Update - the Third Circuit Court of Appeals remanded this case on appeal, indicating that the District Court failed to properly consider precedent on what constituted willfulness. On remand, the District Court found that the conduct did amount to willfulness. See On Remand, District Court Finds Objective Evidence Shows Taxpayer Willfully Failed to Report Foreign Acccount on FBAR Report.

For the IRS the case of Bedrosian v. United States, US DC ED Pa, Case No. 2:15-cv-05853 was ultimately a loss—but the Court did agree that the test for “willfulness” for failing to file a Federal Bank Account Reporting (FBAR) form is whether he “knowingly or recklessly” failed to file the report (the general civil standards for willfulness) rather than whether there was a voluntary, intentional violation of a known legal duty. The court just found the IRS failed to show that the deficiencies in filing his 2007 return was done knowingly or recklessly.

The case was yet another IRS attempt to obtain large penalties for issues related to offshore accounts that the taxpayer had not properly reported, in this case looking for over $1,000,000 in penalties for the failure.

The taxpayer in this case is a CEO at pharmaceutical company. In the 1970s, when he had just started working in the industry, he ended up with a position that required a lot of international travel. In 1973, he opened a savings account with a Swiss bank, initially just to have access to funds while abroad without having to rely on traveler’s checks. But over time he began to make more use of the accounts.

Eventually, after approached by UBS (his Swiss bank) to take out a loan in Swiss francs, he converted the savings account into an investment account, which resulted in an additional account being created at UBS. The taxpayer indicated he wasn’t aware there were two accounts, and he always treated the total amount he had with UBS as a single account.

From 1972 until 2007 he made use of the same accountant. The accountant was not made aware of the Swiss account into sometime in the 1990s. The accountant advised the taxpayer at that time that he had been breaking the law all along. However, rather than suggest the taxpayer seek legal counsel to come back into compliance with the law (arguably the proper action), the accountant indicated that since the taxpayer “could not unbreak the law” he should continue not reporting this account, and that his estate would eventually deal with it when the taxpayer died. The taxpayer took this advice.

In 2007 the prior accountant died, so the taxpayer moved on to another accountant. That accountant prepared the taxpayer’s 2007 and, for the first time, indicated on Schedule B that the taxpayer had an interest in a foreign bank account, listing Switzerland as the location where the account was located. The accountant also prepared, and the taxpayer filed, an FBAR report. However, this FBAR report only listed a single account, an account holding $240,000. The report did not contain information about the much larger account which had a balance of approximately $2,000,000. The taxpayer testified that he did not discuss the foreign accounts with the new accountant and wasn’t sure where he got the information that he used to prepare the FBAR.

The taxpayer around this time became aware of the seriousness of not having properly reported his Swiss account. He obtained legal counsel and was advised to engage an accounting firm and have them prepare amended returns going back to 2004. He amended those returns and fully reported the Swiss income on future returns. At the time, he sought legal counsel the IRS had not yet begun investigating his activities and he was not aware that the IRS had obtained information about his account, along with many other taxpayers, from UBS.

The issue at trial is not, as you might think, his actions through 2006 when he made, in the words of the court, he “took a calculated risk for several years by not complying with his tax reporting obligations.” Rather the IRS was upset about that first FBAR he filed, for 2007, which omitted the second UBS account.

The Court agreed with the IRS that the proof the IRS had to provide was that he had “knowingly or recklessly” failed to properly report in 2007. The IRS had previously prevailed in demonstrating that level of conduct in the cases of United States v. Williams, 489 F. App’x 655 (4th Cir. 2012) and United States v. McBride, 908 F. Supp. 2d 1186, 1201 (D. Utah 2012). But the Court found that, ultimately, the taxpayer’s actions in this case were not as egregious as that of each of the taxpayers in the previous cases. Rather, the Court found in this case the IRS had not demonstrated willfulness.

The Court concluded:

As stated above, this inquiry requires a probing of the factual circumstances of this case to determine whether Bedrosian had the requisite mental state. Having done so, it is simply not sufficiently clear from the record developed that he was willful in submitting his inaccurate 2007 FBAR. Rather, his actions were at most negligent, which does not satisfy the willfulness standard. There is no question that Bedrosian could have easily discovered that what had previously been one UBS account was now two, via the statements he occasionally received from the bank and the meetings he had annually with a UBS representative. In addition, the fact that he signed his 2007 FBAR two weeks prior to sending two separate letters to UBS to close his accounts sways in favor of an inference that he was aware of the existence of the second account at the time he filed the FBAR. Nevertheless, as discussed below, even if he did know that he had a second account yet failed to disclose it on the FBAR, there is no indication that he did so with the requisite voluntary or intentional state of mind; rather, all evidence points to an unintentional oversight or a negligent act.

The Court based this decision by looking at the actions that had been found to demonstrate willfulness in prior cases and compare the taxpayer’s actions to that of the taxpayers in the earlier cases. The Court first compared the taxpayer’s actions to that of the taxpayer in the Williams case.

