A question appears at the bottom of Schedule B (Interest and Dividend Income) of the Form 1040 (U.S. Individual Income Tax Return) that asks individual taxpayers if during the taxable year they had any interest in or signature or other authority over a bank, securities, or other financial account in a foreign country during the tax year.  Based upon a review of historical tax forms, the question first appeared on the 1976 Schedule B.  The historic Form 1040 instructions for 1976 and 1977 indicate that the FBAR was originally a designated a Form 4683 for 1976 and subsequently revised and renumbered as the Form 90-22.1 in 1977.

For many years, the rate of FBAR compliance was quite low.  In 2002, the Treasury Department issued a report to Congress in which it estimated the level of FBAR compliance at less than 20%.  In 2003, the IRS and the Financial Crimes Enforcement Network (“FinCEN”) collaborated to better enforce the FBAR requirement, and the IRS developed the 2003 Offshore Voluntary Compliance Initiative.  Subsequently, the American Jobs Creation Act of 2004 (the “AJCA”) included a statutory change that significantly increased the penalty for willful FBAR failures.  Specifically, 31 U.S.C. § 5321(a)(5)(C) increased the penalty for willful FBAR failures to the greater of $100K or 50% of the account balance.  Non-willful failures are subject to much lower penalties with a reasonable cause exception for situations warranting abatement.  Although the AJCA increased the statutory rate of penalties for willful FBAR failures, Treasury has not revised the the related regulations that were issued prior to the statutory change.  Therefore, the regulations continue to provide that the statutory maximum penalty for willful failures is $100,000.

FBAR compliance became an increasing enforcement focus after the statutory change when it became evident that FBAR noncompliance often signaled the failure to pay income taxes on offshore investment earnings.  In 2006, the IRS estimated the annual tax gap at $450 billion, which prompted attention and enforcement discussions on Capitol Hill, and enforcement activity soon increased, including criminal prosecutions and large penalty assessments.  Court challenges to the penalty assessments have followed with some gaining traction in recent years.  As discussed in the case summaries below, a dispute regarding the appropriate amount of such penalties has developed based in large part on the difference between the penalty statute and the regulations. Based upon differences in judicial interpretations of the effect of Treasury’s failure to update the regulatory maximum penalty for willful failures, the potential for a circuit split regarding the FBAR willfulness penalties could develop, making the issue ripe for potential Supreme Court review.

United States v. Wahdan (D. Col. 2018) and United States v Colliot (W.D. Tex 2018).  In Wahdan and Colliot, a U.S. District Court in the Tenth Circuit and another in the Fifth Circuit, respectively, concluded that the IRS could not assess penalties greater than $100K based upon the language of the regulations (31 C.F.R. § 1010.820(g)) notwithstanding the fact that Congress amended 31 U.S.C. § 5321(a)(5)(C) after the date Treasury issued the regulations.  The courts explained that for a statute to supersede a regulation, the statutory change must be clearly inconsistent with the preexisting regulation.  The courts found that the statute in question retained permissive language applicable to the assessment of penalties for willful FBAR failures (“may assess” and “may impose”), and that the statutory language remained consistent with the language of the applicable penalty regulations.  Accordingly, the courts concluded that the Secretary’s own regulations limited the penalties the IRS could impose for such failures to $100K.  The courts also signaled that the Treasury could amend its regulations, but it did not do so, so the regulations remain in effect and limit willful penalty assessments.

United States v. Garrity, No. 2019-1145 (2d. Cir.).  As we discussed in an earlier post regarding Garrity, the U.S. District Court for the District of Connecticut rejected arguments made by the fiduciaries of Garrity’s estate that the FBAR willfulness penalties should be limited to $100,000 based upon the application of the regulations.  The fiduciaries also argued that that the penalties were excessive and violate the Eighth Amendment.  The estate fiduciaries appealed to the Second Circuit in April 2019.

Norman v. United States, No. 2018-2408 (Fed. Cir.).  Norman is appealing a July 2018, judgment from the U.S. Court of Federal Claims denying a refund for FBAR penalties paid.  On brief, Norman argues that, notwithstanding some conflicting decisions, the applicable regulations cap the amount of the penalty for a willful FBAR violation at $100,000.  In addition, Norman asserts that the Court of Federal Claims erred in concluding that the failure was willful, and that the FBAR penalty violates the Eighth Amendment.

Kimble v. United States, No. 2019-1590 (Fed. Cir.).  Kimble is appealing a December 2018 judgment from the U.S. Court of Federal Claims granting the government’s motion for summary judgment and dismissing her petition for a refund of FBAR penalties paid.  On brief, Kimble argues that the FBAR willfulness penalty should be capped under the applicable regulations, that the lower’s courts finding of willfulness was erroneous and relied on an overly broad interpretation of the willfulness standard, that the IRS improperly refused to mitigate penalties based on the facts of the case, and that the FBAR penalty violates the Eighth Amendment.

 United States v. Horowitz, No. 2019-1280 (4th Cir.).  Mr. and Mrs. Horowitz are seeking reversal of the District of Maryland’s grant of summary judgment for the government that the Horowitzes’ FBAR violation was willful.  On appeal, the Horowitzes argue that the issue of whether the FBAR violation was willful needed to be resolved at trial and could not be decided on summary judgment.  In addition, the Horowitzes argue that the amount of the FBAR willfulness penalty is capped by the regulations, and that the court erred in rejecting the Horowitzes statute of limitations defense.