Overview
On July 22, 2022, the Third Circuit issued a decision in Bedrosian v. United States1 in which it affirmed the District Court's order that the taxpayer, Arthur Bedrosian, pay a penalty of $975,789.17 (plus interest) to the IRS for willfully filing an inaccurate Report of Foreign Bank and Financial Accounts (FBAR).2 The decision is noteworthy, not only because of the large FBAR penalties involved but also due to the Third Circuit’s refusal to revisit the willfulness test it articulated in Mr. Bedrosian's earlier appeal. This article summarizes the Bedrosian case and highlights common law expectations of strict compliance with FBAR requirements. In light of the Third Circuit's broad willfulness standard, taxpayers should review their personal holdings and consult a professional tax advisor to ensure any FBAR reporting requirements are satisfied.
Background
The Bank Secrecy Act and Relevant Case Law
The Bank Secrecy Act3 (the “Act”) was enacted to address the growing concern of tax noncompliance and specifically criminal tax evasion schemes.4 In the relevant part, the Act generally requires that US persons self-report their foreign accounts, as opposed to requiring third parties to report on their behalf5, so there is little likelihood of persons engaging in illegal tax shelter activity to voluntarily disclose such foreign holdings. In those instances, the stick proves more valuable to the IRS than the carrot given the extensive penalties that may be imposed for willful violations: (i) civil penalties are greater than 50% of the amount in the account at the time of the violation or $100,000, and (ii) criminal penalties are a maximum of $10,000 or five years in prison or both.6 Because of the heightened penalties for willful violations, as compared to those for negligent or non-willful violations, the question of what standard should apply to determine willfulness is an important one.7
Although the case law surrounding the willfulness standard is not extensive, there is an indication by certain courts to ensure strict compliance with FBAR reporting requirements. The Fourth Circuit addressed the willfulness standard as applied to FBAR noncompliance in United States v. Williams.8 In an unpublished opinion citing facts similar to those in the Bedrosian case, the court provided that, "Willfulness may be proven through inference from conduct meant to conceal or mislead sources of income or other financial information, and it can be inferred from a conscious effort to avoid learning about reporting requirements."9 Applying this standard, the court reasoned the taxpayer's signature on his return was prima facie evidence that he should have known of his FBAR reporting requirement and, by not reporting, had made a conscious effort to avoid learning of his reporting requirement and his actions were, at a minimum, reckless.10 Thus, willful blindness was sufficient to affirm the penalty, and the IRS was not required to show malice or improper motive.11
In addition, courts have showcased relatively little sympathy towards taxpayers with high penalty assessments. For example, in United States v. Zwerner, a jury returned a verdict ordering the taxpayer to pay 50% of his account balance for each of three years of noncompliance, amounting to a penalty of one hundred and 50% of his account balance.12 In addition, in United States v. Bussell, the Ninth Circuit affirmed the District Court’s modest reduction in penalties from $1,221,806 to $1,120,513, despite the taxpayer’s numerous constitutional objections to the assessment.13
Facts and Procedural History
While working as a pharmaceutical representative and traveling frequently overseas in the late 1960s and early 1970s, Mr. Bedrosian opened a bank account with a Swiss bank that would eventually become acquired by the Union Bank of Switzerland (UBS).14 Mr. Bedrosian originally opened the account to easily make purchases while abroad, but eventually, it transitioned into a form of savings account.15 Mr. Bedrosian informed his personal accountant of the foreign account only in the 1990s, at which time the accountant advised him to report the foreign account on his personal tax returns or risk breaking the law.16 At the time and for the next several years, Mr. Bedrosian refused to heed this advice and omitted the UBS account from his personal tax returns.17 In 2005, following an investment proposal by UBS, Mr. Bedrosian proceeded to open a second account with the bank.18
Following advice from a different personal accountant, Mr. Bedrosian reported one of the two UBS accounts on his 2007 tax year return and filed an FBAR for the same year.19 In addition to only identifying one of the bank accounts, however, the report underrepresented the asset value of his overseas holdings, omitting approximately $2 million of assets from the report.20 Thereafter, Mr. Bedrosian began correcting the prior year reporting inaccuracies, but the IRS, after discovering the omissions, still imposed the maximum penalty (i.e., 50% of the value of the undisclosed account) on Mr. Bedrosian.21 Mr. Bedrosian refused to pay the penalty in full, and the IRS sued to collect.22
