How Does the IRS Determine “Willfulness”?

Penalties for willful failure to file an FBAR

IRC § 5321(a)(5) provides for the imposition of civil penalties for a willful failure to comply with the reporting requirements of IRC 5314 – i.e, when the person maintaining a foreign account fails to timely file an FBAR reporting that account despite having an obligation to do so.

For violations involving the willful failure to report the existence of an account, the maximum amount of the penalty that may be assessed is 50% of the balance of the account at the time of the violation or $100,000, whichever is greater.

According to the court in United States v. McBride, 908 F. Supp. 2d 1186, 1201 (D. Utah 2012), a claim by the government to enforce penalties for a willful violation of section 5314 has
seven elements:

  1. the defendant was a U.S. citizen “or a resident or a person doing business in the United States” during the relevant period;
  2. the defendant “had a financial interest in, or signatory or other authority over, a bank, securities or other financial account” during the relevant period;
  3. the account had a balance that exceeded $10,000 at some point during the relevant period;
  4. the account was in a foreign country;
  5. the defendant failed to disclose the account;
  6. the failure to disclose was willful; and
  7. the amounts of the penalties assessed for failing to disclose the account were proper.

What is a willful failure to file an FBAR?

For clients wishing to correct past non-compliance, the most important question in evaluating their options is whether they are willful or non-willful.

While some actions are clearly willful, it is in that space between non-willfulness and willfulness where things get murky.

The most basic definition of willfulness is an intentional violation of a known legal duty.¹ Per IRM 4.26.16.4.5.3:

Willfulness is shown by the person’s knowledge of the reporting requirements and the person’s conscious choice not to comply with the requirements. In the FBAR Situation, the only thing that a person need know is that he has a reporting requirement. If a person has that knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR.

The willfulness standard has evolved over time through FBAR litigation:

Actual and constructive knowledge

That a taxpayer knowingly disregarded his FBAR reporting obligation can be proven through their actual or constructive knowledge of those obligations.

Example: A taxpayer claims to have no knowledge of his FBAR filing requirement. However, he signs and submits his tax return under penalties of perjury. The tax return contains a Schedule B on which he checks ‘no’ as to whether he has an interest in a foreign financial account.

A taxpayer can be considered to have constructive knowledge of the FBAR filing requirements based on their signature on a tax return that contains a Schedule B.

Important: Clients should not automatically assume they are willful because they checked the wrong box on the Schedule B. This will not disqualify them from the streamlined procedures. The IRS has stated:

The IRS realizes that many taxpayers fail to acknowledge their financial interest in, or signature authority over, foreign financial accounts on Form 1040 Schedule B. If you or your return preparer inadvertently check no on Schedule B lines 7A, please, simply provide your explanation.

Willful blindness

A taxpayer who understands that there may be a filing requirement, but deliberately avoids learning about FBAR filing requirements can be considered to have acted willfully. The law does not protect deliberate ignorance or conscious avoidance.3

Evidence of acts to conceal income and financial information, combined with a taxpayer’s failure to pursue knowledge of further reporting requirements as suggested on Schedule B, provide a sufficient basis to establish willfulness blindness. See U.S. v. Williams, 489 Fed. Appx. 655 (CA-4,2012)

The taxpayer’s background and level of education may help establish willful blindness. For example, an accountant or sophisticated businessman who has financial interests in foreign bank accounts might have reason to know of FBAR filing requirements, and his failure to file an FBAR could be construed as willful without a showing of actual knowledge of filing requirements.4

Recklessness

U.S. v. McBride, 908 F.Supp. 2d 1186 (D.C. Utah, 2012) significantly expanded the definition of willfulness to include reckless violations.

An individual’s actions may be deemed willful if the individual recklessly ignores the risk that conduct is illegal by failing to investigate whether the conduct is legal.

Because McBride acted in reckless disregard of the known or obvious risks created by his involvement with Merrill Scott (an offshore promoter) actual, subjective knowledge is not required for him to have willfully failed to comply with the FBAR requirements.

Therefore, even if McBride did not have actual, subjective knowledge of the FBAR requirements when he signed and filed his federal income tax returns for the tax years 2000 and 2001, the risk of failing to comply with the FBAR requirements was known or obvious.

How is Willfulness Proven?

United States v. Garrity, No. 3:15-cv-00243 (D. Conn. April 3, 2018), suit was brought to reduce to judgment an FBAR penalty assessed for the willful failure to file an FBAR.

The court sided with the government in finding that willfulness need only be proven by a preponderance of the evidence rather than by clear and convincing evidence.

In its reasoning, the court relied on Supreme Court cases which held that the clear and convincing evidentiary standard only applies to matters that involve “important individual rights and interests.”

FBAR penalties, the court reasoned, only impose a financial burden and do not involve important individual rights and interest.

Fact patterns that might indicate willfulness

Since willfulness is a state of mind, it is nearly impossible to prove directly (the only person that knows your state of mind is you). However, it can be established through reasonable inference from a state of facts. For instance, the following acts may suggest that the taxpayer knew of FBAR filing requirements or acted recklessly:

  • Setting up foreign trusts or corporations to conceal sources of income
  • Selectively filing some forms but not others
  • Using different passports
  • Requesting your bank to not send statements
  • Using code words
  • Only making cash deposits and withdrawals, and visiting the bank in person
  • Opening an account in a jurisdiction in which the taxpayer has no other ties
  • Receiving letters from the foreign bank regarding reporting requirements
  • A consistent pattern of underreporting large amounts of income
  • Failure to supply an accountant with accurate and complete information.
  • Keeping a double set of books
  • Hiding, destroying, throwing away, or “losing” books and records.
  • Placing property or a business in the name of another (nominees)
  • Use of bank accounts held under fictitious names

There are a multitude of fact patterns that will vary from case to case.

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:

Why hire us?

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.


Footnotes

  1. Cheek v. United States, 498 U.S. 192 (1991); United States v. Pomponio, 429 U.S. 10, 12 (1976); United States v. Bishop, 412 U.S. 346, 360 (1973).
  2. United States v. Schafer, 580 F.2d 774, 781 (5th Cir. 1978) (proof of evil motive or bad intent not required); United States v. Moylan, 417 F.2d 1002, 1004 (4th Cir. 1969) (“to require a bad purpose would be to confuse the concept of intent with that of motive”).
  3. See United States v. Ramsey, 785 F.2d 184, 189 (7th Cir. 1986).
  4. In other types of penalty cases general educational background and experience of defendant has been considered as bearing on defendant’s ability to form willful intent. United States v. Guidry, 199 F.3d 1150, 1157–58 (10th Cir. 1999) (willfulness inferred from defendant’s expertise in accounting via her business degree and her work experience as comptroller of a company); United States v. Klausner, 80 F.3d 55, 63 (2d Cir. 1996) (defendant’s background as a CPA, and extensive business experience including that as a professional tax preparer); United States v. Smith, 890 F.2d 711, 715 (5th Cir. 1989) (defendant’s background as an entrepreneur probative of willfulness); United States v. Segal, 867 F.2d 1173, 1179 (8th Cir. 1989) (defendant was a successful and sophisticated businessman); United States v. Rischard, 471 F.2d 105, 108 (8th Cir. 1973). See United States v. Diamond, 788 F.2d 1025 (4th Cir. 1986); United States v. MacKenzie, 777 F.2d 811, 818 (2d Cir. 1985) (willfulness inferred from the fact that each defendant had a college degree, one in economics and the other in business).