Eleventh Circuit: FBAR Penalties Violated Eighth Amendment's Excessive Fines Clause

(Parker Tax Publishing September 2024)

The Eleventh Circuit held that penalties of $100,000 imposed on a taxpayer for each of the three years at issue for willfully failing to report his interest in foreign bank accounts by filing a Report of Foreign Bank and Financial Accounts (FBAR) were excessive fines under the Eighth Amendment. The court found that the willful FBAR penalty is a fine because it is in substantial measure punitive in nature and concluded that, as applied to the taxpayer, the penalties were excessive because they were grossly disproportional to the gravity of the offense of failing to file an FBAR. U.S. v Schwarzbaum, 2024 PTC 309 (11th Cir. 2024).

Background

Isac Schwarzbaum was born in Germany in 1955. He has since lived in Germany, Spain, Costa Rica, Switzerland, and the United States, and he speaks English in addition to several other languages. Schwarzbaum became a legal permanent resident of the United States in 1995, and a United States citizen in 2000. From 1993 to 2010, he split his time between Costa Rica, Switzerland -- where his parents lived -- and the United States. In September 2010, Schwarzbaum moved to Switzerland and lived there full time until he returned to the United States in 2016.

Schwarzbaum's father was very successful in the textile and real estate industries in Germany, and Schwarzbaum's assets are derived from his father's gifts and bequests. In 2001, Schwarzbaum's father transferred an existing Swiss bank account into his son's name. Thereafter, Schwarzbaum's father continued to gift Schwarzbaum large sums of money until his death in 2009. After the death of Schwarzbaum's father, the money continued to be managed by bankers based upon the father's instructions, and Schwarzbaum never directed how the money should be invested or disagreed with any recommendations made by the bankers.

Between tax years 2006 and 2009, Schwarzbaum had an interest in 11 Swiss bank accounts and two Costa Rican bank accounts. As an American citizen, Schwarzbaum was subject to the reporting requirements for foreign financial accounts. Under 31 U.S.C. Section 5314 and 31 C.F.R. 100.350, each American citizen with interests in or authority over any foreign bank account with a balance exceeding $10,000 must file an annual Report of Foreign Bank and Financial Accounts form (FBAR) with the IRS identifying and describing that account.

Schwarzbaum used CPAs to prepare his tax returns in the United States. Although Schwarzbaum disclosed his foreign accounts and gifts to his CPAs, he was advised (incorrectly) that he had no duty to report these assets because they were maintained outside of the United States. Schwarzbaum's CPAs at various times filed incomplete FBARs or failed to file FBARs at all.

In 2008, however, Schwarzbaum opted to self-prepare and file an FBAR for the 2007 tax year. On this FBAR, Schwarzbaum disclosed only a single Scotiabank account: the same one he had disclosed on his 2006 FBAR (which had been prepared by a CPA). Schwarzbaum later testified that he had reviewed the instructions on the form to the best of his abilities. Schwarzbaum did not file any FBAR for 2008 until December 2011. For tax year 2009, Schwarzbaum again self-prepared an FBAR and disclosed a single Swiss account and two Scotiabank accounts, although he maintained many other undisclosed foreign bank accounts.

At some point in 2010, Schwarzbaum became aware that he was in violation of the FBAR requirements. In 2010, Schwarzbaum disclosed his financial holdings through the IRS's Offshore Voluntary Disclosure Initiative (OVDI), including 17 Swiss bank accounts and four Costa Rican bank accounts for the years 2003 to 2010. Ultimately, however, Schwarzbaum chose to opt out of the OVDI program and his case was referred to the IRS for investigation.

The IRS determined that Schwarzbaum willfully violated the FBAR reporting requirements for the 2006-2009 tax years. Under 31 U.S.C. Section 5321(a)(5)(C), the maximum penalty for a willful FBAR violation for each tax year is the greater of $100,000 or 50 percent of the account balance at the time of the violation. The IRS imposed an aggregate penalty of $12,555,813 on Schwarzbaum. That amount included a $100,000 penalty for each of the three years at issue for one account (the "Aargauische account"), the maximum balance of which never exceeded $16,000.

