IRS SUFFERS LEGAL BLOW TO ‘EXCESSIVE’ FBAR PENALTIES

IRS Suffers Legal Blow To ‘Excessive’ FBAR Penalties

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An American court has held that penalties for failure to report foreign accounts are protected from excess by the U.S. Constitution – potentially a tool for future arguments against huge penalties.

The 11th U.S. Circuit Court has held that in at least part of one case American FBAR (Foreign Bank Account Reporting) penalties do fall under protection from the U.S. Constitution.

Though the case, United States v. Isac Schwarzbaum, involved a defendant whom the court found had failed to report foreign bank accounts to the IRS for 2007 to 2009 and who had “violated the FBAR statutes recklessly,” the U.S. Internal Revenue Service had imposed overly punitive civil “fines.”

“After careful consideration of the historical development of the Excessive Fines Clause and the FBAR’s text, structure, and history, we … hold that FBAR penalties are in substantial measure punitive in nature. Therefore, under controlling Supreme Court precedent, they are subject to review under the Eighth Amendment’s Excessive Fines Clause,” the 11th Circuit wrote in its opinion.

(The U.S. Constitution’s Eighth Amendment states, “Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.”)

For a few reasons, the ruling opens the door to challenging heavy FBAR penalties in future cases.

‘Willful blindness’

Case papers show that Isac Schwarzbaum, a naturalized citizen of the U.S. and born in Germany, held “significant wealth” in numerous bank accounts in Switzerland and Costa Rica. The U.S. tax regime required him to report foreign bank accounts with a FBAR, which U.S. citizens file annually for any foreign accounts with an aggregate balance exceeding $10,000. Schwarzbaum knew the FBAR filing requirements and had engaged accountants to help with his filings but still failed to report his foreign accounts to the IRS for 2007 to 2009.

The IRS found that Schwarzbaum willfully violated the FBAR reporting requirements; the penalty for each tax year for each unreported bank account was the greater of $100,000 or half of the account balance at the time of the violation. The time of each FBAR violation was the reporting date: June 30 of the year after the tax year being reported.

But in calculating the FBAR penalties, the IRS erroneously used the highest aggregate balance for each account for each year instead of determining the balance in each account as of June 30 of each following year. Using these wrong base numbers, the IRS arrived at an initial aggregate penalty of $35.4 million dollars. The IRS mitigated the penalty by taking the penalties for the highest year and spreading the aggregate penalty for that year across all the years, arriving at an aggregate penalty of $13,729,591.

Schwarzbaum appealed and later failed to pay the penalties; in 2018, the U.S. brought action to collect them. Following trial two years later, the district court opined that Schwarzbaum had violated FBAR reporting requirements in 2007, 2008 and 2009 (but not in 2006), finding that Schwarzbaum did not knowingly violate the FBAR reporting requirements but did so with “willful blindness” or “recklessness” because, after reading the FBAR instructions and self-preparing his own FBAR in 2007, he “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, however, that the IRS miscalculated Schwarzbaum’s FBAR penalties when it used the incorrect base amounts for each account and held that the penalties were therefore not consonant with the law. Instead of remanding to the IRS, the district court instead entered judgment for $12,907,952 based on its own recalculation of the penalties – and rejected Schwarzbaum’s argument that the penalties were subject to review under the Eighth Amendment Excessive Fines Clause.

Previously ruled

Whether FBAR “penalties” are “fines” was recently litigated in Toth v. United States, (denied certiorari by the US Supreme Court last year). In that case, a U.S. citizen, Monica Toth, claimed that several years of failing to report her foreign bank account to the U.S. government was an innocent mistake during which time she did not know of the FBAR reporting obligation and that when she learned of it she completed the disclosures. The IRS assessed Toth a civil penalty of $2.1 million and $1 million more in late fees and interest. Her argument that she violated the Excessive Fines Clause was rejected, the 1st Circuit Court then holding that the IRS assessment wasn’t tied to criminal sanction but instead served a remedial purpose.

