Taxpayer's Conduct in Violating FBAR Rules Was Reckless; Higher Penalties Apply

(Parker Tax Publishing December 2020)

On remand from the Third Circuit, a district court held that a taxpayer's failure to report his foreign bank account to the IRS on a Report of Foreign Bank and Financial Accounts (FBAR) was willful because the taxpayer's conduct was reckless from an objective point of view. The district court found that its prior analysis was focused almost entirely on the taxpayer's subjective intent and did not adequately consider whether the evidence warranted a conclusion that the taxpayer acted either knowingly or recklessly in failing to report his foreign account on an FBAR. Bedrosian v. U.S., 2020 PTC 374 (E.D. Pa. 2020).

Background

Arthur Bedrosian, a successful businessman in the pharmaceutical industry, had a savings account with Union Bank of Switzerland (UBS) beginning in the 1970s. Bedrosian did not tell his accountant and tax return preparer, Seymour Handleman, about his Swiss account until sometime in the mid-1990s, at which point Handleman told Bedrosian that he had been breaking the law every year that he did not report the account on his tax return. In 2005, Bedrosian opened a second bank account with UBS.

Handelman died in 2007, and Bedrosian began filing his taxes through a new accountant, Sheldon Bransky. Bransky prepared Bedrosian's 2007 tax return, on which he indicated that Bedrosian owned a foreign bank account. Bransky also prepared a Report of Foreign Bank and Financial Accounts (FBAR), which identified one of Bedrosian's two accounts at UBS. The account identified had assets totaling approximately $240,000, while the account omitted had assets totaling approximately $2 million. Bedrosian signed but did not review the 2007 return and FBAR.

In 2011, the IRS began an audit of Bedrosian's tax returns. In 2015, the IRS assessed against Bedrosian a penalty for willfully failing to disclose the larger UBS account on his 2007 FBAR. The penalty assessed was equal to the statutory maximum of approximately $975,000, which was 50 percent of the undisclosed account. Bedrosian paid 1 percent (approximately $9,750) of the penalty and then sued in a district court to recover the payment as an unlawful exaction. The government counterclaimed for the full penalty amount plus interest and a late payment penalty.

Under 31 U.S.C. Section 5314(a), an FBAR is required for any interest in a foreign bank account. Failure to timely file an FBAR for each foreign account over $10,000 results in a penalty under 31 U.S.C. Section 5321. The penalty for a nonwillful FBAR violation cannot exceed $10,000, whereas a willful FBAR violation results in a penalty equal to the greater of $100,000 or 50 percent of the account balance.

In Bedrosian v. U.S., 2017 PTC 431 (E.D. Pa. 2017), the district court concluded that the government had failed to establish Bedrosian's willfulness. The government appealed to the Third Circuit, arguing that the district court used an incorrect legal standard for willfulness, because it placed too much weight on Bedrosian's subjective motivations. The Third Circuit agreed with the government and, in Bedrosian v. U.S., 2018 PTC 427 (3d Cir. 2018), held that the district court's findings and conclusions did not contain a sufficiently clear consideration of all the relevant facts in making a conclusion that Bedrosian's conduct was not willful. The Third Circuit found that a person commits a reckless FBAR violation by engaging in conduct that violates an objective standard: action entailing an unjustifiably high risk of harm that is either known or so obvious that it should be known. The Third Circuit referenced the test for recklessness in other tax contexts as the test that should be applied here, holding that a person recklessly fails to comply with an IRS filing requirement when he or she (1) clearly ought to have known that (2) there was a grave risk that the filing requirement was not being met and (3) he or she was in a position to find out for certain very easily. The Third Circuit therefore remanded the case back to the district court to determine whether Bedrosian's conduct satisfied the objective recklessness standard.

