Calling the IRS’ FBAR penalties unconstitutional is a bold statement but in many cases we think they are. To better understand the argument, some history and discussion is necessary.
The Eighth Amendment of the U.S. Constitution says, “Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” Although usually cited in criminal cases, civil fines and forfeitures are every bit as much subject to constitutional scrutiny. Before you get too excited, however, the courts always seem to side with the IRS in civil penalty cases. But that may be changing.
IRS civil penalties are usually based on the amount of unpaid taxes. If you owe the IRS $100,000 and the nonpayment was due to fraud, the IRS can impose a 75% penalty. Steep but legal.
In 2004, Congress quietly increased the penalties for willful failure to report an offshore account. Beginning that year, the maximum penalty increased to the greater of $100,000 or 50% of the highest account balance for each unreported account. Unlike other IRS penalties, this penalty is based on the asset value and not the amount of unpaid tax. That means a million dollar account that generated only $10,000 in interest and just $3500 in unpaid taxes can carry a fine of $500,000. Isn’t that an “excessive fine” and thus unconstitutional? Maybe.
Americans have been required to report offshore financial assets (foreign bank accounts) since 1970. Reporting is done on a Report of Foreign Bank and Financial Accounts or FBAR form. Only recently has the IRS and Justice Department began enforcing the law. It was not until this year that the IRS began seeking FBAR penalties for multiple years.
Let’s look at our earlier hypothetical. Swiss account worth $1 million. Interest at 1% and account not reported for last 4 years. Under our earlier calculations, the IRS could impose a penalty of $2 million – 50% of the total account value for each year the account was unreported. $2,000,000 in penalties even though the total unpaid tax was approximately $14,000.
Lest you think this is just a crazy hypothetical, it isn’t. Case in point – Carl Zwerner of Miami. Earlier this summer a jury upheld an IRS assessment of $2,241,809 on an account that only held $1,691,054. What was the tax that Zwerner owed? Nothing. He paid the taxes on the interest income from his foreign account prior to assessment.
Fearing that Zwerner would challenge the constitutionality of the huge penalties, the government quietly agreed to drop about $700,000 in penalties. The parties then settled for the reduced amount days after the jury’s verdict.
In another case, Ty Warner, creator of the Beanie Babies craze, paid FBAR penalties of almost $54 million dollars. The total tax he owed because of the unreported foeign accounts? Less than a million.
It’s one thing to assess a 50% or 75% penalty but when penalties exceed the total tax owed by a multiple of 50 times like in the Warner case, we believe the penalties are clearly unconstitutional.
What do the courts say? Again, this is a tough question to answer. Although the courts historically uphold IRS penalty assessments, the huge FBAR penalty cases are very new. As we saw last month in the Zwerner case, the IRS blinked on the day the 8th Amendment excessive fines argument was scheduled to be heard by the court.
The IRS and Justice Department are clearly becoming more aggressive with FBAR and other offshore reporting violations. It is still possible to come into compliance and avoid the harshest of penalties, however.
Time is clearly running out and those that wait until they are caught may see the loss of their entire investment. The better course of action is to speak with a good FBAR lawyer, CPA or expat tax service that specializes in missing FBARs. Whatever you do, don’t go it alone and don’t wait.
The IRS tax lawyers at Mahany & Ertl can help with a wide range of foreign reporting concerns including FATCA, the 2014 Offshore Voluntary Disclosure Program, foreign gift reporting and FBAR penalties. For a no obligation, no cost and confidential discussion about your situation, contact attorney Bethany Canfield at or by telephone at (414) 223-0464.