In Williams, for example, the defendant deposited over $7 million into two Swiss bank accounts and failed to report the income from those accounts to the IRS from 1993 to 2000. Williams, 489 F. App’x at 656. In the fall of 2000, government authorities became aware of the accounts, the defendant retained counsel, and Swiss authorities froze both accounts. Even after facing significant government scrutiny regarding his compliance with federal reporting requirements, the defendant nevertheless filed an FBAR for tax year 2000 in which he did not disclose his interest in either Swiss account. The defendant also allocuted, in connection with a simultaneous criminal investigation, to having unlawfully failed to report the existence of the Swiss accounts on his 2000 FBAR. On these facts, the Fourth Circuit overturned the district court’s finding that the defendant’s violation of Section 5314 had not been willful, reasoning that the above-recited facts at least established reckless conduct. Id. at 660.

The defendant’s actions in Williams stand in contrast to Bedrosian’s in 2007 and 2008. Crucially, in Williams the defendant “acknowledged that he willfully failed to report the existence of the [Swiss] accounts to the IRS or Department of the Treasury as part of his larger scheme of tax evasion,” via his guilty plea allocution. Id. Here, there obviously has been no such acknowledgement. In addition, where the defendant in Williams submitted the inaccurate FBAR at issue after he was already the target of a government investigation regarding his noncompliance with federal tax law, showing a continued interest in misleading the authorities, Bedrosian was fully cooperative and honest with the IRS from the moment it began investigating him.

The Court also found important qualitative differences between the taxpayer’s conduct and that of the taxpayer in McBride.

Another of the few cases to have considered this issue is McBride, in which the defendant, cognizant of an imminent sizable increase in his company’s revenue, “sought a way to reduce or defer the income taxes that would normally be paid on [the] revenue,” and hired a financial management firm to help him do so. McBride, 908 F. Supp. 2d at 1189. The firm proposed a plan, which the defendant accepted, to move profits of his company to offshore entities, thereby resulting in approximately $2.7 million in otherwise taxable profits of the company to be routed directly to the defendant. Importantly, when faced with the IRS’ investigation, the defendant repeatedly lied and refused to produce requested documents. Id. at 1200. Again, the willful finding in McBride is hard to map onto the instant facts, which are significantly less egregious and show nothing close to the carefully planned and complex tax evasion scheme perpetrated by the defendant in that case.

Finally, the Court also looked at the case of United States v. Bussell, No. 15-2034, 2015 WL 9957826 (C.D. Cal. Dec. 8, 2015).

In Bussell, the court found that the defendant had “clearly acted with reckless disregard [of the statutory duty]” because she had been convicted of bankruptcy fraud and tax fraud for failing to disclosing offshore accounts, was subjected to civil penalties for her failures to disclose the accounts, was aware of the duty to report them on her FBAR and nevertheless did not. Id. at *5. Again, here there is nothing close to that level of evidence showing Bedrosian’s willful violation of the FBAR requirement.

While the Court found that the IRS had not demonstrated willfulness, the opinion certainly indicates that the taxpayer’s actions got him a lot closer to that line than most would find comfortable.

In summary, the only evidence supporting a finding that Bedrosian willfully violated Section 5314 is: (1) the inaccurate form itself, lacking reference to the account ending in 6167, (2) the fact that he may have learned of the existence of the second account at one of his meetings with a UBS representative, which is supported by his having sent two separate letters closing the accounts, (3) Bedrosian’s sophistication as a businessman, and (4) Handelman’s having told Bedrosian in the mid-1990s that he was breaking the law by not reporting the UBS accounts. None of these indicate “conduct meant to conceal or mislead” or a “conscious effort to avoid learning about reporting requirements,” even if they may show negligence. Williams, 489 F. App’x at 658.

It is obvious that Bedrosian should have handled the situation differently and, in 2007-2008, should have been more careful about reviewing the 2007 FBAR and in being aware of the fact that he had not one but two accounts at UBS. Nevertheless, the facts show that he did check the box indicating he had a foreign account on his 2007 tax return, he did identify Switzerland as the country in which the account as located, and he did file an FBAR for 2007 stating he had assets in a foreign account. His error was in failing to list the second account. Furthermore, he approached his personal lawyer and retained an accounting firm to file amended returns and rectify the issue prior to learning that the government was investigating him and prior to learning that UBS was turning his information over to the IRS. Although we apply the lower, civil standard of willfulness here, we nevertheless do not see Bedrosian’s as the sort of conduct intended by Congress or the IRS to constitute a willful violation. This is especially so in light of the dearth of precedent finding a willful violation on comparable facts. Because we find that the government failed to meet its burden as to the willfulness requirement, we decline to engage in an analysis concerning the calculation of the penalty amount.

Given this was a single District Court judge in a single case with specific facts, it is far from certain that taxpayers with similar facts can take much solace from this decision. Certainly, it isn’t obvious that another judge, looking at the same four facts demonstrated described in the decision, would be obviously in error by finding they were sufficient to sustain a willfulness finding.