Supreme Court case on offshore accounts could slash penalties for undisclosed assets

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For Alexandru Bittner, a U.S. and Romanian dual citizen who lived abroad for years, a looming decision by the U.S. Supreme Court will mean the difference between owing the IRS $50,000 and owing it $2.7 million.

As momentous as the decision will be for Bittner, it could also have far-reaching implications for financial planners whose clients have overseas bank and investment accounts. At the heart of Alexandru Bittner v. United States is a question of how regulators should treat failures to annually report the existence of foreign assets, including offshore bank accounts. Should there be a separate violation arising from each distinct failure to report individual accounts? Or should there instead be only a single violation for failing to fill out the FBAR form the IRS requires for reporting foreign assets every year?

So far, two federal appeals courts — the Fifth and Ninth circuits — have reached very different answers to that question. How the high court now resolves that split is likely to have knock-on effects that go well beyond Bittner and the particulars of his case, according to a recent report by the nonprofit group Better Markets. The ramifications, according to the group, could extend to how the longstanding federal Bank Secrecy Act applies to "a wide variety of persons and overseas accounts, including citizens, residents, corporations, partnerships, estates, and trusts, and their interests in checking accounts, savings accounts, brokerage accounts, mutual funds, commodity-futures accounts, and certain life-insurance policies." 

The Bank Secrecy Act was adopted in 1970 by Congress to require recordkeeping and reports of the sort that could prove useful in criminal, regulatory or tax investigations. As part of the law, U.S. citizens with assets held abroad are required to fill out a Report of Foreign Bank and Financial Accounts, or FBAR, to inform the IRS of their foreign holdings if the aggregate value in their accounts exceeds $10,000 in a given calendar year. The act was amended in 2004 to introduce penalties for "non-willful" violations of the reporting requirements and increase the fines for willful violations. Compiling data from the U.S. Treasury's Federal Crimes Enforcement Network, the nonprofit group Association of American Residents Overseas estimates roughly 1.4 million people filed FBARs in 2020.

Bittner's case, involving only non-willful violations, is scheduled for arguments on Nov. 2. As ruinous as a $2.7 million judgment might be for the plaintiff, a decision the other way could undermine recent U.S. recent efforts to ensure that American citizens aren't evading their U.S. tax obligations and are properly reporting their overseas assets. The U.S. taxes its citizens on their worldwide income, regardless of where it's earned and where they live.

A native of Romania, Bittner moved to the U.S. in his youth and became a citizen before returning to his homeland in 1990 following the collapse of the Romanian Communist regime. There he found success in businesses related to real estate, hotels, restaurants, construction, aquaculture, logging and manufacturing and opened accounts in countries including Romania, Switzerland and Liechtenstein. 

Unbeknownst to him, Congress's 2004 amendment to the Bank Secrecy Act adopted a penalty of $10,000 a year for "non-willful" violations. The IRS defines non-willful violations as violations arising from "conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirement of the law." 

On Bittner's return to the U.S. in 2011, he was hit with the $2.7 million penalty by the IRS, an amount calculated by tallying up $10,000 for each individual overseas account he failed to report over a five-year period. Sued by the IRS in a Texas district court in June 2019, Bittner responded by contending that his violations actually lay in failing to meet the requirement of turning in FBAR forms to report offshore accounts by April 15 every year.

His arguments initially prevailed in district court and he saw his penalty knocked down to $50,000. The federal Fifth Circuit Court of Appeals later restored it to $2.7 million, though, after finding that "Congress's central goal in enacting the (Bank Secrecy Act) was to crack down on the use of foreign financial accounts to evade taxes. It is not absurd — it is instead quite reasonable — to suppose that Congress would penalize each failure to report each foreign account."

Reuben Muller, a tax attorney at Cole Schotz in Hackensack, New Jersey, said part of the trouble is that the Bank Secrecy Act does not spell out how non-willful violations are to be counted. That omission leaves it up to the IRS and the courts to fill in the blanks.

"The law here suffers from a statute that is not written very clearly," he said. "That ceded a lot of the power to the executive branch through the Department of the Treasury."

Muller said he's working with a client who's in a similar position as Bittner. This client has already paid the IRS a $380,000 penalty for non-willful violations of FBAR requirements. If Bittner is successful, that amount will drop to $90,000 and Muller's client will sue for a refund of the difference.

Beyond the immediate implications for people in similar situations, Muller said the Bittner case is significant for showing how serious the IRS is about trying to prevent tax evasion involving overseas accounts. 

"This is indicative of strong movement within the IRS to treat all types of international reporting with very uncharitable views of people who may not even have realized what they have done," he said. 

Separate from the Bittner case, the federal Ninth Circuit Court of Appeals found in March 2021 in U.S. v. Jane Boyd that the IRS should only be able to charge one $10,000 penalty for each failure to turn in an FBAR form on time. In taking up Bittner, the Supreme Court is trying in part to resolve the split between the Fifth and Ninth circuits' decisions.

The U.S.'s policies on overseas accounts and taxation have long been the subject of criticism. The U.S. is one of only two countries, the other being Eritrea, that taxes people according to their citizenship rather than where they live. Even U.S. expatriates who don't owe taxes in the U.S. are required to file an FBAR form every year to acknowledge the existence of their offshore accounts. Critics contend the rules too often ensnare people who may be U.S. citizens by birth but have otherwise lived their entire lives overseas and have almost no real connection to this country.

Houston Shaner, senior counsel for Better Markets, said there are significant reasons for worrying that a Supreme Court decision in Bittner's favor would undermine U.S. efforts to combat money laundering and tax evasion. A $10,000 annual fine is too small to catch the attention of most wealthy investors with overseas assets.

"For the Bank Secrecy Act to have the serious penalties it was intended to have, it will need to be calibrated for the consequences of individual violations and the economic benefits of those violations," Shaner said. "If it were capped at $10,000, that would have serious consequences for deterrence and, ultimately, things like tax evasion."

Niles Elber, a tax attorney at Caplin & Drysdale in Washington, D.C., cautioned that a decision in Bittner's favor could give tax collectors a perverse incentive to go out of their way to make sure violations are labeled as willful violations. Willful violations carry penalties equal to 50% of the money in unreported accounts, or $100,000, whichever is greater. With multiple violations, a taxpayer can end up owing more in penalties and interest than he has in his accounts.

"It's partly just human nature," he said. "You're not going to want to waste your time with insignificant adjustments. You are going to be looking at where's the opportunity to best apply tax or apply the penalties."

If the case should instead go the IRS's way, Elber said he could see many financial planners rethinking the advice they give clients with overseas assets.

"You'll probably want to take greater care about the number of accounts that are open," he said. "Because if you have one account, and you have a non-willful violation, it doesn't matter that much. It's one $10,000 penalty. But if you have 50 accounts, then the IRS could hit you with 50 penalties."

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