Magistrate Recommends Sustaining Imposition of FBAR Willful Penalty (8/28/19)

In United States v. Rum (M.D. Fla. No. 8:17-cv-826-T-35AEP), Magistrate Report and Recommendation dated 8/2/19, here, the Court granted the Government's Motion for Summary Judgment sustaining the FBAR willful penalty at 50% for a single year.  The Court Listener docket entries with available links to some of the underlying docket entries is here.  (Readers wanting to follow the case might check in on the docket entries link for updates.)

The Report is 36 pages long.  I will not provide a detailed analysis here but just point out some of the key points that caught my attention.  Overall, it just did not look good for Rum, which is why the Magistrate recommended that the FBAR willful penalty in the 50% amount be sustained.

1.  Rum unquestionably had a foreign account and it was reportable.  So the issue was willfulness.

2.  Rum claimed that he created the account to hide assets from potential judgment creditors rather than the IRS, but the facts were not consistent with that claim.

3.  UBS sent Rum an annual notice that information was provided for him to meet his U.S. tax reporting obligations.

4.  Rum answered the Form 1040 Schedule B foreign account question no, and did not report any income from the account over the years.

5.  In 2004, Rum signed a document for the foreign account (UBS) that said:  "“In accordance with the regulations applicable under US law relating to withholding tax, I declare, as the holder of the above-mentioned account, that I am liable to tax in the USA as a US person.”

6.  In 2008, Rum moved the account from UBS to another Swiss bank, Arab Bank.  (On the timeline, of course, the U.S. was moving aggressively against UBS in 2008.)

7.  Rum claimed that a tax preparer prepared the tax returns, but the returns indicated that they were self prepared.

8.  If a preparer did prepare the returns, Rum admitted that he did not disclose to the prepare the foreign account; Rum claimed the preparer never asked about foreign accounts.

9.  Rather than join OVDI, Rum attempted a quiet disclosure.  (Easy to hindsight on that, given the ugly facts, and the fact that UBS turned on U.S. clients to protect their own skin, a characteristic of Swiss banks generally.)

10.  The IRS agent and her manager initially recommended a nonwillful penalty. After receiving input from IRS counsel, they changed the recommendation to a willful penalty.

11.  The IRS agent apparently offered to trade a 20% willful penalty (instead of a 50% willful penalty) in exchange for Rum agreeing to a civil fraud penalty on the income tax side.  Rum apparently rejected that offer.

12.  The IRS did not apply mitigation because (i) the amount in the account exceeded $1 million and a civil fraud penalty was asserted.

13. After the FBAR penalty was assessed, the IRS and the taxpayer settled the income tax side in a Tax Court case pursuant to a stipulated decision that did not include the civil fraud penalty.  (Very little is said in the report about this, but it is discussed in the parties briefing, particularly in the US Supplemental Authority in Support of Its Motion for Summary Judgment, here, where the Government argues that review of the FBAR penalty amount is limited to the administrative record at the time the FBAR penalty was assessed and, as to amount, is an abuse of discretion standard rather than de novo.  (The determination of willful liability is de novo, but the amount is abuse of discretion, so argues the Government.)  And the review is based on the administrative record at the time.  A relevant excerpt is:

Indeed, that principle of administrative review supports the United States’ interpretation of the mitigation factor that Mr. Rum argues should have been applied in his favor. In addition to three other factors noted in the Internal Revenue Manual, a person “may be subject to less than the maximum FBAR penalty depending on the amounts in the person’s accounts,” IRM 4.26.16.4.6.1(1) (July 1, 2008) at ADM003629 (available at Doc. 31-21 at 20) (emphasis added), if the “IRS did not determine a fraud penalty against the person for an underpayment of income tax for the year in question due to the failure to report income related to any amount in a foreign account,” IRM Exhibit 4.26.16-2 (July 1, 2008) at ADM003636 (available at Doc. 31-21 at 27) (emphasis added). Mr. Rum wrongly argues that that factor should apply to him because, after the IRS determined the amount of his FBAR penalty, he later settled a related income tax liability in Tax Court with no civil fraud penalty. But the plain language of the IRM provision speaks in terms of whether the IRS had determined a civil fraud penalty, not whether the Tax [*4] Court later determined (or in this case oversaw the settlement of) a civil fraud penalty.1  This plain-language reading of the IRM provision synchronizes with the above principle that the administrative record is limited to administrative activity prior to the decision. Both support ignoring the later actions of the Tax Court here. 

14.  The Magistrate did address the civil fraud penalty (Slip Op., at 22-27) even though that was not technically an issue in the case.

JAT Comments:

1.  Based on the facts recounted there in the section titled the civil fraud penalty, it is by no means self-evident why the IRS settled the income tax case in the Tax Court by dropping the civil fraud penalty.  The Court did start the discussion by noting that the IRS must prove civil fraud in the income tax penalty case by clear and convincing evidence.  The Government burden for the FBAR willful penalty is preponderance.  As litigators will tell you, the clear and convincing is articulated as a higher burden (greater than preponderance and less than beyond a reasonable doubt), and beyond the articulation is a major burden in civil fraud penalty cases.  Perhaps the IRS' attorneys assessment of the civil fraud penalty was that they just could not meet the higher burden, but in imposing the FBAR penalty the Government attorneys felt that they could sustain the lower preponderance burden.

2.  I was surprised that the agent offered a lesser willful penalty (20% rather than 50%) in exchange for the civil fraud penalty.  I have not dug into that issue, but assuming that that offer was made (and could have been approved within the IRS), I suspect that Rum would have been well advised to accept it (from solely a monetary perspective), particularly, if they were talking about a one year civil fraud penalty.  The civil fraud penalty would be 75% of the tax on the omitted foreign account income and in any event, without the civil fraud penalty, the taxpayer would have been subject to the 20% accuracy related penalty.  So, the delta is 55%.  Assuming income of, say, 6% on $1,400,000, that would be $84,000, with tax at, say, 35% of that, or $29,400 in tax.  The extra income tax penalty at the delta of 55% would be $16,170.  That would seem to be a cheap price to have the FBAR willful penalty lowered by 30% from 50% to 20%.  And, it would even be cheap if 5 or 6 years were involved.  (Keep in mind that this analysis is based on hypothetical numbers I have assumed from the facts.)