11th Circuit Rules Some (Not All) FBAR Penalties Unconstitutional
Penalties for willful failure to file reports of foreign financial accounts – commonly called FBARs – are some of the highest civil penalties the government can impose. But until now, no court had been willing to say those fines were excessive. In United States v Schwarzbaum, the Eleventh Circuit did just that, ruling some (not all) FBAR penalties unconstitutional as applied to the facts of the case. The decision could open the door to additional constitutional challenges to willful FBAR penalties, or even the Bank Secrecy Act as a whole.
Schwarzbaum Returns to the Eleventh Circuit Court
This blog has covered United States v Schwarzbaum twice before: at the district court level, and in Mr. Schwarzbaum’s first appeal. The case involved over $12.5 million in willful FBAR penalties imposed by the IRS for Mr. Schwarzbaum’s failure to disclose bank accounts in Switzerland and Costa Rica.
Mr. Schwarzbaum was a German-born naturalized citizen of the U.S. Most of his money came from inheritances and gifts from his German father. Initially, Schwarzbaum hired a CPA to file his annual tax returns and was advised – incorrectly – that he did not have to report any bank accounts without a U.S. connection. But in 2007, Mr. Schwarzbaum decided to file his tax return, and an FBAR, himself. He read the FBAR instructions and filled out the form, applying the bad advice he’d received from his CPA in years past. In 2010, after his father died, Mr. Schwarzbaum discovered he was required to disclose all his overseas accounts, and enrolled for the now-closed Overseas Voluntary Disclosure Initiative. When he later withdrew from the program, the IRS imposed willful FBAR penalties equal to $100,000 or 50% of the highest account balances for each year between 2006 and 2009.
In the district court, the judge determined that there was no willful violation in 2006, since Mr. Schwarzbaum was relying on his CPA, but once he read the FBAR instructions, he had recklessly failed to disclose all his foreign financial accounts. The district court also determined that the IRS had used the wrong account balances in calculating the penalty, and entered a judgment based on its own calculations totaling $12,907,952. That decision also rejected Schwarzbaum’s request that it find the FBAR penalties unconstitutional and excessive fines.
Mr. Schwarzbaum appealed. The Eleventh Circuit Court upheld the district court’s decision that his FBAR violation was willful. However, it determined that the district court should not have imposed its own penalty. Instead, it should have remanded the matter back to the IRS for a new calculation. Because the final amount was still in question, the Eleventh Circuit did not address whether the FBAR penalties were unconstitutionally excessive.
On remand, the IRS provided a new calculation of more than $13.5 million – 7.7% higher than the original assessment, but asked the district court to maintain the $12.5 million judgment. The district court granted the request, and the case was appealed again, returning to the Eleventh Circuit for a second time.
Eleventh Circuit Finds FBAR Penalties are Fines, Constitutionally Speaking
This time, the Eleventh Circuit ruled on the biggest issue first: whether FBAR penalties were fines subject to the U.S. Constitution’s 8th Amendment. The amendment states:
“Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.”
The First Circuit had addressed the same issue in 2022, in United States v Toth. That Court held that the 8th Amendment didn’t apply because the FBAR penalties were “remedial” rather than “punitive” in nature.
But the Eleventh Circuit disagreed. Its decision traced the history of excessive fines back to the English Bill of Rights, the Magna Carta, and even the Charter of Liberties of Henry I, issued in 1101, showing “a centuries-long tradition English tradition prohibiting disproportionate fines.” That prohibition was not even controversial when it was made part of the 8th Amendment. Because of this, the Supreme Court didn’t address the Excessive Fines Clause until 1989. While the constitution was held not to apply to private civil actions in that first case, it was later applied to the government’s power to extract payments as punishments in both civil and criminal contexts, and in civil forfeiture cases. To escape constitutional scrutiny, a penalty must “fairly be said solely to serve a remedial purpose” – removing dangerous or illegal items from society or compensating the government for a loss or costs related to enforcing the laws.
This is where the First and Eleventh Circuit split. The First Circuit said the FBAR penalties were remedial because they compensated the government for the cost of enforcing international tax law. But the Eleventh Circuit said the purpose of FBAR penalties was at least partially a punishment. It looked at the stated purpose of the FBAR penalties, along with the legislative statements that willful FBAR penalties were designed to increase compliance with the reporting requirements. It also noted that the maximum penalty – $100,000 or 50% of the balance – was unrelated to the cost of investigating the case. Instead, the ceiling is tied to the size of the bank account and requires the same culpable state of mind as criminal penalties in the same statute. Finally, the Eleventh Circuit found that willful FBAR penalties were steep, noting “We are aware of no comparable civil penalty in any other statute and none has been cited to us.” The Court said this was plainly designed as a deterrent. Therefore, the penalty was at least partially punitive, and the 8th Amendment applied.
Court Rules Some (Not All) FBAR Penalties Unconstitutional
Next, the Eleventh Circuit had to determine whether the FBAR penalties assessed against Schwarzbaum were excessive fines under the 8th Amendment. Mr. Schwarzbaum did not challenge the statutory penalty as a whole, only as it applied to his own case. Thus, the Court did not strike down willful FBAR penalties generally. Instead, it looked at each penalty imposed against Mr. Schwarzbaum individually. It found the three $100,000 penalties imposed on an account with a maximum balance of $16,000 excessive, noting that the penalties were more than 8 times the balance of the account. However, because the remainder of Mr. Schwarzbaum’s accounts had balances of over $2 million, the Court declined to strike down penalties related to those accounts. In the end, it found only 3 FBAR penalties unconstitutional, and reduced Mr. Schwarzbaum’s assessment by $300,000 to $12,255,813, plus late fees and interest.
The Schwarzbaum decision is important for two reasons. First, in disagreeing with Toth, the Eleventh Circuit created a split in the circuit courts’ ruling on this issue. Toth was already appealed to the U.S. Supreme Court, which declined to hear the case with Judge Gorsuch dissenting. The Schwarzbaum opinion quoted that dissenting opinion. This creates a high chance that the issue will come before the Supreme Court in the future.
In the meantime, the Schwarzbaum decision provides precedent for challenging willful FBAR penalties assessed against smaller accounts. Where the IRS’s penalties are significantly greater than the balance of accounts on which they are imposed, the Eleventh Circuit’s decision suggests that those FBAR penalties are unconstitutional, and should be struck. In addition, the Schwarzbaum decision seems to invite future cases questioning the constitutionality of the FBAR penalty structure as a whole, which could substantially reduce the amount taxpayers have to pay for failing to disclose their financial accounts.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 35 years experience. If you have questions regarding FBAR requirements or penalties, contact Joe Viola to schedule a consultation.