FBAR Penalty to Face Excessive Fines Clause Test

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[author: Jed Silversmith]

Today’s blog post is authored by Jed Silversmith, a former federal prosecutor and member of the Washington State bar who recently joined Blank Rome in its Philadelphia office.  Mr. Silversmith has applied to reactivate his Pennsylvania bar license and is awaiting approval of that application.

Last week, a federal jury in Miami found that Carl Zwerner had willfully failed to disclose his foreign bank account to the Treasury Department for calendar years 2004, 2005 and 2006. Zwerner now potentially owes the United States 150% of the value of his account plus an additional statutory assessment of 12% and interest. Zwerner’s account balance was roughly $1,500,000, resulting in a penalty of about $2,500,000. Another hearing is set in the case for June 6, 2014 where the district court will consider how it intends to compute a civil penalty. Zwerner will likely argue that this 150% penalty violates the Excessive Fines Clause of the Eighth Amendment to the U.S. Constitution.

By way of background, the Bank Secrecy Act requires that taxpayers who have an ownership interest in overseas bank accounts disclose those accounts to the Treasury Department. The disclosures are required to be made every year by June 30 on a reporting form commonly referred to as an “FBAR.” See 31 U.S.C. §§ 5314 & 5321. Taxpayers who willfully fail to disclose these overseas accounts face a maximum penalty which is the greater of $100,000 or 50% of the balance of the account (the “FBAR penalty”). Since the United States entered into a deferred prosecution agreement with UBS (the largest bank in Switzerland) in 2009, there has been an intense focus on identifying overseas accounts. To encourage taxpayers to disclose their accounts, the IRS has offered three amnesty programs called Offshore Voluntary Disclosure Initiatives (“OVDI”). Under the OVDI programs, taxpayers agreed to pay a penalty of between 20% and 27.5% of the balance of the account for one year plus back taxes and interest. In exchange for these payments, the taxpayer received amnesty from criminal prosecution and avoided other potential civil penalties that could be asserted.

Zwerner had an interest in an undeclared Swiss bank account since the 1960s. The account was held in the name of a Liechtenstein foundation. In 2009, Zwerner tried to enter one of the OVDI programs. However, his application was rejected. The IRS (under a delegation authority from the Treasury Department) subsequently assessed Zwerner a 50% penalty for each of the four years, resulting in a total penalty equal to twice the value of his account.

Last year, the United States filed suit in federal district court to collect the unpaid assessment. Zwerner had argued that he never declared the account to the IRS because he viewed his interest as “indirect.” However, as the government notes in one of its pleadings:

Zwerner readily admits that the account was, “as far as I was concerned my secret account. And I didn’t mention it to anybody. Even my lawyer of 40 years”

In a rare jury trial on this issue, Zwerner was found to have willfully failed to disclose his foreign bank account for three years. The jury found that his failure to report the account in 2007 was not willful.  (Zwerner had read about one of the voluntary disclosure programs in May 2008, about one month before the due date for his 2007 FBAR reporting requirement.)  The jury also made a special finding that he did not qualify for the OVDI program in 2009.

The district court has set a hearing for June 6, 2014 to examine post-trial issues. The next phase of the proceeding involves the district court determining the precise amount of the penalty and then entering a judgment. In SEC v. Lipson, Judge Posner explained that a defendant in a civil enforcement action had a right to a jury trial on liability, but that the district court had the ultimate responsibility to determine the amount of the civil penalty. 278 F.3d 656, 662 (7th Cir. 2002) (citing Tull v. United States, 481 U.S. 412, 425 (1987)). See also SEC v. Solow, 554 F. Supp. 2d 1356, 1367 (S.D. Fla. 2008) (“Accordingly, it was Mr. Solow’s constitutional right to have a jury determine his liability, with this Court thereafter determining the amount of penalty, if any.”).

Zwerner’s lawyers will be arguing that the base penalty, 50% of the balance of his foreign account each year for three years, violates the Excessive Fines Clause of the Eighth Amendment. According to court filings, Zwerner’s FBAR penalty vastly exceeded his tax liability:

Year 50% Penalty Tax due and owing on unreported interest Ratio of tax to penalty
2004 $723,762 $27,711 3.8%
2005 $745,209 $26,084 3.5%
2006 $772,838 $26,290 3.4%

These tiny ratios do not even include any understatement penalties that Zwerner may have paid (there was some discussion in the record that he paid a fraud penalty for at least one of the years at issue).

Furthermore, in this case, the United States filed suit pursuant to the Federal Claims Collection Act (the “FCCA”), 31 U.S.C. § 3701 et seq. Section 3716(e) of the FCCA permits the government to collect an additional 6% surcharge on unpaid administrative assessments annually. The government made an administrative determination against Zwerner two years ago. Thus, Zwerner’s penalty has ballooned by another 12%. In its summary judgment brief, the government notes that the statutory surcharge (for all four FBAR penalties) was $465,243. The government also collects interest on the debt as well. In this case, the amount of accrued interest (again on all four penalties) was about $130,000.

