Second Circuit Joins Courts Imposing Recklessness Standard for FBAR Penalties

Earlier this year, the Second Circuit Court of Appeals recently joined the growing consensus of courts imposing the recklessness standard to willful FBAR penalties. In adding its voice to the chorus applying this objective standard, the Court also took up whether the Treasury Department or the courts could set the penalty interest rate imposed against taxpayers who don’t pay their FBAR penalties.

Nicaraguan Surgeon Fails to Disclose Foreign Financial Assets

The Second Circuit’s January 2026 decision came in United States v Reyes, in which the IRS sued to collect unpaid willful FBAR penalties from Dr. Juan Reyes and his wife Catherine. While Catherine was a U.S.-born citizen, Dr. Reyes was born in Nicaragua, moved to the U.S. in 1960 and became a dual citizen in 1982. A decade earlier, in 1972, Dr. Reyes opened a bank account in a financial institution that would later become Lloyds Bank in Managua, Nicaragua, and his parents deposited approximately $200,000 in the account. The account was later transferred to Lloyds Bank in London at which point Catherine was added as a joint owner, and later Lloyds TSB Bank in Switzerland.

Over the years, the value of that initial deposit accumulated and the Reyeses used “a few thousand dollars a month” in cash and credit card payments to pay their domestic expenses. They had their credit card statements sent to a friend in Spain. In 1994, the Reyeses instructed the bank not to send them correspondence, a service which had an additional fee. In 2000, Lloyds Bank sent them paperwork requiring the Reyeses to either provide a W-9 for U.S. tax reporting purposes, or opt not to invest in U.S. securities through their account. They chose the latter. By 2012, the Lloyds account held 42,053,423.00, and made up at least 75% of the couple’s total assets.

IRS Imposes Willful FBAR Penalties for Undisclosed Account

The Reyeses hired an accountant to prepare their tax returns, but never completed the accountant’s “Client Organizer” or disclosed the existence of the foreign bank account. Because of this, their 2010, 2011, and 2012 tax returns falsely reported that they did not have any foreign financial bank accounts. They also did not disclose the interest or other income earned by the account. Dr. Reyes later testified that he had read an article and spoken to a foreign tax attorney, both of which said that, as a Nicaraguan citizen, he was not required to report the foreign income to the IRS. But then, in 2013, the Reyeses decided to close the Lloyds bank account and transfer the funds to a domestic account. Dr. Reyes said that in doing so, he first learned about the FBAR reporting requirements. He consulted a U.S. tax lawyer, and filed amended tax returns for 2010 through 2012.

The Reyeses initially enrolled in the now-closed Offshore Account Voluntary Disclosure Initiative, but withdrew because they felt the “regularized” penalty of $600,000 was too high. In 2018, the IRS determined the Reyeses’ failure to file FBARs was willful, and calculated the maximum penalty of 50% of the balance of the account against each spouse. However, it found that amount “too severe” and instead imposed a mitigated penalty of $516,065 for all three years. After a successful protest to the Office of Appeals, that number was further reduced to $420,051 each, which the Reyeses agreed to. The forms setting the assessment amount warned that there would be a 6% late penalty charged per year for any unpaid balance after 90 days. But the Reyeses did not pay.

Second Circuit Adopts Recklessness Standard for FBAR Penalties

The IRS filed a lawsuit to reduce the assessment to a judgment, and the United States District Court for the Eastern District of New York granted the government summary judgment. Then the taxpayers appealed to the Second Circuit, saying the district court erred in finding that the willful FBAR penalties could be imposed against them for recklessness rather than intentional behavior.

The issue is one that several different courts have been wrestling with in recent years, and the Second Circuit cited many of their decisions, including several cases which have been covered by this blog in the past, agreeing that the IRS could impose willful FBAR penalties for intentional or reckless failure to file the necessary reports. It relied extensively on the United States Supreme Court decision in Safeco Insurance Co of America v Burr, which applied a reckless standard to common law civil liability cases. The Second Circuit, like the other Circuit Courts, said the term recklessness meant “an unjustifiably high risk of harm that is either known or so obvious that it should be known.” It said:

In effect, Congress created a sliding scale:

(i) violations committed with reasonable cause but where the balance or transaction is properly reported are not penalized;

(ii) violations committed without reasonable cause or without a contemporaneous report are subject to the standard penalty;

and (iii) violations committed recklessly or knowingly are subject to an enhanced penalty.

The Court found there was no question of material fact that the Reyeses’ behavior fell into the highest category based on:

• The high value of the account
• The share of the couple’s assets it represented
• Their use of the account for domestic purposes
• The use of a foreign credit card registered in Spain
• Making payments using automatic deductions
• Choices made to avoid Lloyds Bank corresponding or investing in the United States
• Paperwork sent to them by Lloyds Bank and their accountant
• Failure to disclose the account to their accountant through her Client Questionnaire
• Reliance on a news article and foreign attorney rather than consulting a U.S. lawyer

It dismissed the couple’s defense saying that Dr. Reyes’s subjective knowledge of the reporting requirement did not matter as much as his reckless disregard of the duty to get accurate legal advice. Nor did it matter that the Reyeses’ industry was medicine, rather than business, because the standard was objective reasonableness, rather than the individual taxpayer’s sophistication.

Taxpayer Challenges Treasury Department’s 6% Penalty Interest

One unique aspect of US v Reyes is that, in addition to the penalty itself, the defendants here challenged the IRS’s imposition of 6% late penalty interest. The Second Circuit said the Federal Claims Collections ACT (FCCA) authorized the head of executive, judicial, and legislative agencies to assess penalty interest of up to 6% when a debt is more than 90 days past due. The Treasury Department had done so. But the taxpayers said that rate should be reviewed and set by the Judge, rather than the Treasury Department. The Second Circuit disagreed, saying nothing in the statute let a single judge override the policy decision of the head of a different agency. It refused to give the Reyes a lower penalty interest rate simply because they waited to pay, forcing the IRS to file a lawsuit.

While the Reyes decision does not break new ground, by adding its voice to the growing consensus of circuit courts, the Second Circuit increases the chances that the recklessness standard will be the uniform rule applied nationwide, even without a Supreme Court decision on the issue.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions about the IRS’s FBAR penalty assessments or interest calculations, contact Joe Viola to schedule a free consultation.