Willful FBAR Penalties
The Schwarzbaum case has received a lot of attention in the last few years from tax professionals. For example, in 2020, the district court concluded—contrary to some other federal court decisions—that the simple act of signing a federal tax return and not filing an FBAR does not in and of itself constate a finding that there was a willful FBAR violation. See U.S. v. Schwarzbaum, No. 18-CV-81147, 2020 WL 1316232, at *8 (S.D. Fla. Mar. 20, 2020). In 2021, after finding that Schwarzbaum’s conduct in failing to file FBARs was willful, the district court granted the government’s motion for an order requiring Schwarzbaum to repatriate millions of dollars of foreign assets to provide security to the government for full payment on the affirmed willful FBAR penalties. See U.S. v. Schwarzbaum, 128 AFTR 2d 2021-6436 (S.D. Fla. Oct. 26, 2021). Months later, though, the district court changed course and granted Schwarzbaum a stay of repatriation until after the Eleventh Circuit reviewed the district court’s decision on willfulness. See here.
On January 25, 2022, the Eleventh Circuit Court of Appeals issued a published decision in Schwarzbaum. U.S. v. Schwarzbaum, No. 20-12061 (Jan. 25, 2022). In that decision, the Eleventh Circuit upheld the district court’s determination that Schwarzbaum was willful—even if his conduct was only reckless. However, the Eleventh Circuit further held that the district court had erred in failing to remand Schwarzbaum’s case back to the IRS for computation of penalties under the Administrative Procedure Act (“APA”). This article discusses the Eleventh Circuit decision and the ever-growing presence of the APA in FBAR penalty cases.
Schwarzbaum was born in Germany. Later, he moved to the United States and became a naturalized U.S. citizen. After he became a naturalized U.S. citizen, he held foreign accounts in Switzerland and Costa Rica. And from 2006 through 2009, he held interests in eleven Swiss foreign bank accounts and two Costa Rican foreign bank accounts.
Schwarzbaum had various United States reporting obligations, including income tax returns and FBARs. To comply with these obligations, he relied on Certified Public Accountants (“CPAs”). Although Schwarzbaum had FBAR reporting obligations for many years, his prior CPAs had advised him that he had no FBAR filing requirement because the foreign accounts did not have a “U.S. connection.” As indicated by the court in its opinion, “[t]his was bad advice.”
In 2006, Schwarzbaum’s CPA prepared and filed an FBAR on his behalf which listed only a single Costa Rican bank account. In 2007, he attempted to self-prepare and file his own FBAR, which again listed only a single Costa Rican bank account. In 2008, Schwarzbaum did not file an FBAR, and in 2009, he self-prepared and filed his own FBAR, reporting only one of his Swiss bank accounts and his two Costa Rican accounts.
Schwarzbaum later consulted with a tax attorney regarding his FBAR non-compliance for 2006 through 2009. In 2011, Schwarzbaum voluntarily disclosed to the IRS the existence and balance of the foreign accounts that he had previously failed to disclose on FBARs. The IRS eventually initiated an examination of the foreign accounts and concluded that he should be liable for $13,729,591 of willful FBAR penalties for 2006 through 2009. In computing the total assessed penalties, the IRS used its mitigation procedures for some years and the statutory maximum for other years, eventually reducing the penalties further and dividing the total penalties amongst 2006 through 2009. The IRS then made the assessments of willful FBAR penalties against Schwarzbaum.
The government initiated a lawsuit against Schwarzbaum in federal court. The district court held a five-day bench trial and issued an opinion sustaining the willful FBAR penalties for 2007, 2008, and 2009, but not for 2006. The district court concluded that although Schwarzbaum did not knowingly violate the FBAR reporting requirement statute, he acted recklessly, which was sufficient alone to have a willful violation. Finding recklessness, the district court noted that Schwarzbaum had read the FBAR instructions in self-preparing his FBAR in 2007 and therefore should have been aware of a high probability of tax liability with respect to his unreported accounts.
But the district court also picked up on IRS errors in making the assessment computations against Schwarzbaum. Specifically, the court found that the IRS had used maximum account balances self-reported by Schwarzbaum and not the applicable violation dates for the penalty base—i.e., the latter of which should be the amount in the foreign accounts as of the FBAR filing dates. On this basis, the district court found that the penalties were unlawful under the Administrative Procedure Act (the “APA”).
After the parties submitting briefing on the appropriate amounts for 2007, 2008, and 2009, the district court imposed new FBR penalties against Schwarzbaum totaling $12,907,952. The court then entered a judgment for this amount.
