New Court Case Limits the Reasonable cause exception to FBAR penalties
Taxpayers across the country rely on advice from their accountants and CPAs to meet the complicated requirements of the U.S. Tax Code. But a new case, Jarnagin v United States, in the U.S. Court of Federal Claims suggests that CPA advice may not be enough to stop the IRS from assessing FBAR penalties for non-willful reporting violations.
Background: Who Must File FBAR Forms?
The United States Tax Code requires U.S. citizens and taxpayers with interest in foreign bank accounts or other financial accounts to file an annual report of those accounts with the Treasury Department. This Report of Foreign Bank and Financial Accounts (FBAR) requirement applies to any account that hits $10,000 over the course of that tax year.
The Report of Foreign Bank and Financial Accounts (FBAR) is not a tax form. Its filing is not required by the Internal Revenue Code. It is required by Title 31 of the Code of Federal Regulations. Title 31 is the Bank Secrecy Act (BSA). Although FBAR reporting is within the jurisdiction of the Financial Crimes Enforcement Network – a Bureau of the US Department of the Treasury – (FinCEN), (it is E-filed on FinCEN Form 114), the investigation and enforcement of FBAR filing requirements has been relegated to IRS.
When a taxpayer fails to file FBARs on time, he or she may be exposed to penalties. Assuming that non-disclosure was accidental or otherwise non-willful, the penalty is capped at $10,000 per taxpayer, per account, per year.
What Happened in Jarnagin v United States?
A current case in the United States Court of Federal Claims, Jarnagin v United States, Docket No. 15-1534-T, shows what can happen when an unsuspecting taxpayer fails to file FBAR forms. Larry and Linda Jarnagin are a married couple. Larry owns and operates a farm and ranch in British Columbia. He became a Canadian Citizen in 1989 and spends a significant part of each year in the country. Because of his business there, Larry and Linda maintain bank accounts with the Canadian bank CIBC, which had balances of $4 million on December 31, 2006, $3,500,000 in 2007, and $3,860,000 in 2008. Larry employed a Canadian accounting firm to handle all his Canadian tax preparation.
Linda is a real estate broker and property owner in Oklahoma. She relied heavily on her bookkeeper, Misty Fairchild. Every year, Fairchild would turn over the couple’s financial statements, including the CIBC accounts and their balances to Mrs. Jarnagin’s CPA. Over time, Ms. Fairchild went back to school to become an accountant, and eventually a CPA herself. Linda eventually transferred her business to Fairchild and her brother Kyle Zybach, who was also a licensed CPA.
However, neither Zybach nor Fairchild were aware of the Jarnagins’ FBAR reporting requirements until 2010 when Zybach attended continuing education to maintain his CPA license. Even though the Jarnagin’s financial statements had included the foreign bank account, and their tax returns had disclosed the interest, no FBARs were ever filed. In addition, Schedule B, which asks whether the taxpayer has control over foreign accounts was incorrectly marked “No.”
In 2011, the IRS conducted an audit into the Jarnagins’ tax returns for 2008 and 2009. The audit revealed two wire transfers from the CIBC account. While the tax amounts were confirmed by the audit, the transfers triggered an investigation into the couple’s FBAR violations. Because of the audit, the couple were advised not to participate in a voluntary disclosure program or file the missing FBAR forms. The IRS issued non-willful FBAR penalties against both Larry and Linda for four years, a total of $80,000.00.
Is a CPA’s Advice a Defense to FBAR Violations?
The matter came before a federal judge to determine whether those penalties are appropriate. Non-willful FBAR penalties may not be levied if the taxpayer properly reported the “amount of the transaction or the balance of the account” and had “reasonable cause” for failing to file the FBAR on time.
The Jarnagins argue that they did have reasonable cause: the advice (or lack thereof) of their CPA. This argument is based on three tests described in Neonatology Assocs., P.A. v Commissioner, for reasonable cause:
- The taxpayer hired a competent professional adviser with sufficient expertise to justify reliance
- The taxpayer gave that adviser accurate and complete information, and
- The taxpayer relied in good faith on the adviser’s judgment.
The Jarnagins say that by providing complete financial statements to licensed CPAs every year, which included the CIBC account, and relying on those professionals to complete their tax returns, they meet the Neonatology requirements.
But the government says a CPA’s advice isn’t automatically enough to raise a reasonable cause defense. The IRS’s lawyers point to several facts to argue the Jarnagins were willfully negligent in their tax reporting duties:
- Zybach and Fairchild had no experience with foreign accounts
- The Jarnagins didn’t inquire into their CPAs’ experience before hiring them
- The Jarnagins didn’t specifically ask about FBAR reporting requirements or how the international accounts would affect their tax returns
- The Jarnagins did not carefully review the tax returns before signing them.
Taxpayers should be very careful in the delinquent filing of FBARs and the exceptions to penalties for failing to timely file FBARs. The case creates doubt about the utility of the reasonable cause exception to FBAR penalties. Taxpayers should get competent legal advice in light of the new court ruling and should seriously explore voluntary disclosure options with limited penalty exposure.