Sixth Circuit Holds That the Willful FBAR Penalty Applies to Reckless Conduct

(Parker Tax Publishing February 2024)

The Sixth Circuit, joining every other circuit court to have addressed the issue, held that a willful violation of the requirement to file a Report of Foreign Bank and Financial Accounts (FBAR) includes both knowing and reckless violations. The court found that a taxpayer who opened a Swiss bank account, did not seek professional advice about his reporting obligations regarding the account, and failed to inquire whether his FBARs were being prepared and filed after becoming aware of his reporting requirements, recklessly if not knowingly failed to comply with his FBAR obligations. Kelly v. U.S, 2024 PTC 39 (6th Cir. 2024).

Background

James Kelly is a United States citizen. In 2008, Kelly closed his domestic bank accounts and opened an interest-bearing account at Finter Bank in Zurich, Switzerland. He designated the Finter account as "numbered" so that his name would not appear on the statements. He also requested that Finter retain, rather than mail him, any account-related correspondence. Kelly completed a "Tax Form U.S. Withholding/Individual" when he opened this account, which informed him that "persons liable to U.S. taxation can only continue to invest in U.S. securities if they disclose their identity to the IRS by filing a form W-9." Instead of providing an IRS Form W-9 and disclosing the account to the IRS, Kelly chose to divest from U.S. securities.

Kelly never sought professional or legal advice about "federal reporting obligations or requirements in regard to the Finter account" or "potential tax implications," and he never confirmed with Finter whether it was reporting his account to the federal government. He did, though, ask the bank whether it would respond to IRS requests, and Finter told Kelly that the "IRS [would] have to go via Swiss Authorities." Between 2013 and 2015, Kelly maintained a balance of around $1.5 million in the Finter account.

In July 2012, Finter closed Kelly's account after he failed to provide it with U.S. tax compliance documentation. The bank reopened his account a few months later but designated it as "Mandatory High Risk" and blocked any incoming and outgoing transactions. Internal bank documents suggest that "US authorities most probably are not aware of these assets ... since the client is not properly documented for US tax purposes." In December 2013, Finter sent Kelly a letter again requesting proof of Kelly's compliance with U.S. tax laws, including copies of his Report of Foreign Bank and Financial Accounts (FBAR) forms for all years during which the account was open. The bank warned Kelly that it would be required to provide the U.S. Justice Department information concerning his account, and urged him to contact a qualified tax professional.

In April 2014, a few months after receiving the December 2013 letter from Finter, Kelly requested to participate in the IRS Offshore Voluntary Disclosure Program (OVDP) for the years 2008 through 2013. Kelly admitted that he was aware of his FBAR reporting obligations at that time. The IRS preliminarily accepted Kelly's voluntary disclosure but informed him that acceptance depended on him making truthful disclosures, cooperating with the IRS, and trying in good faith to satisfy his tax obligations. Around this same time, Kelly closed his Finter account. With the help of a Swiss advisor, Kelly opened a new account with Bank Alpinum in Liechtenstein and transferred all of the Finter funds there. In December 2016, more than two years after he became aware of his FBAR obligations, Kelly filed delinquent FBARs for the years 2008 through 2013. He did not file any FBARs for 2014 or 2015.

In 2018, Kelly submitted a Form 433-A, Collection Information Statement, to the IRS under penalty of perjury. The form asked him to list his personal bank accounts; he did not include his account with Bank Alpinum. Later that year, the IRS removed Kelly from the OVDP, in part because he failed to provide information about his foreign assets. The IRS then began investigating Kelly's compliance with FBAR requirements. It determined that he failed to meet the requirements of 31 U.S.C. Sec. 5314 by willfully failing to timely file FBARs from 2013 through 2015, and proposed penalties for those years totaling $769,126.

The government initiated an action against Kelly after he failed to pay the FBAR penalties assessed against him. In U.S. v. Kelly, 2023 PTC 113 (E.D. Mich. 2023), a district court held that Kelly willfully failed to file his FBARs. Kelly appealed to the Sixth Circuit.

