Civil FBAR Case Law: Williams and McBride

In contrast to Sturman, two courts that have considered the scope of willfulness in the civil FBAR context have suggested that failing to answer accurately the question regarding a foreign account on Schedule B can, without more, support a finding of willfulness with respect to a failure to file an FBAR. Further, these courts have stated that willfulness in the civil FBAR context includes mere recklessness, which includes careless disregard. These decisions clearly reflect that the government has disavowed the 2006 IRS memorandum’s embrace of a higher standard for willfulness in the civil FBAR context. Regardless of the exact fact patterns at issue in these cases, they state rules of law that may haunt future, more sympathetic account holders.

Williams

In United States v. Williams, the government filed a complaint to recover civil FBAR penalties assessed against the defendant for the year 2000. The defendant had deposited more than $7 million in assets into two Swiss bank accounts from 1993 through 2000, earning more than $800,000 on the deposits, and had failed to disclose these accounts or the income derived therefrom. On his individual income tax returns, Williams checked the relevant box on Schedule B “no,” thereby indicating that he had no foreign accounts. Likewise, Williams indicated on a tax organizer provided to him by his accountant in January 2001, for the purposes of his then-upcoming 2000 tax return, that he did not have a foreign account. However, Williams had retained counsel in the fall of 2000 because Swiss and U.S. authorities had become aware of his Swiss accounts, which were frozen in November 2000 on the day after Williams and his counsel had met with the Swiss authorities to discuss the accounts. Over the course of 2002 and 2003, Williams disclosed these accounts to the IRS, and disclosed them on his 2001 tax return and amended tax returns for 1999 and 2000, as part of his bid to participate in the IRS’s voluntary disclosure program. Williams was not accepted into the program, and he pleaded guilty in June 2003 to tax fraud, on the basis of the funds held in his Swiss accounts from 1993 through 2000. In 2007, he filed FBARs for all years going back to 1993, including for the year 2000.

After a bench trial regarding the basis for the civil FBAR penalties assessed for the 2000 tax year, the district court found that “[d]espite hiring tax lawyers and accountants, Williams had never been advised of the existence of the [FBAR] form prior to June 30, 2001, nor had he ever filed the form in previous years with the Department of Treasury.” The district court also found that Williams had not acted willfully as to his 2000 year FBAR. Specifically, it found that when Williams checked the “no” box on his 2000 personal income tax return indicating that he had no foreign bank accounts, and when he failed to file an FBAR on June 30, 2001, he already knew that the tax authorities were aware of his noncompliance, and he already had begun to meet with Swiss authorities. The district court found that this lack of willfulness was corroborated by Williams’s later disclosures of the accounts to the IRS and his filing of accurate returns. Finally, the district court rejected the government’s claim that Williams’s plea to tax evasion estopped him from arguing that he did not willfully violate his 2000 year FBAR obligation.

The Fourth Circuit, purporting to apply the standard of clear error, reversed the district court’s factual finding that Williams had not acted willfully in a 2012 unpublished opinion. When doing so, the Fourth Circuit also stated that, in the civil context, willfulness includes not just knowing violations, but also reckless ones. Citing Sturman for the proposition that willfulness may be inferred under the willful blindness doctrine, the Fourth Circuit emphasized that Williams had signed his 2000 income tax return, which had put him on notice about the 2000 FBAR filing requirements because of the question on Schedule B regarding foreign bank accounts, which references the FBAR – i.e., Williams should have realized that he had an FBAR filing requirement, but avoided learning about it. The Fourth Circuit also found that Williams’s guilty plea allocution for his tax convictions confirmed that his FBAR violation was willful. However, the Williams opinion contained a dissent, which argued that the record contained sufficient evidence supporting the conclusion of the district court, which had not clearly erred when it found a lack of willfulness. Moreover, the dissent observed that the district court correctly rejected the government’s collateral estoppel argument because Williams never admitted during his guilty plea to failing to file an FBAR, much less failing to do so willfully.

Although Williams involves unusual facts, it implies – because it reversed for clear error the contrary conclusion of the fact finder – that willfully filing a false tax return that does not disclose a foreign account can be inherently synonymous with willfully failing to file the separate FBAR form for the same tax year, at least in a civil penalty case. Although the court also pointed to the inaccurate information Williams provided on his tax organizer as an example of additional conduct meant to conceal, that conduct seems secondary and intrinsic to its immediate consequence – the failure to disclose the account on the tax return. Whether the outcome in Williams was the product of the court’s embrace of the recklessness standard, or was the inevitable product of the court’s interpretation of the willful blindness doctrine, cannot be gleaned from the opinion. Certainly, the court made clear that it viewed the willfulness standard in a civil penalty case as different from the willfulness standard in a criminal case.

