As a general matter, the FBAR is not a difficult tax form to prepare, at least for most taxpayers and their tax professionals. At its very basics, it merely asks for identifying information regarding the taxpayer and certain basic information regarding foreign accounts held outside the United States. Thus, one would suspect that the failure to timely file this seemingly innocuous information return should not result in significant penalties.
However, tax professionals know better. Under Title 31, a taxpayer's willful failure to file a timely and accurate FBAR can result in penalties of up to 50% of the foreign account balances, a penalty that can be applied over multiple years. And because federal courts and the IRS view certain reckless behavior as constituting "willfulness," the bar for willful FBAR penalties can be a seemingly low one.
But what if, after the FBAR filing deadline, a taxpayer takes voluntary and corrective actions to remedy the FBAR violation? For example, assume a taxpayer fails to timely file an FBAR reporting his foreign accounts and fails to report income from the foreign accounts on his United States income tax returns. Further assume that the taxpayer files an FBAR and reports such foreign income (paying all taxes owed) after the FBAR deadline but before the IRS discovers the violations. Are these corrective and arguably good-faith actions enough to rebut a finding of willfulness, thereby reducing FBAR penalty exposure? According to a recent decision from the Third Circuit Court of Appeals, the answer to this question appears to be no. See U.S. v. Collins, 36 F.4th 487 (3d Cir. 2022).
The Facts in Collins.
The facts in Collins are not remarkable—indeed, they fit squarely within the facts of many United States taxpayers who have dual citizenship with employment overseas. Collins was a dual citizen of the United States and Canada. Prior to coming back to the United States in 1994, he had been employed as a professor in various foreign countries. And because he was located overseas, he established foreign bank accounts to deposit his employment earnings.
When Collins returned to the United States, he maintained his foreign bank accounts. From time to time, he had his foreign pension earnings deposited into those foreign accounts, some of which held mutual fund investments. By 2007, Collins's foreign accounts exceeded $800,000.
Although Collins was required to file FBARs, he failed to do so. To attempt to correct his prior FBAR reporting violations, Collins sought to enter the now defunct Offshore Voluntary Disclosure Program (OVDP). Under the OVDP, taxpayers were permitted to file late FBARs for several years and also amend their United States tax returns to include previously unreported foreign income. In exchange for these actions and their paying of any United States income taxes owed, the IRS agreed to impose only a standard penalty (generally, 27.5%) on the highest aggregate foreign account balances over an 8-year lookback period.
But after Collins entered the OVDP, he had second thoughts. More specifically, his accountant prepared amended tax returns for 2002 through 2009 and determined that Collins was actually entitled to modest refunds because he had large capital losses in 2002. Because Collins believed that he did not owe any additional federal income tax, Collins chose to withdraw from the OVDP entirely.
His withdrawal, however, resulted in an IRS examination. During the examination, the IRS learned that Collins had failed to report additional income tax on his amended tax returns associated with his investments in foreign mutual funds (so-called PFIC taxes under section 1291 of the Code). Because of the PFIC rules, Collins learned that he actually owed additional PFIC taxes of $71,324 for 2005, 2006, and 2007 (plus penalties). After the examination concluded, Collins paid the PFIC taxes and penalties.
But the IRS was not done there. In addition to the PFIC taxes and penalties, the IRS sought to impose willful FBAR penalties against Collins due to his failure to timely file FBARs in 2007 and 2008. Although the IRS could have imposed willful FBAR penalties of 50% of the account balance for both 2007 and 2008, the IRS used its own mitigation guidance to reduce the willful FBAR penalties to approximately $300,000. When Collins refused to pay the willful FBAR penalties, the government sued him in federal court. The district court agreed with the government—i.e., that Collins was liable for willful FBAR penalties of $300,000—and Collins appealed the decision to the Third Circuit Court of Appeals.
The Third Circuit's Opinion.
During his appeal, Collins made several arguments as to why he was not willful in failing to timely file FBARs for his 2007 and 2008 tax years. First, Collins contended that his voluntary actions to correct his tax returns prior to any IRS investigation demonstrated that he was not willful. Second, he contended that his prompt payment of the additional PFIC taxes and penalties further demonstrated a lack of willfulness. Third, he argued that he could not have been expected to know about the FBAR filing requirements because even his experienced accountant was unaware of the reporting obligation.
With respect to the third argument, the Third Circuit flatly rejected that Collins was not aware of the FBAR filing requirements. More specifically, the court stated:
Our review of the record leads us to conclude that the District Court committed no error, much less clear error, when it found that Collins's failure to disclose his foreign accounts was willful. Schedule B of IRS Form 1040 contains a check-the-box question (line 7a) that places a taxpayer on notice of this obligation. Schedule B directs taxpayers to check "Yes" if they had authority over, or an interest in, a foreign account. Collins repeatedly checked "No" and filed no FBAR until 2010. He filed returns indicating he had no foreign financial accounts while managing investments worth hundreds of thousands of dollars in his French, Canadian, and Swiss accounts (even after engaging an accountant in 2005). So we agree with the District Court that Collins did not plausibly claim he should not have known about the FBAR filing requirement.
Given other court decisions that have expansively defined the concept of "willfulness" to also include reckless behavior, this is no surprise. Regrettably for Collins, though, his remaining arguments also failed to carry the day:
Collins claims that the District Court gave insufficient weight to his voluntary filing of amended returns, prompt payment of overdue taxes, and subjective belief that he did not owe tax. But disagreement with the District Court's weighing of evidence does not establish clear error. And it is wrong to suggest that 'a voluntary correction . . . should be legally sufficient to negate willfulness as a matter of law.' U.S. v. Klausner, 80 F.3d 55, 63 (2d Cir. 1996) ("[E]ventual cooperation with the government does not negate willfulness."). The penalties imposed under the Bank Secrecy Act stem from Collins' failure to disclose foreign assets, not his failure to pay overdue tax. A subjective belief that he owed no tax is, at best, tangential to the core inquiry of a § 5314 violation—whether a taxpayer 'clearly ought to have known' of his obligation to report his interest in foreign financial accounts. Put simply, Collins should have known of that obligation.
In other words, it simply was not enough for Collins to show that he took corrective actions after the FBAR filing deadline had passed.
As Collins shows, taxpayers who have missed the deadline to file an FBAR must tread carefully when taking steps to correct such violations. In many instances, the taxpayer's filing of corrective returns, even with the payment of United States income tax, will not be sufficient to negate the willful FBAR penalty. Taxpayers therefore need to carefully consider what other options may be available to them. Collins demonstrates that one wrong move can be costly.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.