Under the Bank Secrecy Act, American citizens with interests in foreign financial accounts exceeding $10,000 must annually file an FBAR with the Treasury Department. Civil penalties may be imposed on an individual who fails to file an FBAR by the deadline. Under 31 U.S.C. Sec. 5321(a)(5)(B), the penalty is up to $10,000 if the failure to file an FBAR is not willful. However, for any person willfully violating the FBAR requirement, 31 U.S.C. Sec. 5321(a)(5)(C) increases the maximum penalty to the greater of $100,000 or 50 percent of the balance in the account at the time of the violation. The Treasury Secretary has delegated authority to the IRS to enforce the FBAR requirements, which includes investigating potential violations, and assessing and collecting penalties.

Before deciding this case, the Sixth Circuit had not yet addressed what "willfully" means in the context of a civil penalty for an FBAR violation. In Safeco Insurance Company of America v. Burr, 551 U.S. 47 (S. Ct. 2007), the Supreme Court held that "where willfulness is a statutory condition of civil liability," it encompasses "not only knowing violations of a standard, but reckless ones as well."

Analysis

The Sixth Circuit held that, for purposes of an FBAR civil penalty, a willful violation of the FBAR reporting requirements includes both knowing and reckless violations. In so holding, the Sixth Circuit joined every other circuit to have addressed this issue (i.e., the Eleventh Circuit in U.S. v. Rum, 2021 PTC 120 (11th Cir. 2021); the Federal Circuit in Kimble v. U.S., 2021 PTC 75 (Fed. Cir. 2021); the Fourth Circuit in U.S. v. Horowitz, 2020 PTC 410 (4th Cir. 2020); and the Third Circuit in Bedrosian v. U.S., 2018 PTC 427 (3d Cir. 2018)).

Next., the court considered whether Kelly, at a minimum, acted recklessly in failing to adhere to his FBAR obligations. The court found that a reasonable factfinder could reach only one conclusion - Kelly's conduct in failing to comply with his FBAR obligations was reckless, if not knowing.

The court explained that recklessness requires proof of more than negligence. According to the court, in the context of a civil FBAR penalty, the government can establish a willful violation based on recklessness by proving that the taxpayer (1) clearly ought to have known that (2) there was a grave risk that an accurate FBAR was not being filed and that (3) he was in a position to find out for certain very easily.

In the court's view, the evidence was undisputed that Kelly willfully failed to timely file FBARs for 2013 through 2015. For one, the court found that he took steps to intentionally evade his legal duties. Kelly designated his Finter account as "numbered" so that his name would not appear on the statements, and he requested that the bank retain any account-related correspondence. In the court's view, these efforts showed more than mere negligence. The court noted that Kelly also shielded his account from U.S. authorities by opting out of investing in U.S. securities, which would have required him to file a Form W-9 with the IRS. Moreover, the court found that Kelly's subsequent statements to the IRS about his foreign assets were found to be false and incomplete.

The court went on to find that Kelly's conduct was, at any rate, objectively reckless. The court noted that Kelly did not seek professional advice about his reporting obligations or the potential tax implications of the assets in his Swiss account. Kelly also did not confirm with Finter whether it would report his assets to U.S. authorities. Further, after Kelly applied to participate in the OVDP and became aware of his reporting obligations, he still failed to inquire whether his FBARs were being prepared and filed. The court noted that Kelly never consulted a tax advisor or an attorney. In the court's view, given that he ought to have known about the risk of noncompliance, and could have found out by simply asking, his failure to disclose was, at the very least, reckless.

Kelly's participation in the OVDP did not, in the court's view, entitle him to a penalty under the non-willful standard. The court observed that Kelly failed to provide the government with information about his foreign assets and he was ultimately removed from the program for his noncompliance. The evasive actions Kelly took while participating in the OVDP, the court found, largely negated his theory that he intended to remedy his reporting failures. Further, the court did not think that Kelly's decision to engage a Swiss account manager excused his noncompliance. The court noted that Kelly could not recall the advisor ever telling him that the 2014 or 2015 had been filed, and Kelly never asked anyone else to prepare these forms.

The court concluded that Kelly knew about his foreign account, undertook considerable efforts to keep it secret, did not consult with any professionals about his tax obligations, and then failed to ensure that the FBARs were submitted after learning he had not met the reporting requirements in the past. Given all of this, the court found that Kelly's failure to satisfy his FBAR requirements for the years 2013, 2014, and 2015 was a willful violation of the Bank Secrecy Act.

For a discussion of the information reporting requirements for foreign bank accounts, 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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