McBride

The District of Utah cited Williams when holding in 2012 that the willful filing of signed false income tax return supports a finding of willfulness with respect to failing to file an FBAR. In United States v. McBride, the defendant sought to reduce his tax liabilities arising from his increasingly successful company, and so contacted a financial management firm devoted to tax minimization, Merrill Scott and Associates (MSA). MSA presented McBride with a plan to shift his company’s income to offshore accounts owned by MSA’s foreign entities, over which McBride would have indirect control. MSA also gave McBride a pamphlet setting forth duty as a U.S. taxpayer to report his interest in any foreign account to the government. Pursuant to MSA’s plan, McBride created a transfer pricing scheme whereby the company purchased inventory from a manufacturer at an inflated price and the manufacturer then deposited the overpayment into the offshore accounts that McBride indirectly controlled. During 2000 and 2001, McBride routed roughly $2.7 million through these offshore accounts. McBride failed to inform his preparers of the MSA plan or his interest in the offshore accounts. On his individual income tax returns for both years, he checked “no” on Schedule B and signed the returns. In 2004, the IRS began to investigate McBride; he denied using MSA’s plan or having an interest in the foreign accounts and refused to complete FBARs for 2000 and 2001. Ultimately, the IRS asserted civil penalties against McBride for tax years 2000 and 2001.

After a bench trial, the district court found that McBride’s failure to file FBARs for 2000 and 2001 was willful. As in Williams, the court stated that “willfulness” for civil FBAR enforcement proceedings has the same definition as in other civil contexts: recklessness and willful blindness both constitute civil willfulness, which can be inferred from circumstances, including actions taken to conceal or mislead. However, invoking a recklessness standard hardly seemed necessary to establish liability: according to the court, ample evidence demonstrated that McBride had actual knowledge of his obligation to file an FBAR. The court found that McBride had read the pamphlet from MSA discussing the filing requirement and, more tellingly, he testified that he did not check “yes” on Schedule B “because . . . if you disclose the accounts on the form, then you pay tax on them, so it went against what I set up [MSA] for in the first place.” Despite this seemingly ample evidence of actual knowledge, the court also engaged in an imputed knowledge analysis; it held that because “a taxpayer’s signature on a return is sufficient proof of a taxpayer’s knowledge of the instructions contained in the tax return form,” and because McBride signed the return, which contained instructions concerning the FBAR filing requirement, McBride had imputed knowledge of the FBAR requirement. The court further noted, relying on Sturman, that circumstantial evidence of McBride’s willfulness included his misstatements to, and concealments from, the IRS during their 2004 investigation, which also contradicted his claim that he did not know he had a legal duty to file FBARs.

Finally, the court rejected McBride’s contention that he was not willful because he subjectively believed that he lacked a reportable interest in the foreign accounts based on professional advice. The court held that any belief by McBride that he was not legally required to file an FBAR was “irrelevant” in light of his signing of his tax returns. According to the court, under Lefcourt v. United States, once it is established that a filing was required by law, the only relevant inquiry is whether the failure to file was voluntary rather than accidental. This statement, considered in the abstract, is simply contrary to a definition of willfulness requiring an intentional violation of a legal duty that is subjectively understood by the individual.

Legislative Proposal

The Williams and McBride opinions both reflect that the government has disavowed the more measured position articulated by the IRS in its 2006 Chief Counsel Advisory Memorandum. They also provide ammunition for the government’s anticipated efforts to advance in future civil FBAR cases a lax definition of willfulness which allows for mere recklessness. Further, the McBride court’s reasoning under Lefcourt and the Williams court’s reversal for clear error suggest that simply failing to “check the box” on Schedule B of a tax return regarding a foreign account might cause any failure to file an FBAR to be deemed – at least by the IRS, if not a court – a per se willful failure in a civil case. Given this erosion of the willfulness standard, the suggestion by the National Taxpayer Advocate that the willfulness requirement for civil FBAR actions be amended legislatively to make clear that willfulness requires not just recklessness, but a voluntary and intentional violation of a known legal duty, therefore makes particular sense. As the Report suggests, restoring the integrity of the willfulness standard in civil cases will honor the intent of Congress that the draconian 50% penalty address the problem of bad actors concealing their income. Likewise, clarity regarding the standard for willfulness, and excluding the merely reckless from its net, would accomplish several goals:

