Third Circuit Clarifies Standard for Proving a "Willful" FBAR Violation

(Parker Tax Publishing January 2019)

In addressing two issues of first impression, The Third Circuit (1) clarified that, to prove a "willful" violation with respect to the filing of a Report of Foreign Bank and Financial Accounts (FBAR), the government must satisfy the civil willfulness standard, which includes both knowing and reckless conduct, and (2) concluded that while jurisdiction existed in the instant situation, it was reserving judgment on the question of whether jurisdiction is established in a district court when a taxpayer files suit to challenge an FBAR penalty before fully paying that penalty. The Third Circuit then remanded the case for the district court to determine whether it correctly applied the "willful" standard by considering whether the individual's conduct satisfied the objective recklessness standard. Bedrosian v. U.S., 2018 PTC 427 (3d Cir. 2018).

Background

Arthur Bedrosian is a successful businessman who has worked in the pharmaceutical industry since the late 1960s. By 1973, Bedrosian opened a savings account in Switzerland so that he could make purchases while traveling abroad for work without relying solely on traveler's checks. Later, he began using the account as a savings account. Union Bank of Switzerland (UBS) eventually acquired the bank where Bedrosian opened his account.

From 1973 until 2007, Bedrosian used the accounting services of Seymour Handelman to prepare his income tax returns. Bedrosian did not tell Handelman about his Swiss account until sometime in the mid-1990s. Handelman responded that Bedrosian had been breaking the law every year that he did not report the account on his tax return. However, Handelman advised that Bedrosian should take no action because his estate would deal with it on his death.

In 2005, UBS offered to lend Bedrosian 750,000 Swiss francs and convert his savings account into an investment account. The transaction resulted in a second account being created under Bedrosian's control at UBS.

Handelman died in 2007, and Bedrosian began filing his taxes through a new accountant, Sheldon Bransky. Bedrosian authorized Bransky to obtain his records from Handelman's offices and gave Bransky the same materials that he was accustomed to giving Handelman in prior years. Bransky then 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; the account omitted had assets totaling approximately $2 million.

Bedrosian later testified at trial that he did not recall discussing his Swiss bank accounts with Bransky. Bedrosian also testified that he did not know how Bransky knew to acknowledge the existence of a foreign bank account on the tax return or how Bransky knew to prepare the FBAR. Bedrosian signed but did not review the 2007 return and FBAR.

After submitting these documents for 2007, Bedrosian became more aware of the seriousness of not reporting foreign bank accounts to the IRS. After seeking legal counsel, he began correcting the inaccuracies on his prior tax filings. Nonetheless, in April 2011 the IRS notified Bedrosian that it would audit his recent tax returns.

In January 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.

The only disputed issue in the district court was whether Bedrosian's failure to disclose his $2 million UBS account was willful. 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, placed too much weight on Bedrosian's subjective motivations, and erred in finding that Bedrosian did not know he owned a second foreign bank account.

Analysis

The Third Circuit noted that it was faced with two issues of first impression - one involving the correct "willfulness" standard for assessing the FBAR penalty and the second involving its jurisdiction over the case. The court held that the district court correctly determined that the civil standard of willfulness applies for civil penalties under the FBAR statute. The Third Circuit agreed with the district court that the civil willfulness standard required a showing that a person either knowingly or reckless failed to file an accurate FBAR. The court found a general consensus that where willfulness is an element of civil liability, it includes not just knowing violations of a standard but reckless ones as well. Thus, the Third Circuit held that a person commits a reckless violation of the FBAR statute by engaging in conduct that, measured by an objective standard, entails an unjustifiably high risk of harm that is either known or so obvious that it should be known. With respect to IRS filings in particular, the court held, a person recklessly fails to comply with a 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.

