A Bitt[n]er pill to swallow

Albert Einstein, considered a rather bright fellow, was once quoted saying, "The hardest thing to understand in the world is the income tax." All things being relative, Mr. Einstein would be particularly confused with the IRS' stance on how it believes U.S. citizens living abroad, and others sporting U.S. citizenship who hold financial accounts overseas, should be punished for unintentional violations of the Bank Secrecy Act - a matter the Supreme Court will encounter this Wednesday when it hears argument in the case of Alexandru Bittner v. United States, Docket No. 21-1195.

At issue in Bittner is whether the $10,000 maximum penalty for a non-willful violation of the FBAR filing requirement applies for each annual FBAR a taxpayer fails to file (the "per report" approach to calculating a BSA violation), or whether that penalty applies for each foreign financial account a taxpayer fails to report in a FBAR (the "per account" approach to calculating a BSA violation). As Alexandru Bittner and others caught in this debate have discovered, how the Supreme Court resolves this conundrum will have a drastic impact on the IRS' ability to impose financial penalties on those who hold foreign financial accounts and unintentionally stray from the BSA's sometimes confounding reporting requirements.

Bittner was born in Romania, moved to the U.S. in 1982 when he was 25 years' old, and became a naturalized U.S. citizen in 1987. He returned to Romania just three years later and stayed there until 2011 before moving back to America. While living in Romania, Bittner generated tens of millions of dollars in business and investment income and maintained numerous foreign financial accounts.

Because Bittner never renounced his U.S. citizenship, he was required under the BSA to file an annual FBAR reporting the foreign financial accounts he held while living in Romania. When he returned to the United States in 2011, he was advised of this obligation to file FBARs, and he hired a CPA who filed FBARs for him in 2012 covering the previous five years. Those FBARs were deficient, however, because they only reported the most significant foreign financial accounts Bittner controlled, and Bittner did not check a box indicating that he owned interests in 25 or more foreign financial accounts (even though checking such a box would not have triggered any obligation on Bittner's part to provide any further information regarding any foreign financial account he held unless the government requested such information).

In 2013, Bittner hired a new CPA, who filed amended FBARs for Bittner for the years 2007 through 2011. This time, Bittner's CPA not only checked the box on these reports indicating that Bittner had an interest in 25 or more foreign financial accounts over this time period, his CPA voluntarily provided detailed information concerning more than 200 foreign financial accounts Bittner controlled during that time span.

After this disclosure, the IRS determined that the original FBARs filed by Bittner were deficient because they had failed to report 272 foreign financial accounts linked to Bittner, and, notwithstanding his efforts to correct these deficient FBARs, the IRS slammed Bittner with a $2.72 million tax penalty for what were determined to be non-willful violations of the BSA's FBAR reporting requirements - a penalty amounting to $10,000 for each of Bittner's unreported foreign accounts.

The government sued Bittner in the Eastern District of Texas to reduce this penalty to a judgment. At the time, district courts throughout the United States had reached divergent results on whether to apply the BSA's FBAR reporting penalties on a "per form" or "per account" account basis. In Bittner's case, the district court adopted the "per form" interpretation, and reduced Bittner's penalty to $50,000 - a penalty amounting to $10,000 for each of Bittner's improperly filed FBAR forms.

On appeal, the Fifth Circuit reversed the district court's decision and reinstated the IRS's assessed penalty, holding that "the 'violation' contemplated by Section 5321(a)(5)(A) [the BSA's FBAR provision] is the failure to report an account, not the failure to file an FBAR." The court explained that this interpretation was supported by the statutory text of Title 31, United States Code, Sections 5314 and 5321, which authorize penalties for violations of the statutory requirement to report qualifying transactions or relations with foreign financial agencies, not the regulatory requirement to file a FBAR. This decision created a circuit split with the Ninth Circuit, which only months earlier held that Section 5321(a)(5)(A) applies on a "per form," rather than a "per account," basis. See United States v. Boyd, 991 F.3d 1077, 1080-86 (9th Cir. 2021).

