The U.S. District Court of Connecticut has held that the IRS may prove that a taxpayer failed to timely file a Foreign Bank and Financial Accounts Report (FBAR) by a “preponderance of evidence” — rather than a higher “clear and convincing” standard. The court also determined that the IRS needn’t show that the failure was willful (Garrity, 121 AFTR 2d, 2018-629).

Facts of this Case

The IRS filed suit to reduce to judgment a civil penalty, which it assessed against the taxpayer for his alleged willful failure to report his interest in a foreign account that he held in 2005. Under the Bank Secrecy Act, U.S. citizens must file FBARs with the U.S. Treasury disclosing that they have a financial interest in, or signatory or other authority over, any foreign financial account with assets exceeding $10,000.

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. The IRS argued that the standard of proof was preponderance of the evidence. The taxpayer (represented by fiduciaries of his estate) argued that the standard of proof was clear and convincing evidence.

The parties also briefed the separate question of whether the IRS must show that the taxpayer intentionally violated a known legal duty to establish a “willful” FBAR violation (as the taxpayer’s representatives contended) or whether the IRS may satisfy its burden of proof by showing that the taxpayer acted recklessly (as the IRS contended).

Court’s Conclusion

The court determined that the 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 the IRS’s burden on the element of willfulness.

The civil FBAR penalty didn’t implicate important individual interests or rights, the court concluded. It reasoned that the fact that the taxpayers might be liable for a substantially larger sum of money for a willful FBAR violation than if the IRS had pursued a civil tax fraud action didn’t warrant a higher standard of proof. The court determined that it was the type of interest or right involved that triggered a higher standard of proof, not the amount in controversy. The court cited Herman & MacLean v. Huddleston and Grogan v. Garner.*

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 hadn’t demonstrated how the penalty the IRS sought would affect important individual interests or rights to warrant a higher standard of proof.

The taxpayer’s representatives also argued that the IRS’s proof of willfulness likely would involve allegations of fraud, which could tarnish the taxpayer’s reputation, implicating a more important interest than those involved in typical civil cases. But the court, looking to Huddleston and Grogan, 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 created substantive causes of action for fraud.

No Need to Deviate from Supreme Court Precedent

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. However, they maintained that the IRS, in order to satisfy the element of willfulness, must prove that the taxpayer intentionally violated a known legal duty, and that proof of reckless conduct was insufficient. The district court found that the taxpayer’s representatives ignored the clear distinction that the Supreme Court had drawn between willfulness in the civil and criminal contexts (Ratzlaf v. U.S. (S. Ct. 1994)). 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 (Safeco Insurance Company of America v. Burr, 2007).

* 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 (S. Ct. 1983) 459 U.S. 375). 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 Grogan v. Garner ((S. Ct. 1991) 498 U.S. 279), the Supreme Court rejected arguments that the higher standard of clear and convincing evidence applies to particular civil actions (where the Court held that the preponderance of the evidence standard applied to exceptions to the discharging of debt for fraud in certain bankruptcy actions).

** Except in the case of willful failures, the amount of any civil penalty imposed for violating this rule won’t exceed $10,000. However, those who willfully fail to file their FBARs on a timely basis (on or before June 30 of the following year) 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. The IRS has discretion as to the amount of the penalty, subject to these limits.

A “reasonable cause” exception exists for nonwillful violations, but not for willful ones.

For a no-obligation discussion on the possible impact and steps you should take now, contact Lien Le, the head of our International Tax practice.

© 2018