Enforcing foreign bank account reporting requirements through penalties has been an IRS priority for several years, spawning numerous precedent-setting cases throughout the courts. In the latest such case[1], a federal appeals court rebuffed foreign bank accountholders’ efforts to resist the federal government’s robust powers to collect those penalties. This case demonstrates two things: (1) not all IRS-administered penalties are treated like taxes and (2) understanding the difference is critical to effectively challenging them—especially for foreign bank accountholders who could face far-reaching consequences.
Foreign Bank Account Report (FBAR)
Under the Bank Secrecy Act, U.S. persons holding foreign bank accounts are required to report them annually to the Treasury—commonly called FBARs. Failure to file an annual FBAR is subject to criminal prosecution and civil penalties. Although they are not taxes, the Secretary of the Treasury delegated to the IRS the administration of civil FBAR penalties. And when the IRS determines to impose a civil FBAR penalty, that penalty becomes a non-tax debt owed to the United States.
The Treasury Department Bureau of the Fiscal Service (the Bureau) can collect federal non-tax debts—such as civil FBAR penalties—in a variety of ways, including by offsetting that debt against payments the U.S. owes to the debtor, like Social Security benefits. Before it does so, the Bureau notifies the debtor that it intends to conduct an offset, i.e., to withhold benefits, and invites the debtor to contact the Bureau to make arrangements to prevent that offset.
The Case
In this case, the IRS determined that a husband and wife failed to report their foreign bank accounts and imposed civil FBAR penalties on them. The accountholders believed that the penalties were improper because the statute of limitations had passed. When the Bureau sent notice of its intent to offset their Social Security benefits, rather than contact the Bureau as instructed, the accountholders instead sought to invoke procedures for challenging IRS levies (seizures of assets to satisfy outstanding tax liabilities) under the Internal Revenue Code. Their logic was that the IRS imposed and referred the FBAR penalties for collection, and, therefore, procedures applicable to challenging IRS tax-collection efforts should also apply to the collection of these FBAR penalties.
The accountholders first invoked internal IRS administrative mechanisms for challenging the collection of tax liabilities (sometimes called Collection Due Process Hearings), and, when that effort failed, sought relief in the U.S. Tax Court. But the Eleventh Circuit held that the Tax Court properly dismissed their action. Because FBAR penalties arise under the Bank Secrecy Act—not the Internal Revenue Code —the court held they are not tax liabilities and therefore not subject to IRS Collection Due Process procedures. Rather, FBAR penalties are non-tax debts owed to the U.S. and are collected under the Treasury’s general procedures for non-tax debts. That the IRS imposed the penalties is irrelevant. If they wished to challenge the FBAR penalties, the Eleventh Circuit held, the accountholders should have brought an action in a U.S. District Court or the Court of Federal Claims.
As a result, the accountholders’ Social Security benefits have now been subject to ongoing administrative offset for nearly three years to satisfy the FBAR penalties. Although they may still have time to file an action in a proper court, there is always the danger that a later challenge could be dismissed as untimely.
Key Considerations
Holders of foreign bank accounts should keep these key considerations in mind:
- The Bank Secrecy Act requires annual reporting of all foreign banking relations.
- Failure to file the required reports can result in the imposition of civil penalties or even criminal liability. These penalties can be as much as 50% of the value of the foreign bank account per year.
- The government has a potent arsenal of tools to collect FBAR penalties, including administrative offset of payments owed to accountholders, such as Social Security benefits.
- Challenging the imposition and collection of FBAR penalties can be a complex process, with different rules applying at different stages.
- Choosing the wrong procedure for challenging the collection of FBAR penalties can be costly.
- It is important to work with an experienced attorney who is familiar with not only the law and rules governing the imposition of FBAR penalties by the IRS, but also their collection by the Treasury Department.
Further, this case stands as a cautionary tale to all who may owe debts to the federal government. Although this case involved foreign bank account reporting penalties administered by the IRS, the government’s collection authority (including its administrative offset power) extends to many types of debts claimed to be owed to the government. And each agency seeking to collect a purported debt owed to the federal government is bound by regulations adopted by the agency, as well as standards prescribed by the Attorney General and the Secretary of the Treasury. For that reason, when facing collection actions for debts owed to the federal government, it is crucial to understand which statutes, regulations, and procedures govern the rights and responsibilities of both the federal government and the purported debtor, and which courts have jurisdiction to intervene.
Experienced attorneys in PilieroMazza’s Litigation & Dispute Resolution and Audits & Investigations teams help clients navigate these complex waters. For assistance with FBAR filing requirements and legal challenges to their imposition and collection, contact Paul Allulis, Matt Feinberg, or another member of the team.