• Imposition of the severe 50% penalty for willfulness would be limited, at least in principle, to those who actually deserve it and to whom it was intended to apply: those individuals who intentionally disregarded a known legal duty, rather than those who merely “should have known better.”
• Public criticisms of the IRS offshore disclosure programs and related enforcement should be muted. Although case-specific disagreements likely will remain regarding the application of the willfulness standard, it simply will be easier as a matter of principle for the IRS to justify imposing high penalties on intentional law breakers.
• Excluding recklessness from the definition of willfulness enhances the clarity and fairness of the process of certifying non-willfulness, as required by the current “streamlined” program for offshore accounts. Programs such as the streamlined program, which offer the government the benefits of administrative convenience and maximizing the amount of taxpayers who enter into compliance with the tax system, succeed best when individuals and their advisors feel relatively secure about how the rules are both defined and applied. If willfulness includes recklessness, it is simply harder to predict what conduct eventually may be deemed to be willful. Further, if not checking the box on one’s tax returns to indicate the presence of a foreign account is regarded by the government as synonymous with civil willfulness for the purposes of the FBAR, then the streamlined program becomes almost incoherent, because its benefits and purpose will not be realized except in the most unusual cases.

However, we respectfully disagree with the Report that any legislative or policy change should reflect that the government cannot meet its burden through “circumstantial evidence.” Given the entrenched role of circumstantial evidence in gleaning mental state in both civil and criminal contexts, such line drawing seems unworkable in practice and would contradict basic principles regarding proof of mental state, for which “direct evidence” – to the extent that it is even possible in practice to distinguish direct and indirect evidence – rarely is available. Likewise, we disagree that the government should not have access to the doctrine of willful blindness when attempting to prove mental state. Again, willful blindness – like it or not – is an accepted method of proving mental state. Although the doctrine of willful blindness invites the unfortunate risk that fact finders will inappropriately conflate negligence with actual knowledge or intent, the doctrine itself, properly articulated, demands more than mere recklessness. Indeed, as the Supreme Court made clear in 2011 in Global-Tech Appliances, Inc. v. SEB S.A., willfulness blindness is not a substitute for actual subjective belief, and the doctrine requires that the defendant take deliberate, affirmative actions to avoid learning the critical facts. Deliberate indifference and the existence of known risks, standing alone, will not suffice. Ultimately, a clear definition of willfulness as an intentional violation of a known legal duty will harmonize the civil and criminal law for FBARs; how mental state may be proved should be left to traditional principles of civil and criminal law.

We agree. Court victories by the government in civil FBAR enforcement actions have diluted the willfulness threshold, from the more appropriate standard of an intentional and voluntary violation of a known legal duty, to a standard of mere recklessness. A “recklessness” standard lacks precision and invites severe penalties simply because an individual is presumed – or is concerned about being presumed – to have “known better,” even if he in fact did not know.

The Report therefore wisely proposes that the willfulness requirement for civil FBAR actions be amended legislatively to make clear that willfulness requires not just recklessness, but a voluntary and intentional violation of a known legal duty. In the first part of this two-part post, we describe how, prior to the current offshore enforcement campaign, willfulness in the civil FBAR context was understood to be equivalent to willfulness in the criminal context. In the second part, we describe how recent case law in the civil FBAR context has eroded this definition, and why the Report’s legislative proposal would benefit both taxpayers and the IRS by correcting this apparent trend. As practitioners who assist taxpayers with disclosing their offshore accounts and becoming fully tax compliant, we join with the Report and the public and private comments of many of our colleagues in observing that this erosion of the willfulness standard fails to distinguish adequately between most account holders and true bad actors, and therefore can discourage those who otherwise wish to become fully compliant.

