Ninth Circuit Upholds Reckless FBAR Penalties Against Tax Preparer

The Ninth Circuit – known as one of the most taxpayer friendly of the federal circuit courts – has joined many other courts in holding that reckless violations of the Bank Secrecy Act were sufficient to uphold willful FBAR penalties. The Court affirmed the IRS’s reckless FBAR penalties and said it was entitled to prejudgment and penalty interest, as long as it recalculated those penalties to exclude certain bank errors. The decision demonstrates a growing consensus among the courts that intentional and reckless behavior will both result in higher penalties against taxpayers who fail to file FBARs disclosing foreign financial accounts.

Tax Preparer and International Winery Owner Faces Reckless FBAR Penalties

Taxpayer Timberly Hughes provided bookkeeping services for a $1 billion family trust, along with aiding others in tracking the basis of financial assets and preparing their tax returns. She also owned a winery in New Zealand since 2001, and maintained bank accounts in that country related to that business. In 2013, she opened a wine bar under a separate limited company, also in New Zealand. She was the sole owner of both companies with control over their bank accounts at ANZ Bank New Zealand Limited.

IRS Says Tax Preparer’s Failure to File FBARs was Willful

Hughes, a tax preparer, disclosed the existence of her New Zealand bank accounts on her 2012 annual tax return. She also completed that section of her tax return (albeit incorrectly) in 2013. However, between 2010 and 2013, she failed to file the additional FBARs as required by the Bank Secrecy Act. As has been discussed repeatedly on this blog, the Bank Secrecy Act requires U.S. taxpayers to file an annual report known as the Report of Foreign Bank and Financial Accounts (“FBAR”) if they have bank accounts worth an aggregate of at least $10,000 in another country. The penalty for failing to file FBARs is up to $10,000, but if the IRS determines that the failure to file was willful, the penalty increases to the greater of 50% of the account balance at the end of the year.

In Hughes’ case, the IRS determined that that failure was willful and imposed $678,899 in willful FBAR penalties. When Hughes did not pay those penalties, the IRS sued to collect them, and requested prejudgment interest and late payment penalties.

After the case went to trial in October 2021, the District Court determined that Hughes’ failure to file was willful because it was the result of “recklessness or willful blindness.” This adopted the standards of the Third and Fourth Circuit Courts and multiple district courts across the country. The District Court noted that, by answering the question about foreign financial accounts on her tax returns in 2012 and 2013, the taxpayer had “at least the basic instructions” that she was required to file FBARs. Failing to do so after being so informed was reckless, and willful FBAR penalties applied. However, the District Court held that there was no evidence that Hughes knew about the filing requirement in 2010 or 2011, so only non-willful penalties could be imposed for the earlier two years.

Ninth Circuit Says Recklessness is Enough to Impose Willful FBAR Penalties

Both parties appealed the District Court’s ruling – Hughes on the question of reckless FBAR penalties, and the IRS on the question of whether the government is entitled to prejudgment interest and late payment penalties. On appeal, Hughes argued that the IRS should have been required to prove she had the subjective intent not to file her 2012 and 2013 FBARs before willful penalties could be imposed. Essentially, she was arguing that reckless FBAR penalties were inappropriate.

The Ninth Circuit applied the reasoning of a Supreme Court case, Safeco Insurance Co. of America v. Burr, from a different civil context, holding:

“[F]or the purposes of civil penalties for failure to report foreign bank accounts, ‘willfulness’ can be shown by proof of objective recklessness as well as subjective intent.”

It noted that Hughes’s argument would require the Court to “break with the Third, Fourth, Sixth, Eleventh, and Federal Circuits and hold that Safeco’s reasoning does not apply to the FBAR statute.” Even though Safeco interpreted the Fair Credit Reporting Act, the Ninth Circuit found that its reasoning around reckless violations of civil laws applied just as well to civil FBAR penalties. It applied the standard that, for purposes of civil liability – rather than criminal charges – “not only knowing violations of a standard, but reckless ones as well.”

The Court refused Hughes’s efforts to cast reckless FBAR penalties as punitive, as well as her argument that by that standard almost every failure to file FBARs could be deemed willful, making the non-willful penalty superfluous. It said this conflated the ideas of mere negligence and civil recklessness, which required something more:

“[T]hat (1) the filer “clearly ought to have known that there was a grave risk that” the filing requirement was not being met, and (2) the filer “was in a position to find out for certain very easily.”

The Ninth Circuit said the District Court had not found mere negligence. Instead, Hughes’ failure to file FBARs in light of responses on her tax returns were “inconsistent” and “not credible.” It also noted that the District Court had found she was merely negligent in 2010 and 2011 and imposed the lower penalty.

In a separate decision, the Ninth Circuit determined that the IRS was allowed to impose prejudgment interest and late penalties on the corrected reckless FBAR penalty, holding that Hughes was required to pay the IRS $238,125.19, less than half the amount originally imposed.

With even the Ninth Circuit agreeing that reckless FBAR penalties can be upheld, it becomes more important than ever for taxpayers with foreign financial accounts to work with knowledgeable tax preparers and tax attorneys in preparing their tax returns and FBARs. With defenses to willful FBAR penalties narrowing, it is best to disclose assets the first time and avoid unnecessary penalties, interest, and late fees.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 35 years experience. If you have questions regarding reckless FBAR penalties, contact Joe Viola to schedule a consultation.