Introduction
For years, FBAR litigants have made the commonsense argument that large willful FBAR penalties, which can exceed the value of the unreported foreign accounts themselves, violate the excessive fines clause of the Eighth Amendment. Until recently, every court to consider this argument has held that the Eighth Amendment did not apply. On August 30, 2024, the Eleventh Circuit upset that trend, created a circuit split, and held that the willful FBAR penalty is subject to the excessive fines clause. United States v. Schwarzbaum, — F.4th —, 2024 WL 3997326 (11th Cir. 2024). While this holding resulted in only a minor reduction of the total penalties assessed against Mr. Schwarzbaum, it could have larger implications for other litigants facing severe penalties and cause the IRS to exercise greater leniency in their initial FBAR penalty assessment decisions.
Background: The Mechanics of the Willful FBAR Penalty
The Bank Secrecy Act requires American citizens and residents with foreign bank accounts to report those accounts to the government. Every year, those persons must file a Report of Foreign Bank and Financial Accounts form (“FBAR”) with the IRS identifying and describing their foreign accounts. 31 U.S.C. § 5314(a); 31 C.F.R. § 1010.350.
The IRS imposes harsh penalties against individuals who fail to file an FBAR. In particular, the maximum civil penalty for a “willful” violation of the FBAR reporting requirement is the greater of $100,000 or 50% of the balance in the unreported account at the time of the violation. 31 U.S.C. § 5321(a)(5)(C).
These penalties can be especially severe when they are assessed for multiple years. Persons with unreported foreign accounts often fail to file FBARs for consecutive years, meaning that the total maximum FBAR penalty assessed across all years included in an audit can exceed all funds in the person’s unreported foreign accounts. Possibly out of a concern that a penalty exceeding the total balance in the unreported accounts would be excessive, the IRS has instructed its revenue agents to consider limiting the total penalty to 50 % of the highest aggregate balance of all unreported accounts and allocating that penalty across the FBAR violations for all tax years. I.R.M. 4.26.16.5.5.3 (2), (4). However, the IRS provides revenue agents with discretion to assess the maximum possible penalty in circumstances they deem appropriate. Id.
The Constitutional Question: Does the Eighth Amendment Apply to FBAR Violations?
For many years, taxpayers subject to FBAR penalties have argued that the Eighth Amendment’s excessive fines clause applied to willful FBAR penalties and thus limited the penalties the IRS could assess. Until the Schwarzbaum decision however, this argument was rejected by every court to consider it. See, e.g., United States v. Toth, 33 F.4th 1, 15 (1st Cir. 2022), cert. denied, 143 S. Ct. 552, 214 L. Ed. 2d 458 (2023), reh’g denied, 143 S. Ct. 2604, 216 L. Ed. 2d 1205 (2023); see also United States v. Rund, 2024 WL 3690774, at *8 (E.D. Va. Aug. 6, 2024); Landa v. United States, 153 Fed. Cl. 585, 601 (2021); United States v. Est. of Schoenfeld, 344 F. Supp. 3d 1354, 1370 (M.D. Fla. 2018).
However, the tide may have turned after Justice Gorsuch’s dissent from denial of certiorari in Toth. 143 S. Ct. 552. There, Justice Gorsuch criticized the First Circuit’s decision and urged lower courts “not [to] repeat [the First Circuit’s] mistakes.” Id. at 553. His dissent argued that civil penalties are not immune from constitutional scrutiny simply because they are unconnected to a criminal proceeding or partially serve a remedial purpose. Id. at 553.
Citing Justice Gorsuch’s dissent, on August 30, 2024, the Eleventh Circuit held, for the first time, that the willful FBAR penalty is subject to the Eighth Amendment’s excessive fines clause. See Schwarzbaum, 2024 WL 3997326 at *10. In reaching this decision, the Eleventh Circuit focused on the disconnect between the amount of the penalty and the (unarticulated) harm suffered by the government, the fact that the severity of the penalty is tied to an individual’s culpability, and the legislative history indicating that the purpose of the penalty was to promote compliance with the FBAR filing requirement. Id. at * 8-9. In the Eleventh Circuit’s view, the FBAR penalty is punitive and not solely remedial which warrants constitutional scrutiny.
