A California district court in United States v. Hughes recently found that the taxpayer willfully failed to file her FBARs in the tax periods for which she filed a Schedule B but was not willful in the periods for which she did not file a Schedule B.

Facts

Taxpayer, Ms. Hughes, is a U.S. citizen.

In 1991, taxpayer started a bookkeeping company and then began to work for a CPA firm where she provided bookkeeping services for a $1 billion trust. She also prepared tax returns for family members and friends.

Taxpayer used TurboTax to prepare tax returns for herself and others. Prior to using TurboTax, she would fill out tax returns by hand.

In 2001, taxpayer formed a limited liability entity in New Zealand (“TW”). In 2013, she formed another limited liability entity in New Zealand (“CU”).

As the sole owner of the foreign entities, taxpayer had financial interest in the entities’ accounts in New Zealand. She was therefore required to report those accounts on a timely filed FBAR.

Taxpayer failed to file her FBARs until she was audited by the IRS in 2014. At the conclusion of the audit, the IRS asserted willful FBAR penalties for periods 2010-2013 totaling more than $800,000.

The TVV and CU company accounts earned interest income in the amounts of $3,822.88, $5,090.61, $1,418.55, and $6,826.62 in taxable years 2010, 2011, 2012, and 2013, respectively. Some or all of the interest income was reported on the taxpayer’s 2012 and 2013 tax returns. So it would appear that the assessed FBAR penalty was perhaps up to several hundred times over the amount of unpaid tax (i.e., the loss to the government) for these periods.

Willfulness standard

To assess a willful penalty under U.S.C. § 5321(a)(5)(C)(i) for the failure to file an FBAR, the government must prove by preponderance of the evidence that the failure was willful.

Most courts to consider the issue have held that, for the purpose of civil FBAR penalties, either recklessness or willful blindness can suffice to show a willful violation. 

A reckless action is one entailing an unjustifiably high risk of harm that is either known or so obvious that it should be known.

Schedule B

With respect to a foreign account, a taxpayer has several duties which include correctly answering Questions 7a and 7b of Schedule B.

Question 7a of Schedule B asks:

“At any time during 2021, did you have a financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign country? See instructions.”

“If “Yes,” are you required to file FinCEN Form 114, Report of Foreign Bank and Financial
Accounts (FBAR), to report that financial interest or signature authority? See FinCEN Form 114
and its instructions for filing requirements and exceptions to those requirements.”

In this case, the taxpayer checked the box indicating that she was required to file an FBAR for some periods and ‘no’ in other periods. In yet other periods, she did not file a Schedule B at all.

Question 7b states:

“If you are required to file FinCEN Form 114, enter the name of the foreign country where the financial account is located.”

Although many facts were provided and even an employee from Intuit testified about TurboTax software, the court found willfulness through the mere filing of a Schedule B.

The court argued that the taxpayer “plainly saw at least the basic instructions on the face of Schedule B, because in her 2012 return she checked the box accompanying those instructions indicating that she was required to file an FBAR. She also saw those instructions in her 2013 return, where she answered that question differently (and inaccurately).”

The court concludes that the periods in which the taxpayer filed a Schedule B and failed to file an FBAR, her failure to file was at least reckless, and thus constituted “willful” violations of the filing requirement for those years.

However, for the periods that she did NOT include a Schedule B with her tax returns, the court finds that “there is no indication that Hughes reviewed Schedule B, with its instructions regarding the FBAR requirement…In the absence of any evidence that Hughes was aware of the FBAR filing requirement when she completed her returns for those years, or that she was presented with any information that should have put her on notice of that requirement, the United States has not met its burden to show that her failure to file FBARs in those years was anything more than negligent. The United States therefore cannot assess penalties for “willful” violations for those years.”

Can Schedule B by itself make you willful?

What the IRS says:

The IRS has informally implied that answering Schedule B incorrectly does not preclude non-willfulness. In their video transcript about the streamlined procedures, the IRS states that it “realizes that many taxpayers fail to acknowledge their financial interest in, or signature authority over, foreign financial accounts on Form 1040 Schedule B. If you or your return preparer inadvertently check no on Schedule B lines 7A, please, simply provide your explanation [on the certification of non-willfulness].”

Additionally, Internal Revenue Manual (IRM) Section 4.26.16.6.5.1 used to state as recently as last year that “[t]he mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness.” That section has been since removed and no longer appears in the IRM.

What the court in Hughes says:

The holding in Hughes very narrowly focused on the Schedule B without including in its holding other facts which may have led the IRS to assert willful penalties in the first place. The court’s holding can be summarized as follows:

  • Taxpayer files a Schedule B on which she answers question 7A incorrectly and fails to timely file an FBAR –> taxpayer acted recklessly and is willful
  • Taxpayer files a Schedule B on which she answers question 7A correctly and fails to timely file an FBAR –> taxpayer acted recklessly and is willful
  • Taxpayer does not file a Schedule B and fails to timely file an FBAR –> taxpayer did not necessarily act recklessly and willfully

One way to reconcile these two seemingly different views is that voluntarily coming into compliance (and not after an IRS audit) is seen as a major mitigating factor, and that non-willfulness for purposes of coming into compliance through the streamlined procedures is to be interpreted more broadly. Otherwise, if filing a Schedule B without an FBAR makes a taxpayer willful, nearly every failure to file an FBAR would be willful, rendering the willfulness standard superfluous. Unfortunately, we just don’t know with an ever-evolving FBAR willfulness standard. It’s murky, confusing, and perhaps not even the courts can make sense of it at this point. This was a strange decision.

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