FBAR penalties can violate Excessive Fines Clause

The Eleventh Circuit held that foreign bank account reporting (FBAR) penalties imposed under 31 U.S.C. Section 5312 are punitive in nature and therefore can violate the Eighth Amendment’s Excessive Fines Clause.

Background

Isac Schwarzbaum, who was born in Germany, became a naturalized U.S. citizen in 2000. From 1993 to 2010, he split his time among Costa Rica, Switzerland, and the United States. In September 2010, Schwarzbaum moved to Switzerland and lived there full time until he returned to the United States in 2016. Schwarzbaum’s father was a wealthy textile and real estate magnate who, until he died in 2009, gave Schwarzbaum large sums of money.

Schwarzbaum kept some of the funds he had received from his father in banks outside the United States. In 2006 through 2009, he had accounts with 11 Swiss banks and two Costa Rican banks. As a U.S. citizen during those years, he was subject to the FBAR reporting requirements for these accounts. However, he did not know the full extent of the requirements, and through 2009 he filed only incomplete FBARs for the foreign accounts or none at all.

At some point in 2010, he became aware that he had not complied with the FBAR reporting requirements and disclosed his foreign financial holdings through the IRS’s Offshore Voluntary Disclosure Initiative. He later opted out of the program, and his case was referred to the IRS for investigation.

As a result of its investigation, the IRS determined that Schwarzbaum willfully violated the FBAR reporting requirements for the 2006–2009 tax years. Consistent with the applicable statute, 31 U.S.C. Section 5321, he was charged a penalty for each of those tax years for each unreported bank account of the greater of $100,000 or 50% of the account balance “at the time of the violation” (31 U.S.C. §§5321(a)(5)(C)(i) and (D) (ii)). The time of each FBAR violation was the reporting date: June 30 of the year after the tax year being reported.

The initial total amount of penalties that the IRS calculated was $35.4 million, but it reduced them to $13.7 million. Schwarzbaum appealed the proposed penalties, but the IRS sustained the penalties and assessed them in 2016.

Schwarzbaum did not pay the penalties, and the IRS brought an action in district court to collect them. After a trial, the district court held that Schwarzbaum had willfully violated the FBAR reporting requirements for 2007 through 2009 but not for 2006. Schwarzbaum argued that the fines were subject to review under the Eighth Amendment’s Excessive Fines Clause, but the court rejected that argument (Schwarzbaum, No. 18-cv-81147 (S.D. Fla. 5/18/20)).

The district court, however, also found that the IRS had miscalculated the amount of the FBAR penalties Schwarzbaum owed and, based on its own calculations, entered a judgment for $12.9 million against him. The IRS subsequently moved that the court limit Schwarzbaum’s total FBAR penalties to $12.5 million. The court granted the IRS’s motion and entered a judgment for that amount.

Schwarzbaum appealed the district court’s decision to the Eleventh Circuit. On appeal, he argued, as he had in district court, that FBAR penalties are “fines” within the meaning of the Excessive Fines Clause and that the multimillion-dollar judgment against him was an excessive fine prohibited by the clause.

The Eleventh Circuit’s decision

The Eleventh Circuit held that FBAR penalties are “fines” within the meaning of the Excessive Fines Clause. However, after reviewing the penalties imposed on Schwarzbaum on an account-by-account basis, it found that only $300,000 (the total of the $100,000 minimum fine amounts imposed on one of his foreign accounts for each of the years 2007 through 2009) of the total FBAR reporting penalties assessed by the IRS for 2007 through 2009 were constitutionally prohibited excessive fines.

Application of the Excessive Fines Clause

The Excessive Fines Clause, which has roots going all the way back to before England’s Magna Carta, had always been understood to apply to fines imposed in criminal cases brought by the government. However, in 1993, in Austin, 509 U.S. 602 (1993), the Supreme Court definitively held that the Excessive Fines Clause also applies to fines in civil cases.