However, the Third Circuit questioned whether the district court properly evaluated Bedrosian's conduct. The Third Circuit observed that the district court compared Bedrosian's conduct to other individuals in recent cases involving civil FBAR penalties and concluded that Bedrosian did not act willfully. The Third Circuit noted that, in doing so, the district court's analysis was based on findings related to Bedrosian's subjective motivations and the overall egregiousness of his conduct, which were not required to establish willfulness in this context.

The Third Circuit further found that the district court did not consider whether, when his 2007 FBAR filing came due, Bedrosian clearly ought to have known that there was a grave risk that an accurate FBAR was not being filed and if he was in a position to easily find out for certain. The district court's failure to do so left the impression, in the view of the Third Circuit, that it did not consider whether Bedrosian's conduct satisfied the objective recklessness standard. The Third Circuit therefore found it necessary to remand to the district court for further consideration and to render a new judgment.

With respect to the jurisdiction issue, the court noted that both parties contended that the Third Circuit had jurisdiction under 28 U.S.C. Sec. 1291 to review the district court's judgment. But, citing its decision in Papotto v. Hartford Life & Acc. Ins. Co., 731 F.3d 265 (3d Cir. 2013), the Third Circuit said that it had "an independent duty to satisfy ourselves of our appellate jurisdiction regardless of the parties' positions."

The jurisdictional inquiry in this case, the court noted, was also a matter of first impression. Unlike most cases involving the IRS's assessment of a civil FBAR penalty, in which the IRS files suit to recover the penalty, the instant case began when Bedrosian paid 1 percent of the assessed penalty and then filed a complaint in the district court seeking to recover his partial payment. The government did not challenge that court's jurisdiction over Bedrosian's claim; it instead answered the complaint and filed a counterclaim seeking the full penalty amount.

The Third Circuit noted that both parties contended that the district court had jurisdiction over Bedrosian's claim under the so-called Little Tucker Act (28 U.S.C. Sec. 1346(a)(2)), which provides district courts with original jurisdiction, concurrent with the U.S. Court of Federal Claims, over certain claims against the United States not exceeding $10,000 in amount, including certain claims "founded . . . upon the Constitution . . . or [an] Act of Congress." The parties contended Bedrosian's claim qualified for jurisdiction under the Little Tucker Act because it did not exceed $10,000 in amount and was founded on the FBAR statute, 31 U.S.C. Sec. 5314 and Sec. 5321.

The Third Circuit declined to hold that Bedrosian's initial claim against the government gained jurisdiction under the Little Tucker Act. According to the court, a claim may qualify only if it does not fall within the scope of the so-called tax refund statute. The tax refund statute encompasses, among other things, claims to seek recovery of any "penalty" that is wrongfully collected "under the internal-revenue laws." The court noted that while the parties conceded that a civil penalty under the FBAR statute is a "penalty" under 28 U.S.C. Sec. 1346(a)(1), they argued that it was not assessed "under the internal-revenue laws" because the FBAR statute, 31 U.S.C. Sec. 5314 and Sec. 5321, is in Title 31 of the U.S. Code, not Title 26 (the Internal Revenue Code). The Third Circuit said it was skeptical of this argument's elevation of form over substance and was inclined to believe that Bedrosian's initial claim did not qualify for district court jurisdiction at all. The court noted that, under 28 U.S.C. Sec. 1295(a)(2), the Federal Circuit generally has exclusive jurisdiction over appeals from cases in which a district court's jurisdiction was based, in whole or in part, on the Little Tucker Act unless the claim stemmed from "an Act of Congress or a regulation of an executive department providing for internal revenue." Although the statute does not define the phrase "providing for internal revenue," the Third Circuit concluded that the FBAR statute is part of the IRS's machinery for the collection of federal taxes and concluded that the Federal Circuit would not have exclusive jurisdiction over the appeal in this case even if the district court's jurisdiction were based in part on the Little Tucker Act. The court left open the question of whether Bedrosian's initial claim created original jurisdiction in the district court and satisfied itself that it had jurisdiction to render judgment in the case.

For a discussion of FBAR reporting requirements and penalties for not filing an FBAR, 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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