A district court held that a taxpayer's failure to report all of his foreign accounts in years in which he self-prepared his Report of Foreign Bank and Financial Accounts (FBAR) was willful despite his misunderstanding of the rules based on advice given to him by an accountant in an earlier year. The court found that because he had reviewed the FBAR instructions the first year he self-prepared the form, he knew or should have known the FBAR reporting requirements, and his violation of the requirements for those years was willful because he exhibited willful blindness and recklessness in violating them.
Isac Schwarzbaum was born in Germany in 1955 but became a U.S. permanent resident in 1995 and a U.S. citizen in 2000. Schwarzbaum depended on his father, who had made a fortune in textiles and real estate, for financial support. Through the years, his father transferred Schwarzbaum between $100,000 and $200,000 a year, but also, in 2001, he signed over a Swiss account with approximately $3 million in it and made another large gift to Schwarzbaum in 2007. During the years in question, 2006-2009, Schwarzbaum had interests in 11 Swiss bank accounts and interests in two bank accounts in Costa Rica.
Schwarzbaum hired Doris Shaw to prepare his income tax return in 2006. He told Shaw about the gifts he received from his father. She advised him that gifts are not reportable in the United States unless there is a U.S. connection, which Schwarzbaum interpreted to mean that a gift was only reportable if it came from a foreign country to the United States or went out from the United States to a foreign country. Although it is unclear what, if anything, Shaw told Schwarzbaum about foreign account reporting, he believed based on her advice about gifts that foreign accounts were only reportable if they had a U.S. connection (i.e., they had received transfers from or sent transfers to a U.S. account).
On his 2006 Form 1040, Schedule B, Interest and Ordinary Dividends (in Part III, "Foreign Accounts and Trusts") and a 2006 FBAR, Schwarzbaum should have reported three of his Swiss accounts and his two Costa Rican accounts. However, only one of the Costa Rican accounts and none of the Swiss accounts had a U.S. connection, so he only told Shaw about the Costa Rican account with the U.S. connection. Based on this information, she reported only the Costa Rican account on Schwarzbaum's Form 1040, Schedule B. Likewise, she prepared a 2006 FBAR for him that reported only that account. According to Schwarzbaum, he first learned about the Schedule B and FBAR reporting requirements in 2006.
In 2007-2009, Steven Weitz prepared Schwarzbaum's returns. In 2007, the same five foreign accounts were reportable. However, Weitz did not ask about foreign accounts, and Schwarzbaum did not tell him about his accounts. Consequently, Weitz did not report any foreign accounts on Schwarz-baum's 2007 Schedule B or prepare a 2007 FBAR for him. Schwarzbaum, however, self-prepared a 2007 FBAR reporting the Costa Rican account that he had reported in 2006.
The income tax return prepared for Schwarzbaum by Weitz also did not report any accounts on his 2008 Schedule B, and Weitz did not prepare a 2008 FBAR. Due to the death of his father and other family matters, however, Schwarzbaum did not self-prepare and file a 2008 FBAR.
In 2009, although Schwarzbaum claimed he had told Weitz about both Costa Rican accounts, the Schedule B of his return did not report any foreign accounts. Schwarzbaum did personally prepare and file a 2009 FBAR, though, on which he reported the Costa Rican account and one of his Swiss bank accounts. He included the Swiss account in 2009 because he made multiple transfers to it from U.S. accounts in anticipation of a move to Switzerland, and thus the account had a U.S. connection, which he believed made it reportable.
In 2013, the IRS began an examination of Schwarzbaum's foreign tax reporting. The two revenue agents assigned to the exam recommended that he be assessed 31 U.S.C. Section 5321(a)(5)(B) nonwillful FBAR penalties for his failures to file a complete and accurate FBAR for 2006-2009. After consulting with an IRS offshore technical adviser, the agents changed the recommendation to an assessment of a willful FBAR penalty under 31 U.S.C. Section 5321(a)(5)(C). This recommendation was approved by IRS counsel, and Schwarzbaum was initially assessed mitigated penalties for willful violations of the FBAR reporting requirements for 2006-2009 of $35.4 million. This amount, though mitigated, was deemed excessive, and the IRS later further mitigated the penalties, arriving at a total penalty amount of $13.7 million.
The IRS brought suit in district court to collect the penalties it assessed against Schwarzbaum for 2006-2009. Schwarzbaum did not contest he had violated the disclosure and FBAR filing requirements for each of the years. Rather, he argued that his violations were not willful and he should therefore not be subject to a willful FBAR penalty, and also that the penalties imposed were arbitrary and capricious.
Elements of willful FBAR penalty
To be subject to a willful FBAR penalty: (1) the taxpayer must be a U.S. citizen; (2) the taxpayer must have or have had an interest in, or authority over, a foreign financial account; (3) the account had a balance exceeding $10,000 at some point during the reporting period; and (4) the person must have willfully failed to disclose the account and file an FBAR (31 C.F.R. §§1010.350(a) and 1010.306(c)). "Willfully" in this context means the taxpayer must have knowingly violated the FBAR reporting requirements or exhibited willful blindness or recklessness in violating them. The maximum penalty for a willful FBAR violation is the greater of $100,000 or 50% of the balance in the account at the time of the violation. The IRS may reduce the amount of the penalty at its discretion if mitigating factors exist.
