Definition of "Willful" in Civil Cases Includes Reckless Disregard of Tax Laws

Definition of "Willful" in Civil Cases Includes Reckless Disregard of Tax Laws

United States v. Bohanec,

2016 U.S. Dist. LEXIS 170149, 2016-2 U.S. Tax Cas. (CCH) P50,498  ( D.C. Cent. Dist. Cal. 2016)

Dean D. Pregerson, United States District Judge.

Plaintiff, United States of America, sought to collect a civil penalty assessed to Defendants August Bohanec and Maria Bohanec for willful failure to report their interest in foreign bank accounts during tax year 2007, as required under 31 U.S.C. § 5314 and its implementing regulations.

The matter was tried before the Court on November 1, 2016.

The Court made the following findings of facts and conclusions of law.

In the 1970s, the Bohanecs purchased a camera shop in Pasadena, California, called Alvin's.  The Bohanecs knew that they had to file tax returns for the camera shop business (“The Camera Shop”) and that if they earned money, they had to pay taxes. The Bohanecs always had a tax preparer prepare the camera shop's tax returns.

The Bohanecs came to an agreement with Leica, a German camera manufacturer, to become an exclusive Leica dealer.  The camera shop was the only exclusive Leica dealer in the world.

Leica had a subsidiary in Canada called Leitz Canada.  Through the camera shop, the Bohanecs became acquainted with the president of Leitz Canada, Walter Kluck ("Kluck").  Sometime in the late 1970s or the early-to-mid 1980s, Kluck offered to sell Leica cameras to the Bohanecs directly from Leitz Canada.  By purchasing Leica cameras from Leitz Canada, the camera shop was able to avoid the supply constraints imposed by Leica's exclusive United States distributor.

The camera shop gained a worldwide reputation for repairing and refurbishing certain Leica camera parts. The camera shop shipped to customers around the world, including in the United States, the Philippines, England, South Korea, and Hong Kong.

Commissions for international sales were deposited into an account at UBS AG in Switzerland in the Bohanecs' name.  Kluck opened the Swiss account on the Bohanecs' behalf. The Bohanecs did not provide UBS AG with their home address. The Bohanecs did not tell anyone in the United States, other than their two children, of the existence of the Swiss account.

By the time the Bohanecs had the Swiss account, they no longer used a bookkeeper or kept any books.  The Bohanecs never discussed the Swiss account with an accountant, lawyer, or banker.
In addition to the Leitz Canada commission deposits, the Bohanecs directed their international customers, on at least a few occasions, to deposit money directly into the Swiss UBS [*5]  account.

The Bohanecs did not report the commission income they received from Leitz Canada on their federal income-tax returns.  The UBS account was managed by Walter Kluck while he was alive and, thereafter, by UBS.   At some point, Kluck told the Bohanecs that the Bohanecs' UBS account had a balance in excess of $700,000.

The Bohanecs closed Alvin's Camera sometime in the late 1980s.  Beginning in the early 2000s and continuing through at least 2009, the Bohanecs sold Leitz cameras and parts on Ebay.  The Bohanecs would occasionally withdraw money from their UBS account.

From October 2004 through October 2008, the Bohanecs made several other withdrawals from their UBS account in Switzerland.

The UBS account had balance on December 31, 1999 of $1,096,500 which was gradually reduced to a balance on December 31, 2007 of $687,600.

United States citizens who have a financial interest in, or signature authority over, a foreign bank account are required to file a Report of Foreign Bank and Financial Accounts ("FBAR").  The deadline for filing the FBAR for 2007 was June 30, 2008.

In 2007, in addition to the UBS account in Switzerland, August Bohanec had the bank account in Austria, into which were deposited periodic disability payments he received for an eye injury he sustained before immigrating to the United States.

In 2007, in addition to the bank accounts in Austria and Switzerland, the Bohanecs also maintained the bank account in Mexico, into which they would deposit money from their UBS account in Switzerland to build and maintain the house in Mexico.

The Bohanecs did not file an FBAR for 2007.  As of June 30, 2008, the most recent tax return the Bohanecs filed was for tax year 1998.  In their 1998 tax return, the Bohanecs reported an adjusted gross income of $62,237.

Part III to Schedule B of the 1998 tax form 1040 concerns foreign accounts and trusts. Question 7a in Part III to the Schedule B asks the following question: "At any time during 1998, did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account? See page B-2 for exceptions and filing requirements for Form TD F 90-22.1."

Page B-2 of the instructions for Schedule B for 1998 states: "See [FBAR] Form TD F 90-22.1 to find out if you are considered to have an interest in or signature or other authority over a financial account in a foreign country (such as a bank account, securities account, or other financial account)."

Page B-2 of the instructions for Schedule B for 1998 also states: "If you checked the Yes box on line 7a, file [FBAR] Form TD F 90-22.1 by June 30, 1999, with the Department of the Treasury at the address shown on that form."

