Recent years have brought about a significantly heightened awareness concerning the potential imposition of penalties for failure to timely file a foreign bank account report (FinCEN Form 114, Report of Foreign Bank and Financial Accounts, commonly known as FBAR). (1) Before 2009, FBAR filing infractions were commonly resolved with relatively minor penalties. Then, under the potential threat of criminal prosecution, combined with the U.S. effort to lift the veil of secrecy at Swiss banks, tens of thousands of taxpayers were prompted to voluntarily pay a hefty "miscellaneous offshore penalty" in lieu of FBAR penalties in various iterations of the IRS offshore voluntary disclosure program.
Now FBAR penalty cases are emerging for account holders who, willingly or unwillingly, have been subjected to IRS examinations for unreported foreign bank accounts. Certain of these account holders willingly chose to submit to examination by opting out of the IRS Offshore Voluntary Disclosure Program (OVDP) for penalties they considered unreasonably harsh for the particular situation. (2) Others were unwillingly snared by the turnover of account information by foreign banks or by random audits. (3) Regardless of the route, each faces critical strategic decisions as the case moves through the examination and appeals process. A poor strategy in defending against FBAR penalties may doom otherwise meritorious arguments before they are even raised.
Because FBAR penalties arise under Title 31 of the U.S. Code (which deals with money laundering), they are not subject to the same assessment and collection procedures with which many tax practitioners are familiar. (4) To the contrary, the only reason the IRS handles FBAR penalty examinations is because Treasury and the Financial Crimes Enforcement Network (FinCEN) have delegated enforcement authority to the IRS. (5) Moreover, despite the potentially severe magnitude of FBAR penalties, there are no regulations or published procedures for the assessment of FBAR penalties or an administrative appeal process for account holders. Against this backdrop, account holders and their advisers must take care to preserve and optimize defensive positions once the IRS concludes that FBAR penalties are warranted.
APA arguments could affect strategic considerations
For decades, the IRS has enjoyed what has been coined "tax exceptionalism," essentially meaning that agency actions on tax matters have avoided the same scrutiny to which other federal agencies have been subject under the Administrative Procedure Act (APA). (6) However, the legal landscape has changed, and the IRS increasingly is faced with successful challenges based on APA violations. (7) Moreover, since FBAR penalties do not fall under Tide 26 of the U.S. Code (the Internal Revenue Code), final actions the IRS takes on FBAR penalty enforcement may be more susceptible to APA arguments than other tax matters.
The APA provides a number of safeguards to ensure that federal agencies are acting within the bounds of their authority and that rule-making standards for the administrative enforcement of statutes by government agencies are followed and subject to judicial review. On a high level, this requires that federal agencies engage in a prescribed rule-making process where notice and comment occurs before they adopt regulations. (8) Further, it demands that federal agencies not take final actions that are arbitrary and capricious. (9)
A number of aspects might make FBAR penalty assessments susceptible to challenge on grounds of APA violations. For example, although Congress increased the statutory penalty maximum in 2004, (10) FinCEN has never issued corresponding regulations to adopt the higher maximum penalties (FinCEN, and not the IRS, has regulatory authority for the Bank Secrecy Act). (11) There is a complete absence of substantive regulations to guide the relative determinations of willful versus nonwillful violations, or to articulate standards for setting the penalty amount within the range of permissible penalties. (12) Moreover, the IRS is not adhering to existing FinCEN regulations (reissued in 2010 without substantive changes) that still limit the maximum penalty to $100,000 per occurrence for willful penalties. (13) And, depending on the facts of the case, the IRS's failure to establish that it engaged in contemporaneous reasoned decision-making both in deciding to impose an FBAR penalty and determining the amount of the penalty could amount to a per se violation of the arbitrary and capricious standard. (14)
In this context, there are a number of critical decisions that an adviser must address with the account holder as they look to move beyond an impasse with the examining IRS revenue agent.
Should the account holder seek reconsideration of the proposed FBAR penalty assessment through administrative appeals?
Typically, any opportunity to further discuss and potentially resolve FBAR penalties before going to court would appear logical and desirable. However, that may not be true if the APA is the premise of some of the account holder's best and strongest defense arguments. (15) That is because there generally must be final agency action to successfully invoke judicial review under the APA. (16)
In the income tax context, courts have consistently held that deficiency determinations are reviewed de novo in the Tax Court. (17) This essentially means that all administrative actions up to and including the issuance of a Tax Court decision may be considered in determining whether the government has fulfilled its obligations under the APA. Therefore, if an account holder seeks Appeals consideration, a court ultimately may consider any action taken by Appeals to determine whether an APA violation occurred.
Indeed, this very scenario played out in one of the few reported FBAR penalty cases. In Moore, (18) the account holder challenged the assessment of nonwillful FBAR penalties. Procedurally, penalties for one of the years at issue were assessed (due to an expiring statute of limitation) while assessments were proposed for the remaining...