Friday, April 27, 2018

FBAR violation can be shown by preponderance of the evidence and willfulness by reckless conduct


Under the Bank Secrecy Act, U.S. citizens must file an FBAR with the U.S. Treasury disclosing any financial account in a foreign country with assets in excess of $10,000 in which they have a financial interest, or over which they have signatory or other authority.

Those who willfully fail to file their FBARs on a timely basis can be assessed a penalty of up to the greater of $100,000 or 50% of the balance in the unreported bank account for each year they fail to file a required FBAR. IRS has discretion as to the amount of the penalty, subject to these limits

A "reasonable cause" exception exists for non-willful violations, but not for willful ones.

Courts have previously considered the level of the burden of proof needed sustain civil penalties for a willful failure to file the FBAR disclosure by holding that the preponderance of the evidence standard governs suits by IRS to recover civil FBAR penalties[1].

A number of courts have found that willfulness in the civil FBAR context includes reckless conduct[2].

In a case dealing with a fraudulent misrepresentation claim, the Supreme Court held that a heightened clear and convincing burden of proof applies in civil matters "where particularly important individual interests or rights are at stake." (Herman & MacLean v. Huddleston, 459 U.S. 375 (S Ct 1983)) Such interests include parental rights, involuntary commitment, and deportation. The lower, more generally applicable preponderance of the evidence standard applies, however, where "even severe civil sanctions that do not implicate such interests" are contemplated.

In U.S. v. Garrity, 121 AFTR 2d ¶2018-629, (DC CT, 4/3/2018) the IRS filed suit to reduce to judgment a civil penalty that it assessed against Paul G. Garrity, Sr. for his alleged willful failure to report his interest in a foreign account that he held in 2005.

In anticipation of trial, the parties submitted briefs addressing the legal question of what standard of proof governs; preponderance of the evidence or clear and convincing evidence. IRS argued that the standard of proof was preponderance of the evidence. The taxpayer argued that the standard of proof was clear and convincing evidence.

The parties also briefed the separate question of whether IRS must show that Mr. Garrity, Sr. intentionally violated a known legal duty to establish a "willful" FBAR violation (as the taxpayer's representatives contended) or whether IRS may satisfy its burden of proof by showing that Mr. Garrity, Sr. acted recklessly (as IRS contended).

The district court determined that IRS must prove the elements of its claim for a judgment by a preponderance of the evidence and that proof of reckless conduct would satisfy IRS's burden on the element of willfulness.

The district court found that the civil FBAR penalty did not implicate important individual interests or rights. The court reasoned that the fact that the taxpayers might be liable for a substantially larger sum of money for a willful FBAR violation than if IRS had pursued a civil tax fraud action did not warrant a higher standard of proof. As Huddleston indicated, it was the type of interest or right involved that triggered a higher standard of proof, not the amount in controversy. 

The district court reasoned that the sanction that the taxpayer might be exposed to, regardless of how "draconian" it might be, was monetary only. Despite characterizing the taxpayer's exposure to a monetary sanction as implicating a "property interest that require[s] protection" the taxpayer's representatives had not demonstrated how the penalty IRS sought would affect important individual interests or rights to warrant a higher standard of proof.

The taxpayer's representatives also argued that IRS's proof of willfulness likely would involve allegations of fraud, which could tarnish Mr. Garrity, Sr.'s reputation, implicating a more important interest than those involved in typical civil cases. But the court, looking to Huddleston and noted that even allegations of fraud did not necessitate a higher standard of proof. Unlike a large number, and perhaps the majority, of the States, Congress had chosen the preponderance standard when it has created substantive causes of action for fraud.

While the taxpayer's representatives conceded that numerous courts had found that willfulness in the civil FBAR context included reckless conduct, relying principally on criminal cases, they maintained that IRS must prove that Mr. Garrity, Sr. intentionally violated a known legal duty in order to satisfy the element of willfulness, and that proof of reckless conduct was insufficient. The district found that the taxpayer's representatives ignored the clear distinction that the Supreme Court had drawn between willfulness in the civil and criminal contexts[3]. The taxpayer's representatives pointed to no other authority that would warrant deviating from the Supreme Court's holdings that statutory willfulness in the civil context covered reckless conduct.

The District Court held that IRS may prove that a taxpayer failed to timely file a Foreign Bank and Financial Accounts Report (FBAR) by a preponderance of the evidence rather than by a higher, clear and convincing evidence standard. The court also determined that IRS could show willfulness on the taxpayer's part by proof of his reckless conduct and did not need to show that he intentionally violated a known legal duty.

 



[1] (Bedrosian v. U.S., (DC PA 9/20/2017) 120 AFTR 2d 2017-5832 ; U.S. v. Bohanec, (DC CA 2016) 118 AFTR 2d 2016-6757 ; U.S. v. McBride, (DC UT 2012) 110 AFTR 2d 2012-6600 ; U.S. v. Williams, (2010, DC VA) 106 AFTR 2d 2010-6150 , rev'd on other grounds, U.S. v. Williams, (CA 4 2012) 110 AFTR 2d 2012-5298
[3] See Ratzlaf v. U.S.,(S Ct 1994) 510 U.S. 135.

Monday, April 16, 2018

Distributions from account that had ceased to be an IRA were not taxable



Stacey Marks owned a retirement account, the custodian of which was the Argent Trust Co. (the Argent account). Before 2005, the Argent account qualified as an IRA.

In 2005, the Argent account made a $40,000 loan to Marks' father. It received a promissory note in exchange. In 2012, the Argent account made another loan, of $60,000, to one of Marks' friends, again receiving a promissory note in exchange.

As of December 2013, the Argent account had the following assets: (1) the two notes (with a combined face value of $100,000) and (2) $96,508 in cash. In December 2013, Marks opened a new retirement account, the custodian of which was the Equity Trust Co. (the Equity account). In December 2013, Marks attempted to roll over the assets of the Argent account to the Equity account.

On her 2013 tax return, Marks did not report that she had received a taxable distribution from the Argent account.

IRS initially determined that Marks successfully rolled over the $96,508 into the Equity account, but that the two notes were not successfully rolled over and thus had to be included in income in 2013. In its deficiency notice, IRS found that she had received a $98,000 taxable distribution from the Argent account (representing the two notes; it's unclear why they weren't valued at their full $100,000 face value), and that this amount was subject to the 10% additional penalty on early distributions under Code Sec. 72(t), and that Marks had a substantial underpayment of tax and was thus subject to a $7,071 accuracy-related penalty.

Marks challenged the determination, asserting that the two notes were distributed to her then rolled over into the Equity account.

The Tax Court, after reviewing the parties' positions, ordered them to file additional memoranda addressing the effect of the prohibited transaction rule under Code Sec. 408(e)(2)(A).

Both sides agreed that, by making the loan to Marks' father in 2005, the Argent account had engaged in a prohibited transaction and ceased to be an IRA.

Accordingly, as agreed by the parties, the Tax Court held that Marks was not required to include the $98,000 in income for 2013 because the distribution was not from an IRA. As a result, the early distribution penalty didn't apply, and there was no substantial understatement of tax giving rise to a penalty under Code Sec. 6662.
What the court did not address was whether a tax can be levied against the taxpayer for the prohibited transaction in 2005. As the audit year was 2013 it is likely that the 3 year and 6 year statute of limitations has expired and barring fraud there would be no way for the IRS to make an assessment.