Schwarzbaum failed to pay the penalties and in 2018 the United States brought an action in a district court to collect them. In U.S. v. Schwarzbaum, 2020 PTC 405 (S.D. Fla. 2020), the district court concluded that Schwarzbaum had willfully violated the FBAR reporting requirements. The district court also rejected Schwarzbaum's argument that the penalties were subject to review under the Eighth Amendment Excessive Fines Clause. Schwarzbaum appealed to the Eleventh Circuit.

Analysis

The Eleventh Circuit held, as a matter of first impression, that FBAR penalties are in substantial measure punitive in nature and therefore are subject to review under the Eighth Amendment's Excessive Fines Clause. The court further held that in this case, the $100,000 in penalties levied against Schwarzbaum's Aargauische account in each of the years 2007-2009, for a total of $300,000, was grossly disproportionate to the offense of concealing that account and therefore violated the Excessive Fines Clause.

The court found that the willful FBAR penalty is punitive in nature because the text of the statute mandates that it is calculated "irrespective of the magnitude of the financial injury to the United States, if any." The court reasoned that the government can impose a $1 million penalty on a $2 million account, regardless of whether the government spent $1 million investigating the case or whether it spent nothing at all, or any number in between. The design of the FBAR penalty statute itself makes clear, in the court's view, that the severity of the penalty is tied directly to culpability. A willful violation of the FBAR statute thus has a ceiling limited only by the size of the violator's bank account, regardless of the corresponding tax liability or the time or cost spent by the government remediating the problem. The court also noted that the willfulness culpability standard, for which this high penalty is reserved, is identical to that found in the FBAR statute's criminal penalties. In other words, this civil penalty only applies to those with a culpable mindset equivalent to that of a criminal under the same statute. The court said that the severity of the willful FBAR penalty, which is imposed each year and can constitute 50 percent of the account balance on the date of the violation, also clearly bears the hallmark of punishment.

Observation: The court noted that in U.S. v. Toth, 2022 PTC 121 (1st Cir. 2022), the First Circuit heard a similar case and concluded that FBAR penalties are not subject to the Eighth Amendment Excessive Fines Clause. In the court's view, the First Circuit failed to consider that even if the FBAR penalty has some remedial purpose, the test in the Excessive Fines context is whether the purpose of the penalty is solely compensatory. Having concluded that it is not, the Eleventh Circuit was unpersuaded by the First Circuit's decision and declined the follow it.

The court found that there was little doubt that each of the $100,000 penalties was grossly disproportionate because each $100,000 fine involved an account never exceeding $16,000. The court observed that Section 5321 dictates only the maximum penalty to be imposed on each account; nothing forbade the government from assessing a penalty proportionated to the nature and extent of the violation on the Aargauishe account in each year. Instead, the government sought the statutory maximum of $100,000 each time.

The penalties assessed on the remainder of Schwarzbaum's accounts, however, raised no proportionality problems for the Eleventh Circuit. The government sought to impose the statutory maximum $100,000 fine on each of eight accounts with an unknown balance on June 30 but with a known maximum balance. The court found that although the FBAR penalty is calculated based on the June 30 reporting date, the conduct it must be proportional to is the concealment of funds found in each account the previous year, given that the duty to report under 31 C.F.R. Section 1010.306(c) is triggered not by the June 30 balance but by the prior year's maximum balance. The court noted that the lowest maximum balance for the eight accounts was $672,185 and therefore, the $100,000 imposed on those accounts was not grossly disproportionate to the offense of attempting to conceal nearly seven times the amount of the fine. On six other accounts, the IRS imposed penalties of 50 percent of the account balance on June 30. The court noted that each of these accounts held millions of dollars - in some instances, many millions of dollars - that Schwarzbaum willfully failed to disclose to the United States. The court found that by enacting the Bank Secrecy Act, Congress sought to deter the precisely the harm for which Schwarzbaum was culpable, Congress considered the harm to be very serious, and the statute's method of deterring that harm is rational. The court concluded that although the 50 percent penalties were substantial, they were not violative of the Excessive Fines Clause.

For a discussion of information reporting 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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