The Muddier Waters of Willful FBAR Penalty Maximums

From the Court of Federal Claims to District Courts across the country, it seems everyone has an opinion on whether an old IRS regulation caps willful FBAR penalty maximums well below the amounts authorized in the statute. Now a new decision further muddies the waters, ruling on both regulatory limits and constitutional issues tied to FBAR penalties.

FBAR Penalty Statute vs IRS Regulation

Over the last year, it seems each month brings with it another federal court decision about the interaction between the Bank Secrecy Act, last modified in 2004, and a 1987 IRS regulation. The 2004 amendment to the law created a civil penalty for non-willful violations of reporting requirements connected to the control of foreign financial accounts and increased the willful FBAR penalty maximums already in place.

Before 2004, the most you could be required to pay was $25,000 or the balance of the unreported account at the time of the violation up to a maximum of $100,000. The 2004 amendment set the penalty for non-willful violations at $10,000 and the willful FBAR penalty maximums to $100,000 or 50% of the balance of the account, whichever is higher.

The IRS regulation that controls how the agency will enforce the FBAR filing requirements still contains the earlier language, setting the willful FBAR penalty maximums at $100,000. Taxpayers’ lawyers argue that if the IRS wants to impose a higher penalty, it must first change the regulation. But the IRS attorneys say that when Congress amended the statute in 2004, they essentially overruled the regulation and automatically allowed the higher penalties.

Federal Court Rules IRS Can Use Higher Willful FBAR Penalty Maximums

There have been federal court rulings on both sides of the issue. Judges have differed on whether the statute’s language replaced the regulation regarding willful FBAR penalty maximums, or simply raised the ceiling underneath which the IRS can operate. Now the United States District Court for the District of Connecticut has weighed in on the issue, ruling in favor of the IRS and higher penalties.

In United States v. Garrity, a federal judge ruled that when Congress amended the law in 2004, it “effectively abrogated the regulation capping FBAR penalties at $100,000.” The court focused on the language of the statute and whether the law was “self-executing” or whether it directed the IRS to create regulations. Even though the court quoted portions of the Bank Secrecy Act directing the IRS to create regulations for the reporting of foreign financial accounts, it held that “Once the Secretary establishes reporting requirements under Section 5314, though, the civil penalties in Section 5321(a)(5) attach whenever the Secretary chooses to impose them for a reporting violation, as he has in this case.”

Interestingly, unlike other federal judges considering this issue, this decision also found that the IRS regulations were initiated without using a “notice and comment” procedure. The court relied on that finding, saying “the old regulation will not bear the freight the Defendants attempt to foist upon it.”

Excessive Fines and the Eighth Amendment

The court also considered whether the willful FBAR penalty maximums violated the U.S. Constitution’s Eighth Amendment, which protects individuals from excessive bail, excessive fines, and cruel and unusual punishment. The court went through the 4-factor analysis established by the U.S. Supreme Court in United States v Bajakajian:

1. The essence of the defendant’s crime and its relation to other criminal activity
2. Whether the defendant was the class of persons the statute was designed for
3. The maximum sentence and fine that could be imposed
4. The nature of the harm caused by the defendant’s conduct

However, the court required the taxpayers to show each of the four elements, and found that they had not done so.

• The judge said the taxpayers had “offered no explanation for why Mr. Garrity opened the foreign account” or where the money came from, which he said, together with the common use of Liechtenstein trust accounts as tax havens, showed criminal intent.
• The judge found some evidence to show Mr. Garrity and his children were avoiding disclosing the account, so the judge said he was the type of person the statute was designed for.
• The judge found the ratio of 4:1 in criminal to civil penalties for willful FBAR violations was not “grossly disproportional” compared to other similar statutes.
• The judge said the harm done by Mr. Garrity’s failure to disclose foreign assets meant the penalty was not an fine excessive.

The issue of how the Bank Secrecy Act and the IRS regulations interact is looking increasingly appealing for a Supreme Court decision, once the various Circuit Courts of Appeals have had their turn. Until that time, taxpayers accused of willfully failing to file FBAR requirements will need the help of skilled tax attorneys to argue on their behalf and to protect their rights and their money.

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.