In that case, the Supreme Court concluded that whether the clause applies does not rely on whether a penalty was imposed in a civil case versus a criminal case but instead on whether it is imposed as punishment for some offense or for a remedial purpose. The Supreme Court held that a penalty’s purpose could be considered remedial if it serves to remove “dangerous or illegal items from society” or to compensate the government for a loss or the costs of enforcing the law (Austin, 509 U.S. at 621) . However, the Court also held that if a penalty serves either retributive or deterrent purposes, it is punishment.

In Bajakajian, 524 U.S. 321 (1998), the Supreme Court moved a step further and held that even if a penalty serves some remedial purpose, if it also serves as punishment, it is within the scope of the Excessive Fines Clause. The Court reiterated this point in 2017 in Kokesh v. Securities and Exchange Commission, 581 U.S. 455 (2017), stating in dicta that a “modern statutory forfeiture is a ‘fine’ for Eighth Amendment purposes if it constitutes punishment even in part” (id. At 467).

Is the purpose of the FBAR reporting penalty punishment?

The court then turned to determining whether the FBAR reporting penalty is for the purpose of punishment. After analyzing the statute, 31 U.S.C. Section 5321, that contains the FBAR reporting penalty and considering Congress’s statements about the purpose of the FBAR reporting penalty, it concluded that its purpose was at least in part punishment.

The statute: The IRS argued that the purpose of this penalty is not to deter violations but to remedy its investigation and enforcement expenses associated with violations of the FBAR statute. However, based on the way the penalty is calculated under 31 U.S.C. Section 5321 (as the greater of $100,000 or 50% of the balance in the account at the time of the violation), the court found the penalty was calculated with no regard to the magnitude of the financial injury to the government. The Eleventh Circuit noted that it had previously held where a penalty bears no relationship to the government’s costs, an inquiry into whether the penalty is remedial is not necessary, as it is almost certain that a portion of the penalty will constitute punishment.

The Eleventh Circuit further observed that the severity of the penalty was tied directly to culpability. For the enhanced penalty for a willful FBAR reporting violation to apply (which, unlike the non-willful FBAR penalty, is limited only by the size of the violator’s bank account), the required mental state (mensrea) of a taxpayer was equivalent to the mens rea necessary for the taxpayer to be found guilty of a criminal FBAR reporting violation. The Eleventh Circuit, citing the Supreme Court (Austin, 509 U. S. at 619), found that provisions that focus on the culpability of the defendant make a statutory penalty “look more like punishment, not less.”

The Eleventh Circuit also pointed to the severity of the penalty. Because the upward bound of the penalty was 50% of the account balance on the date of the violation, the FBAR penalty could, if applied to a series of years, wipe out an account in two years. The court stated that it had found no comparable civil penalty in terms of severity.

Congress’s statements: The Eleventh Circuit also found, based on what Congress had expressed in its statements in the legislative history when it enacted the first FBAR penalties and when it later increased those penalties, that “the very design and purpose of the FBAR penalties is to deter.” The Supreme Court had made it “crystal clear” in Bajakajian and more recently in Tyler v. Hennepin County, 598 U.S. 631 (2023), that, for Eighth Amendment purposes, deterrence is punitive in nature. Thus, the Eleventh Circuit found that Congress’s statements supported the proposition that the FBAR reporting penalty’s purpose is punishment.

FBAR reporting penalty is punitive: Thus, based on the text and structure of the FBAR penalty statute — including severe penalties for a willful violation of the FBAR reporting requirements on those with a criminal mens rea, a lack of connection to the government’s costs and expenses related to the violation, and the reasons Congress had given for creating the regime — the court concluded that the purpose of the FBAR reporting penalty was punishment. Therefore, the court held it is a fine subject to the Excessive Fines Clause and could be found to be unconstitutionally excessive.

Were the penalties against Schwarzbaum excessive?

Having determined that the penalties imposed against Schwarzbaum for the years in question could be excessive, the Eleventh Circuit considered whether they were excessive. The court started by stating, “The touchstone of the constitutional inquiry under the Excessive Fines Clause is the principle of proportionality” (quoting Yates v. Pinellas Hematology & Oncology,P.A., 21 F.4th 1288 (11th Cir. 2021): (1) 524 U.S. at 334) and that a fine will violate the clause if it is “grossly disproportional to the gravity of a defendant’s offense” (id.).

