Definition of Willfulness in FBAR and OVDP Context Examined by Recent Court Case

U.S. v. Bohanec, 118AFTR 2d 2016-6757, provides the U.S. District Court’s most recent guidance on the facts that taxpayers and international tax attorneys must consider in cases involving the definition of willful in the context of delinquent FBAR filings and an Offshore Voluntary Disclosure Program (“OVDP”) application.

Background & Facts.

The Bohanecs (hereinafter “Taxpayers” or the “Bohanecs”), husband and wife, were born abroad. Taxpayer’s owned a cameral shop in Pasadena, California, called Alvin's (“the camera shop”). Taxpayer’s entered into a series of exclusive contracts and licenses Leica, a German camera manufacturer, to become an exclusive Leica dealer. The camera shop was the only exclusive Leica dealer in the world.

 

Eventually, 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.

 

Leica had a subsidiary in Canada called Leitz Canada. The Canadian subsidiary was interested in expanding its market worldwide. The Canadian requested the assistance of Taxpayer to expand the market. During the 1980s, the Bohanecs brokered transactions between Leitz Canada and various camera retailers around the world. Commissions for international sales were deposited into an account at UBS AG in Switzerland in the Bohanecs' name.

 

Setup of a Initial Foreign Bank Account Subject to FBAR Filings.

 

The UBS AG Swiss bank account was initially setup to receive commissions from the international sales. As related to the Swiss bank account, however, the Taxpayer: (1) did not provide UBS AG with their home address; (2) did not tell anyone in the United States, other than their two children, of the existence of the Swiss account; and (3) 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 account.

 

Transactions with the Foreign Bank Account.

 

The Bohanecs would occasionally withdraw money from their UBS account.

 

  • In June 2003, the Bohanecs transferred $10,000 from their UBS account in Switzerland to their daughter, Yolanda Reischer-Bohanec.

 

  • In July, 2003, the Bohanecs transferred $25,000 from their UBS account in Switzerland to August Bohanec's account at Steiermarkische Bank in Austria.

 

  • In December 2003, the Bohanecs transferred $20,000 from their UBS account in Switzerland to their bank account in Austria.

 

  • In February 2006, the Bohanecs opened a bank account in Mexico and transferred $25,000 from their UBS account in Switzerland to Mexico for expenses related to a house they were building in Mexico.

 

  • In November 2006, the Bohanecs transferred $7,500 from their UBS account in Switzerland to their Bank of America account in Pasadena, California. Exhibit 15 is a copy of the UBS notice regarding this transfer.

 

Other Foreign Bank Accounts Subject to FBAR Filings Requirements.

 

In 2007, in addition to the UBS account in Switzerland, Mr. 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.  Before June 30, 2008, the initial year of the OVDP application, the most recent tax return the Bohanecs filed was for tax year 1998.

 

In addition, the Bohanecs did not report the commission income they received from Leitz Canada on their federal income-tax returns.

 

Offshore Voluntary Disclosure Program Application.

 

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.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.

 

District Court Ruling on FBAR Willfulness Standard.

 

The issue for consideration by the Court was whether the Taxpayer’s missed FBAR filings were “willful”. 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 court ultimately found that the Taxpayer was willful.

 

The court reviewed the standard to determine willfulness in a FBAR case. As the court points out, 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 (2007) 

 

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 (internal quotation marks and citation omitted). 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 [110 AFTR 2d 2012-5298] (4th Cir. 2012); United States v. Bussell, No. CV 15-02034 SJO(VBKx), 2015 WL 9957826 [117 AFTR 2d 2016-439] at *5 (C.D. Cal. Dec. 8, 2015); see also United States v. McBride, 908 F.Supp. 2d 1186, 1204 [110 AFTR 2d 2012-6600], 1209 (D. Utah 2012).

 

The Court also discussed the burden to apply in an FBAR case. The court stated that because an FBAR civil case is only one of monetary sanctions, the higher standard of clear and convincing does not apply. Instead, the preponderance of the evidence standard applies. See also McBride, 908 F.Supp.2d at 1214.

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

 

  1. Defendants were reasonably sophisticated businesspeople. For a time, Defendants' camera shop was the only exclusive Leica dealer in the world. The deals Defendants negotiated with Leica's U.S. distributor were so favorable as to motivate other Leica retailers to protest. Defendants were able to circumvent Leica's supply restrictions by entering into an international agreement with Leitz Canada. Defendants had a worldwide reputation and sold and shipped to customers around the world. Defendants knew that they had to pay taxes if they earned money, and that they had to file tax returns. Defendants always used a tax preparer to prepare the camera shop's tax returns. Defendant August Bohanec was sufficiently sophisticated to obtain two patents without assistance. Defendants also managed the construction of a home along the coast of Mexico, including the hiring of a contractor and the opening of a Mexican bank account.

 

  1. 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.

 

  1. Defendants' were found to not be credible. Taxpayer’s representations that they were unaware of or did not understand their obligations, and deferred entirely to Kluck, are not credible. Part III of Schedule B of Defendants' 1998 tax return put them on notice that they needed to file an FBAR. Defendants not only deposited commissions from their Leitz Canada deals into the UBS account, but also directed customers to deposit payment into the account and made several transfers and withdrawals from the UBS account to other foreign and domestic accounts. Self-serving testimony that Defendants believed that there were no requirements regarding the account because they were intended to use the funds in the account “for retirement” is sufficiently incredible, particularly in light of Defendants' level of sophistication, to call into question the veracity of the remainder of their testimony.

 

  1. Defendants' credibility is further undermined by their conduct with respect to their application to participate in the IRS' Voluntary Disclosure Program for Offshore Accounts. Defendants 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.

 

Importance of Case.

 

This case is a cautionary tale for taxpayer’s and tax attorney’s representing clients with international tax matter clients.

 

First, the case provides further extrapolation of the definition of willfulness in the FBAR context. The reckless standard argued by the IRS and accepted by the Court includes a Taxpayer's situation that "unjustifiably high risk of harm that is either known or so obvious that it should be known".

 

Second, the court continues to accept the IRS’s argument that the clear and convincing standard should apply.

 

Finally, and importantly, once the Taxpayer finally reported accounts and returns to the IRS, the Taxpayer failed to properly report. Specifically, when applying for the OVDP, the Taxpayer still failed to report 2 of the 3 foreign bank account, and also made statements under penalty of perjury that were false. Taxpayer had a track record of not properly reporting other types of income when submitting tax returns. These facts, maybe more than anything, led to the Taxpayer receiving the harshest of FBAR penalties in the end, and provides another example of why it is important to have OVDP and Streamline Filing Compliance Procedures applications filed through a competent attorney or other international tax professional.

IRS CIRCULAR 230 NOTICE: ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY ATTORNEYS AT HARLOWE & FALK LLP TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.