The government filed a motion to alter or amend the judgment. In its motion, the government contended that the willful FBAR penalties should be reduced further to $12,555,813, or the amount that the IRS had already assessed against Schwarzbaum for 2007, 2008, and 2009. Schwarzbaum timely appealed.
Opinion of the Court.
Schwarzbaum was Willful.
Schwarzbaum contended that the district court erred in finding that his failure to file FBARs was willful. More specifically, Schwarzbaum maintained that the proper standard for willfulness should not include acts of recklessness.
The Eleventh Circuit disagreed, reasoning that its prior decision in U.S. v. Rum, 995 F.3d 882 (11th Cir. 2021), already held that “willful conduct, in the FBAR civil penalty context, includes knowing or reckless conduct.” And for purposes of showing recklessness, the government merely had to show “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.” Given this relaxed standard of willfulness, the Eleventh Circuit found that the district court did not err in finding that although Schwarzbaum did not knowingly violate the FBAR reporting requirements, he acted recklessly when he reviewed the FBAR instructions in 2007 and then, for the next three years, failed to report the foreign assets those instructions directed him to report.
Significantly, the Eleventh Circuit also rejected Schwarzbaum’s tax professional defense and reliance on U.S. v. Boyle, 469 U.S. 241 (1985). In that case, the Supreme Court stated that, at least for purposes of another late filing penalty associated with income tax returns: “When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether liability exists, it is reasonable for the taxpayer to rely on that advice.” The Eleventh Circuit found Boyle inapplicable, stating that Boyle“concerned a different tax statute and did not provide the legal standard for willfulness in the FBAR context.”
The FBAR Penalties were Unlawful Under the APA.
Although the Eleventh Circuit sustained the willful FBAR penalties, it concluded that the district court had erred in redetermining the amount of the willful FBAR penalties. In this regard, the court noted that the district court, as a reviewing court, must hold unlawful and set aside agency action that is arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. See 5 U.S.C. § 706(2)(A). Under the APA, the district court effectively sits as “an appellate tribunal” and does not function in its normal role. Cnty. Of L.A. v. Shalala, 192 F.3d 1005, 1011 (D.C. Cir. 1999). And the court is generally bound to judge the propriety of the agency’s action solely on the grounds invoked by the agency—if those grounds are inadequate or improper, the court is powerless to affirm the administrative action by substituting what it considers to be a more adequate or proper basis. SEC v. Chenery Corp, 332 U.S. 194, 196 (1947). Based on these well-known rules of administrative law, the Eleventh Circuit stated:
The district court lacked the power to recalculate Schwarzbaum’s FBAR penalties. Nonetheless, finding that the IRS had miscalculated, the district court prepared new penalties from scratch, substituting its judgment for the agency’s. Courts do not have ‘original calculation’ jurisdiction over FBAR penalties. That power belongs to the IRS. By replacing the IRS’s penalty calculations with its own, the district court invaded the agency’s turf.
Given the agency’s error, the district court should have remanded Schwarzbaum’s FBAR penalties to the IRS for recalculation. Remand is the appropriate remedy when an administrative agency makes an error of law, for it affords the agency an opportunity to receive and examine the evidence in light of the correct legal principle. And, as the district court correctly found, the IRS’s original penalties were not in accordance with law. The statutory maximum penalty for a willful FBAR violation is the greater of $100,000 or 50% of the balance in the account at the time of the violation. The “time of [an FBAR] violation is June 30, the annual FBAR filing deadline. Indeed, the government concedes that the IRS mistakenly calculated Schwarzbaum’s statutory maximum penalties using his foreign accounts’ highest annual balances rather than their June 30 balances. Because the IRS miscalculated Schwarzbaum’s penalties, a remand is in order to allow the IRS to fix the mistake.
The Schwarzbaum decision is not the first federal court decision to conclude that the APA applies in the FBAR penalty context. However, the decision adds to a growing list of FBAR penalty cases that have now directly interacted with the APA. Tax professionals should take notice that more FBAR penalty cases involving the APA will surely follow in the future. Accordingly, tax professionals should ensure that they have a good working knowledge of the APA when representing taxpayers against potential FBAR penalties. Tax professionals who do not raise APA arguments, where appropriate, are leaving good penalty defenses on the table.
Other Helpful FBAR Articles.
The FBAR (Report of Foreign Bank and Financial Accounts): Everything You Need to Know
Beware of Your FBAR Obligations – U.S. v. Solomon
A Current “Playoff Picture” of Non-Willful FBAR Violations
United States v. Hughes: FBAR Penalties and a Willfulness Roadmap
Challenging FBAR Penalties in Federal Court: FBAR Litigation
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