The court admitted that translating the gravity of a crime into a monetary amount was not an easy task but that it had previously identified three factors to consider in its excessiveness analysis, in Yates v. Pinellas Hematology & Oncology, P. A., 21 F.4th 1288 (11th Cir. 2021): (1) whether the defendant is in the class of persons at whom the statute was principally directed; (2) how the imposed penalties compare to other penalties authorized by the legislature; and (3) the harm caused by the defendant in the case.

Schwarzbaum contended that the Eleventh Circuit’s excessive-fines analysis should focus on the total aggregated fine, but the court reasoned that this approach could not be reconciled with the FBAR reporting regime. Because the reporting regime characterizes each failure to report a bank account as a violation, the court concluded that, to determine how much (if any) of the entire aggregate penalty was excessive, it must conduct its analysis on an account-by-account basis.

Of the various accounts Schwarzbaum owned, one (referred to as the Aargauische account) had a maximum account balance of less than $16,000 for each year in question, and the minimum willful FBAR penalty of $100,000 was imposed on the account for each year. For all the other accounts, the maximum balance held in the account during each year was at least twice (where the 50% penalty was imposed) and in most cases (where the minimum $100,000 penalty was charged) much more than twice the amount of the penalty imposed.

With respect to the Aargauische account, the Eleventh Circuit noted that there is a “strong presumption” that the penalties Congress has created are constitutional, but that presumption has limits. The Eleventh Circuit found that the penalty for this account, which in all years was at least six times the maximum amount held in the account for the year, was grossly disproportional to the gravity of the FBAR offense. Thus, the court held that the penalties for the Aargauische account for all three years violated the Excessive Fines Clause.

Schwarzbaum did not fare as well with the penalties imposed for his failure to file FBARs for the years in question for the other accounts. After applying the Yates factors to each of these accounts, the court determined that none of the remaining fines, even those taking 50% of an account in a particular year, were grossly disproportionate to the serious offenses of willfully concealing foreign bank accounts containing many millions of dollars. Thus, the court held that these penalties, totaling over $12.2 million, were not unconstitutionally excessive under the Excessive Fines Clause.

Reflections

The Eleventh Circuit’s decision creates a circuit split between it and the First Circuit. In a similar case, Toth, 33 F.4th 1 (1st Cir. 2022), the First Circuit held that FBAR penalties are not subject to the Eighth Amendment’s Excessive Fines Clause. The First Circuit came to this conclusion by comparing the FBAR penalties to the penalty or civil forfeiture in cases where the nature (punitive or remedial) of a penalty or civil forfeiture was being determined for purposes of the Fifth Amendment’s Double Jeopardy Clause (e.g., One Lot Emerald Cut Stones and One Ring, 409 U.S. 232 (1972), and Helvering v. Mitchell, 303 U. S. 391 (1938)).

Notably, as the Eleventh Circuit explained, under the double-jeopardy standard as it currently stands, a penalty or civil forfeiture does not have to be solely remedial to escape the scope of the Double Jeopardy Clause. The Eleventh CirYates v. Pinellas Hematology & OncologyYates v. Pinellas Hematology & Oncologycuit found fault with using the double-jeopardy standard in the context of the Excessive Fines Clause, because after Austin and Hudson, 522 U. S. 93 (1997), a penalty does not fall in the scope of the Excessive Fines Clause only if it has a solely remedial or compensatory purpose. As the court stated, “[t]he issue with the First Circuit’s opinion in Toth, as we see it, is that it fails to circumnavigate the problem that even if the FBAR penalty has some remedial purpose, the test in the Excessive Fines context remains whether the purpose of the penalty is solely compensatory.”

Schwarzbaum, No. 22-14058 (11th Cir. 8/30/24)

Contributor

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 thetaxadviser@aicpa.org.