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Fourth Circuit Adopts “Recklessness” Standard For Willful FBAR Violation and Rejects $100,000 Willfulness Penalty Cap Argument.

Scissors cutting into money bag

If you decide to take advantage of more favorable terms and interest rates in foreign financial accounts, you may not realize how significantly those investment choices may complicate your tax filing requirements. Failing to file annual FBAR reports disclosing the existence of your foreign financial accounts with high account balances could cost you up to the greater of $100,000 or 50 percent of the foreign accounts’ value.

Couple Fails to File FBAR Reports Disclosing Swiss Bank Account and Omits Swiss Bank Interest Income on U.S. Tax Returns

Peter and Susan Horowitz moved to Riyadh, Saudi Arabia, in 1984, so that Peter could take a position as an anesthesiologist. Soon after, Susan, who had a Ph.D. in clinical social work, found new employment in Saudi Arabia that was sufficient to cover the family’s living expenses. They saved Peter’s income, $120,000 per year, for their retirement. At first, this money was in a Saudi Arabian account, but that account didn’t bear any interest for religious reasons.

In 1987, the Horowitzes opened an account in the Swiss Foreign Commerce Bank (FOCO), to take advantage of the superior interest rates. In 1994, they moved that account to the Union Bank of Switzerland (UBS) after FOCO was purchased by an Italian bank. In 2001, the Horowitzes returned to the United States, but they kept their UBS account, which was now valued at $1.6 million. Susan thought of this account as the family’s “nest-egg retirement account”.

In October 2008, after news broke that UBS was having financial troubles and planned to close all American accounts, Peter traveled to Switzerland to transfer the “nest-egg”, now worth nearly $2 million, to another Swiss bank: Finter Bank Zürich. But because Susan wasn’t with him, he could only open the account in his own name. Susan went with him back to Switzerland the next year to correct the error.

Throughout their time in Saudi Arabia, Peter and Susan Horowitz knew they had to report their foreign earned income to the IRS. They hired a U.S. accountant to complete their tax returns every year and disclosed their Saudi income as well as the interest earned by their domestic bank accounts. But they never told their accountant about the Swiss bank account or the interest income earned from their foreign financial account.

After the couple returned from Switzerland in 2009, they received a letter from UBS notifying them that the IRS was seeking information about U.S. persons who had UBS accounts. They decided to consult a tax attorney and learned that they should have been reporting their interest income on their tax returns and filing foreign bank account reports (FBARs) disclosing their Swiss bank account all along.

They submitted an application to the Department of Treasury’s now defunct Offshore Voluntary Disclosure Program (OVDP), reporting $215,126 in additional income and paying more than $100,000 in back taxes before opting out of the program. As was generally the case under the OVDP, had they completed this program, they would have been assessed a 27.5% penalty on the highest aggregate annual balance of their foreign accounts. This would have been roughly $500,000 based on their foreign holdings of close to $2 million. However, the Horowitzes chose to “opt out” of the program to avoid that assessment and rely instead on individualized treatment -- including a determination of willfulness or non-willfulness -- through an IRS FBAR examination.

Getting Tax Advice from Friends was Reckless, Court Says

When asked why he never disclosed his Swiss bank account to his accountant, Peter said the couple had discussed the situation with friends in Saudi Arabia, and didn’t believe they needed to pay taxes related to interest income from foreign financial accounts. Since the Horowitzes perceived no need to consult their professional tax advisers regarding the Swiss account, the opportunity to learn of the distinct issue of the Bank Secrecy Act’s FBAR reporting requirement never arose.

The IRS disagreed that the Horowitzes’ excuse amounted to non-willfulness. On June 13, 2014, the IRS assessed willful FBAR penalties against both parties. When the couple refused to pay, the U.S. Department of Treasury sued to collect the unpaid tax debt. Following cross-motions for summary judgment, the trial court assessed the following penalties:

  • Against Peter for 2007 and 2008: $494,060 plus $160,508 in interest and post-assessment penalties, totalling $654,586
  • Against Susan for 2007 only: $247,030 plus $80,254 in interest and post-assessment penalties, totalling $327,284

The trial court found that Susan did not have an ownership interest in the Finter Bank Zürich account in 2008, so it did not grant the IRS’s request for willful FBAR penalties against her for that year.

The Horowitzes appealed the decision to the Fourth Circuit Court of Appeals. They raised three issues (only two of which will be covered here):

  • That their actions did not amount to the level of civil “willfulness” since they had no knowledge they had to report interest income from foreign financial accounts.
  • That the Treasury department had capped the penalty for willful FBAR violations at $100,000, and the awards in this case violated that penalty cap.
  • That technical procedures within the IRS meant the statute of limitations had run before the case was filed.

The Court of Appeals ruled that the Horowitzes’ reliance on their friends’ advice was reckless, and therefore a willful violation of the FBAR reporting requirements:

“With this compound knowledge -- that interest income was taxable income and that foreign income was taxable in the United States -- the Horowitzes could hardly conclude reasonably that interest income from their Swiss accounts was not subject to taxes. At the very least, this tension should have triggered a question for their accountant. Instead, their only explanation for not disclosing foreign interest income related to some unspecified conversations they had with friends in Saudi Arabia in the late 1980s. Yet if the question of whether they had to pay taxes on foreign interest income was significant enough to discuss with their friends, they were reckless in failing to discuss the same question with their accountant at any point over the next 20 years. An exception for foreign interest income simply made no sense in the circumstances of their knowledge.”

Fourth Circuit Appeals Court Says Willfulness Penalty Cap Overturned by Statute

Having determined the Horowitzes acted recklessly, the Fourth Circuit Court of Appeals turned to a question raised by taxpayers in several lower courts: whether amendments to the Bank Secrecy Act in 2004, combined with the failure of the U.S. Department of Treasury to amend its regulations to match, created a cap on willful FBAR penalties of $100,000. This blog has explained this legal theory in detail elsewhere, after District Court judges made conflicting rulings on the issue.

Essentially, the argument says that the amended Bank Secrecy Act may have raised the limit on penalties the Treasury Department was authorized to assess, but its own internal regulations set a limit lower than the statutory maximum. The taxpayers say the Treasury Department had the authority to change those regulations and didn’t, so it should now remain bound by its own standing policy. In this case, Horowitz v United States, one of those cases has made its way to the appellate court level, giving the Fourth Circuit an opportunity to weigh in.

The appellate court determined that Congress’s statutory amendment “abrogated” the 1987 regulation -- rendering it no longer valid. It said:

“[T]he statue’s language is hardly consistent with the intent by Congress to allow the Secretary to impose a lower maximum penalty by regulation; rather, Congress itself set a specific ‘maximum penalty’ for a willful violation.”

This will likely not be the last time the issue of the 1987 willful FBAR penalty cap comes before a court. Many analysts believe the split decisions at the lower court level will likely lead to additional appeals. If future circuit courts disagree with the Fourth Circuit, it could set up a conflict among the courts and result in a U.S. Supreme Court decision over just how much taxpayers like the Horowitzes have to pay when they recklessly fail to file FBARs disclosing foreign bank accounts.

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

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