The district court's decision
The district court held that Schwarzbaum did not commit a willful FBAR violation for his unreported foreign accounts in 2006 but did so for his unreported accounts in 2007-2009. The court found that he had not knowingly violated the FBAR reporting requirements for any of the years but that he had acted with willful blindness or recklessness of the requirements in 2007-2009.
Knowing violation: The IRS argued that a taxpayer is charged with knowledge of the information on a tax return by virtue of signing it under penalties of perjury; thus, since Schwarz-baum filed his income tax returns and FBARs, and they did not properly report his accounts, he knowingly violated the FBAR reporting requirements. The court rejected this argument because the rule would render the distinction between willful and nonwillful penalties meaningless. The court came to this conclusion because taxpayers are required to sign their tax returns and, if the IRS's proposed rule was followed, a violation of the FBAR filing requirements could never be nonwillful, despite the fact that the statute provides for a nonwillful penalty.
The IRS also pointed to certain actions by Schwarzbaum that it claimed were evidence that he knowingly violated the FBAR reporting requirements, but the court, taking into account Schwarzbaum's explanations for his actions, found that the IRS had not proved that he knowingly violated the requirements.
Exhibiting willful blindness or recklessness — 2006: Schwarzbaum argued that the willful FBAR penalty should not be imposed because he had reasonable cause for his failure to properly report all of his accounts. He claimed he had reasonable cause because he had reasonably relied on the advice of his accountant, Shaw, that gifts are not reportable unless there is a U.S. connection. Although Shaw's advice was incorrect, Schwarzbaum testified that he had followed this advice by reporting the Costa Rican account that had received funds transferred from the United States. The IRS pointed to inconsistencies in Schwarzbaum's deposition testimony and trial testimony regarding what he had told Shaw and his previous accountant but did not present any evidence that any of the accounts other than the Costa Rican account he reported in 2006 had received transfers from a U.S. account, which would prove that he had not followed Shaw's advice regarding the U.S. connection requirement for reporting.
Therefore, the court determined that the IRS had failed to prove that Schwarzbaum had not relied on Shaw's advice regarding which accounts to report. Because he had relied on Shaw's advice for 2006, the court found he had reasonable cause for failing to report all his reportable foreign accounts and had not violated the willful FBAR reporting requirement. Consequently, the court held that the IRS could only impose a nonwillful FBAR penalty for his failure to report all of his reportable foreign accounts in 2006.
Exhibiting willful blindness or recklessness — 2007 through 2009: The court was not as charitable to Schwarzbaum regarding his 2007-2009 FBARs. Because he self-prepared the FBARs for 2007 and 2009, and, by his own admission, reviewed the instructions for the FBAR in 2007 when preparing the form, the court looked at the instructions to the FBAR form to analyze whether Schwarzbaum could continue to rely on Shaw's advice from previous years as reasonable cause for failing to report all of his foreign accounts.
It found that he could not. Because the form nowhere stated (and Schwarz-baum admitted it did not) a U.S. connection requirement, the court reasoned his continued reliance on Shaw's advice was untenable. Finding that the FBAR instructions are "unequivocal about their application," the court determined that after he reviewed the 2007 FBAR instructions, "Schwarzbaum was aware, or should have been aware, of a high probability of tax liability with respect to his unreported accounts." Furthermore, despite this knowledge he had or should have had, he did not inform his current accountants of the existence of the foreign accounts or ask for their advice on how the accounts should be reported, which he should have done, even though the accountants did not ask him about the accounts.
Accordingly, the court held that his failure to correctly report his foreign accounts for 2007-2009 was a result of recklessness or a willful blindness of the reporting requirements and that his violation of the reporting requirements for those years was willful.
Amount of the penalties: In addition to claiming he was not subject to the willful FBAR penalty in any of the years, Schwarzbaum also argued that the IRS had incorrectly determined the penalties assessed and that they should be set aside as arbitrary and capricious. The court determined that the IRS had failed to correctly calculate the mitigated FBAR penalty using the balance in each account at the time of the FBAR violation as required by the statute, instead using balance amounts at the end of each year as reported by Schwarzbaum. To determine the correct amount of the penalties Schewarzbaum owed, the court requested that the parties file supplemental briefs on what the willful penalties for 2007-2009 calculated under the correct standard should be, as well as the amount of the nonwillful penalty for 2006.
This case highlights the importance of tax practitioners' having a thorough knowledge of the rules regarding foreign account reporting, asking clients about the existence of foreign accounts, making sure clients understand which accounts are reportable, and following up with clients if the practitioner sees evidence that they have reportable foreign accounts that they have intentionally or inadvertently failed to disclose to the practitioner. In addition, practitioners would be well advised to completely and contemporaneously document all discussions with clients about foreign accounts and any substantive advice given. As happened in this case, undisclosed accounts can lead to gargantuan penalties, and practitioners that are negligent in advising clients about foreign account reporting could find themselves facing large malpractice claims.
Schwarzbaum, No. 18-cv-81147-BLOOM/Reinhart (S.D. Fla. 3/20/20)