We welcome guest blogger Andy Weiner today to provide insight on a very important case decided last year. Professor Weiner teaches at Temple Law School where he directs their LLM program in Tax and, starting this fall, also directs their low income taxpayer clinic. Prior to arriving at Temple, Professor Weiner spent more than a decade as an attorney in the Tax Division of the Department of Justice, initially in the Appellate Section, where he briefed and argued approximately 50 cases throughout the United States Courts of Appeals, and then at the trial level in the Court of Federal Claims Section. He received numerous distinguished service awards during his tenure. Keith
In United States v. Bittner, the Fifth Circuit reckons with the crack down on hiding wealth offshore. At issue is the non-willful penalty in 31 U.S.C. § 5321(a)(5)(A) for failing to report interest in foreign financial accounts on an annual Report of Foreign Bank and Financial Accounts known as an FBAR. The statute provides the Secretary of the Treasury “may impose a civil monetary penalty on any person who violates, or causes any violation of, any provision of section 5314 . . . not [to] exceed $10,000.” As explained by the Fifth Circuit, the case “hinges on what constitutes a ‘violation’ of section 5314: the failure to file an FBAR (as urged by Bittner) or the failure to report an account (as urged by the government).” Slip Op. at 13. On the surface, it’s a straightforward question of statutory interpretation, and not a particularly close one at that. It becomes more complicated, however, when you consider questions of purpose and fairness, which may help to explain why the Fifth Circuit and the Ninth Circuit split on the issue.
Bittner has spent most of his life in Romania. Between 1982 and 1990, he lived in the United States and became a citizen. He then returned to Romania and made a fortune as an investor. Through holding companies, Bittner controlled dozens of bank accounts in Romania, Switzerland and Liechtenstein. He did not file timely FBARs for 2007 to 2011 disclosing these accounts. The IRS imposed the maximum non-willful penalty of $10,000 regarding each account for each year. Bittner’s total penalty liability came to $1.77 million.
Bittner argued his liability should be capped at $50,000 based on his failure to file an FBAR for each of five years. As mentioned, that depends on what qualifies as a violation of 31 U.S.C. § 5314 subject to a penalty. Section 5314 states that the Secretary “shall require a resident or citizen of the United States . . . to keep records, file reports, or keep records and file reports, when the . . . person makes a transaction or maintains a relation for any person with a foreign financial agency.” By the Fifth Circuit’s reading, a person violates the statute according when he or she fails to report “a relation . . . with a foreign financial agency.” Bittner pointed out that the statute is not self-effectuating and that the implementing regulations require filing one FBAR that reports all applicable accounts. But that does not affect the meaning of the statute, as the Fifth Circuit explained: “Streamlining the process in this way, . . . cannot redefine the underlying reporting requirement imposed by section 5314.” Slip Op. at 17.
The Fifth Circuit also looked to the surrounding penalty provisions. Section 5321(a)(5) includes both a non-willful and a willful penalty, and the latter unquestionably treats each failure to report an account as a violation. Specifically, 31 U.S.C. § 5321(a)(5)(C) provides that “any person willfully violating, or willfully causing any violation of, any provision of section 5314” is subject to a maximum penalty equal to the greater of $100,000 or 50% of “the balance in the account at the time of the violation.” The reasonable cause exception to the non-willful penalty at 31 U.S.C. § 5321(a)(5)(B)(ii) likewise treats each failure to report an account as a violation, excusing “such violation” if “due to reasonable cause” and “the balance in the account at the time of the transaction was properly reported.” The same word in the definition of the non-willful penalty presumably bears the same meaning as it does in these related provisions.
The Fifth Circuit presents a compelling case based on the text of the statute that each failure to report a foreign bank account is a violation subject to a non-willful FBAR penalty. But why should Bittner, who maintained many foreign accounts ostensibly for legitimate business reasons and who did not willfully fail to report them on an FBAR, owe $1.77 million? Given the unintentional nature of the conduct, there’s little, if any, deterrence value to be gained. What then is the point of such significant penalty liability? The history of the non-willful penalty raises the prospect that it has outlived some of its usefulness.
The original FBAR reporting requirement in the Bank Secrecy Act of 1970 was enforced only by a willful penalty up to $100,000. In 2004, following a report by Treasury that perhaps hundreds of thousands of taxpayers were hiding wealth offshore and not filing FBARs, Congress increased the maximum willful penalty to 50% of the balance in an account not properly reported and added a non-willful penalty up to $10,000. Congress sought to make getting caught prohibitively expense and installed the non-willful penalty as a floor on the cost of non-compliance. Then, in 2010, Congress enacted the Foreign Account Tax Compliance Act, which required foreign banks to report account information of U.S. taxpayers. Bank reporting has proven much more efficient and effective at enforcing FBAR compliance and weakened the justification for the maximum non-willful penalty.
Still, the maximum penalty has its place, for example, as a proxy for taxes that the account holder avoided. Finding the appropriate balance is a matter of IRS discretion and the penalty mitigation guidelines at IRM 4.26.16-2. A person must cooperate with the examination and have a clean record in terms of prior FBAR penalty assessments, criminal activities, and civil tax fraud in any year of a non-willful FBAR violation. If these criteria are met, examiners are instructed to “limit the total mitigated penalties for each year to the statutory maximum for a single non-willful violation,” unless “in the examiner’s discretion . . . , the facts and circumstances of a case warrant a different penalty amount.” IRM 18.104.22.168.4.1 (06-24-2021). Among the factors an examiner should consider is “the harm caused by the FBAR violation,” i.e., lost tax revenue. IRM 22.214.171.124.2.1 (06-24-2021).
There is no indication why the IRS sought the maximum penalty liability against Bittner. The Fifth Circuit seemed to assume that Bittner’s liability was justified by “Congress’s central goal in enacting the BSA . . . to crack down on the use of foreign financial accounts to evade tax.” Slip Op. at 22. The Ninth Circuit in United States v. Boyd, 991 F.3d 1077 (2021), on the other hand, observed that Boyd amended her return to include income from her foreign bank accounts and proceeded to conclude that her non-willful penalty liability from failing to report 13 accounts in one year could not exceed $10,000. Tax avoidance (or the lack thereof) weighs heavily on courts notwithstanding that the relevant information is not necessarily disclosed in FBAR cases.
The lesson here for foreign account holders is to cooperate with an examination and pay the tax owed on income from foreign bank accounts. If the IRS does not mitigate the non-willful penalty liability, the account holder is in position to seize the higher equitable ground in court. The lesson for the IRS is to follow the mitigation guidelines and consider any departures from those rules carefully. The Supreme Court may take up Bittner to resolve the conflict with the Ninth Circuit, in which case I would expect it to affirm that each failure to report a foreign bank account is a violation of section 5314. But that will not end the debate over the appropriate level of non-willful penalty liability. To the contrary, the more the IRS has discretion, the more likely those disputes will endure.