Fifth Circuit Weighs In on FBAR Penalty Issue; Finds Taxpayer Liable for Higher Penalty.

(Parker Tax Publishing December 2021)

The Fifth Circuit reversed a district court and held that the penalty on a taxpayer who fails to report interests in foreign bank accounts attaches to each failure to report a qualifying foreign account rather than each failure to file an annual foreign bank account report (FBAR). As a result, the court found the taxpayer liable for the $2.72 million in civil penalties originally assessed by the government rather than the $50,000 determined by the district court. U.S. v. Bittner, 2021 PTC 372 (5th Cir. 2021).

Background

Alexandru Bittner was born in Romania in 1957 and immigrated to the United States in 1982. He was naturalized in 1987. In 1990, Bittner returned to Romania, where he became a successful businessman and investor. To manage his growing wealth, Bittner maintained dozens of bank accounts in foreign countries using "numbered accounts" to hide his name. While he used accountants to maintain financial records and ensure compliance with Romanian tax laws, Bittner was unaware that as a U.S. citizen he had to report his interests in certain foreign accounts. Consequently, Bittner never filed a Foreign Bank Account Report (FBAR) while living in Romania. Both the Internal Revenue Code and Section 5314 of Title 31 of the U.S. Code (the Bank Secrecy Act (BSA)) require individuals to disclose their interests in foreign bank accounts if certain conditions are met.

From 1996 - 2011, Bittner was required to, but did not, file FBARs. When he became aware of his FBAR responsibilities after returning to the United States in 2011, he began filing FBARs in 2012. In 2017, the IRS assessed $2.72 million in penalties against Bittner for non-willful violations of Section 5314 - $10,000 for each unreported account from 2007 to 2011, specifically 61 accounts in 2007, 51 in 2008, 53 in 2009, 53 in 2010, and 54 in 2011. Bittner disputed the amount of the penalties. Specifically, he argued that the non-willful civil penalty applied per annual FBAR report not properly or timely filed, not per foreign financial account maintained. He also argued that he had reasonable cause for failing to file the FBARs and thus should not be liable for the penalties.

FBAR Requirements and Penalties

The requirement to file an FBAR applies to an individual who (1) is a resident or a person doing business in the United States; (2) had a financial account or accounts that exceeded $10,000 during the calendar year and that financial account was in a foreign country; and (3) had a financial interest in the account or signatory or other authority over the foreign financial account.

Under Code Sec. 7701(b)(1)(A), an alien individual who is a lawful permanent resident of the United States is treated as a resident of the United States for tax payment and reporting purposes. Thus, such person is responsible for filing an FBAR if he or she has a foreign bank account.

Regulations provide that each person with a financial interest in a financial account in a foreign country must report such relationship to the IRS for each year in which that relationship exists and must provide the information specified in a reporting form prescribed under 31 U.S.C. Section 5314 (i.e., the FBAR). A person is treated as having a "financial interest" in any foreign account that the person owns or that is owned by a corporation in which the person has an ownership interest greater than 50 percent. Additionally, regulations require the FBAR to be filed on or before June 30 of each calendar year with respect to foreign financial accounts exceeding $10,000 maintained during the previous calendar year. A person generally is required to disclose on an FBAR specific information about each qualifying foreign account. But when a person has a financial interest in 25 or more qualifying accounts, the person need only disclose the number of accounts. Those who fall within this exception, however, are required to provide detailed information concerning each account when so requested by the Treasury Secretary.

Civil penalties are imposed under 31 U.S.C. Section 5321(a)(5)(A) on any person who violates, or causes any violation of, any provision of Section 5314. Initially, only willful violations were subject to penalty; but Congress added penalties for non-willful violations in 2004. Different penalties attach to non-willful and willful violations. For a non-willful violation, 31 U.S.C. Section 5321(a)(5)(B)(i) provides that the amount of any civil penalty imposed cannot exceed $10,000. But no penalty attaches if the violation was due to reasonable cause and the balance in the account was properly reported. For a willful violation, the maximum penalty increases to the greater of $100,000 or 50 percent of the amount of the transaction (when a violation involves a transaction) or the balance in the account at the time of the violation (when a violation involves a failure to report the existence of an account). Willful violations are excluded from the reasonable-cause exception.

