants not only deposited commissions from their Leitz Canada deals into the UBS account, but also directed customers to deposit payment into the account and made several transfers and withdrawals from the UBS account to other foreign and domestic accounts. Self-serving testimony that Defendants believed that there were no requirements regarding the account because they were intended to use the funds in the account "for retirement" is sufficiently incredible, particularly in light of Defendants' level of sophistication, to call into question the veracity of the remainder of their testimony. (RT 14:7-23.) 
d. Defendants' credibility is further undermined by their conduct with respect to their application to participate in the IRS' Voluntary Disclosure Program for Offshore Accounts. Defendants made several misrepresentations under penalty of perjury. Defendants misrepresented, for example, that all of the funds in the UBS account were after-tax proceeds from Defendants' used camera business, when in fact the account included Leitz Canada commissions that had never been reported on income tax returns. The application also failed to disclose Defendants' Austrian bank account. Furthermore, Defendants then proceeded to file false tax returns for 2003-2008 that did not include any of Defendants' income from internet sales. Defendants' FBARs for 2003-2008 did not disclose the Austrian account and the FBARs for 2006-2008 did not disclose the Mexican account.
Here are certain key filings in the case.  I include them because, given the importance of the issues that are really not yet settled, the Government should have taken its best shot and, given the quality of the attorneys representing the Defendants, the briefing is probably also a very good, if not the best, shot:
  • U.S. Complaint, here.
  • Bohanec Answer to Complaint, here.
  • U.S. Pretrial Memo, here.
  • U.S. Proposed Findings of Fact and Conclusions of Law, here.
  • U.S. Supplemental Proposed Findings of Fact and Conclusions of Law, here.
  • Bohanec Pretrial Memo, here.
  • Bohanec Proposed Findings of FAct and Conclusion of Law, here.
  • Final Pretrial Order, here.
  • U.S. Trial Brief, here.
  • Docket Entries as of 12/10/16, here.

JAT Comments:

1.  Discouraging result on the definition of willfulness to include not only willful blindness but even reckless conduct.  While it is true that willfulness can have different meanings in different contexts, I don't think the contexts are different -- the civil and criminal penalties for FBARs are part of the same Code provisions.  I just don't believe that any legislator would have defined willful differently for the civil penalty than for the criminal penalty.  The Supreme Court has said that the criminal penalty uses willful to mean intentional violation of a know legal duty.  That is the definition that, in my mind, should apply for the civil penalty as well.  I think the Court's dismissal of the CCA and IRM is too casual.  It is one thing to say that the CCA should not be cited and the IRM does not confer rights, but they do indicate the obvious relationship between the civil and criminal FBAR penalties defined the same way.  (One thing I had not considered was whether there might be some form of Skidmore deference at least for the IRM, but I won't dig into that right now.)

2.  Also a discouraging result on the burden of proof.  Again, the analog is civil fraud penalty which requires proof of fraud by clear and convincing evidence.  It is true that the clear and convincing burden is required by § 7454(a) in Tax Court cases.  But, that burden for the civil fraud penalty applies in the other courts where it is litigated in refund suits (district courts and court of federal claims).  I would think the construct is that wherever there is a punitive civil penalty attending conduct also defined as criminal, the clear and convincing standard should apply.  I just am not persuaded by the court's reasoning that the higher clear and convincing standard applies only where "important individual interests or rights are at stake" but concluding that such interests are not at stake where, in essence, the Government asserts a punitive civil penalty for conduct that is criminal.  (See par. 86.)  I suppose one good thing from the Court's holding is that, by inference, the Court did not find by clear and convincing evidence, otherwise, presumably, he would have said so as an additional basis to confirm the penalty.  (In a related sense, I had a case where, on opt out of OVDP, the IRS asserted the willful FBAR penalty but did not assert the civil fraud penalty on the income tax side; the only rationale I could perceive for that was that, then assuming that the definition of FBAR willfulness and civil fraud was the same (intent to violate a known legal duty), the IRS believed it could not prove civil fraud by clear and convincing evidence, but could prove FBAR willfulness by a preponderance, so that, if the clear and convincing standard applied for FBAR willfulness, we had a winner on that ground alone; the IRS gave up the FBAR willful penalty on appeal without explanation, but, in that case, the best I have ever had for complete innocence, the IRS did not explain why it gave upo the FBAR willful penalty.)

Addendum 9:00pm:

I wonder about the gradations of mens rea.  Specific intent to violate a known legal duty is required for the willfulness element of the FBAR crime and for most federal tax crimes.  That is often called Cheek willfulness.  Then there are two other notions thrown around at least in the FBAR willfulness civil penalty -- willful blindness (or any of its other wordings, such as conscious avoidance) and recklessness.  Willful blindness is a curious when it is used in a criminal context.  If the law requires that a defendant act knowingly or willfully, then it is sometimes said that willful blindness of a fact that, if known, would establish the crime is either proof from which the trier may infer that the defendant really knew the law and the illegality of the conduct or, alternatively, that proof of willful blindness is a substitute for the knowing the facts constituting the crime or intending to violate the law.  At least in the case of willfulness in the Cheek sense (most tax crimes and the FBAR crime), I would think that the former better fits the requirement that the defendant specifically intend to violate the law -- an intent that really has two components (i) that the law is knowable in the James sense and (ii) that the defendant knew the law with indications of steps to avoid knowing the facts that make the conduct a crime merely permitting the inference that the defendant had the required intent.  That means that those facts of willful blindness are not a substitute for the required intent.  So, when that concept is transported to the civil FBAR penalty, I would think it should serve the same function.  But, in the judge's analysis above, he seems to use recklessness as permitting a finding of willfulness.  That seems a significantly looser standard than willful blindness and approaches something like gross negligence.  Since willfulness can mean different things in different contexts, I can't disprove recklessness as a ground for FBAR civil penalty, but it just seems to me that the punishment does not fit that crime, so to speak.

Finally, I have written many blog entries with variations of the themes discussed above.  Those entries in reverse chronological order are:
  • U.S. Taxpayer Seeks Declaratory Judgment that Government Must Prove Willfulness for the FBAR Willful Penalty by Clear and Convincing Evidence (Federal Tax Crimes Blog 12/22/15), here.
  • ABA Tax Lawyer Publication Comment on FBAR Willful Penalty (Federal Tax Crimes Blog 2/16/15), here.
  • More on Recklessness as Cheek Willfulness (Including for FBAR Civil Penalty) or Willful Blindness (Federal Tax Crimes Blog 7/22/14), here.
  • Willful Blindness / Conscious Avoidance and Crimes Requiring Intent to Violate a Known Legal Duty (Federal Tax Crimes Blog 7/21/14), here.
  • 11th Circuit Holds Clear and Convincing Evidence Required for Section 6701 Penalty; Can Reasoning be Extended to FBAR Willful Penalty? (Federal Tax Crimes Blog 6/14/14), here.
  • Hale Sheppard Article on Willful FBAR Penalty Cases (Federal Tax Crimes Blog 4/26/13), here.
  • McBride #2 - Proof of Willfulness (Federal Tax Crimes Blog 11/13/12), here.
  • McBride #1 - Court Holds Government Must Prove FBAR Willful Penalty by a Preponderance (Federal Tax Crimes Blog 11/11/12), here.
  • Fourth Circuit Reverses Williams on Willfulness (Federal Tax Crimes Blog 7/20/12; revised 7/24/12), here.
  • Burden of Proof for Willfulness in FBAR Violations (Federal Tax Crimes Blog 9/6/11), here.

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