The Third Circuit affirmed a district court’s holding that a taxpayer’s failure to report his foreign accounts on Financial Crimes Enforcement Network (FinCEN) Forms 114, Report of Foreign Bank and Financial Accounts (FBAR), was willful. However, while it did not agree with the district court that the IRS had proved the amount of the penalty assessed against the taxpayer, the Third Circuit nonetheless upheld the penalty amount because it found the taxpayer’s counsel had admitted in the court proceedings that the balance in the taxpayer’s undisclosed foreign account was enough to support the penalty assessed.
Arthur Bedrosian is a U.S. citizen who has worked in the pharmaceutical industry since the 1970s. He has been highly successful in his career, rising to the position of CEO of a generic drug manufacturer. In the early 1970s, when he was still a manufacturer’s sales representative, he opened a bank account with a Swiss bank that would later become United Bank of Switzerland (UBS). Sometime during 2005, he opened a second account with UBS, although Bedrosian claimed he considered them to be one account. Bedrosian met with a UBS banker once a year to review the accounts’ performance. During 2007, the tax year at issue in the proceeding, both UBS accounts carried balances of significantly more than $10,000. He closed the accounts at the end of 2008.
Bedrosian did not tell his accountant about the existence of the two accounts until 2006, claiming he had failed to do so because the accountant had never asked about them. The accountant, upon learning of the accounts, told Bedrosian he was and had been required to report on his personal tax returns that he had the foreign bank accounts and file any FBARs for them. According to Bedrosian, on advice of the accountant, he did not report the accounts on his 2006 personal returns.
Bedrosian’s accountant died in 2007 and, working with a new accountant, Bedrosian finally disclosed his foreign accounts on his 2007 tax return and a 2007 FBAR. However, his disclosure in the 2007 FBAR was somewhat less than complete. It listed only one of the UBS accounts with a balance of $240,000, even though the second account’s balance was approximately $2.3 million. He did not report any of the income from the accounts in 2007 on his personal return.
The IRS found out about Bedrosian’s account in the 2000s when the U.S. government negotiated an agreement with Swiss banks to provide it account information about their customers. The IRS opened an investigation of Bedrosian in 2011, and eventually the Service assessed the maximum penalty under the Bank Secrecy Act against Bedrosian for willfully filing an inaccurate FBAR: 50% of the balance of the undisclosed account at the time of the violation. The IRS determined the balance in the account at the time of the violation was $1,951,578.34, and it calculated the 50% penalty to be $975,789.17. Bedrosian initially refused to pay the penalty but eventually did and then filed a refund suit in district court.
The district court sided with Bedrosian. After a one-day bench trial, the court determined that the IRS had failed to prove Bedrosian had willfully filed an inaccurate FBAR. It found that the evidence did not reflect “conduct meant to conceal or mislead or a conscious effort to avoid learning about the reporting requirements.” According to the court, Bedrosian was at most negligent.
The IRS appealed the decision to the Third Circuit, which took a more expansive view of the scope of willfulness for an FBAR (Bedrosian, 912 F.3d 144 (3d Cir. 2018)), finding that it includes not only knowing but reckless conduct. The court stated that if the IRS could show Bedrosian (1) “clearly ought to have known” (2) “there was a grave risk” the FBAR filing requirement “was not being met,” and if (3) he “was in a position to find out for certain very easily,” it would satisfy the willfulness element (quoting Carrigan, 31 F.3d 130, 134 (3d Cir. 1994)). The court was, however, unsure whether the district court had applied the test, so it remanded the case “for further proceedings consistent with our opinion” and for the court to “render a new judgment.”
On remand, the district court, after reevaluating the trial record from an objective viewpoint, determined Bedrosian acted willfully because he “recklessly disregarded the risk that his FBAR was inaccurate.” The district court also ordered him to pay the penalty in the amount the IRS calculated (plus interest) because the agency had “not abused its discretion in the amount of the penalty imposed.” Bedrosian again appealed the court’s decision to the Third Circuit.
