FBAR Litigation 101
With the Internal Revenue Service making Foreign Bank and Financial Account (FBAR aka FinCEN Form 114) a key enforcement priority, it is important to understand how Taxpayers can litigate an FBAR matter in court. Unlike other types of tax litigation, FBAR litigation is much more complicated — if for no other reason then the fact that the FBAR is not actually a tax. And, since the FBAR is not a tax per se — Taxpayers are somewhat limited and how they can pursue an FBAR matter in court. Although, it should be noted that a recent Flora Case FBAR ruling did confirm the Federal Courts may not require taxpayers to fully satisfy the FBAR Penalty at issue before pursuing a Federal Case (which is great news for Taxpayers). Let’s take a look at some of the basics of FBAR Litigation and how you can litigate an FBAR case in federal court.
FBAR Penalties are Issued by the IRS
At the outset, it is important to understand that even though the Internal Revenue Service is tasked with enforcing FBAR penalties – the FBAR penalty is not a tax. FBAR is a creature of FinCEN (Financial Crimes Enforcement Network). And, although the FBAR has been around for over 50 years, it has only been since 2003 in which the IRS has taken over enforcement. Therefore, when a Taxpayer does not properly file the FBAR, it is the Internal Revenue Service that will issue the penalties against the Taxpayer.
So what happens when the taxpayer does not believe the penalty is just?
Pre-FBAR Litigation: Letter 3708 or 3709
Once the IRS is considering issuing an FBAR penalty, the taxpayer will normally receive a letter 3709 which is a proposed FBAR Penalty. At that time, the Taxpayer normally has 30 days to respond to the letter and seek an appeal of the proposed penalty. After a 3709 is issued and if the appeal is denied, the Taxpayer will receive a letter 3708, which demands the taxpayer to submit the penalty amount.
FBAR Litigation: Federal or Tax Court?
As we mentioned above, since the FBAR is not actually a tax, the taxpayer cannot take the FBAR matter through Tax Court. Instead, the Taxpayer must either wait for the IRS to pursue a case against the taxpayer in Federal Court, or (as it was previously believed) pay the full penalty in first — and then pursue a case for refund in District Court as is required for tax matters. But, in a recent case the court of federal claims disagreed with the IRS’s position that the taxpayer must first satisfy the full amount of the penalty (which can be astronomical) before pursuing a case in federal court. In other words, the Flora “full payment rule “may not apply to FBAR cases. This means that Taxpayers who have been dinged with a FBAR penalty may have the ability to pursue litigation against the US government in federal court without first making full payment.
This was a great ruling, since it is inherently unjust to prevent the Taxpayer from litigating the matter in Tax Court — since Tax Court does not require the taxpayer to first make full payment before pursuing the matter — but requiring full payment in order to litigate in Federal Court, even though it is the IRS that issues the penalty. Thus, based on this new ruling, while Tax Court may not be available in order for a taxpayer to litigate the FBAR penalty, a Taxpayer may now have the opportunity to sue the US government in Federal Court — without making full payment first — in order to try to minimize or abate the FBAR penalty.
This is especially important in light of many recent rulings in which Courts of Appeals across the nation have determined that non-willful FBAR penalties should be limited to a per form violation and not a per account violation. Moreover, it is equally important on the willful penalty front, since (unfortunately) several courts have found that if a taxpayer acted with reckless disregard and not intent, that the lower standard of reckless disregard is sufficient to meet the willfulness standard — and the Taxpayer can still be hit with the full willful FBAR Penalty — despite the lack of intent of the Taxpayer.
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