Robert Goulder

Arguing about civil penalties is quite topical these days. A few months ago, the Supreme Court issued its decision in Bittner, providing clarity on whether penalties for non-willful violations of the foreign bank account reporting regime apply on a per-form or per-account basis.¹ In requiring that FBAR penalties be applied per form, the Court (by a slender 5-4 majority) reversed the Fifth Circuit in the taxpayer’s favor.²

This decision settled a split among the circuits. Previously, the facts in Bittner would have produced an FBAR penalty of $2.72 million in the Fifth Circuit, but a penalty of only $50,000 in the Ninth Circuit. It was a textbook case for granting certiorari. We can’t have the Bank Secrecy Act producing wildly divergent outcomes based solely on where you happen to live.

I praised the Court’s Bittner decision, in part, because of the rule of lenity.³ When confronted with legal ambiguity, courts should aim to resolve matters in the way most favorable to the taxpayer. After all, Congress can flip the result if lawmakers feel strongly enough that the FBAR penalty should apply differently.

Not every case lends itself to the rule of lenity. The doctrine is not meant to insulate scofflaws and crooks from the natural consequences of their actions. The lenity argument happened to be persuasive in Bittner because we’re talking about non-willful FBAR violations. When Congress bifurcated FBAR violations between willful and non-willful varieties, it allowed for a penalty regime that would tread lightly on violators who were merely ignorant of their filing obligations while allowing space for tax administrators to throw the book at those who knew the rules and purposefully ignored them.⁴

Bittner is done, but it’s not the last word on FBAR penalties. Controversy lingers over our understanding of willfulness.

The statute calls for stiff penalties, as much as $100,000 or 50 percent of the violator’s unreported account balance, whichever is greater.⁵ The gray area concerns the proper standard for establishing a willful violation. How do we know it when we see it? Should the determination turn exclusively on the person’s subjective state of mind, or does it include an objective evaluation?

A case out of the Third Circuit provides a suitable vehicle for settling the matter: the Bedrosian litigation. The taxpayer seeks a Supreme Court review.⁶ Unlike Bittner, there is no split among circuits that begs for resolution. Still, I hope the Supreme Court takes the case.

A writ of certiorari makes intuitive sense, as it serves the broader needs of U.S. taxpayers potentially affected by the FBAR regime. Bedrosian is the perfect complement to Bittner.

You Can’t Unbreak the Law

Arthur Bedrosian is a U.S. citizen who worked for many years in pharmaceutical sales. As far back as the 1970s, his job required frequent travel to Europe. To facilitate this business travel, he opened a savings account with a Swiss bank that was later acquired by UBS.

During the 1980s, Bedrosian started to use the account in ways not directly supportive of his business travel. It changed from a simple savings account into an investment account. Around that time, the account balance reached the equivalent of $2 million.

Later, in the 1990s, Bedrosian stumbled across an article in The Wall Street Journal indicating that U.S. tax authorities were attempting to trace mail entering the country from Swiss banks. It was at that point Bedrosian acknowledged the existence of the UBS account to his longtime accountant. The accountant replied that Bedrosian had been “breaking the law for 20 years” by not disclosing the account on his income tax returns.⁷ If he didn’t already know his conduct was illegal, he did then.

That moment could have been an inflection point in this drama. It was an opportunity for Bedrosian to come clean about his offshore dabbling. That’s not what happened. As his accountant put it, “You can’t unbreak the law.”⁸ That’s true, but past transgressions need not dictate our future course of action.

Bedrosian (or the accountant — it’s unclear whom) hatched a plan that involved everyone keeping quiet about the undisclosed UBS account. So long as Bedrosian didn’t require the offshore funds to cover his living expenses — and he didn’t — he’d let the UBS account remain in place until he eventually dropped dead. After his passing, the heirs of his testamentary estate could deal with the mess left behind.

This practice is not uncommon. It leaves heirs with a classic good news/bad news scenario. The good news is that they’ve inherited an offshore financial account with a substantial balance; the bad news is they’ll need to contact the IRS about normalizing things. On balance, most heirs will take that as a good day. It’s preferable to discovering that your beloved ancestor left everything to a mail-order bride.