District Court's Analysis

On remand, the district court vacated its prior judgment, supplemented its prior findings and conclusions, and entered judgment for the government. The district court found that Bedrosian's actions were willful because he recklessly disregarded the risk that his FBAR was inaccurate. The court noted that the concept of willfulness encompasses both knowing and reckless conduct and that, as the Third Circuit emphasized, in the law of taxation, reckless conduct can be violative of IRS statutes and/or rules, from an objective point of view, even if not "willful" from a subjective point of view.

The district court's supplemental findings of fact included the following evidence which, in the court's view, supported a finding that Bedrosian's conduct was reckless. The court found that Bedrosian's cooperation with the government (which the court previously emphasized as negating willfulness) began only after he was exposed as having hidden foreign accounts. The court found that shortly after filing the 2007 FBAR, Bedrosian sent two letters to UBS directing the closure of two accounts, but only one of these accounts had been disclosed on his FBAR. The second account was moved to a different Swiss bank and the funds were not repatriated to the United States. The court noted that Bedrosian saw a newspaper article about the federal government tracing mail coming into the United States from foreign banks and was therefore alerted to the possibility of the United States finding out about his foreign bank accounts if UBS sent information through the mail. The court found that Bedrosian paid for a "mail hold" service with respect to his Swiss accounts, the purpose of which was to prevent correspondence from the foreign bank being tracked by the IRS. Finally, the court found that Bedrosian acknowledged that he was aware of the significant amount of money held in his foreign bank accounts.

After following the Third Circuit's order to review other cases in which taxpayer conduct was found to be willful because it satisfied an objective standard of recklessness, the district court found that a Fourth Circuit case involving an FBAR violation, U.S. v. Horowitz, 978 F.3d 80 (4th Cir. 2020), was the most factually similar to this case. In Horowitz, the Fourth Circuit found several circumstances which warranted a finding of willfulness. The Fourth Circuit found that the taxpayers knew their interest income from domestic bank accounts was taxable and that their foreign income was taxable, and reasoned that it would make no sense to conclude that foreign interest was not taxable. The Fourth Circuit found that the foreign account was set up with hold mail service, which the bank knew would assist U.S. clients in concealing assets and income from the IRS. In addition, the Fourth Circuit noted that the amounts in the foreign account were significant and thus not susceptible to being overlooked. Finally, the Fourth Circuit noted that the taxpayers answered "no" to a question on their tax returns asking whether they had a foreign bank account. The Fourth Circuit found that, even if they did not review the returns, the taxpayers signed them under penalties of perjury.

In the instant case, the district court found that Bedrosian knew about the FBAR requirement because his prior accountant told him about it. The district court also noted that, like the taxpayers in Horowitz, Bedrosian used hold mail services. The district court found that the Horowitzes had a significant amount of money in their accounts, which meant the accounts were not easily overlooked, and the amount in their account was comparable to the amount in Bedrosian's accounts. The district court noted that Bedrosian also claimed to not have reviewed his FBAR closely but, like the Horowitzes, he signed the form.

The district court observed that, while the majority of cases applying the recklessness test do not concern FBAR filings, they emphasize the importance of how an individual's general awareness of a business's operations can impact the analysis of willfulness. When a taxpayer is responsible for reviewing tax forms and signing checks, the court said, the taxpayer is responsible for errors that would have been apparent had they reviewed such forms and checks closely. Thus, the court said that if Bedrosian, a successful and sophisticated businessman, had looked at the forms he signed, it was reasonable to conclude that he should have noticed the amount stated for the accounts was not accurate. Further, the court found that even if Bedrosian did not know that there were two accounts, the stated amount on the FBAR he signed should have prompted him to investigate further, which he could have done easily by contacting the bank. The court found that, based on Third and Fourth Circuit precedent, claiming to not have reviewed the form did not negate recklessness. Thus, the court inferred that Bedrosian had reason to know of his second overseas account and that he did not disclose it.

For a discussion of the reporting requirements for foreign bank accounts and the penalties for not correctly reporting such amounts, see Parker Tax ¶203,170.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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