Foreign Nationals & Expats
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- 1 FBAR Penalty Suit: U.S. v. Gracie et al
FBAR Penalty Suit: U.S. v. Gracie et al
A mixed martial artist and his spouse challenge over $210,000 in penalties for failing to report foreign bank accounts in U.S. v. Royce Gracie and Marianen Cuttic (2:17-cv-3308).
On the heels of last year’s Colliot and Wahdan decisions, Gracie and Cuttic filed for motion for partial summary judgment on 12/11/2018, arguing that a 1986 regulation (31 CFR § 1010.820(g)) caps civil penalties for willful FBAR violations to $100,000. The Government recently filed its response.
Obligation of U.S. persons to report foreign financial accounts
A person who has foreign financial accounts has the following information and tax reporting duties:
- Form 1040, Schedule B – if required to file a Schedule B, taxpayer has a duty to disclose the existence and location of all foreign financial accounts
- Form 1040, Form 8938 – if the accounts exceed the thresholds prescribed under the regulations to I.R.C. 6038D, taxpayer is required to report specified foreign financial assets on Form 8938
- Form 1040 – taxpayers who are U.S. tax residents are required to report all income, including from foreign sources
- FinCEN 114 “FBAR” – if foreign financial accounts exceed $10,000 in the aggregate, a U.S. person is required to report them annually to the Department of Treasury on the FBAR
Applicable statute and regulation
31 U.S.C. § 5321(a)(5) (after 2004)
(C)Willful violations.—In the case of any person willfully violating, or willfully causing any violation of, any provision of section 5314—
(i) the maximum penalty under subparagraph (B)(i) shall be increased to the greater of—
(I) $100,000, or
(II) 50 percent of the amount determined under subparagraph (D)
31 CFR § 1010.820
(2) In the case of a violation of § 1010.350…involving a failure to report the existence of an account or any identifying information required to be provided with respect to such account, a civil penalty not to exceed the greater of the amount (not to exceed $100,000) equal to the balance in the account at the time of the violation, or $25,000.
Alleged FBAR violations in U.S. v. Gracie et al
In May 2017, the Government filed suit against Gracie and Cuttic to reduce FBAR penalty assessments to judgment in the U.S. District Court for the Central District of California, alleging the following:
- During the years 2007 through 2012 defendants (United States citizens) had financial interests, signature authority, and /or otherwise controlled at least three foreign bank accounts
- During the years 2007 through 2009, defendants had a foreign bank account, including an investment account, at HSBC bank, located in Switzerland, and a foreign bank account at Caixa Penedes bank, located in Spain. The high balance in the Swiss account for each of the years 2007 through 2009 was over $1 million.
- In August 2009, the defendants closed the Swiss account, and opened a bank account at First Gulf bank, located in the United Arab Emirates.
- On August 11, 2009, defendants transferred approximately $1.4 million from the Swiss account to the UAE account.
- Defendants held funds in the Spanish account and the UAE account during the years 2009 through 2012. The high balance in the UAE account was over $1 million in 2009 and 2010, and the high balance in the UAE account was over $500,000 in 2011 and 2012.
- Defendants were required by law to file FBARs reporting their financial interest in their foreign accounts for the years 2007 through 2012, as well as any other year that satisfied the FBAR reporting requirements
- Defendants did not file FBARs disclosing their foreign accounts for the years 2007 through 2012.
Alleged facts supporting penalty assessment for willful FBAR violations:
- Defendants filed joint individual federal income tax returns (Forms 1040) for the years 2007 through 2012. The tax returns were prepared by the same tax return preparer, D.P., located in Hermosa Beach, California.
- On Schedule B to their 2007, 2011, 2012 Form 1040, defendants falsely stated that then did not a have an interest in any foreign bank account in 2007.
- On Schedule B to their 2009 and 2010 Forms 1040, defendants falsely stated that they only had an interest in a Spanish bank account in 2009, the year they caused $1.4 million to be transferred from the Swiss account to the UAE account
- Defendants did not disclose their Swiss account or their UAE account to their tax return preparer for any of the years 2007 through 2012
- During the years 2007 through 2011, defendants transferred by wire transfer approximately $2 million from their foreign bank accounts to pay personal expenses in the United States, including to pay for residential real estate purchases and credit card expenses.
- In 2010, defendants wired approximately $500,000 from the UAE account to an account in the United States to fund the purchase of residential real estate in Mammoth Lakes, California.
- In 2011, defendants wired approximately $20,000 from the UAE account to American Express credit card company in the United States.
- In May 2012, while under audit by the Internal Revenue Service, defendant Royce Gracie, falsely stated within the judicial district, under penalty of perjury, that during the years 2001 through 2012 he had no interest in any foreign bank account.
- In May 2012, while under audit by the Internal Revenue Service, defendant Marianne Cuttic, falsely stated within the judicial district, under penalty of perjury, that during the years 2001 through 2012 she only had an interest in one foreign bank account, located in Spain.
On about May 8, 2015, the IRS assessed willful FBAR penalties against defendants Royce Gracie and Marianne Cuttic each in the total amount of $210,081.75 for the year 2008. Penalties were assessed with respect to their interests in foreign bank accounts at Caixa Penedes (Spain) and HSBC (Switzerland).
