Eleventh Circuit Remands Case to Recalculate Taxpayer's FBAR Penalties

(Parker Tax Publishing February 2022)

The Eleventh Circuit held that while a district court applied the correct standard in determining that a taxpayer's foreign bank account reporting (FBAR) violations were willful, the FBAR penalties were miscalculated and were thus unlawful under the Administrative Procedures Act. As a result, the court vacated the lower court's judgment and remanded the case with directions that the IRS recalculate the taxpayer's FBAR penalties. U.S. v. Schwarzbaum, 2022 PTC 20 (11th Cir. 2022).

Background

Isac Schwarzbaum is a wealthy, naturalized U.S. citizen who was born in Germany and has lived intermittently in the United States since the 1990s. Beginning in the early 2000s, Schwarzbaum held interests in foreign bank accounts in Switzerland and Costa Rica. Between 2006 and 2009, Schwarzbaum held interests in 11 Swiss accounts and two Costa Rican accounts. As a U.S. citizen, Schwarzbaum was, and is, subject to the requirements for filing foreign bank account reports (FBARs) under 31 U.S.C. Section 5314(a). Schwarzbaum uses CPAs to prepare his U.S. tax returns. In the past, some of Schwarzbaum's CPAs advised him that he did not need to report his foreign assets to the IRS unless those assets had a "U.S. connection." The FBAR regulations, however, require U.S. citizens to report their foreign accounts with balances exceeding $10,000 to the IRS every year, whether or not the accounts have any connection to the United States.

Nonetheless, in 2006, Schwarzbaum's CPA prepared and filed an FBAR on his behalf listing only a single Costa Rican bank account. In 2007, Schwarzbaum self-prepared and filed his own FBAR, which again listed only a single Costa Rican bank account. When self-preparing his 2007 FBAR, Schwarzbaum reviewed the instructions that accompanied the FBAR form. In 2008, Schwarzbaum did not file an FBAR, and in 2009, he again self-prepared and filed his own FBAR, listing only one of his Swiss accounts and his two Costa Rican accounts. Subsequently, Schwarzbaum consulted with a U.S. attorney, who advised him that he had violated the FBAR reporting requirements by failing to report many of his foreign accounts. In 2011, Schwarzbaum then voluntarily disclosed to the IRS the existence and balances of the foreign accounts he had previously failed to report. In 2013 and 2014, the IRS proposed civil penalties totaling $13.7 million against Schwarzbaum for willful violations of the FBAR reporting requirements for the 2006 - 2009 tax years.

In calculating Schwarzbaum's FBAR penalties, the IRS started with the highest annual balances for the foreign accounts Schwarzbaum had failed to report to the IRS during the relevant tax years. For accounts with balances exceeding $1 million, the IRS then divided the balances in half, arriving at the statutory maximum penalties. Under 31 U.S.C. Section 5321(a)(5)(C)(i), (D)(ii), the maximum penalty for willful FBAR violations is the greater of $100,000 or 50 percent of the balance in the account at the time of the violation. For accounts with balances of $1 million or less, the IRS calculated a mitigated set of penalties using a computational formula set out in the IRS's internal guidelines, the Internal Revenue Manual (IRM). The IRS then added up the statutory maximum penalties for the $1 million-plus accounts and the mitigated penalties for the $1 million-or-less accounts, for a total potential penalty of $35.4 million. Deciding that a $35 million-plus penalty would be excessive, the IRS then further mitigated Schwarzbaum's penalties by dropping his 2006, 2007, and 2009 penalties to $0 and dividing his 2008 penalties, which totaled $13.7 million, across all four tax years, assigning $1,173,778 to tax year 2006 and $4,185,271 each to tax years 2007, 2008, and 2009. Schwarzbaum appealed the IRS's proposed penalties to the IRS Appeals Office, which sustained the penalties in September 2016.

Schwarzbaum did not pay his FBAR penalties, and in August 2018, the government filed suit to collect them. In March 2020, in U.S. v. Schwarzbaum, 2020 PTC 405 (S.D. Fla. 2020), a district court held that Schwarzbaum willfully violated the FBAR reporting requirements in 2007, 2008, and 2009, but not in 2006. The district court stated that, in the FBAR civil penalty context, "willful" conduct includes both knowing and reckless violations of the reporting requirements, and defined recklessness as "conduct violating an objective standard: action entailing an unjustifiably high risk of harm that is either known or so obvious that it should be known." The district court found that Schwarzbaum did not knowingly violate the FBAR requirements in any year. However, it found that Schwarzbaum recklessly violated the FBAR requirements in 2007, 2008, and 2009, because, after he read the FBAR instructions and self-prepared his own FBAR in 2007, Schwarzbaum "was aware, or should have been aware, of a high probability of tax liability with respect to his unreported accounts."