District Court's Decision

In a case of first impression, the district court, in U.S. v. Bittner, 2020 PTC 195 (E.D. Tex. 2020), held that the non-willful penalty for failing to file an FBAR under 31 U.S.C. Sec. 5321(a)(5) relates to each FBAR report not timely or properly filed rather than to each foreign financial account maintained. In reaching its decision, the district court declined to follow the holding in U.S. v. Boyd, 2019 PTC 161 (C.D. Cal. 2019), where a district court held that the non-willful FBAR penalty applies to each bank account a taxpayer fails to list on the report (a decision which was later reversed by a panel of the Ninth Circuit in U.S. v. Boyd, 2021 PTC 72 (9th Cir. 2021), which held that the non-willful FBAR penalty applies on a per-filing basis rather than per account).

The district court cited the Supreme Court's decision in Cal. Bakers Ass'n v. Shultz, 416 U.S. 21 (1974), where the Court found that the BSA's civil and criminal penalties attach only upon violation of regulations issued by the Treasury Secretary and, if the Secretary were to do nothing, the BSA itself would impose no penalties on anyone. Thus, the district court said, it is the violations of the Treasury Secretary's implementing regulations to which Section 5321(a)(5)'s civil penalties attach. Those regulations, the court determined, provide that the form prescribed under Section 5314 is the FBAR and it is the failure to file an annual FBAR that is the violation contemplated and that triggers the civil penalty provisions of Section 5321.

Finally, the court rejected Bittner's reasonable cause defense. The court concluded that, given Bittner's business and investment sophistication and awareness of at least some of his U.S. income tax obligations, he could not claim with a straight face that he was so unaware that he might have U.S. reporting obligations that he did not even feel compelled to investigate the matter.

Both parties appealed. The government argued that the district court erred in focusing on the regulations to the exclusion of Section 5314 itself in determining that the penalty to applied to each FBAR report not timely or properly filed rather than to each foreign financial account maintained. Bittner argued that the district court misunderstood the reasonable-cause standard by equating it with ordinary business care and prudence.

Fifth Circuit's Decision

The Fifth Circuit reversed the district court's decision with respect to the application of the FBAR penalty, but affirmed with respect to its rejection of Bittner's reasonable cause defense. According to the court, properly assessing the FBAR penalty hinges on what constitutes a "violation" of Section 5314: the failure to file an FBAR (as argued by Bittner) or the failure to report an account (as argued by the government). The court agreed with the government's argument that the district court erred by focusing on the regulations to the exclusion of Section 5314 itself.

The Fifth Circuit said that the Shultz decision did not interpret any penalty provision of the BSA, as the court was doing in this case. Rather, it addressed constitutional challenges to the BSA and its regulations. As for the Section 5314 regulations themselves, the court found that they distinguish (1) the substantive obligation to file reports disclosing each account from (2) the procedural obligation to file the appropriate reporting form. The Fifth Circuit disagreed with the district court's reasoning that a violation of Section 5314 attaches directly to the obligation that the statute creates - the filing of a single report. According to the court, Section 5314 does not create the obligation to file "a single report." Rather, it gives the Treasury Secretary discretion to prescribe how to fulfill the statute's requirement of reporting qualifying accounts.

Further, the Fifth Circuit said, the use of the term "violation" in other parts of Section 5321(a)(5) confirms that the "violation" contemplated by Section 5321(a)(5)(A) is the failure to report an account, not the failure to file an FBAR.

With respect to Bittner's argument that he had reasonable cause for failing to file the FBARs, the court noted that the BSA and the pertinent regulations do not define "reasonable cause," and so it consulted the reasonable-cause exceptions in the Internal Revenue Code. Drawing on several reasonable-cause exceptions in the Code and in regulations and caselaw interpreting these exceptions, the Fifth Circuit concluded that the reasonable-cause exception in Section 5321(a)(5)(B)(ii)(I) requires showing that the individual exercised ordinary business care and prudence, considering all pertinent facts and circumstances on a case-by-case basis. In the instant case, the court concluded that Bittner did not exercise ordinary business care and prudence in failing to fulfill his reporting obligations.

For a discussion of FBAR penalties, see Parker Tax ¶203,170.

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