The Third Circuit’s decision
The Third Circuit affirmed the district court’s decision. It found that the court had correctly held that Bedrosian’s conduct was willful and that while the IRS had not proved the balance in his accounts supported the penalty imposed, Bedrosian’s lawyer had acknowledged that the balance was large enough to support the penalty assessed.
The Third Circuit explained the amount of a civil penalty for a violation of the Bank Secrecy Act depends on three things: (1) whether the violation was willful, (2) the calculation of the maximum penalty permitted by law, and (3) the IRS’s discretionary decision whether to assess a penalty at or below the statutory maximum. Bedrosian, in his appeal, only challenged the district court’s holding regarding the first two requirements.
Willfulness: Bedrosian challenged the district court’s findings on two fronts: (1) the court exceeded the scope of the remand by making supplemental findings that led to its conclusion he acted willfully; and (2) his conduct was not willful.
On the first point, Bedrosian argued that the Third Circuit remanded only “to confirm that the district court’s result would be the same under the now-settled standard,” not for it to reopen the evidentiary record and make or reconsider factual findings. The Third Circuit disagreed, stating that it placed no limitation on the proceedings on remand. Instead, it noted, its opinion actually anticipated that the district court would reconsider its factual findings and its judgment. Though the opinion did not explicitly state that the district court could review the full record and make supplemental factual findings, the court found doing so was well within the “spirit of the mandate.”
On the second point, reviewing the district court’s decision under the clear error standard, the Third Circuit found the court had made a rational decision that was grounded in credible evidence. In its analysis, the district court made five supplemental findings to aid in its analysis, and the Third Circuit concluded that the trial record supported each of them. Applying the definition of willfulness it had set out in Bedrosian’s earlier appeal to the facts, the Third Circuit held that the district court did not err in determining that Bedrosian acted willfully by failing to disclose his second Swiss bank account on the FBAR.
Maximum penalty: The maximum penalty amount — like willfulness — is an element of the cause of action to collect the penalty. So, similar to a determination of willfulness, it was a factual finding the district court must have made based on the evidence presented at trial. The IRS based its penalty calculation on information from a document — labeled Exhibit R — it introduced that purported to be a listing of the monthly balances in Bedrosian’s undisclosed accounts. Bedrosian argued that Exhibit R was lacking any detail connecting the numbers on it to the undisclosed account, so it was inadmissible evidence that could not be relied on to prove that the penalty amount assessed was lawful.
The Third Circuit agreed with Bedrosian. Exhibit R contained no name on the page, no account number, and no bank name, and the numbers listed did not even indicate what currency they referred to. The court observed that the document only showed “someone’s ‘monthly balance’ for something somewhere,” and, because the IRS had entered the evidence without testimony from a witness laying a foundation for it, it was just a slip of paper with no relevance to Bedrosian’s case. Thus, the exhibit could not be used to confirm that the penalty Bedrosian was charged was 50% of the undisclosed account balance.
Nonetheless, the Third Circuit found that the penalty amount was confirmed because Bedrosian’s counsel had admitted that the account balance was at least $1,951,578.34 in the proceedings. In particular, the court pointed to the counsel’s opening statement, in which he conceded that “there was about 2 million U.S. dollars” in the undisclosed account. The court found that this concession was a judicial admission that did not need to be proved in litigation and, thus, Bedrosian was bound by that admission. Consequently, the court held that the penalty of $975,789.17 was below the statutory maximum amount (50% of the account balance).
Why did the IRS think it could get away with a clearly inadequate document like Exhibit R? It claimed that Exhibit R was a self-authenticating business record that could be submitted into evidence without a live witness under Federal Rule of Evidence 902(12) because it was accompanied by a custodian certification. But, as the Third Circuit pointed out, authenticity (which was proved by the custodian certificate) and relevance are “two separate matters.” As the court explained, a business record may be self-authenticating, but there must still be testimony linking a defendant with the documents to establish relevance. The IRS caught a break when Bedrosian’s counsel conceded the amount in the account; otherwise, the IRS would have been out of luck.
Bedrosian, No. 21-1583 (3d Cir. 7/22/22)
James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact email@example.com.