When the case was first tried in District Court, the issue before the court was whether Mr. Bedrosian’s omission of the second bank account and its full account balance was "willful." Following a one-day bench trial, the court held that the IRS failed to establish that such conduct was willful, and the taxpayer prevailed.23 On appeal the Third Circuit reversed, stating that the District Court erred in only considering Mr. Bedrosian's "subjective motivations and the overall 'egregiousness' of his conduct," which it opined was not a requirement to establish willfulness.24 Indeed, the court held that the same civil standard of willfulness that applies in other areas of civil liability applies equally to the willfulness standard under the FBAR reporting statute, and therefore, fact finders must also consider whether the conduct was "reckless."25 "Recklessness," the court furthered, exists - in particular with respect to IRS filings - when, "a person '(1) clearly ought to have known that (2) there was a grave risk that the filing requirement was not met and if (3) he or she was in a position to find out for certain very easily.'"26 Thereafter, the Third Circuit remanded the case back to the District Court for further consideration.27
The IRS prevailed the second time at the District Court level. With instructions from the Third Circuit to consider whether Mr. Bedrosian’s conduct was reckless, the District Court found that he indeed acted willfully because he "recklessly disregarded the risk that his FBAR was inaccurate."28 Mr. Bedrosian was ordered to pay the full penalty plus interest, and his appeal followed thereafter.29
Bedrosian's Second Appearance with the Third Circuit
In the July 2022 decision, the Bedrosian court affirmed the District Court's decision to reconsider the evidence and its previous factual findings to determine whether the taxpayer acted recklessly.30 Furthermore, the Third Circuit rejected Mr. Bedrosian's request to find that the District Court clearly erred in making its determination, instead noting that the District Court decision was "grounded in credible evidence" and "well-reasoned."31 As noted above, the court also declined to revisit its test for willfulness, thereby ensuring that any future FBAR violations in its jurisdiction would be examined under the Third Circuit’s more expansive standard for willfulness.32
Conclusion
Although the results may appear extreme, they are not altogether surprising given the case law surrounding the willfulness standard and the apparent trend toward holding taxpayers accountable for less than strict FBAR compliance. As noted above, courts have found willfulness where the taxpayer merely failed to act in accordance with their apparent duty, and the Bedrosian decision is yet another feather in the IRS' cap in cases involving large penalties where the government need not prove malice or improper motive. In light of the apparent deference afforded to the government in these cases and the trend towards developing a broad willfulness standard, taxpayers should be extremely diligent in ensuring compliance with any reporting requirements or should consult with a tax advisor well-versed in these requirements.
Notes
1Bedrosian v. United States, No. 21-1583, 2022 WL 2899266 (3d Cir. July 22, 2022).
2 Id. at *1.
3 31 U.S.C. § 5311.
4 Foreign Bank Secrecy and Bank Records: Hearings Before the House Comm. on Banking and Currency on H.R. 15073, 91st Cong. 8 (1970).
5But see FATCA Information for Individuals, IRS (last visited Aug. 12, 2022) https://www.irs.gov/businesses/corporations/fatca-information-for-individuals (Third-party reporting may be provided to the IRS for certain financial accounts).
6 Report of Foreign Bank & Financial Accounts (FBAR) Reference Guide, IRS 1, 10 (last visited Aug. 12, 2022) https://www.irs.gov/pub/irs-pdf/p5569.pdf.
7 For a description of the penalties imposed for negligent or non-willful violations, see id.
8United States v. Williams, 489 Fed.Appx. 655 (4th Cir. 2012).
9 Id. at 658.
10 Id. at 659-660.
11Id. at 658 n. 5.
12Verdict Form and Special Interrogatories, United States v. Zwerner, No. 1:13-CV-22082 (S.D. Fla. May 28, 2014). The parties subsequently settled the case, so the question of whether the penalties violated the Eighth Amendment Excessive Fines Clause remained open.
13United States v. Bussell, 699 Fed.Appx. 695, 696 (9th Cir. Oct. 25, 2017).
14 Bedrosian v. United States, 912 F.3d 144, 147-148 (3d Cir. 2018).
15 Id. at 147.
16 Id. at 148.
17Id.
18Id.
19 Id.
20 Id.
21Id.
22 Id.; see also Bedrosian, 2022 WL 2899266, at *1.
23 Bedrosian, 912 F.3d at 148.
24 Id. at 153.
25 Id. at 152-153.
26 Id. at 153 (quoting United States v. Vespe, 868 F.2d. 1328, 1335 (3d Cir. 1989)).
27 Id.
28 Bedrosian, 2022 WL 2899266, at *2.
29 Id.
30Id. at *3.
31Id.
32 Id. at 4.