Waiting for the grim reaper is rarely a sound strategy. The downside can be summarized in a single word: longevity. If you take too long to kick the bucket, your inactions can come back in frustrating ways. Bedrosian faces legal headaches today because he didn’t face up to disclosure decades ago.

Blame It on Zurich

Bedrosian chose not to file amended returns when he mentioned the UBS matter to his accountant. This would have been sometime in the 1990s, according to the chronology laid out in the court pleadings. Nor did he begin to report the income related to his UBS account on his income tax returns or start to file annual FBARs. It’s unclear whether Bedrosian or the accountant specifically knew about FBAR obligations at the time.

We do know that Bedrosian wasn’t completely inattentive to the situation. For instance, he instructed UBS to stop sending him mail. That sounds like an act of concealment, done in direct response to The Wall Street Journal article foreshadowing enhanced enforcement of the offshore sector. At a minimum, the request to halt mailing shows an effort to avoid IRS detection.

There’s more. In 2005 Bedrosian converted the account status so that UBS managed the investments on his behalf. At that point, UBS was acting as more than a mere custodian; it was actively advising him. Around that time, he accepted a loan from UBS in the amount of CHF 750,000, which the bank invested for him. The lending arrangement necessitated opening a second UBS account in his name, also based in Switzerland. From 2005 onward, he had multiple undisclosed offshore accounts.

Bedrosian’s accountant died in 2007. At the time, Bedrosian still wasn’t filing FBARs or reporting the offshore income on his tax returns. The original UBS account balance had grown to $2.3 million, and the secondary UBS account had a balance of $240,000. The next accountant would have some tidying up to do.

Finally, beginning with the 2008 filing season, Bedrosian checked that innocuous-looking box on Schedule B of Form 1040, declaring to the IRS that he held an interest in one or more foreign financial accounts. He also filed his first FBAR, though there was a problem with it. He disclosed the smaller of the two UBS accounts, but not the larger one. Again, a purposeful act of concealment. He might have been ignorant of his FBAR obligations back in the 1990s or even as late as 2005, but he certainly knew about FBARs by 2008.

That same year, UBS informed Bedrosian that he must take steps to close his offshore accounts in 60 days or risk having them unilaterally terminated by the bank. This was around the time when federal courts authorized the use of John Doe summons issued to foreign banks so that U.S. tax authorities could obtain the account information of U.S. clients thought to be engaging in tax fraud.

In November 2008 Bedrosian instructed UBS to close his accounts. The assets comprising the larger account were transferred, at his request, to another Swiss financial institution: Hyposwiss Private Bank. The assets from the smaller account were transferred to a bank located in the United States.

There’s no good answer to explain that, apart from not wanting the IRS to know about the stash that remained offshore. He might have been thinking the IRS wouldn’t look any further, having recently learned about the one account. That’s wishful thinking.

In 2009 Bedrosian consulted with an attorney who advised him to file amended returns for each tax year going back to 2004, correcting his prior omissions. That would take care of his income tax problems for all open years. However, there was still the matter of his incomplete FBARs.

He filed an FBAR in October 2009 — his second — pertaining to the 2008 reporting period. It omitted any reference to his recently established Hyposwiss account. The omission was consistent with his FBAR filing from the prior year. He didn’t get around to disclosing the Hyposwiss account until the following year, 2010, when he included it on his next (third) FBAR filing covering the 2009 reporting period. He then filed tardy FBARs for the reporting periods from 2003 through 2006, and amended FBARs for 2007 and 2008.

At long last, his offshore accounts were fully disclosed. Now, about those penalties.

Under the limitation period, there were multiple years for which Bedrosian failed to file a timely FBAR and two years for which he made incomplete FBAR filings — concealing the larger of his offshore accounts. The IRS assessed him with a single penalty under section 5321(a)(5)(C), relating to the FBAR he filed in October 2008, covering the 2007 reporting period. Having determined the violation to be willful, the IRS set the penalty at 50 percent of the account balance, or $979,589. Had the IRS determined the violation was non-willful, the penalty would have been capped at $10,000 per year.