The district court also concluded that the IRS miscalculated Schwarzbaum's FBAR penalties under the relevant statute and regulations, and that the penalties were therefore unlawful under the Administrative Procedure Act (APA). The district court noted that the IRS calculated Schwarzbaum's penalties using the highest annual balances in his foreign accounts for each tax year; that the statutory maximum penalty for willful FBAR violations is the greater of $100,000 or, under 31 U.S.C. Sec. 5321(a)(5)(C)(i), (D)(ii), 50 percent of the balance in the account at the time of the violation and that the annual deadline to file an FBAR (i.e., the "time of" an FBAR violation) is June 30. Because the IRS did not calculate Schwarzbaum's FBAR penalties using June 30 balances, the district court held that it had used the incorrect base amounts to calculate Schwarzbaum's FBAR penalties and that the penalties therefore had to be set aside under the APA.

At the end of its opinion, the district court directed the parties to submit supplemental briefings with respect to the new proposed amount of penalties to be assessed against Schwarzbaum for a non-willful FBAR violation in tax year 2006, and willful FBAR penalties for tax years 2007, 2008, and 2009. The government subsequently mitigated Schwarzbaum's penalties by dropping his 2006, 2007, and 2009 penalties altogether and dividing his 2008 penalties across all years. The government then requested that the district court reduce Schwarzbaum's FBAR penalties to $12,555,813, which was equal to the penalty amount the IRS had originally imposed against Schwarzbaum for tax years 2007 - 2009. The district court agreed and Schwarzbaum appealed the penalty assessment to the Eleventh Circuit.

Schwarzbaum made three arguments on appeal. First, that the district court applied an incorrect legal standard in determining that his FBAR violations were willful. Second, that his FBAR penalties were miscalculated and, therefore, unlawful under the APA. Third, that his FBAR penalties were excessive fines under the Eighth Amendment.

Analysis

The Eleventh Circuit held that while the district court applied the correct standard in determining that Schwarzbaum's violations were willful, the FBAR penalties were miscalculated and therefore unlawful under the APA. As a result, the court did not address the question of whether the FBAR penalties were excessive fines under the Eighth Amendment. The court vacated the district court's amended judgment, remanded the case back to the district court, and directed the IRS to recalculate the penalties it had already assessed.

The court rejected the government's position that because the IRS's original calculation errors were harmless and the district court ultimately imposed penalties identical to the agency's, remand was unnecessary. According to the Eleventh Circuit, to understand whether the IRS's error was harmless, the court had to understand precisely how the IRS erred. The court noted that the IRS calculated Schwarzbaum's FBAR penalties in three steps. First, it collected the highest annual balances for the foreign accounts Schwarzbaum had failed to report. Then, using a formula set out in the IRM, it calculated the statutory maximum penalties for the accounts with balances greater than $1 million - by dividing the balances in half - and calculated a mitigated set of penalties for the lower-balance accounts. Finally, it further mitigated Schwarzbaum's penalties by dropping his 2006, 2007, and 2009 penalties altogether and dividing his 2008 penalties across all years.

According to the court, in calculating Schwarzbaum's FBAR penalties, the IRS took a wrong fork in the road by starting with the wrong numbers. The court noted that, for each tax year and for each account, the statutory maximum penalty for a willful FBAR violation is the greater of $100,000 or 50 percent of the account's June 30 balance. By using the wrong account balances, the court said, the IRS calculated the wrong statutory maximums for Schwarzbaum's penalties, and from there, mitigated the penalties across the board. It appeared to the court that the IRS's error flowed through its calculations from beginning to end.

Thus, the court could not say that the IRS's error was harmless and the fact that the IRS may reach a different result when it recalculates Schwarzbaum's penalties in accordance with the FBAR civil penalty statute and regulations, the court said, is enough to justify remand.

The court also rejected Schwarzbaum's assertion that, on remand from judicial review under the APA, an agency could be time-barred from re-evaluating its original actions. The Eleventh Circuit said it was aware of no such limitation and there was no dispute that the IRS timely assessed Schwarzbaum's original FBAR penalties and the remand is not for the IRS to issue new penalties, but for it to recalculate the penalties it has already assessed.

For a discussion of FBAR reporting penalties, 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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