In May and June of 2009, the Bohanecs transferred a total of $522,796.55 from their UBS account to a new account at Steiermärkische Bank. On January 29, 2010, the Bohanecs closed the Austrian account at Steiermärkische Bank and transferred the balance of $523,677.40 to their account at Bank of America in Pasadena, California.

Between the filing of their 1998 federal income-tax return and May 19, 2011, the Bohanecs did not file any federal income-tax returns. Between the opening of the UBS account and May 19, 2011, the Bohanecs did not file any FBARs.

On January 6, 2010, the Bohanecs executed an application to participate in the IRS's Voluntary Disclosure Program for Offshore Accounts. The Bohanecs' application, submitted under penalty of perjury, represented that the "original balance and all funds deposited into the [Swiss UBS] account were after-tax earnings from our used camera business."

On January 19, 2010, the Bohanecs were preliminarily accepted into the Voluntary Disclosure Program for Offshore Accounts. On May 19, 2011, the Bohanecs executed and filed FBARs for 2003, 2004, 2005, 2006, 2007, and 2008.

On May 19, 2011, the Bohanecs executed and filed federal income-tax returns for 2003, 2004, 2005, 2006, 2007, and 2008. While the FBARs filed by the Bohanecs in May 2011 for 2003, 2004, 2005, 2006, 2007, and 2008 included the UBS account, they did not include the Austrian account, which was in existence during 2003 through 2008.  Further, the FBARs for 2006, 2007, and 2008 filed by the Bohanecs in May 2011 did not include the Mexican account, which was in existence during 2006 through 2008.

The Bohanecs were ultimately rejected by the IRS for the Voluntary Disclosure Program for Offshore Accounts.  While the federal income-tax returns for 2003, 2004, 2005, 2006, 2007, and 2008 included the interest earned on the UBS accounts, they did not include the income earned by the Bohanecs from their EBay sales.

On October 3, 2013, the IRS issued a notice of deficiency for tax year 2003 through 2010. Exhibit 37 is a copy of this notice of deficiency. As reflected in the October 3, 2013, notice of deficiency, after audit, the IRS determined the additional tax and penalties:
 
Year    Additional tax    Failure-to-file penalty        Fraud penalty
                                     (IRC § 6651(a)(1))          (IRC § 6663)

2003    $16,651                    $  4,162.75        $  7,341.00
2005    $53,330                    $13,332.50        $39,997.50
2006    $23,221                    $  5,806.00        $17,415.75
2007    $50,148                    $12,537.75         $37,611.00
2008    $  8,253                    $  2,063.25        $  6,189.75
2009    $20,690                          –0–             $14,052.00
    

The Bohanecs did not file a suit in Tax Court challenging the tax deficiencies reflected in the October 3, 2013, notice of deficiency.  The IRS subsequently assessed the additional tax liabilities and penalties specified the October 3, 2013, notice of deficiency. As of September 19, 2016, the outstanding balance on the Bohanecs' federal income-tax liabilities for 2003, 2005, 2006, 2007, 2008, 2009, and 2010 was a total of $492,163.61.

Court's Holdings:

Each year, U.S. citizens who hold a financial account in a foreign country must report certain details about the account to the Treasury Department. See 31 U.S.C. § 5314; 31 C.F.R. § 103.24 (2009).  The report must be made each year by filing an FBAR with the Treasury Department no later than June 30 of the following year. See 31 C.F.R. § § 103.27(c), (d), (e) (2009).

 Failure to file an FBAR can result in a fine up to $10,000. 31 U.S.C. § 5321(a)(5)(B).  If a foreign account holder "willfully" failed to report the account on an FBAR, the maximum penalty is increased from $10,000 to the greater of $100,000 or fifty percent of the balance in the account at the time of violation. 31 U.S.C. §§ 5321(a)(5)(C), (D)(ii).

The only dispute in this matter is whether the Bohanecs' failure to timely file an FBAR disclosing their financial interest in their foreign accounts for 2007 was willful. Section 5321 (a)(5) of Title 31 does not define willfulness. 31 U.S.C. § 5321(a)(5).

The Supreme Court has explained that "willfully is a word of many meanings whose construction is often dependent on the context in which it appears." Safeco Ins. Co. of America v. Burr, 551 U.S. 47, 57, 127 S. Ct. 2201, 167 L. Ed. 2d 1045 (2007).

Defendants asserted that "willfulness" encompasses only intentional violations of known legal duties, and not reckless disregard of statutory duties, no court has adopted that principle in a civil tax matter. The cases Defendants cited to support their argument that "willful" means that a defendant must have knowledge and specific intent are criminal cases. See Ratzlaf v. United States, 510 U.S. 135, 114 S. Ct. 655, 126 L. Ed. 2d 615 (1994) (structuring); United States v. Eisenstein, 731 F.2d 1540 (11th Cir. 1984) (felonious failure to file currency transaction reports).

