11th Circ. Finds $300,000 of $12.6M FBAR Fine In Violation of Eighth Amendment, Causing a Split

According to Law360, $300,000 of the $12.6 million in penalties the IRS on imposed a man for willfully failing to report foreign bank accounts were in violation of the Eighth Amendment's bar on excessive fines, the Eleventh Circuit ruled, creating an apparent circuit split.

Examining the penalties assessed against Schwarzbaum account by account as the court concluded that $100,000 in penalties levied against one account in each of the years 2007–2009, for a total of $300,000, that are grossly disproportionate to the offense of concealing that account, and are therefore in violation of the Excessive Fines Clause.  

The Court Upheld The Remaining $12.3 Million In
FBAR Penalties, Plus Late Fees And Interest.

"No matter how you cut it, it's apparent that this statute is designed to inflict punishment at least in part," Circuit Judge Stanley Marcus said in the court's opinion.

A federal court in 2020 found that Schwarzbaum willfully failed to file FBARs for 23 Swiss and Costa Rican accounts from 2007 through 2009, according to court documents. After initially miscalculating his penalty, the Internal Revenue Service assessed the $12.6 million fine against him, which Schwarzbaum appealed to the Eleventh Circuit.

The Eleventh Circuit disagreed with the First Circuit Court of Appeals in U.S. v. Toth, saying the penalties are at least partially punitive and subject to the Eighth Amendment because they greatly outstrip the cost of reimbursing the government for its investigations, the court said. The penalty also has a deterrent effect, according to the court.

Courts must review the constitutionality of the penalties on a case-by-case basis, the Eleventh Circuit ruled. 

It Determined That In The Case Of One Particular Account, Three $100,000 Penalties ... Were Excessive Because They Were Six To Eight Times The Amount Schwarzbaum Had Deposited.

"There is little doubt in our mind that each of these penalties is grossly disproportionate," Judge Marcus said.

Regarding the remainder of the $12.3 million in penalties, the court said that although they were substantial, they were not disproportionate to the amount of funds Schwarzbaum failed to disclose. The court remanded the case in order for late fees and interest on those penalties to be calculated.

In 2022, the First Circuit Court of Appeals in  U.S. v. Toth, held that a civil FBAR penalty was not a “fine” and therefore not subject to the Excessive Fines Clause. The U.S. Supreme Court declined to hear an appeal to the Toth decision. 

The Schwarzbaum opinion creates a split between two different U.S. Circuit Courts of Appeal. Circuit splits make U.S. Supreme Court review of an issue more likely. It remains to be seen if the United States (or the taxpayer who was still subject to other hefty penalties) will appeal Schwarzbaum.

Regardless Of Whether The Excessive Fines Clause
Applies To FBAR Penalties, It Should Be Expected
That FBAR Penalties Will Remain Material.

If a taxpayer has exposure to FBAR penalties, there are numerous procedural avenues available to mitigate the exposure, both civil and criminal exposure. 

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Supreme Court Will Not Rehear Toth's 8th Amendment FBAR Penalty Case

The Supreme Court declined again to take up a grandmother’s challenge of a $2 million penalty assessed by the IRS for a willful failure to not report a Swiss bank account on the grounds of excessive fines under the Eighth Amendment, despite pushback from one dissenting justice.

On June 5, the Supreme Court denied the petition for rehearing filed by Monica Toth, an 82-year-old taxpayer who had previously asked the Court to overturn the rulings of the First Circuit and the U.S. District Court for the District of Massachusetts. Both courts held that civil penalties applied under 31 U.S.C. § 5321(a)(5)(C)-(D) are not covered by the excessive-fine clause. Toth filed her initial cert petition in August 2022, which the Court rejected in January.

Toth had maintained that she did not purposefully avoid reporting to the IRS a foreign bank account left to her by her father, who took his family from Germany at the onset of World War II to Argentina. Monica eventually settled down in the United States but claimed she was unaware of the reporting rules under the Bank Secrecy Act.

The nondisclosed account had a balance of about $4.2 million. Because the IRS deemed the failure to disclose as willful, Toth was assessed penalties equal to half of the balance, plus interest and late fees. By contrast, the maximum penalty for non-willful failures to disclose is $10,000.

Supreme Court Justice Neil Gorsuch made it known in the Court's denial of Toth's petition for rehearing that he would have granted her request. He wrote in January in dissenting from the first denial that the "government did not calculate Ms. Toth's penalty with reference to any losses or expenses it had incurred."

Instead, the IRS "imposed its penalty to punish her and, in that way, deter others," wrote Gorsuch. "Even supposing, however, that Ms. Toth's penalty bore both punitive and compensatory purposes, it would still merit constitutional review." He closed in saying that the case "would have been well worth" the Court's time and that he hopes the lower courts do not repeat their "mistakes."