ANALYSIS

Despite these daunting sums, which do not reflect the economic harm that the United Statues suffered, the government has a strong argument that the fine is constitutional. The lead case on the subject is the United States v. Bajakajian, 524 U.S. 324 (1998). In that case, the government seized $357,000 from a family as they were boarding an international flight. The U.S. Supreme Court held that the seizure violated the Eighth Amendment’s Excessive Fines Clause. The Court’s ruling provided guidance to district courts, directing them to look to Congress and the Sentencing Commission to determine the reasonableness of a fine. In interpreting Bajakajian, the Eleventh Circuit has articulated a three-pronged test to determine the constitutionality of a seizure:

(1) whether the defendant falls into the class of persons at whom the … statute was principally directed; (2) other penalties authorized by the legislature (or the Sentencing Commission); and (3) the harm caused by the defendant.

United States v. Browne, 505 F.3d 1229 (11th Cir. 2007). See also United States v. Prochnow, 2006-2 Trade Cas. (CCH) ¶ 75408 (N.D. Ga. 2006) (applying Bajakajian in an FTC penalty case).

A.  Zwerner was likely in the class of people designed to be punished by this statute

The government will argue that this is not solely a reporting violation. In Bajakajian, the Court found a constitutional violation because Bajakajian’s “money was the proceeds of legal activity and was to be used to repay a lawful debt. Whatever his other vices, respondent does not fit into the class of persons for whom the statute was principally designed: He is not a money launderer, a drug trafficker, or a tax evader.” Bajakajian, 524 U.S.at 338. In contrast, Zwerner was hiding his money from the IRS. The FBAR penalty was meant to reach individuals who hide their income from the IRS. He is likely among the class of individuals designed to be punished by this statute.

B.  The maximum penalty was authorized by Congress, but the advisory criminal fine under the federal sentencing guidelines would be minimal

In terms of weighing the constitutionality of a fine, courts defer to Congress in the first instance as well as the U.S. Sentencing Commission. The Eleventh Circuit has explained in a criminal forfeiture case:

Because Congress is a representative body, its pronouncements regarding the appropriate range of fines for a crime represent the collective opinion of the American people as to what is and is not excessive. Given that excessiveness is a highly subjective judgment, the courts should be hesitant to substitute their opinion for that of the people.… Consequently, if the value of forfeited property is within the range of fines prescribed by Congress, a strong presumption arises that the forfeiture is constitutional.

United States v. 817 N.E. 29th Drive, 175 F.3d 1304 (11th Cir. 1999).

Here, the government can point to the Bank Secrecy Act itself. Congress prescribed that those who willfully fail to report the existence of a foreign account are liable for penalties of the greater of $100,000 or 50% of the balance in the account at the time of each violation. 31 U.S.C. § 5321(a)(5). In the same statute, Congress further prescribed a six-year period of limitations for assessing such penalties. 31 U.S.C. § 5321(b)(1). Thus, Congress contemplated a maximum fine of six 50% penalties. Zwerner was assessed only three 50% penalties.

In contrast, an analysis under the federal sentencing guidelines would yield a dramatically lower penalty. Although this is not a criminal case, such an argument may have some appeal. In 817 NE 29th Drive, the Eleventh Circuit remarked: “although we retain a duty under the Eighth Amendment independently to examine fines for excessiveness, a defendant would need to present a very compelling argument to persuade us to substitute our judgment for that of the United States Sentencing Commission.” Under the federal sentencing guidelines, the advisory penalty would be significantly less. Zwerner’s offense level would be calculated under U.S.S.G. §§ 2S1.3(a) & 2B1.1, which would yield an advisory guideline range of either 22 or 24 (depending on whether each year was treated as a separate offense under the grouping rules). Alternatively, if the court found that Zwerner’s primary motivation was to evade taxes, it would apply U.S.S.G. §§ 2S1.3(c) & 2T4.1. This would yield a guideline range of 14. The relevant fine range would be $10,000 to $100,000 (using the fraud tables) or $4,000 to $40,000 (using the tax tables).   Given the circumstances of this case, a district court would likely apply the lower tax guideline at a sentencing hearing.

C.  Zwerner’s harm to the Treasury was minimal

Zwerner’s best argument is simply one of proportionality. As noted above, the base penalty constitutes about 3% to 4% of the harm that he caused. Even that figure is overstated because Zwerner appears to have paid some understatement penalties directly to the IRS. Zwerner is also subject to the 6% annual statutory assessment under the FCCA. The total penalty simply does not bear any representation to the harm to the Treasury.

Moreover, Zwerner can point out that the IRS has, as a matter of course, apparently collected smaller penalties from pretty much every other similarly situated taxpayer. In the three OVDI programs, the Service has required that taxpayers pay only between 20% and 27.5% of the balance of their account in one year. In recent criminal cases, individuals who pleaded guilty also had to pay only 50% of the balance of the account(s) in one year. Zwerner’s penalty will be significantly higher than any of these individuals.

CONCLUSION

Zwerner does have some compelling arguments to ask the district court to mitigate his penalty. Given the focus of the IRS and the Department of Justice on FBAR penalties in general, and the novel posture of this case in particular, the district court’s decision will receive substantial attention.

Topics:  Bank Secrecy Act, Banks, Compliance, Excessive Fines Clause, FBAR, Foreign Banks, IRS, Offshore Banks, Offshore Funds, SEC, Tax Evasion

Published In: Constitutional Law Updates, Criminal Law Updates, Finance & Banking Updates, International Trade Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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