As one might suspect, computing FBAR reporting penalties on a "per account," as opposed to a "per form," basis could have a drastic impact on the penalty a taxpayer faces for FBAR reporting violations. It certainly did in Bittner's case, as he currently faces a penalty of $2.72 million, as opposed to $50,000, for an unintentional failure to check a box on five FBAR forms he filed with the assistance of a CPA.

This week, at the same time the Supreme Court combs through the text of relevant parts of Title 31, and their accompanying legislative history, to see if the Fifth Circuit's or the Ninth Circuit's take on this debate should win out, it should also ask which approach is more firmly based in common sense. If that is where the debate turns, Bittner has some strong arguments.

Specifically, as pointed out in an amicus brief filed by the Center for Taxpayer Rights in the Bittner case, calculating FBAR penalties for non-willful conduct on a "per account" basis, as opposed to a "per form" basis, will, in many cases, lead to bizarre results that undermine the fundamental premise that the IRS should be administering the tax system in a fair, equitable, and consistent manner. For instance:

Calculating FBAR penalties on a "per account" basis renders penalties that disproportionately impact taxpayers who maintain smaller foreign financial accounts. For example, a taxpayer who unintentionally fails to report a single foreign financial account with a balance of $100,001 over the course of the six year statute of limitation period governing FBAR violations would face the same exact maximum statutory penalty - $60,000 - as a taxpayer who unintentionally fails to report a single foreign financial account with a balance of only $10,000 over the same time period.

The IRS' favored "per account" basis of calculating FBAR penalties also disparately treats similarly-situated taxpayers who unintentionally failed to report bank accounts holding the same exact aggregate sum. For instance, under the rule advocated by the IRS, a taxpayer who failed to report one overseas account holding $1 million will be assessed a maximum penalty $10,000 penalty per year, while a taxpayer who failed to report ten different accounts, which each held $100,000, would face a maximum penalty of $100,000 for a failure to report the same exact total amount of offshore funds.

Finally, since the relevant sections in Title 31 contain no provision preventing multiple penalties for a failure to report the same funds, even if such funds are merely transferred from one overseas account to another, the "per account" basis of calculating FBAR penalties could be utilized to drastically increase those penalties for a taxpayer who does nothing more than innocently transfer money around to different overseas accounts during the course of a year. Under this scenario, a taxpayer with $100,000 in one overseas account at the start of the year will face a FBAR penalty that is inexplicably four times higher if the taxpayer does nothing more than transfer $25,000 of those funds into four different overseas accounts at some point in the year for a legitimate business purpose, despite the fact the total amount the taxpayer held in his overseas accounts did not change a dime over the course of the year.

Making all of these scenarios even more troubling is that the "per account" basis for calculating FBAR penalties, and the indiscriminate manner in which it fails to differentiate low value overseas account from accounts with high balances, is the fact this approach results in punishing less culpable violators more harshly. After all, the taxpayer most likely to commit a non-willful violation of the BSA's spiderweb of reporting requirements is not the sophisticated businessman with tens of millions of dollars sitting in a single overseas account who has the assistance of an army of tax consultants, but rather the recently-naturalized immigrant in the U.S. who may have left behind several bank accounts in his native land, or the recent U.S. expat with no clear understanding of how the U.S. tax laws might apply to him after relocating elsewhere in the world and who needed to set up a few bank accounts in his new country to simply carry on with his life.

No one should question that intentional violations of the BSA's reporting requirements, committed by tax cheats who attempt to hide taxable income overseas, should be punished severely. However, what is at issue in Bittner is how the IRS should be constrained when it comes to penalizing non-willful violations of those reporting requirements.

The Supreme Court's answer to the question posed in Bittner should address the practical impacts of imposing a "per form" versus a "per account" approach to penalizing non-willful violations of the BSA, and it does not take a genius of Albert Einstein's caliber to see that the draconian way in which the IRS dolled out its sanction in Bittner's case authorizes absurd results that undermine the fairness of the tax system.