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SCOTUS SEC Fraud Ruling Could Affect Tax Penalty Disputes

According to Law360, The U.S. Supreme Court's groundbreaking decision to curb the U.S. Securities and Exchange Commission's in-house fraud enforcement could hamper the IRS' ability to assert certain penalties, including in contested conservation easement cases, and challenge the U.S. Tax Court's authority to review them.

In a 6-3 decision in a case known as SEC v. Jarkesy et al., a majority of the Supreme Court justices in June struck down the SEC's longtime use of tribunal administrative proceedings to impose securities fraud penalties on a hedge fund manager and his investment firm. They said the antifraud provisions the agency had sought to enforce mirrored common-law fraud, which warrants a federal jury trial to adjudicate them under the Seventh Amendment.

Although the underlying dispute in the Jarkesy case does not pertain to the tax code, the opinion's constraints on SEC enforcement may trickle down to other regulatory agencies, including the Internal Revenue Service. The effect could be a further restriction of tax administration amid other Supreme Court decisions this summer that have reduced agencies' powers, including in Loper Bright Enterprises v. Raimondo, Relentless Inc. v. Department of Commerce and Corner Post Inc. v. Board of Governors.

The current Supreme Court majority is "very suspicious of administrative power and administrative overreach, and is doing things to rein in lawmaking and regulatory work through the executive branch," Christopher J. Walker, professor at University of Michigan Law School, told Law360.

Individuals, businesses and other entities are starting to pounce on the opportunity to use the Jarkesy opinion as another arrow in their legal quiver to challenge the IRS' penalties.

For example, six partnerships with pending U.S. Tax Court disputes have already asked the court to toss the civil fraud penalties the IRS has assessed against them under Internal Revenue Code Section 6663. They all made similar claims influenced by the Jarkesy case that the Tax Court, which is unable to provide a jury trial, is not the forum to adjudicate the fines, which have amounted to millions of dollars for some partnerships.

Some practitioners told Law360 that the decision could implicate other IRS penalties, such as fees levied on tax filing inaccuracies and on promoting arrangements the agency deems to be abusive tax shelters.    

The Jarkesy decision also raises the question on whether the Tax Court — which settles disputes between the IRS and taxpayers — is indeed the appropriate forum to formally judge tax penalties.

Frank Agostino of Agostino & Associates PC said if those challenges are successful, it could prevent the IRS from assessing the penalties in the first place.

"The hope," he said, is that the Jarkesy decision "will get the Tax Court out of the penalty business and thereby essentially stop the IRS from asserting the penalties."

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TIGTA - Annual Review of IRS Compliance with Tax Lien and Collection Due Process Procedures

In Report #2024-300-037, TIGTA’s systemic review of 103,460 NFTLs that were filed from July 1, 2022, to June 30, 2023, in which a CDP notice was required to be sent to the taxpayer, and a separate review of a statistical sample of 117 NFTLs from the same population, identified a total of 272 taxpayers that were potentially not timely mailed a CDP notice as required by I.R.C. § 6320(a). 

TIGTA also identified thousands of levies that were issued during the period when taxpayers had the right to request a lien CDP hearing.  TIGTA’s analysis of NFTLs filed from July 1, 2022, to June 30, 2023, identified: 

• 5,801 cases in which levies were issued during the 30-calendar-day period while the taxpayer had the right to elect a CDP hearing.

• 4 cases in which levies were issued while the taxpayer's appeal was pending.

In addition, taxpayer representatives should be provided copies of all taxpayer correspondence if designated by the taxpayer.  

From the statistical sample of 117 NFTLs, there were 41 cases in which the taxpayer designated their authorized representative to receive notices. However, in three of the 41 cases, the IRS did not provide CDP notices to the taxpayers’ authorized representatives.  

TIGTA also reviewed procedures for filing NFTLs in cases where taxpayers were in a disaster zone due to Hurricane Ian.  TIGTA determined that the IRS did not take any of the required preemptive steps that were available to it to suspend collection activity on taxpayers that were impacted by the hurricane on September 28, 2022. 

TIGTA recommended that the IRS:  

1. take corrective action on the cases identified in the statistical sample in which the lien notice was not mailed timely; 
2. ensure that the corrective actions initiated on the cases systemically identified are completed, and safeguards are implemented to protect against the recurrence of the causal issues; 
3. direct the Director, Collection, to establish Field Collection Internal Revenue Manual procedures that prohibit field employees from taking levy action during the 30-calendar-day period that the law provides taxpayers can elect lien CDP hearings; 
4. apply the retention standard when evaluating IRS Collection employees, managers, and executives who intentionally disregard IRS policies designed to protect taxpayers; and 
5. review disaster procedures for NFTL processing and consider updates, as needed, to reduce burden for taxpayers impacted by disasters. The IRS agreed with four of the five recommendations provided in this report.  

