Prof. Brunetti's Tax News: 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.