Circuit Court Weighs in on Meaning of Willfulness, Maximum Penalty and SOL Issues in Important FBAR Case

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In US v Horowitz  the Fourth Circuit issued a published opinion addressing a number of issues relating to the willful penalty for failing to file an annual Report of Foreign Bank and Financial Accounts, commonly referred to as an FBAR. 

The opinion addresses 1) the meaning of willful, holding that willful encompasses recklessness and that the term has different meanings for civil and criminal law purposes, 2) the maximum penalty for willful violations when a 1987 regulation that capped the willful penalty at $100,000 is inconsistent with a 2004 statutory change that boosted the “maximum penalty” for a willful violation to the greater of $100,000, or 50 percent of the account balance, holding that the statutory change effectively abrogated the $100,000 regulatory cap, and 3) the meaning of the term assessment when during the course of a post-assessment administrative appeal of the penalty there was uncertainty as to whether the IRS had abated the assessment.

In this post, I will discuss the third issue, focusing on the SOL argument the taxpayers raised. 

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As background, the Horowitzes had lived and worked in Saudi Arabia since 1984. While there, they initially had a bank account in a Saudi Arabian bank, but they eventually transferred the funds to FOCO, a Swiss bank. When FOCO was bought by an Italian bank, the Horowitzes moved the funds to another Swiss bank, UBS. By the time they moved back to the US in 2001 the account had grown to approximately $1.6 million. All the while they did not report income earned on the account on their US tax returns, and they never provided UBS with their US address.  By 2008, after UBS experienced financial setbacks, Mr. Horowitz traveled to Switzerland and withdrew the funds, depositing the proceeds in Finter Bank, another Swiss bank, this time in his name only. For an additional fee, Finter created the account as a “numbered” account with “hold mail” service, which meant that there was only a number associated with the account and that the bank would hold all correspondence associated with the secret account.

By 2009, there was widespread attention around the IRS crackdown on offshore accounts. The opinion discusses its impact on the Horowitzes:

In January 2010, the Horowitzes submitted a letter to the IRS disclosing the FOCO, UBS, and Finter Bank accounts and requesting that they be accepted into the Department of Treasury’s Offshore Voluntary Disclosure Program. This program provided potential protection from criminal prosecution and reduced penalties in exchange for cooperation. After entering the program, the Horowitzes filed FBARs, as well as amended income tax returns, for 2003 through 2008. As part of that process, they reported additional income of $215,126 and paid more than $100,000 in back taxes. In 2012, however, the Horowitzes opted out of the program.

In May of 2014 IRS sent letters to the Horowitzes proposing FBAR penalties for the undisclosed UBS accounts that they owned in 2007 and 2008. The letters proposed enhanced penalties based on an IRS determination that their conduct was willful and gave them about a month to respond. 

The Horowitzes, through their counsel, did respond to the May letter proposing penalties. In a June 3, 2014 letter they requested an administrative appeal of the still yet to be assessed penalties. The letter included a consent to extend the SOL on assessment of the penalties to December 31, 2015.

While the Horowitzes’ counsel letter began the process of an administrative appeal of the penalties, and had hoped that the extension would put off any possible assessment, on June 13, 2014 the IRS assessed the penalties. The opinion goes into some detail about the assessment process for FBAR penalties, including the work of the FBAR Penalty Coordinator at the Department of Treasury, and how she prepared four Form 13448 Penalty Assessment Certifications that a supervisor signed.

Here is where we get to the SOL issue.  The failure to file the annual FBAR gives the IRS six years to assess penalties, as per 31 USC § 5321(b)(1). At the time the FBAR had to be filed by June 30, so the SOL for assessing the 2007 FBAR penalty was June 30, 2014.  (Note that Title 31 gives the US two-years post-assessment to commence enforcement. 31 USC § 5321(b)(2)). 

There was no dispute that the penalty for 2007 was assessed prior to June 30, 2014, but the Horowitzes contended that the IRS’s actions after they protested the penalty amounted to an abatement of the assessment. 

In October of 2014, the Appeals Officer sent an email to the Appeals FBAR coordinator (with the very cool last name Batman) requesting that the assessments be “removed.” Internal emails between Appeals and the FBAR penalty coordinator suggested that the June 2014 assessment was “assessed prematurely.” In light of the protest and extension, Treasury’s FBAR penalty coordinator “simply deleted “6/13/2014” (the assessment date) from the “date penalty input” field in the assessment database.”

When the appeals process culminated in 2016 with no resolution, the Horowitzes argued that the IRS post-Appeals actions amounted to a reassessment of the penalty—this time beyond the six-year SOL for both 2007 and 2008 as per 31 USC § 5321(b)(1). 

The Fourth Circuit disagreed. In so holding, the opinion discussed the internal IRS procedures that allowed Appeals to hear the matter. Importantly, the opinion notes that the coordinator’s entry in the database was not accompanied by any more formal action:

But she did nothing more. Significantly, she generated no document, and her supervisor, Calamas, did not sign any document reversing the assessment certifications he had executed on June 13, 2014. Moreover, the Horowitzes were never informed that the penalties against them had been placed back into an unassessed status.

As the opinion discusses, the administrative appeals process continued for a couple of years. By May of 2016, Appeals informed the Horowitzes that there was insufficient time to reach resolution, in light of the two-year deadline to commence enforcement action “given that the government’s time for filing suit was set to expire in June 2016 (i.e., two years after the penalties were assessed in June 2014).”

Prior to closing the case at Appeals, the Appeals FBAR coordinator and the Treasury FBAR Penalty coordinator spoke about the legal effect of the database entry. That exchange, as well as its decision to end the Appeals process, highlighted that the government did not believe its actions amounted to an unwinding of the original assessment.

The Fourth Circuit emphasized that even if there were any subjective misunderstanding surrounding the legal effect of its data base deletion it concluded as a “matter of law” that the “mere act of deleting that date did not have the legal effect of reversing the assessments that had been formally certified … on June 13, 2014. Accordingly, the civil penalties against the Horowitzes were timely assessed, and the enforcement action was timely filed.”

Conclusion

The Horowitz opinion highlights the importance of the legal effect of an assessment. The opinion suggests that there were few formal mechanisms in place to allow Appeals to consider a post-assessment challenge to the penalty. The workaround that Appeals facilitated, which temporarily delayed the practical effect of an assessment, did not unwind its legal effect.

UPDATE

There are some excellent discussions in other blogs about the opinion. See Jack Townsend in his Federal Tax Crimes blog, discussing all aspects of the case, as well as Carolyn Kendall of Post & Schell who blogged the case in the firm’s White Collar blog with a focus on the opinion’s discussion of willfulness.

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

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