Defendants’ motion for partial summary judgment
On 12/18/18, Defedants filed a motion for partial summary judgment. A summary of the summary judgment:
Prior to October 2004, 31 U.S.C. § 5321(a)(5) allowed the Treasury Secretary to impose civil penalties for failing to file an FBAR in the amount of $25,000 or the balance of the unreported account up to $100,000. The corresponding Treasury regulation (31 C.F.R. § 103.57), which was issued via notice and comment, was in accordance with the statute.
In 2004, Congress amended § 5321 to increase the maximum penalty for a willful FBAR violation. The maximum penalty that can be imposed for a willful violation is the greater of $100,000 or 50% of the amount in the account on the date of the violation.
Congress changed the statute, but the Treasury affirmatively kept the regulations in place, capping a willful FBAR violation at $100,000. FinCen subsequently renumbered the regulations, and § 103.57 became § 1010.820.
So, as we have it, the regulation was never updated to increase the cap on FBAR penalties, even though the 2004 statute was updated.
On 1/31/2019 the Government filed a response to Defendants’ motion for partial summary judgment. A summary on the response to Defendants’ motion for partial summary judgment:
- The government argues that the 1986 regulation and its purported $100,000 penalty cap have been superseded by statute.
- Alternatively, 31 C.F.R. § 1010.820(g) continues to establish a maximum FBAR penalty amount of $100,000, it does so on an individual penalty and per-account basis; it does not provide an aggregate cap for penalties based on a defendant’s failure to report multiple foreign accounts.
- That Colliot and Wahdan did not support an aggregate limit on FBAR penalty assessments because both cases dealt only with FBAR penalties that individually exceeded $100,000.
We hope that the court seriously considers defendants’ affirmative argument that FBAR fines are a violation of the 8th Amendment’s prohibition of excessive fines, and its broader impact on offshore compliance cases.
The Government’s interest in FBARs is two fold: 1.) prevention of tax evasion and 2.) information.
- Tax evasion. In the vast majority of cases, the FBAR penalty is grossly disproportionate to the Title 26 violation(s). FBAR penalties are not correlated at all to the amount of unpaid tax; they’re assessed on the amount of monies in the foreign account, the source of which is oftentimes previously taxed income, or non-taxable income. Moreover, there are a multitude of Title 26 penalties that are available and applied along with FBAR penalties – failure-to-pay, accuracy penalties, civil fraud penalties, and information related penalties (6038D, etc). In short, there are sufficient penalties available under Title 26 without the need for stacking on FBAR penalties for tax evasion.
- Information. According to the BSA, the FBAR is used to “fight fraud, money laundering, terrorist financing, tax evasion and other financial crime.” In probably 99% of cases where taxpayers have failed to file an FBAR, they are not involved in any of these nefarious activities, and the Government has not been deprived of any important information. Yet, these taxpayers are subject to enormous FBAR penalties for failing to file an information form.
There’s probably a lot more going on in this case than what meets the eye. But the judicial interpretation of willfulness reverberates down to “small fish” cases, often leading to absurd results. A hypothetical – which is not so much a hypothetical since practitioners who handle offshore compliance cases will routinely come across a variation of this fact pattern:
Bob immigrated to the U.S. four years ago, leaving behind foreign financial accounts in his home country. He hired a CPA to prepare his tax returns. Bob failed to file his FBARs and report foreign interest income. The amount of unreported interest income is about $4,000/yr, resulting in $1,000/yr in additional tax. His foreign accounts total $500,000. While Bob was completely unaware of his FBAR filing requirements, he did check ‘no’ on his Schedule B on the foreign account question. He also filled out his CPA’s organizer on which he indicated that he did not have interest income. Maybe he carelessly checked off boxes on the organizer, not realizing the importance of the question and the repercussions.
With how ‘willfulness’ has been interpreted judicially, Bob could be charged with constructive knowledge of the FBAR filing requirement, leaving him open to willful failure to file FBAR penalties. But before he gets to that point, Bob goes to a tax attorney to come into compliance. This puts the practitioner in a very difficult position. Bob could probably apply under the streamlined procedures and certify that he was ‘non-willful” without any issues. Under the streamlined procedures, he would be paying $4,000 in taxes ($1,000 per year) plus a $25,000 misc. offshore penalty – which is still an absurd result. But there’s a real chance that he could end up in an audit where after IRS requests Bob’s organizers from his CPA, could argue he was willfully blind – an even more absurd result. And who knows how a court would find, since these types of “small fish” cases haven’t been litigated much, or at all. And no one wants to be the guinea pig. So what is Bob to do?
If Bob was willful, the maximum authorized FBAR penalties for willful penalties could lead to enormous penalties, forcing the practioner to apply Bob under the traditional voluntary program, leading to “lesser” penalties that are still several hundred or thousands of times the amount of unpaid tax. Sure, we could argue that in practice, the IRS can be fair and will mitigate the penalty, or they won’t go after the “small fish”. But who gets to decide, and what exactly keeps the IRS from assessing the maximum FBAR penalties? The concept of willfulness is edging on strict liability (e.g., Schedule B, constructive knowledge by virtue of signing a tax return) in the FBAR context, which is a very dangerous trend.
In short, the evolving interpretation of ‘willfulness’ continues to stack the cards against the taxpayer, forcing them into “one size fits all” voluntary compliance options.
What should non-compliant taxpayers do?
If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:
- Voluntary disclosure program
- Streamlined domestic offshore program
- Streamlined foreign offshore program
- Delinquent international information return submission procedures
We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.