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The Secretary of Treasury and the Internal Revenue Service (IRS) are controlled by a number of laws and regulations that set the rules for issuing taxes, fines, and penalties against U.S. taxpayers. But when the law related to willful FBAR penalties changed, the regulations didn't keep up. That could mean the IRS is breaking its own rules in imposing high penalties for willful FBAR violations.
The Bank Secrecy Act, initially passed into law by Congress in 1970, requires anyone who owns or controls a foreign financial account worth at least $10,000 to file a Report of Foreign Bank and Financial Accounts (FBAR) each year. Failure to file FBARs with the Financial Crimes Enforcement Network (FinCEN) on time means that the IRS may impose penalties.
Originally, under the Bank Secrecy Act, an FBAR penalty could only be imposed against people who willfully failed to file the necessary forms. Even then, the penalty was limited to $25,000 or the balance of the unreported account up to $100,000. 31 U.S.C. Section 5321(a)(5).
The Bank Secrecy Act gives the Secretary of Treasury the authority to set regulations for how the law would be enacted - including when and where the disclosures must be filed and how penalties would be imposed. The result was a regulation, issued following notice and an opportunity for public comment, 31 C.F.R. Section 103.57, which says:
"For any willful violation . . . the Secretary may assess upon any person, a civil penalty . . . not to exceed the greater of the amount (not to exceed $100,000) equal to the balance in the account at the time of the violation, or $25,000."
Then in 2004, Congress decided to make the foreign asset disclosure laws even tighter by passing the America Jobs Creation Act. It granted the Secretary of Treasury the authority to impose non-willful FBAR penalties and increased the maximum willful FBAR penalty to the greater of $100,000 or 50% of the highest balance in the account during that tax year.
But the FBAR regulation didn't keep up. There have been several amendments to the regulation, mostly increasing penalties to keep up with inflation. However, in the 14 years since Congress raised the penalty limits, the Secretary of Treasury has never changed the regulation to match the new version of the law.
That hasn't stopped the IRS from taking advantage of the higher maximum penalties, though. The IRS regularly imposes the statutory maximum of 50% of the highest balance in a taxpayer's largest account when investigating taxpayers' failure to file FBARs or disclose foreign financial accounts on their tax returns. Now that unchanged regulation is giving some tax payers the ability to fight back against severe, some even say "draconian" willful FBAR penalties.
The Secretary of Treasury used a notice-and-comment rulemaking procedure to create the FBAR penalty regulation. That means the regulation stays in effect until it has been repealed or amended — just like any law passed by Congress. If the Treasury Department wants to change the regulation, it must provide the same notice and opportunity for comment before new language can be adopted. As long as the regulation is in place, taxpayers can argue that the IRS acted "arbitrarily and capriciously" when it ignores the regulation and imposes higher penalties authorized under the statute.
This has created a legal battle over the effect of laws and regulations that is echoing through tax courts and the U.S. Federal Court of Claims. The IRS says that the 2004 American Jobs Creation Act superseded the prior regulation, mandating the higher maximum willful FBAR penalties. But taxpayers in several courts have argued that the law simply raised the ceiling. The discretion to impose penalties still rests with the Secretary of Treasury. Under this argument, the regulation and the new law can be read together consistently, so the law doesn't replace the existing regulation.
This issue has already arisen in no less than four cases between taxpayers facing willful FBAR penalties and the government this year. The courts are not all ruling the same way. The next blog post will look at three cases where the court has sided with taxpayers in favor of the regulation. Then the following post will review a case where the court found in favor of the IRS and the amended statute. A final post will review what this split in decisions means for taxpayers with foreign assets, and look at whether a Supreme Court decision could be coming in the future.
Tax law is inherently complicated. When Treasury regulations and IRS practices don't align it can leave taxpayers wondering what their future will hold. Whenever there is a question of FBAR penalties, it is important to speak to an attorney familiar with the foreign reporting requirements, or you may end up paying more than you have to.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding willful FBAR penalties, contact Joe Viola to schedule a free consultation.