There’s a heck of a difference between a penalty of almost $980,000 and one of only $10,000. That said, there’s nothing about the magnitude of the differential that’s inconsistent with how the statutory scheme is supposed to operate. That’s what I meant, above, about a penalty regime that leaves room for the IRS to throw the book at willful violators.

Bedrosian paid a portion of the penalty amount and then filed suit against the government in the U.S. District Court for the Eastern District of Pennsylvania. The claim was brought under the Little Tucker Act (28 U.S.C. section 1346(a)(2)), which allows for judicial review of penalty assessments. The government counterclaimed for the remaining unpaid fraction of the penalty plus interest and late penalties.

A Bad Year for Good Facts

The district court had two go-arounds with Bedrosian. The first occasion was a bench trial in which the court ruled against the government, finding the FBAR violations to have been nothing more than reckless and therefore non-willful.

You might think that’s odd, given the history discussed above. On the face of it, we can detect at least four acts of concealment:

• first, in the 1990s, he instructed UBS to cease all written correspondence to him, motivated by his awareness of the IRS’s mail-tracking efforts;

• second, in 2008 in response to UBS prompting him to close his accounts, he chose to transfer the assets from the larger UBS account to Hyposwiss;

• third, his FBAR filing for 2007 neglected to mention the larger of his UBS accounts; and

• fourth, his FBAR filing from 2008 neglected to mention the Hyposwiss account.

Some folks will scrutinize this behavior, which stretches over decades, and have little problem finding willful concealment. Not the district court. It determined that Bedrosian lacked “the requisite voluntary or intentional state of mind” for a finding of willfulness. That is, he acted recklessly but not knowingly.

How did the court come to this conclusion given all the above? For starters, the focus was confined to a single FBAR filing — the one submitted for the 2007 reporting period. Recall that 2007 was before Bedrosian closed out his UBS accounts and shifted assets to a different Swiss bank.

Any acts of noncompliance dating from the 1970s, 1980s, 1990s, and early 2000s might have been excluded as not germane to the inquiry. Basically, that’s everything from the period involving the original accountant — who gave us the poetic utterance that you can’t unbreak the law. Likewise, any acts of noncompliance from later reporting periods (post-2007) would have been excluded. That covers the dodgy tactic of shifting assets to another Swiss bank.

Here’s what I don’t get: If the government had to select a single year’s FBAR filing to serve as the basis for a penalty assessment, why not go with 2008, when the facts were more favorable to a finding of willfulness? By picking 2007, the IRS seems to have chosen poorly. The more egregious acts of concealment occurred later.

By any criteria, the transfer to Hyposwiss is not a good look. Especially so when it occurred alongside repatriation of the smaller account. But that’s the business of the 2008 filing, not the 2007 filing. Did the IRS pick a reporting period that made its job more difficult than it needed to be?

Whatever the case, the government appealed the district court’s decision. The Third Circuit offered a different take on the willfulness standard for FBAR purposes. It unanimously reversed the district court in 2018 — about a decade after the FBAR filing in question. The wheels of justice turn slowly.

On remand, the court was instructed to apply the usual civil standard for willfulness, which supplements the subjective consideration (a person who knowingly fails to comply) with an objective consideration (a person who recklessly fails to comply).

Here’s another odd thing. The district court recited the correct standard of review, or at least the same one endorsed by the Third Circuit. It was the nature of the court’s finding that caused the Third Circuit to question whether it adhered to the correct standard — thus the need for remand with specific instructions to focus on objective considerations. The government mentions this in its opposition brief.⁹

There’s a significant difference between ascribing error to a legal issue (you applied the wrong standard) and an erroneous factual determination (you applied the correct standard but botched the analysis). That’s why some adverse rulings call for an appeal, while others call for a rehearing before the same tribunal. The Third Circuit’s reversal takes the form of the former but carries the flavor of the latter.

The district court demonstrated that it got the message loud and clear.¹⁰ Claiming to have applied a broader standard — as instructed — it found Bedrosian’s FBAR violation for 2007 to have been willful. We might have guessed that all along, given that only the smaller of the two UBS accounts was disclosed. A skeptic might question whether the district court, in substance, applied the same standard on each occasion but reached a different conclusion after being told off by the Third Circuit.

