In United States v. Hughes, (N.D. Cal. 3:18-cv-05931-JCS Entry 162 10/13/21), CL hereand TN here, the Court (Magistrate Judge by consent) held in Findings of Fact and Conclusions of Law Regarding Willfulness (“FF&CL”) in an FBAR collection suit that the defendant, Timberly E. Hughes, was liable for the FBAR willful penalty for 2 of the 4 years for which the Government sought judgment. For the two years that the Court did not sustain the willful FBAR penalty, the Court did not find Hughes nonwillful but held that the Government had not met its burden of proof. (As the Court worded it, if the Court could have found her nonwillful, it would have done so, but instead found that the Government had not met its burden of proof, which I infer means that the Court was in equipoise, the only circumstances that permits burden of proof to control the result.)
I am not sure that the conclusion that the Government had not met its burden of proof is supported by the Court’s findings. I think that the inferences the Court drew on the objective findings are suspect. The Court does state that it applied the reckless standard for the finding of willfulness. But I am surprised that, on the objective facts recounted, the Court found the Government failed to meet burden of proof (preponderance).
There is a lot that could be discussed about the FF&CL I offer below just some points that I focused on and think worth mentioning, but there are surely more interesting points. Those wishing to go further will find a lot of the documents in the case available free at CourtListener docket entries here.
1. One factor that I think the Court gave short shrift to was Hughes’ income tax issues for those years. The Government’s Post Trial Brief, Dkt. 158, here, at pp. 3-6, states the following under captions of “Income Shifting” and “False Business Addresses”): Hughes had a bookkeeping service business, a Schedule C business, generating substantial U.S. source service income. Hughes owned two foreign corporations which she improperly reported as Schedule C U.S/ operations. One of those businesses generated major net losses (raising the hobby loss issue permitting deductions only against income which was minimal). Hughes reported her bookkeeping service income as income of the businesses which she improperly reported on Schedule C, thus claiming deductions to which she was not entitled. The erroneous deductions were from $331,145 to $1,306,505 for the years. Apparently, she also gave a false U.S. business address for the foreign entity, the inference being that she was trying to hide the foreign nature of the entity. As a result of this reporting, Hughes underreported her income tax liability by over $600,000 in the years involved. In dismissing this as a relevant factor, the Court said (p. 22):
173. There is evidence that could perhaps support an inference that Hughes misrepresented the country in which TVV was located or the revenue it received in order to reduce her tax liability, and portions of the United States’ briefing are devoted to those issues. Assuming for the sake of argument that is so, it does not tip the scales as to the separate issue of whether Hughes’s failure to file FBARs in any particular year was intentional or reckless, as opposed to merely negligent. Even if Hughes fraudulently misrepresented other aspects of her tax returns, that does not preclude the possibility that her omission of the particular forms at issue in this case was a result of negligence rather than recklessness or willful disregard.
174. Hughes’s post-trial brief includes arguments as to whether TVV should be treated as a pass-through entity, but that issue is not relevant to the question here — whether Hughes’s failure to file FBARs was willful.
2. The opinion does not state the aggregate amount of the penalties assessed or the breakdown by years. The complaint, here, at p. 6, ¶ 34, states the aggregate amount for the 4 years as $678,899. I could not quickly find the breakdown of the assessment for each year. Readers may recall that the IRS policy reflected in the IRM 184.108.40.206.5.3 (11-06-2015), Penalty for Willful FBAR Violations – Calculation calculated a maximum aggregate FBAR penalty of 50% of the aggregate high balance year and then spread that penalty among the years to which the willful otherwise penalty applied. Thus, for example, assume a single foreign account static high balance in each year was $2 million. Setting aside possible mitigation, the FBAR willful penalty would be $1 million allocated among 4 willful penalty years at $250,000 each year. If that (or some variation) occurred in Hughes, then Hughes successfully avoided half (or some variation) of the penalty. (Note that IRM has changed; although I have not analyzed it, seems to adopt a variation of the methodology. See IRM 220.127.116.11.5.3 (06-24-2021). Penalty for Willful FBAR Violations – Calculation, here; with the possibility of some years may be found nonwillful, perhaps the IRS’ assessment strategy should be to the maximum it can for the year or years with the strongest facts for willfulness and then the remainder, if any, allocated to the weaker years.)
3. The defendant was represented by counsel, Steven Morris Katz earlier in the proceedings until he was formally terminated, May 4, 2020, after which Hughes apparently handled the matter pro se. (See the Parties and Attorneys tab at the CL docket entries, here.) Katz is mentioned in the Court’s FF&CL (p. 14, ¶ 195) in the context of his representation during the audit. I infer that the back story to Katz’s dismissal is that, according to Hughes in seeking to overturn default judgment against her, Katz advised her that there was no need to oppose the default judgment by timely pleadings because “the government always wins” so the failure to respond was based on bad advice of her attorney. See Order dated 3/31/21 (Dkt. Entry 48), here, at p. 8. (I did not read the Order that carefully, but I perceived some exasperation about erratic behavior on Hughes’ part.) After that date, Hughes signed the few defense pleadings I reviewed. I suppose that, if Hughes handled the case the rest of the time, she did one hell of a job in terms of result pro se.
4. The FF&CL offers a lot of discussion of Turbo Tax and how Hughes’ use thereof may have not focused her attention on the FBAR requirement. While at some level, that might be relevant, I think it marginal in relevance and not really worth the attention the Court gave it. I understand that the Turbo Tax commotion was a centerpiece of Hughes’ defense so that the Court probably felt that it had to deal with it.
5. The Court made this finding (FF&CL p. 14, ¶ 112):
The IRS also assessed penalties for failure to file Form 5471 and Form 926. Form 5471 has a $10,000 penalty for failure to file. Form 926 has a penalty of 10% of money sent to foreign corporations. The IRS assessed penalties for failure to file Forms 5471 and 926 for years 2010, 2011, and 2013, which were reduced by fifty percent on appeal.