On December 21, 2018, the United States Court of Appeals for the Third Circuit, in Arthur Bedrosian v. United States of America, Department of Treasury, Internal Revenue Service, 912 F.3d 144 (3d Cir. 2018), held that the civil willfulness standard which includes both knowing and reckless behavior applies to determine whether a “willful” Federal Bank Account Report (“FBAR”) violation has occurred. The Third Circuit also left open the question as to whether the District Court had jurisdiction over the plaintiff’s initial claim. 

Background

Congress passed the Bank Secrecy Act of 1970 to require certain reports and records from individuals. One provision of the Act authorized the Secretary of the Treasury to prescribe rules that require persons to file an annual report identifying certain transactions or relations with foreign agencies. Pursuant to this authority, the Secretary of Treasury implemented the FBAR rules. The FBAR rules require US persons with an interest in or authority over financial accounts located outside the United States to file a report with the IRS if the aggregate value of all such accounts exceeds $10,000 at any time during the calendar year. If a US person is required to file an FBAR and fails to do so properly, he or she may be subject to civil monetary penalties. While penalties for a non-willful FBAR violation may not exceed $10,000, the maximum penalty for a willful violation is the greater of $100,000 or 50 percent of the balance in the unreported account at the time of the violation. (All monetary figures are adjusted annually for inflation.)

In the instant case, Arthur Bedrosian is a US person who works in the pharmaceutical industry. In 1973, he opened a savings account in Switzerland in order to make purchases while traveling abroad for work, in lieu of using traveler’s checks. Bedrosian was using the services of Seymour Handelman as his accountant during this time, and Bedrosian initially did not inform Handelman that he maintained a bank account in Switzerland. Bedrosian informed Handelman of this Swiss account sometime in the 1990s and, although Handelman told Bedrosian that he was breaking the law by not reporting the Swiss account to the IRS, Handelman also told him that Bedrosian’s estate could deal with the consequences upon his death. Based on that advice, Bedrosian continued not to report this Swiss account to the IRS when he filed his annual tax returns.

In 2005, the Swiss bank offered Bedrosian a loan and the opportunity to convert his savings account into an investment account. Bedrosian accepted the bank’s offer, which resulted in the creation of a second Swiss account under Bedrosian’s name and control. Upon the death of his then accountant, Handelman, in 2007, Bedrosian hired Sheldon Bransky to act as his new accountant. Bransky obtained and used Handelman’s records in preparing Bedrosian’s 2007 federal income tax return, and Bedrosian provided Branksy with the same information he normally gave Handelman.

On Bedrosian’s 2007 tax return, Bransky indicated that Bedrosian owned a foreign bank account. Bransky also prepared an FBAR for Bedrosian, which only identified one of the two Swiss bank accounts. The identified account had assets totaling approximately $240,000, and the unreported account had assets totaling approximately $2 million. At trial, Bedrosian later testified that he had not reviewed the 2007 tax return or the associated FBAR at that time, and that he simply signed these documents. Upon submitting his 2007 tax return and FBAR to the IRS, Bedrosian sought legal counsel and began correcting his prior filings to declare both of the Swiss bank accounts. In 2011, the IRS began auditing Bedrosian’s past tax returns.

In January 2015 the IRS assessed a $975,789 penalty against Bedrosian for “willful” failure to disclose the larger Swiss account on his 2007 FBAR. Bedrosian paid 1% of the assessed penalty and subsequently filed a complaint requesting recovery of this payment. The IRS counterclaimed demanding Bedrosian pay the full penalty, plus interest.

The primary issue argued in the District Court was whether Bedrosian’s failure to disclose his $2 million Swiss bank account constituted “willful” conduct. The District Court held that Bedrosian’s failure to disclose was not “willful” and entered judgment for Bedrosian on both his claim and the IRS’s counterclaim. The IRS appealed to the Third Circuit.

Third Circuit Court of Appeals

On appeal, the Third Circuit focused on two separate issues: (1) whether they had jurisdiction to review the District Court’s entry of final judgement; and (2) whether the District court used the proper standard to evaluate Bedrosian’s conduct.

What distinguished the jurisdictional question in this case from most FBAR cases is that the IRS did not bring the suit. Generally, the IRS files suit to recover an assessed FBAR penalty, whereas in the instant case Bedrosian paid a portion of the assessed penalty and then filed a claim in the District Court seeking to recover his partial payment. The IRS did not challenge the District Court’s jurisdiction over Bedrosian’s claim, and instead filed a counterclaim against him.

While the parties asserted that the District Court had jurisdiction over Bedrosian’s initial claim, the Third Circuit left this question open. The parties argued that the District Court had jurisdiction over Bedrosian’s claim under the Little Tucker Act, which provides district courts and the US Court of Federal Claims with concurrent jurisdiction over claims against the United States that do not exceed $10,000. Since Bedrosian’s claim was for reimbursement of the amount he paid, which did not exceed $10,000, the parties asserted that the claim fell within the Little Tucker Act.

The Third Circuit disagreed with the parties’ assertion that Bedrosian’s claim provided for jurisdiction under the Little Tucker Act. The Little Tucker Act only provides jurisdiction to claims that do not fall within the scope of the so-called “tax refund statute,” which includes claims that seek recovery of any penalty that is wrongfully collected “under the internal revenue laws.” The parties contended that the penalty was not assessed “under the internal revenue laws” since this phrase refers only to laws codified in title 26, i.e., the Internal Revenue Code, and the FBAR statute is codified under title 31.

The Third Circuit disagreed with the parties and construed the phrase “under the internal revenue laws” to encompass all federal statutes and regulations that are “part of the IRS’s machinery for the collection of federal taxes.” The Third Circuit concluded that the FBAR statute constitutes an “internal revenue law,” and suggested that Bedrosian’s claim was outside the scope of the Little Tucker Act’s jurisdictional reach. The Third Circuit further suggested that the tax refund statute would also fail to supply the District Court jurisdiction over the initial claim since Bedrosian did not pay the full penalty before filing suit, as is required for tax litigation. However, while the Third Circuit ultimately held that the District Court had jurisdiction by virtue of the IRS’s counterclaim, they left open the question as to whether Bedrosian’s initial claim, standing alone, would fall under the jurisdiction of the District Court.

As to the second issue, the Third Circuit agreed with the District Court and held that the proper standard to evaluate Bedrosian’s conduct was the civil willfulness standard, which covers not only knowing violations, but also reckless violations. The Third Circuit stated, however, that in determining whether Bedrosian’s conduct was willful, the District Court’s analysis improperly applied the willfulness standard. In their determination that Bedrosian was non-willful, the District Court had compared Bedrosian’s conduct to that of other individuals in prior FBAR cases. According to the Third Circuit, this focus implied that the determination of non-willfulness was based on findings related to Bedrosian’s subjective motivations or the overall egregiousness of his conduct, which are not required to establish that he was willful under the FBAR statute. While the District Court discussed whether Bedrosian acted knowingly, and indicated that it is unclear whether Bedrosian had knowledge of the omission on the 2007 FBAR violation, their opinion did not address whether he acted recklessly. The Third Circuit was therefore unsure as to whether the District Court fully evaluated Bedrosian’s conduct under the civil standard for willfulness, and remanded the case to the District Court to determine whether Bedrosian knowingly or recklessly failed to report one of his two Swiss accounts on his 2007 FBAR.