Can You Plead the Fifth Amendment on FBAR Filings?

After spending years trying to hide money in a “secret account” in Switzerland, one couple was assessed civil willful FBAR penalties after they filed a report that simply said “Fifth Amendment”. The tactic raises the question, can you plead the Fifth Amendment on your FBARs to avoid disclosing foreign assets?

Couple Hides “Secret Account” at Swiss Bank

In 2002, Daniel and Yana Bernstein and their financial advisor went to Switzerland to open a bank account. The foreign financial account was titled in the name of a shell company and set up to shelter the money from government disclosures. With their financial advisor’s help, Daniel Bernstein instructed the Swiss UBS not to call or mail communications about the account and to withhold all account statements. Two years later, in 2004, they did it again, setting up a second, smaller UBS account directly in their names. Combined, the two accounts held about $1 million. The next year, they combined the two accounts.

Every year, between 2002 and 2009, the Bernsteins hired an accountant to prepare their tax returns, but didn’t give the accountant information about the UBS account. Daniel Burnstein said that to tell the accountant “would defeat the purpose,” because “it was a secret account” and he “didn’t want anyone to know about this account.” In February 2009, the U.S. government negotiated with UBS to release the identities and account information of U.S. customers. Two days after this deal went public, the Bernsteins and their financial advisor transferred their money to a private Swiss bank, Bank Sal.

Taxpayers Seek Legal Help to Avoid Disclosing Assets

On September 25, 2009, UBS sent the Bernsteins a letter, warning that the IRS was seeking information and suggesting that the couple participate in the IRS’s voluntary disclosure program. The Bernsteins consulted with a lawyer who told them “nothing serious” would happen because the account was “only a million dollars” so the Government would likely not pursue it. That attorney was wrong.

In April 2011, the IRS began an audit of the Bernsteins’ 2007 tax return. By that time, the IRS had begun criminally prosecuting other UBS account holders. Nervous, the Bernsteins went back to their lawyer, but he referred them to a white-collar criminal attorney specializing in tax prosecutions.

That criminal attorney found the Bernsteins’ decision not to participate in the voluntary disclosure program “deeply disturbing.” In light of the “substantial risk” of criminal prosecution, he advised the Bernsteins to file a foreign bank account report (FBAR) for 2010, and invoke their Fifth Amendment privilege not to incriminate themselves. He believed this would protect the Bernsteins from criminal prosecution, but that they still might be required to pay a fine. The Bernsteins did just that: they wrote “Fifth Amendment” on their FBAR and on Schedule B on their 2010 tax return.

IRS Says Writing Fifth Amendment on FBARs Was Willful Violation of the Bank Secrecy Act

True to their criminal tax attorney’s word, the IRS did impose a fine against the Bernsteins for writing Fifth Amendment on their FBARs, rather than disclosing their foreign accounts. The government imposed a willful FBAR penalty in the amount of $262,288.50 against each spouse. When the IRS sued to collect the debt, the Bernsteins objected that their failure to disclose was not willful because they reasonably believed they had satisfied their obligation by filing an FBAR asserting their Fifth Amendment right not to incriminate themselves.

Court Says Fifth Amendment Doesn’t Protect Against Civil FBAR Penalties

Judge Cogan of the United States District Court for the Eastern District of New York began by weighing the two definitions of willfulness in U.S. tax law:

• The subjective criminal standard, where a defendant’s ignorance or good-faith misunderstanding of the law can be a defense, and
• The objective civil standard, which can include intentional, knowing, voluntary, or reckless disregard for the lawfulness of the action, “entailing an unjustifiably high risk of harm that is either known or so obvious that it should be known.”

Judge Cogan noted that in the past, even getting the help of an accountant or tax attorney wasn’t automatically enough to shield a taxpayer from a willful FBAR penalty.

Next, the court turned to the parties’ Fifth Amendment claims. Judge Cogan said even without addressing the protections of the Fifth Amendment, the Bernsteins’ use of off-shore tax havens clearly showed willful action.

“[T]heri situation was driven by their long history of deception that exposed them to serious criminal liability.”

The court continued:

“[T]here was nothing reckless about their reporting in 2020 -- they retained a pre-eminent tax attorney and followed his instructions on the best way to proceed to a T. . . .

Here, the Bernsteins’ very deliberate decision not to disclose the account in 2010 despite having full information and advice of the potential criminal and civil consequences of disclosure versus non-disclosure was not in the least bit reckless. But it was the epitome of willfulness.”

That is not to say it was the wrong decision. The court noted:

“The Bernsteins had a clear choice: disclose the required information and risk a criminal prosecution for earlier years, or abstain from disclosing with a good-faith assertion of their privilege and hope they would eliminate criminal liability and hopefully, perhaps as a matter of negotiation, limit civil liability.”

The choice appears to have worked, because, as the court noted, the Bernsteins have avoided criminal tax fraud charges for their actions. However, the consequence of that choice was a willful decision not to disclose foreign financial accounts, and a willful FBAR penalty to go along with it, just like their lawyer had said.

If this case demonstrates anything, it is the importance of working with an experienced tax attorney who understands the Bank Secrecy Act and the foreign financial account reporting requirements. The Bernsteins’ first attorney gave them bad advice. As a result, they ended up having to make a difficult choice between a higher civil penalty and possible criminal consequences. Had they worked with a more knowledgeable attorney from the start, they may have been able to take advantage of the IRS’s voluntary disclosure program and minimize how much they had to pay to the IRS.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years’ experience. If you have questions regarding FBAR penalties, contact Joe Viola to schedule a consultation.