By now readers of my blog know of the possible draconian penalties that can be assessed for failure to file a so-called FBAR (Report of Foreign Bank and Financial Accounts). You can read more about FBAR at my tax blog posts here and here.
A brand new FBAR case has reared its ugly head and perhaps serves as an indicator for what the Internal Revenue Service (IRS) considers sufficient reason to avert an FBAR penalty. There are many technical aspects to the case which I will not discuss – predominantly issues of jurisdiction, waiver of sovereign immunity and whether there exists any other adequate remedy at law for the plaintiffs outside of the lawsuit they brought to District Court. I am not concerned with these aspects of the case, but wish to give the reader some insight into how the IRS may look at an FBAR penalty matter for what was clearly a nonwillful violation.
In Kentera v. United States, 2017 U.S. Dist. LEXIS 12450 (ED WI 2017), the US District Court dismissed a complaint filed by a husband and wife living in California. The Kentera’s were seeking review of FBAR nonwillful penalties asserted by the IRS. The nonwillful FBAR penalties were assessed pursuant to an audit after the couple withdrew from the IRS’ 2011 Offshore Voluntary Disclosure Initiative (OVDI).
The facts of the case are taken from the plaintiff’s complaint, which can be read here. In summary, they are as follows:
In 1984, after the death of his father, the plaintiff-husband, Milo Kentera, inherited a Swiss foreign bank account at Banque Cantonale de Geneve (Swiss Account). The account was automatically transferred to the plaintiff at the death of his father, so the plaintiff did not take any action in creating this account. Sometime soon afterwards, Milo added his wife’s name to the Swiss Account. The balance in the account was under USD10,000 through 2004 but increased somewhat in 2005-06 going over the USD10,000 FBAR filing threshold. The Swiss Account increased significantly in 2007 upon the sale of the plaintiff’s parents’ Montenegro real property. Some of the sales proceeds were distributed to plaintiff Milo and deposited in the Swiss Account, with the balance paid to Milo’s siblings.
Neither of the plaintiffs were well-versed in US tax matters. The husband was a pharmacist and his wife was a homemaker. Since 1984 when the account was inherited, the plaintiffs always disclosed the Swiss Account to their various accountants on tax organizers and always disclosed the account on their federal income tax returns (Schedule B). However, when the account first exceeded USD 10,000 in 2005, their first accountant failed to prepare or file an FBAR for the plaintiffs. Their second accountant continued this FBAR failure for a number of years despite the fact he clearly knew of the existence of the account from the prior tax returns given to him by the plaintiffs; he also failed to ask if any foreign interest was earned on the account, and consequently, interest income was omitted. In 2010, a third accountant acknowledged the existence of the Swiss Account on the plaintiffs’ return and included interest income from the Account, but she also failed to prepare or file an FBAR. Please note, certainly a tax professional should have been well aware of the FBAR filing rules by the time a 2010 FBAR should have been filed (i.e., June 30 2011). At this time the first IRS OVDI had been in full swing, having been initiated in 2009 and many professional and non-professional articles were written about the problems with FBAR.
Sometime in approximately September 2011, the plaintiffs entered the recently announced IRS 2011 OVDI program. They amended tax returns to include omitted interest income from the Swiss Account and filed completed FBARs for the 6 year period, 2005-2010. In August 2013, the IRS provided Plaintiffs with a Form 906, Closing Agreement assessing a miscellaneous penalty of $90,092. The complaint stated that plaintiffs “withdrew” from the OVDI program the following month. I believe the plaintiffs “opted out” of the program, but am not sure. They were soon the subject of examination by an IRS agent. The IRS agent recommended that plaintiffs be assessed non-willful FBAR penalties under the Bank Secrecy Act, and later proposed assessing the penalties as follows:
1) As to the husband, Milo Kentera: $500 for calendar year 2006; and $10,000 per year for calendar years 2007, 2008, 2009, and 2010, for a total penalty of $40,500.
2) As to the wife, Lois Kentera: $500 for calendar year 2006; and $2,500 per year for calendar years 2007, 2008, 2009, and 2010, for a total penalty of $10,500; and
Plaintiffs protested the penalties at IRS conferences, but their protests fell on deaf ears and the IRS sent each of the plaintiffs a letter of an “appeals determination,” upholding the IRS’ proposed FBAR penalties against each of them. The plaintiffs then filed the complaint in District Court. In their complaint, plaintiffs asserted that the IRS incorrectly assessed the FBAR penalties. First, on grounds that the Bank Secrecy Act prohibits the imposition of an FBAR penalty if the violation was “due to reasonable cause.” 31 U.S.C. § 5321(a)(5)(B)(ii)(I). [I note here that the statute requires not only “reasonable cause” but also that “the amount of the transaction or the balance in the account at the time of the transaction was properly reported”.]
