Can an Informal Trust Shield a Trustee from FBAR Penalties?

When family money is passed down through the generations, it isn’t always clear who owns the accounts, or who is required to disclose them to the IRS. A recent case from the Federal Court of Claims considers whether an undocumented, informal trust or Swiss banking laws can prevent a would-be trustee from facing willful FBAR penalties.

Grandfather’s Accounts Handed Down for the Family’s Benefit

Leon Landa’s family escaped communism in the Ukraine and emigrated to the United States in 1975. He came to the U.S. with his father, Gersch, mother, and his brother Mark. Five years later, Leon became a U.S. citizen.

That same year, Gersch Landa learned that decades earlier, in 1939, Leon’s grandfather had deposited money into the Banca Popolare Svizzera, now part of Credit Suisse AG. This money was intended to be “for the family” in case of “another situation like World War II.” It had never been used, even when the family was desperately short on money while fleeing communist Ukraine.

From the 1980s through 2005, Gersh Landa managed this family money, which was held in accounts in UBS and Credit Suisse. In 1985 Gersh named both his sons and their mother powers of attorney on these accounts. However, because of his failing health, Gersh stopped traveling to Switzerland to manage the accounts in 2006, and Leon Landa took over supervising the family money.

Leon made annual trips to Switzerland, transferred money between the two accounts, signed documents on the accounts, and ultimately transferred the funds to a new account at BSI, which did not do any operations in the United States. At the time of the transfer in September 2009, the Credit Suisse account held $4,235,233 (USD) and the UBS account held $2,154,000 (USD). The new BSI account was opened in Leon Landa’s name only.

But when Leon filed his 2009 tax returns, he checked “No” on Schedule B when asked if he had an interest in or signature or other authority over a foreign financial account. He also did not submit an FBAR as required by the IRS until February 1, 2011. At that time, he listed himself as “Account Owner” and “Trustee,” claiming that the funds in the Credit Suisse account were held in trust with Gersh Landa as trustee.

When the IRS investigated the filing, the Landa family hired an attorney, who drafted handwritten documents claiming to create a trust with Gersh Landa as trustee, and Mark and Leon Landa as successor trustees. These documents were submitted to the IRS. Nonetheless, on June 17, 2014, the IRS assessed Leon Landa a willful FBAR penalty in the amount of $3,173,464, representing 50% of the BSI account balance as of December 31, 2009. Leon paid the assessment and then sued to recover the penalty in the United States Federal Court of Claims.

Swiss vs U.S. Law: Which One Applies to Financial Interests in Foreign Bank Accounts

Landa argued that he had no obligation to file FBARs reporting the family bank accounts since under Swiss law, he was the “holder of record” but may not have been considered the “owner of record,” “holder of legal title,” or “beneficial owner.” However, the Court was not convinced that it needed to consider Swiss law at all:

“The fundamental issue underlying the plaintiff's illegal exaction claim is an action taken by a U.S. federal agency to enforce a U.S. law meant to prevent U.S. taxpayers from failing to disclose foreign bank accounts, precisely like the plaintiff's BSI account.”

The FBAR instructions were broader than the Swiss law regarding ownership. They stated:

“A United States person has a financial interest in each account for which such person is the owner of record or has legal title, whether the account is maintained for his or her own benefit or for the benefit of others including non-United States persons.”

The Court refused to require the IRS to interpret and apply worldwide regulatory schemes for every country in which a U.S. taxpayer maintained a bank account. Instead, it held that only U.S. laws and regulations applied to U.S. filing requirements.

Informal Trust Does Not Excuse Trustee’s FBAR Filings

Nor was the court convinced that Leon’s role as informal trustee shielded him from FBAR reporting requirements or penalties for failing to meet those requirements. The Court noted that, under the regulations quoted above, even accounts held for the benefit of others must be disclosed. While the Court did not believe that an enforceable trust existed in 2009, it would not have mattered if it had. Leon Landa would still have been required to report his financial interest in the accounts holding the family money for the family’s benefit.

Was the Would-Be Trustee’s Violation Willful?

To sustain the $3 million willful FBAR penalty, the IRS needed to show that Landa acted willfully, either by intentionally avoiding a known duty to file FBARS, or recklessly disregarding his responsibility to do so. The Court compared Leon’s behavior to other cases where willful FBAR penalties were held. It found support for the willfulness determination in Leon’s:

• 2009 tax return bearing the mark “No” on the Schedule B question relating to foreign financial accounts
• Failure to disclose the family money to his accountant or ask about an tax filing requirements related to the account
• Failure to include the income from the foreign accounts on his tax return
• Transferring money out of the UBS account after the IRS began investigating that bank
• Withholding all correspondence and destroying financial documents related to the account
• Directing BSI not to invest in U.S. securities

Based on these facts, the Court held that Mr. Landa was at least behaving recklessly and the willful FBAR penalty was appropriate.

Are 50% Willful FBAR Penalties Excessive Fines?

Leon Landa is one of many taxpayers facing willful FBAR penalties to argue that the 50% penalty assessed on the balance of the account is unconstitutionally excessive under the Eighth Amendment. However, the Court refused to treat the penalty as a punitive fine for constitutional purposes. As a remedial penalty, the Court said the willful FBAR penalty falls outside the Eighth Amendment. It also refused to overturn the IRS’s determination as to amount, even though it far exceeded the $1 million threshold in the Internal Revenue Manual for applying mitigation guidelines. The Court concluded:

“The Court appreciates the plaintiff's unusual family history. These funds were hidden from the Nazis and subsequently hidden from the Communist authorities in the Soviet Union, where the Landa family resided until fleeing to the West. That history may help explain the plaintiff's behavior, but it cannot relieve the plaintiff of a broadly applicable filing requirement.”

Even though Leon was managing what he saw as family money, the Court said he still had a personal reporting obligation to the IRS.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you are facing FBAR penalties on a family trust or shared financial account, contact Joe Viola to schedule a free consultation.