Admittedly, the Report’s legislative proposal is unlikely to attract much Congressional support, given current budget deficits and the presumed desire of legislators to avoid being depicted as protecting offshore account holders. Nonetheless, the legal point remains: if an individual did not act with the intent to violate a known legal duty, then it is difficult to argue why he should be subject to a very draconian, albeit civil, penalty from the perspective of either fairness or the smart use of limited enforcement resources. As the Report states, the enhanced civil penalties for willful conduct were enacted to target bad actors, not to ensnare the inadvertent or negligent. Moreover, and aside from the benefits of attaining consistency between the civil and criminal penalty regimes for willful conduct, the practical reality is that the current IRS “streamlined” program for disclosing offshore accounts, which requires that the taxpayer submit a certificate attesting to his non-willfulness, is complicated by the possibility that the taxpayer is really being asked to assert that he did not act “recklessly,” which is a potentially much murkier claim than asserting that he did not act with fraudulent intent. Indeed, and as we explain, even the IRS used to state that willfulness for the substantial civil FBAR penalties demanded the same heightened showing required for criminal willfulness.

However, and as we note in our second post, we respectfully disagree with the Report that any legislative or policy change should prevent the government from meeting its burden through use of circumstantial evidence or the doctrine of willful blindness. Such proposals would contradict well-settled methods of showing mental state, and would be unworkable in practice.

United States v. Sturman and the IRS’s 2006 Chief Counsel Advisory Memo

If performed “willfully,” failing to file an FBAR, or filing a false FBAR, is a felony violation of the BSA under 31 U.S.C. §§5314 and 5322(a). A “willful” act, for the purposes of Section 5322 – and also for the vast majority of criminal tax offenses – means a voluntary and intentional violation of a known legal duty.

Prior to the government’s relatively recent offshore account enforcement campaign, the federal courts offered scant guidance as to what qualified as a “willful” failure to file an FBAR. In 1991, the Sixth Circuit upheld a criminal conviction for a willful failure to file an FBAR in United States v. Sturman. Defendant Sturman challenged on appeal his convictions for tax fraud and failing to file FBARs pertaining to business proceeds deposited into Swiss bank accounts. He argued in part that the government had failed to establish he was aware of the legal requirement to file FBARs. The Sturman court rejected this claim and upheld the convictions. In so doing, it cited Cheek v. United States, the seminal case regarding willfulness in the criminal tax context, for the propositions that the test for willfulness is a “voluntary, intentional violation of a known legal duty” and that willfulness “may be proven through inference from conduct meant to conceal or mislead sources of income or other financial information.” In upholding the convictions, the Sixth Circuit noted that the defendant had taken multiple steps to conceal his overseas assets from the government apart from his failure to file the FBAR, including concealing his signatory authority, interest in various transactions, and interest in the corporations that were transferring money to the foreign accounts. The Sturman court also noted that the defendant had admitted his “knowledge of and failure to answer” the question on Schedule B of his federal income tax return, which referred taxpayers to a booklet outlining the FBAR reporting requirements. The court found that the evidence of Sturman’s “acts to conceal income and financial information, combined with the defendant’s failure to pursue knowledge of further reporting requirements as suggested on Schedule B[,]”established willfulness.

The analysis in Sturman therefore reflects that an individual’s mere knowledge of and failure to answer correctly the question on Schedule B concerning foreign bank accounts, absent some other affirmative acts of concealment, is insufficient evidence to establish that the individual knew of the FBAR reporting requirement and willfully violated it – at least in a criminal case.

Once, the IRS itself took its cues from Sturman and embraced a more robust definition of willfulness in the civil FBAR context. In an IRS Chief Counsel Advisory Memorandum released on January 20, 2006, the IRS outlined its position on the willfulness requirement for imposing elevated civil penalties under 31 U.S.C. §5321(a)(5)(C) for an FBAR violation. The IRS stated in this 2006 memorandum that there were no cases “in which the issue presented is construing ‘willful’ in the civil penalty context[,]” a statement that was true at the time. The IRS then expressed its view that the willfulness requirement for imposing a Section 5321 civil penalty is identical to the willfulness requirement for criminal penalties under Section 5322 – i.e., a voluntary and intentional violation of a known legal duty – because both sections use the same word: “willful.” The IRS further noted in the 2006 memorandum that willfulness can be inferred where an “entire course of conduct establishes the necessary intent,” and as an example in the context of a criminal FBAR violation cited to Sturman. This reference to Sturman was potentially instructive because, as noted, the defendant’s criminal conviction for failing to file an FBAR in that case rested on additional affirmative acts of concealment beyond merely failing to check the correct box on Schedule B of his income tax return.

In our second and final post, we will discuss how some recent court rulings have relaxed this standard of willfulness in the civil FBAR context, so as to allow for mere recklessness, and how a legislative fix regarding the definition of willfulness would help to inject needed clarity into the “streamlined” program for offshore accounts, and restore overall fairness.