“The most significant issue we face is Schwarzbaum’s Eighth Amendment Excessive Fines Clause claim,” the 11th Circuit opinion reads in the latest ruling. “He says that the multi-million-dollar judgment sought by the [g]overnment violates the Excessive Fines Clause … We conclude that FBAR penalties are ‘fines’ within the meaning of the Excessive Fines Clause.”

One point is how the IRS views the assessments. In at least one previous case, courts found that “economic penalties imposed to deter willful noncompliance with the law are fines by any other name.”

“Until recently, the IRS itself appears to have considered the purpose of the FBAR penalty to be deterrence, not remedial in nature,” the 11th Circuit opinion reads. “At the time when the original penalties were imposed against Schwarzbaum, the Internal Revenue Manual … stated that ‘[p]enalties should be determined to promote compliance with the FBAR reporting and recordkeeping requirements.’

“Deterrence, in other words. And the Supreme Court has been crystal clear that, at least for the purposes of the Eighth Amendment, deterrence is punitive in nature.”

When is a “penalty” a “fine” for international tax non-compliance? When is each “remedial” and when “punitive?” What are the rules and restrictions for authorities concerning any of these words?

And what does the recent 11th Circuit opinion do for international taxpayers who look to litigate massive assessments in the future?

Your tax specialist needs to stay on top of this and many other issues of wealth, foreign income and tax enforcement. If we can help, please let us know.

About the Author?

Alicea Castellanos is the CEO and Founder of Global Taxes LLC. Alicea provides personalized U.S. tax advisory and compliance services to high-net-worth families and their advisors.

Alicea has more than 20 years of experience. Prior to forming Global Taxes, Alicea founded and oversaw operations at a boutique tax firm, worked at a prestigious global law firm and CPA firm.

Alicea specializes in U.S. tax planning and compliance for non-U.S. families with global wealth and asset protection structures which include non-U.S. trusts, estates and foundations that have a U.S. connection.

Alicea also specializes in foreign investment in U.S. real estate property, and other U.S. assets, pre-immigration tax planning, U.S. expatriation matters, U.S. persons in receipt of foreign gifts and inheritances, foreign accounts and assets compliance, offshore voluntary disclosures/tax amnesties, FATCA registration, and foreign companies wanting to do business in the U.S.

Alicea is fluent in Spanish and has a working knowledge of Portuguese.

Alicea is an active member of the Society of Trusts & Estates Practitioners (STEP), the New York State Society of Certified Public Accountants (NYSSCPAs), the American Institute of Certified Public Accountants (AICPA), the International Fiscal Association (IFA), a member of Clarkson Hyde Global, a world-wide association of accountants, auditors, tax specialists and business advisors and the Global Referral Network (GRN).

Distinctly, in 2020, Alicea was awarded with a prestigious NYSSCPA?Forty?Under 40 Award.?She was selected as someone that has notable skills and is visibly making a difference in the accounting profession.

In 2021 and 2022, Alicea was the Gold and Silver Winner, respectively, of Citywealth's Powerwomen Awards in the category USA - Woman of the Year - Business Growth (Boutique). In 2023, she continued her winning streak by receiving the Gold award for Company of the Year Female Leadership (Boutique) and the Silver award for Accountancy Firm of the Year at the Magic Circle Awards. Furthermore, Alicea has consistently secured her position in the Global Elite Directory for four consecutive years, being recognized as a Private Client Global Elite Advisor and is currently listed for 2024 as a Non-Legal Adviser. This exclusive directory annually highlights the world's elite lawyers and outstanding wealth advisors serving ultra-high net-worth clients.

Please note: This content is intended for informational purposes only and is not a replacement for professional accounting or tax preparatory services. Consult your own accounting, tax, and legal professionals for advice related to your individual situation. Any copy or reproduction of our presentation is expressly prohibited. Any names or situations have been made up for illustrative purposes — any similarities found in real life are purely coincidental.?