It remains to be seen whether other circuits will follow Schwarzbaum. Although the Schwarzbaum decision discussed Toth, it did not attempt to distinguish the FBAR penalty from penalties under the Internal Revenue Code that are similarly severe. See Toth, 33 F.4th at 18 (discussing Helvering v. Mitchell, 303 U.S. 391 (1938)); Landa, 153 Fed. Cl. At 599 (comparing the FBAR penalty to tax penalties). Due to the circuit split created by the conflicting Schwarzbaum and Toth decisions, this issue will continue to be litigated outside the Eleventh and First Circuits and may reach the Supreme Court.
Dollars and Cents: Do the FBAR Penalties Assessed Against Mr. Schwarzbaum Violate the Eighth Amendment?
Unfortunately for Mr. Schwarzbaum, although the Eleventh Circuit reversed the District Court on the question of whether the Eighth Amendment applies to FBAR penalties generally, it upheld the vast majority of his FBAR penalties as consistent with the Eighth Amendment.
The court in Schwarzbaum focused primarily on whether the penalty (on an account by account basis) was proportional to the offense. Schwarzbaum, 2024 WL 3997326, at *12. One of Mr. Schwarzbaum’s unreported foreign accounts had a maximum balance of less than $16,000 for each of the years at issue in the case. The court found that the IRS’s assessment of a $100,000 penalty related to this account for each year was “grossly disproportionate” and therefore constitutionally excessive. Id.
However, the court upheld the remainder of the FBAR penalties finding that the IRS properly assessed penalties equal to 50% of the balance in the account as of June 30 for each year. Id. at *13-16. These 50% penalties accounted for the vast majority of Mr. Schwarzbaum’s liability, but were constitutionally proper in large part because they were “proportionally tied to the amount in the account…” Id.
The penalties upheld as not violating the Eighth Amendment also included situations where an account had held a large (multi-million dollar) balance but had been closed prior to June 30 and situations where the June 30 balance was unknown. In both situations, the court found that the IRS properly assessed $100,000 penalties against Mr. Schwarzbaum. Id. Discussing the accounts with unknown balances, the court noted that it was Mr. Schwarzbaum’s burden to explain why the penalties for the accounts with unknown balances were excessive and that he had failed to tell the court anything about the balances or purpose of the accounts. Id.
While the court upheld the substantial (approx. $12 million) penalties assessed against Mr. Schwarzbaum, including penalties that wiped out multi-million-dollar accounts,it noted that it “it [had] no trouble imagining situations where such a penalty would be clearly excessive.” Id. at *43. The court did not explain what those circumstances might be, but there is plainly room for litigants in future cases to distinguish their circumstances from Mr. Schwarzbaum’s and argue that the penalties the IRS imposes against them are disproportionate to the offense of failing to file the required FBAR forms.
Takeaways
After Schwarzbaum, the Eighth Amendment gives FBAR litigants another basis to contest the penalties assessed against them. Outside the Eleventh Circuit, the government will likely continue to argue that the excessive fines clause is inapplicable to FBAR penalties. However, litigants with distinctive facts or penalties that are (individually or in aggregate) disproportionate to their undisclosed accounts could (and should) challenge such penalties as violating the excessive fines clause. These challenges may result in modest (or in unusual circumstances, dramatic) reductions in FBAR penalty liabilities.
The Schwarzbaum decision could also impact how the IRS calculates willful FBAR penalties at the outset. The IRS provides revenue agents with broad discretion to assess the maximum penalty for all accounts and all delinquent years if those agents decide doing so is appropriate considering all the facts and circumstances. I.R.M. 4.26.16.5.5.3 (4) (FBAR penalty calculation); 4.26.16.5.2.1 (examiner discretion). After Schwarzbaum, the IRS could be less likely to seek the maximum possible penalty, and even if they do, litigants could be more successful in pushing for reductions in the total amount of the assessed penalties at the administrative level.
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