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If things have gone wrong and you find yourself and your overseas bank accounts the subject of an IRS audit, you may feel like you are preparing for the worst. But what is the worst? How do the IRS and tax courts calculate willful FBAR penalties when they find you have violated your reporting obligations?
Every year, U.S. taxpayers -- including immigrants with permanent resident status and expatriate U.S. citizens living overseas -- must report their holdings in foreign financial accounts. Any time a bank account, trust, or stocks crosses the $10,000 threshold, its owners must file a separate Report of Foreign Bank and Financial Accounts (FBAR), FinCEN Form 114. (This is on top of reporting any income from the accounts on their personal or business income tax returns.)
When taxpayers fail to file their FBARs on time, it opens them up to substantial financial penalties. The penalties for FBAR violations start at $10,000 for “non-willful” violations and go up from there. When the IRS determines that that a taxpayer willfully violated the statute -- by acting intentionally or recklessly ignoring his or her duty to file -- the maximum amount raises even higher: to $100,000 or 50% of the balance of the unreported account, whichever is higher.
As anyone with foreign financial accounts knows, calculating the value of assets held overseas can be difficult. Exchange rates, investment transactions, and market influences can mean the balance in your account changes daily. With the cost of FBAR penalties tied to the account balances, it is important to know how courts will measure those penalties.
How the IRS calculates willful FBAR penalties was the focus of a recent court decision in United States vs Schwarzbaum in the United States District Court for the Southern District of Florida. Isac Schwarzbaum, who immigrated to the United States from Germany in 1995 and became a U.S. citizen in 2000, was alleged by the IRS to own over a dozen Swiss bank accounts as well as several more in Costa Rica, for which Schwarzbaun failed to file annual FBAR reports, with a total balance reaching in excess of $28 million. The IRS became aware of the FBAR violations and imposed non-willful FBAR penalties against Mr. Schwarzbaum for 2006, but determined his violations of the reporting requirements in 2007 through 2009 were willful. The IRS used the highest total balance for each account each year to calculate the penalties, initially assessing more than $35 million in willful FBAR penalties but eventually reducing the assessment by $22 million to $13,729,591.00 because it decided that the initial assessment (which the district court would later explain was about $12 million too high even using the IRS methodology) was “excessive.” Mr. Schwarzbaum objected to the willfulness determination and the calculation of penalties, and refused to pay the assessment. The IRS referred the matter to the Justice Department Tax Division, which filed a collection action against Schwarzbaum in federal district court.
The federal district court judge sided with the IRS on the determination of willfulness. Then the court asked both sides to provide their calculations for the proper willful FBAR penalties for 2007 - 2009. The Government fully complied with this directive but Schwarzman did not. Nevertheless, after reviewing the figures, the court determined that the IRS had valued the accounts incorrectly.
When assessing an FBAR penalty, the IRS should use the cash value of the account in U.S. dollars, based on the conversion rate on the day the violation happened (when the missing FBAR was due). In 2006 - 2009, the deadline to file FBARs was June 30 (it is now April 15). The court said that the IRS should have obtained the account balances for the relevant date -- June 30 -- for each year and based its calculations on those, rather than on estimates created after the fact. In the end, after applying the same mitigation guidelines, the trial court reduced Mr. Schwarzbaum’s penalty by well over $800,000.00 dollars, assessing a maximum willful FBAR penalty of $12,907,952.00.
If those values sound excessive to you, you are not alone. Mr. Schwarzbaum’s attorney argued that the willful FBAR penalties amounted to an unconstitutionally excessive fine under the Eighth Amendment. This constitutional provision, most often used in prison cases, says:
“Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.”
But the district court here said civil penalties like those imposed for FBAR violations don’t count as fines. It said the Eighth Amendment controls penalties that “serve primarily punitive, retributive, or deterrent purposes, rather than being remedial.” The court said FBAR penalties can’t be called forfeitures or disgorgement like in past Eighth Amendment cases and that tax penalties generally are remedial rather than punitive. Because of that, Mr. Schwarzbaum could not escape a nearly $24 million willful FBAR penalty because it technically did not count as a fine.
The Schwarzbaum case shows how substantial a willful FBAR penalty can be, especially when those penalties accumulate over several years. That is why it is important to work with a CPA and tax attorney skilled in addressing international issues. Early negotiations with the IRS can help reduce the chances your violation is considered willful and limit the penalties to something you can afford.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding FBAR requirements or penalties, contact Joe Viola to schedule a consultation.