Miscalculated Willful FBAR Penalties Create Problems for the Court
What happens when a court decides the IRS miscalculated willful FBAR penalties? Will the penalty be forgiven? Is it the court’s job to fix the math errors, or should it remand the matter to the IRS to recalculate? And could that miscalculation actually leave the taxpayer paying more even after winning the appeal?
Taxpayer Fails to File FBAR Reports for Accounts Without “U.S. Connection”
Isac Schwarzbaum was a naturalized U.S. citizen originally from Germany. He lived in the U.S. since the mid-nineties. However, in the early 2000s, he opened and maintained bank accounts in Switzerland and Costa Rica.
In 2006, his CPA gave him some bad advice. He said Schwarzbaum only had to report foreign financial accounts with a “U.S. connection.” That was false. U.S. citizens are required to report all foreign financial accounts if their aggregate value exceeds $10,000 at any time during the calendar year, whether they are connected to the U.S. or not. Still, Schwarzbaum’s CPA prepared and filed an FBAR listing only a single Costa Rican account. In 2007, Schwarzbaum followed his example, self-preparing and filing a similar FBAR with one account listed. He skipped filing an FBAR in 2008 altogether, and then only listed one Swiss account and two Costa Rican accounts in 2009. In 2011, Schwarzbaum talked to a tax attorney, who recognized the error. He then voluntarily disclosed the missing foreign accounts to the IRS, along with their balances.
IRS Miscalculated Willful FBAR Penalties for Unreported Accounts
Based on those disclosures, the IRS determined that Schwarzbaum had committed a willful violation of the FBAR filing requirements. It found a total potential willful FBAR penalties of $35,416,667, but eventually mitigated that penalty to $13,729,591: the sum of $1,173,778 for tax year 2006 and $4,185,271 each for tax years 2007, 2008, and 2009.
However, in so doing, the IRS miscalculated willful FBAR penalties. It started with the highest annual balance for each account in each of the relevant tax years. If an account balance was above $1 million, the IRS divided that balance in half, applying the statutory maximum penalty. For balances below $1 million, the IRS applied the mitigation formula in the Internal Revenue Manual. It then added all these up and further mitigated the penalties by dropping the 2006, 2007, and 2009 penalties, and spreading the 2008 penalties (totallying $13,729,591) across all four tax years.
Reliance on “U.S. Connections” Rather than Reading Instructions was Reckless, Court Says
Schwarzbaum appealed, and the matter ultimately went to court before the United States District Court for the Southern District of Florida. The judge there determined that Schwarzbaum’s 2006 FBAR violations were non-willful, since his CPA had prepared and filed the form. However, from 2007 forward, willful FBAR penalties applied because he had presumably read the instructions in completing his 2007 FBAR, and recklessly disregarded the risk of not disclosing his foreign accounts without U.S. connections.
District Court Clarifies FBAR Penalties are Calculated Based on Filing Date
The District Court also found that the IRS had miscalculated the Willful FBAR penalties it assigned for those years. That is because the IRS calculated the penalties based on the accounts’ highest balance in the tax year, rather than the balance in the account “at the time of the violation.” For the years in question, FBAR penalties were due on June 30 (it is now April 15). Therefore, the appropriate calculation would be based on each account’s balance as of June 30 of the year following the FBAR’s tax year.
After determining the IRS had miscalculated Schwarzbaum’s willful FBAR penalties, the District Court asked each party to submit briefs on the correct calculation. The District Court then, on its own initiative, calculated and imposed new FBAR penalties against Schwarzbaum:
- $4,498,486 in 2007
- $4,212,871 in 2008
- $4,196,595 in 2009
The total was $12,907,952. The IRS actually objected, filing a motion to amend or alter the judgment, because the District Court’s calculations ended up higher than the original willful FBAR penalty imposed. The District Court granted the motion, and Schwarzbaum was left with just as large an FBAR penalty as when he started.
Circuit Court Says District Court’s Recalculations “Invaded the Agency’s Turf”
So Schwarzbaum appealed again. The 11th Circuit Court agreed with the District Court regarding applying willful FBAR penalties to reckless failures to file. It also agreed that the IRS “took the wrong fork” and had miscalculated willful FBAR penalties by starting from the wrong balances. That error was not harmless because it carried forward through all the IRS’s later calculations.
However, the Circuit Court disagreed with where the District Court went from there. It said:
The district court lacked the power to recalculate Schwarzbaum’s FBAR penalties. … Courts do not have ‘original calculation’ jurisdiction over FBAR penalties. That power belongs to the IRS. … By replacing the IRS’s penalty calculations with its own, the district court invaded the agency’s turf.
What the District Court should have done, the Court said, was remand Schwarzbaum’s FBAR penalties to the IRS for recalculation.
Carefully Consider the Cost of Miscalculated Willful FBAR Penalties Before Filing Suit
The Circuit Court recognized that this remand could end up being more expensive for Schwarzbaum in the end:
On remand, if the IRS calculates Schwarzbaum’s penalties using his accounts’ June 30 balances rather than their highest annual balances, the statutory maximum penalties could very well be lower. If the IRS chooses to mitigate Schwarzbaum’s penalties, as it did originally, the mitigated penalties could be lower too. That is not to say the penalties will be lower. We do not presume to guess what the IRS will do.
This shows how important it is to carefully consider all possible outcomes of a potential tax appeal or lawsuit. Even if you win part of your appeal, there is a chance that, like Schwarzbaum, you could end up facing higher penalties in the end. If the IRS miscalculated willful FBAR penalties on your behalf but then mitigated that penalty, it may not be worth the risk that you could win your appeal only to end up paying more.
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.