According to plaintiffs, “reasonable cause” for their FBAR violations existed because the fault in failing to file the FBARs lay with their various accountants (ummm, this makes complete sense to me!). The IRS disregarded this defense, and plaintiffs believe this was a violation of their due process rights under the Fifth Amendment. In addition, plaintiffs asserted that because the IRS wrongfully rejected their reasonable cause defense under the Bank Secrecy Act, its assessment of the penalties was arbitrary and capricious, in violation of the Administrative Procedure Act. Here is where various technical and procedural aspects of the case, arise, which will not be discussed.
The point to be taken is the IRS’ apparent lack of sympathy with the taxpayers’ arguments concerning “reasonable cause”. It will be remembered that the IRS has discretion to assess FBAR penalties after taking into account all the facts and circumstances. See the IRS Manual regarding FBAR penalties here. Current IRS procedures state that an examiner may determine that the facts and circumstances of a particular case do not justify asserting a penalty and that instead an examiner should issue a warning letter. The IRS has established penalty mitigation guidelines, but examiners may determine that a penalty is not appropriate or that a lesser (or greater) penalty amount than the guidelines would otherwise provide is appropriate. Examiners are instructed to consider whether compliance objectives would be achieved by issuance of a warning letter; whether the person who committed the violation had been previously issued a warning letter or has been assessed the FBAR penalty; the nature of the violation and the amounts involved; and the cooperation of the taxpayer during the examination.
In my practice I have found that taxpayers living and working abroad may not have ready access to competent US tax advice or preparation services and they are often at a disadvantage in getting good tax help. It is possible that because the plaintiffs were living in the US, the IRS had less sympathy for them. This notion is reflected in the difference between the current versions of the Streamlined Foreign Offshore Procedure (available only to US persons living abroad who meet a specific non-residency requirement; no penalties assessed) and the Streamlined Domestic Offshore Procedure (for US residents; assessment of a 5% miscellaneous offshore penalty). For more information on the Streamlined programs, see my tax blog post here. This same notion is reflected in FS 2011-13 wherein the IRS discusses among other things, FBAR penalties and how these can be averted by “reasonable cause” in the case of dual-nationals and US citizens residing outside of the United States. In FS 2011-13 the IRS states:
“Factors that might weigh in favor of a determination that an FBAR violation was due to reasonable cause include reliance upon the advice of a professional tax advisor who was informed of the existence of the foreign financial account, that the unreported account was established for a legitimate purpose and there were no indications of efforts taken to intentionally conceal the reporting of income or assets, and that there was no tax deficiency (or there was a tax deficiency but the amount was de minimis) related to the unreported foreign account. There may be factors in addition to those listed that weigh in favor of a determination that a violation was due to reasonable cause. No single factor is determinative.”
In order to establish reasonable cause through reliance on a tax adviser’s advice, various cases have noted that the taxpayer must prove three elements. First, the adviser must be a competent professional with sufficient expertise (for example, you cannot rely on an insurance agent for tax advice); second, the taxpayer must provide necessary and accurate information to the adviser; and finally, the taxpayer must rely in good faith on the adviser’s judgment. See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, at page 91 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002) and Flume v. Commissioner, T.C. Memo. 2017-21 at page 16 (2017).
Didn’t Mr. and Mrs. Kintera meet these 3 tests?
The IRS disposition of the case was disappointing, to say the least. One has to ask why, on these facts, the taxpayers joined OVDI in the first place? My guess is that the fear factor was ramped up significantly and they may not have been given full detailed advice by their tax advisor as to all of the possible options, risks with each one and so on. One must also remember that at the time the taxpayers joined OVDI, the Streamlined options did not exist. The case demonstrates that one must be very careful in taking actions. Get a second or even third opinion.
For readers wishing more detail on the Kentera case, please refer to the following court documents:
The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.
Virginia La Torre Jeker J.D.
Virginia La Torre Jeker J.D., is based in Dubai. Virginia has been a member of the New York Bar since 1984 and is also admitted to practice before the United States Tax Court. She has over 30 years of experience specializing in the international aspects of US tax, including FATCA. She has been quoted in the New York Times and Newsweek, and is regularly quoted in many local news articles and publications."
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