Where willfulness is an element of civil liability, the Supreme Court generally understands the term as covering "not only knowing violations of a standard, but reckless ones as well." Safeco, 551 U.S. at 57.  "Recklessness" is an objective standard that looks to whether conduct entails "an unjustifiably high risk of harm that is either known or so obvious that it should be known." Safeco, 551 U.S. at 68.

Several other courts, citing Safeco, have held that "willfulness" under 31 U.S.C. § 5321 includes reckless disregard of a statutory duty. See United States v Williams, 489 Fed.Appx. 655, 658 (4th Cir. 2012); United States v. Bussell, No. CV 15-02034 SJO, 2015 U.S. Dist. LEXIS 175952, 2015 WL 9957826 (C.D. Cal. Dec. 8, 2015); see also United States v. McBride, 908 F.Supp. 2d 1186, 1204, 1209 (D. Utah 2012).

Defendants argued that the Chief Counsel of the Internal Revenue Service has opined, prior to Safeco, that the willfulness standard for purposes of 31 U.S.C. § 5321 is the same as the criminal standard. IRS CCA 200603026. However, the Court held that Chief Counsel Advice may not be used or cited as precedent. 26 U.S.C. § 6110(k)(3); see also Elbaz v. Commissioner of Internal Revenue, T.C. Memo. 2015-49, 2015 WL 1197533 (T.C. 2015).

The Court also held that the Internal Revenue Manual's interpretation of "willfulness" for purposes of 31 U.S.C. § 5321, cited by Defendants, does not have the force of law, and is not relevant here. See Fargo v. Commissioner of Internal Revenue, 447 F.3d 706, 713 (9th Cir. 2006); and Kimdun Inc. v. United States, No. 16-cv-01500-CAS, 2016 U.S. Dist. LEXIS 108651, 2016 WL 4408816 (C.D. Cal. Aug. 15 2016).

The Court initially noted that the Supreme Court has held that a heightened, clear and convincing burden of proof applies in civil matters "where particularly important individual interests or rights are at stake." Herman & MacLean v. Huddleston, 459 U.S. 375, 389, 103 S. Ct. 683, 74 L. Ed. 2d 548 (1983). Such interests include parental rights, involuntary commitment, and deportation.

The Court stated that the lower, more generally applicable preponderance of the evidence standard applies, however, where "even severe civil sanctions that do not implicate such interests" are contemplated. Id. at 390; see also Grogan v. Garner, 498 U.S. 279, 286, 111 S. Ct. 654, 112 L. Ed. 2d 755 (1991). The Court held that the monetary sanctions at issue here do not rise to the level of "particularly important individual interests or rights." Accordingly, the Court found that the preponderance of the evidence standard applied. See also McBride, 908 F.Supp.2d at 1214.

The Court found that the government had proved by a preponderance of the evidence that Defendants were at least recklessly indifferent to a statutory duty for the following reasons:

Defendants were reasonably sophisticated businesspeople. Defendants knew that they had to pay taxes if they earned money, and that they had to file tax returns.

Defendants were at least reckless, if not willfully blind, in their conduct with respect to their Swiss UBS account and their reporting obligations regarding the account.

Defendants never provided UBS with their home address, and never told anyone other than their children of the existence of the UBS account, including the tax preparers Defendants hired to help them file tax returns. Defendants never asked a lawyer, accountant, or banker about requirements regarding the UBS account, and never used a bookkeeper or kept any books once the UBS account was opened.

The Court found that Defendants' representations that they were unaware of or did not understand their obligations were not credible. Part III of Schedule B of Defendants' 1998 tax return put them on notice that they needed to file an FBAR.

The Court held that Defendants had made several misrepresentations under penalty of perjury. Defendants misrepresented, for example, that all of the funds in the UBS account were after-tax proceeds from Defendants' used camera business, when in fact the account included Leitz Canada commissions that had never been reported on income tax returns. The application also failed to disclose Defendants’ Austrian bank account. Furthermore, Defendants then proceeded to file false tax returns for 2003-2008 that did not include any of Defendants' income from internet sales. Defendants' FBARs for 2003-2008 did not disclose the Austrian account and the FBARs for 2006-2008 did not disclose the Mexican account.


CONCLUSION

Defendants' failure to timely file an FBAR for 2007 was willful. The maximum penalty is therefore increased to the greater of $100,000 or fifty percent of the balance in the foreign accounts on June 30, 2008.

Note:

When the IRS assesses a FBAR penalty, the government may file a lawsuit in district court to collect the penalty. A taxpayer assessed with a FBAR penalty may challenge the liability in court.  See, United States v. Williams, (E.D. Va. 2010) and United States v. Simonelli, 614 F. Supp. 2d 241 (D. Conn. 2008). The taxpayer has a right to a jury trial. See, Tull v.  United States, 481 U.S. 412, 425 (1987) (Clean Water Act case); United States v. Zwerner (S.D. Fla 2013); and Moore v. United States No. 2:13-cv-02063 (W.D. Wash 2015).

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