For recommendation 3, the IRS did not agree to establish Field Collection IRM procedures to prohibit field employees from taking levy action on taxpayers during the period the law provides taxpayers to elect a lien CDP hearing, which potentially impacted 5,801 taxpayers. 

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9th Circ. Upholds FBAR Penalty Willful and Holds That FBAR Violations Include Recklessness

According to Law360, a woman who operates a New Zealand winery must pay $238,000 in penalties and an extra $105,000 in interest and fees for failing to report her New Zealand financial accounts to the U.S. government, the Ninth Circuit ruled.

Timberly Hughes, who represented herself, failed to show that a district court erred in determining that she willfully failed to file reports of foreign bank and financial accounts, the Ninth Circuit said in its opinion. However, the panel overturned the lower court's decision that the U.S. could not calculate interest from the date of the Internal Revenue Service's notification letter to her. While the letter contained an inaccurate calculation of the penalty, which the IRS later corrected, it put Hughes on notice that she failed to report, the panel said.

The California federal district court had held in March 2023 that Hughes was liable for $238,000 for failing to file FBARs in 2012 and 2013 for bank accounts in New Zealand, but it declined to add over $15,000 in interest and over $90,000 in late payment fees. The IRS originally sent Hughes a demand letter in 2016 with an incorrect amount. A second demand letter recalculated the amount but set interest and late fees from the original date. The district court said the government failed to show why the date of the erroneous letter should still be used for calculating interest and fees. Both sides appealed.

Hughes argued that the lower court conflated negligence with recklessness in determining that she willfully failed to file. If recklessness were sufficient to find willfulness, then nearly every violation of the FBAR rules could be deemed willful, she said in court documents.

The Ninth Circuit disagreed. Other circuits have clearly held that recklessness requires proof of something more than negligence, it said. It requires a finding that the filer ought to have known there was a grave risk that the filing requirement was not met, the panel said. 

Hughes Had Indicated On Her Tax Returns That
She Held A Foreign Account And Was Required
To File An FBAR, The Court Said.

Her explanations for failing to do so were not credible and were inconsistent, it said.

The U.S. claimed that it could run interest from the date of the original letter, and the Ninth Circuit agreed, finding the lower court erred in throwing out the interest and fees. The district court cited no authority for determining that the calculation of interest from the initial demand letter was arbitrary, the Ninth Circuit said, and also hadn't required the U.S. to send a new demand letter.

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IRS Continues To Pursue Complex Arrangements To Evade Taxes

The IRS released IR 2024-223, 8/23/2024 which reports and highlighting significant improvements made in the second year of funding from the Inflation Reduction Act. The report showcases advancements in taxpayer service, technology upgrades, and compliance efforts. Other achievements include increased electronic filing and scanning capabilities, enhanced efforts to disrupt tax scams, and focusing on tax compliance for certain individuals and businesses. 

The IRS ramped up efforts to pursue high-income, high-wealth individuals who failed to pay tax bills, collecting over $1 billion so far. A new initiative focused on high-income non-filers, targeting over 125,000 instances of unfiled returns since 2017. The IRS' Strategic Operating Plan mentioned that the increased areas of enforcement includes areas where audit coverage declined, including employment taxes.

Prior to the Inflation Reduction Act, more than a decade of budget cuts prevented IRS from keeping pace with the increasingly complicated set of devices that aggressive taxpayers use to hide their income and evade paying their share. The IRS is now taking swift and aggressive action to close this gap.

• The IRS ramped up efforts to pursue high-income, high-wealth individuals who failed to pay a tax bill. These high-end collection cases are concentrated among taxpayers with more than $1 million in income and more than $250,000 in recognized tax debt. Out of a total of 1,600 of these cases, the IRS has assigned 1,500 to revenue officers, with over $1 billion collected so far.
• 
  
  The IRS announced a new effort focused on high-income individuals who have failed to file federal income tax returns in more than 125,000 instances since 2017. Non-filers receive IRS
  compliance letters alerting them that the IRS is aware of their missing return and encouraging them to file or contact the IRS. The new initiative involves more than 25,000 people with more than $1 million in income, and over 100,000 people with incomes between $400,000 and $1 million between tax years 2017 and 2021.
  
• Other elements of the agency’s renewed compliance focus include:
• Abusive use of partnerships. Last month, the IRS announced a new series of steps to combat abusive partnership transactions that allow aggressive taxpayers to avoid paying what they owe.
• Activities involving large corporations and partnerships. These efforts include opening examinations of 76 of the largest partnerships in the U.S., representing a cross section of industries including hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms and other industries. Other activities include expanding the large corporate compliance (LCC) program.
• Aircraft use. In February, the IRS announced plans to begin dozens of audits involving personal use of business aircraft. The audits are focused on aircraft usage by large corporations, large partnerships and high-income taxpayers. The IRS are examining whether the use of jets is being properly allocated between business and personal use.

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