That meant it was Bedrosian’s turn to seek an appeal. In July 2022 the Third Circuit surprised nobody by upholding the district court’s finding that the willfulness standard was satisfied, confirming an FBAR penalty that had risen to $1.3 million, including interest and late penalties.¹¹ The last hoorah for Bedrosian would be a writ of certiorari.

Strict Liability?

Why should the Supreme Court hear this case when there’s no split among the circuits, as there was in the case of Bittner? For that, I turn to the amicus brief filed by the Center for Taxpayer Rights.¹² Readers might recall the group separately filed an amicus brief in Bittner, which also sided with the FBAR violator. Note that the cause of taxpayer rights extends to situations beyond the scope of the Internal Revenue Code. (Bittner and Bedrosian are not tax cases in the true sense, though the IRS is the federal agency called on to chase the penalties.)

The amicus brief offers two grounds for granting certiorari. First, it finds a problem in how application of the objective standard has blurred the distinction between a recklessly willful violation and a non-willful violation. In their words:

The Center and undersigned counsel are gravely concerned that the objective recklessness standard, which has been increasingly applied by the lower courts, including by the Third Circuit in this case, to find a “willful” violation under 31 U.S.C. section 5321(a)(5)(C), is eroding the distinction between penalized willful and non-willful conduct. Moreover, the diluted standard of “willfulness” minimizes the government’s burden to establish that the violation was indeed due to willful misconduct to sustain exorbitant and often disproportionate penalty assessments. The overly broad definition of “willfulness” results in uninformed and unwary taxpayers being assessed willful penalties when Congress has expressly provided for non-willful penalties. Taxpayers who are subject to willful FBAR penalties are forced to defend against them in United States District Court after the penalty has been assessed.¹³

Their point is that extreme penalties ought to require a heavy burden on the state, and the use of an objective recklessness standard does just the opposite. It’s too easy to find that a violation was reckless and therefore willful. Perhaps Bedrosian deserves his exorbitant penalty, but what about the next guy who strikes us as uninformed and unwary, as alluded to above?

Let’s recall that the U.S. Tax Court is not an option here. An affected person would need to go the route of paying the penalty (or at least a portion of it), then seeking a refund claim in the appropriate U.S. district court. That places the burden of proof always on the individual, never on the state. That’s unsettling.

The Center for Taxpayer Rights is correct to raise the issue. To critique the procedural dynamic, it feels like we’re forcing people to pay for access to the courts. That’s something we don’t talk about in the context of strict tax litigation. The availability of the Tax Court docket means we don’t have to. I’d feel better about FBAR penalties generally if there was no hint of constrained access to judicial review.

The brief’s second point is that a thoughtful review of penalties for non-willful violations calls for a parallel review of penalties for willful violations. The brief refers to Bedrosian’s request for certiorari as a rare opportunity for a “holistic” review of enforcement measures under the Bank Secrecy Act. I agree with them.

The amicus brief references a comment of Justice Elena Kagan, who was among the dissenters in Bittner:

“Willfulness is an awfully hard standard in contexts like this for the government to meet, and we know that in countless contexts,” [citing the oral argument in Bittner] . . . But, as a matter of fact, for the reasons stated above, it is not [emphasis in the original] a hard standard at all for the government to meet under the current objective recklessness standard that lower courts are applying. This case presents the Court with an opportunity to clarify exactly how hard the standard the government must meet to prove a willful FBAR violation should be under the statute.¹⁴

The point can be summarized in a straightforward question: If this is how Congress intended for the FBAR penalty regime to function, with severe penalties, then why is the objective recklessness standard so easily satisfied?

Where is the “awfully hard standard” to which Kagan alluded? It seems to have gone missing.

You can tell from my description of Bedrosian’s entanglement with the offshore sector that I don’t regard his conduct as that of a model citizen. Nevertheless, I find a lot of wisdom in the amicus brief. The Supreme Court should grant certiorari and hear Bedrosian’s appeal. One of the interesting things about the field of taxpayer rights is that the litigants you encounter aren’t necessarily choirboys, but the issues at hand are bigger than their shortcomings.