FBAR and the Eighth Amendment: The Mistakes of Toth

Robert Goulder

I don’t always agree with the dissenting opinions of Justice Neil M. Gorsuch, but when I do, it usually concerns foreign bank account reporting penalties. I draw your attention to Gorsuch’s dissent in Toth from January of last year.¹

Readers may recall that the dissent exists in isolation, accompanying the Court’s denial of certiorari in an FBAR appeal. The Court is not obliged to explain why it declines a case. It takes a minimum of four justices to grant cert, and sometimes the votes aren’t there. No articulation of a thought process is required. With Toth, we lack a statement from the majority to provide context for the dissent. The most we can infer is that an insufficient number of justices agreed with Gorsuch that the case merited further scrutiny. That left in place the judgment of the First Circuit.

The First Circuit agreed with the lower court,² holding that FBAR penalties — acknowledged to be partly deterrent in nature — are not subject to the constitutional protection against excessive fines. The penalty is not regarded as a fine, period, because it is taken to possess a compensatory element.³ Gorsuch’s dissent lays out a persuasive argument as to why the Court should have taken the case, hinting that the First Circuit arrived at the wrong result: “For all these reasons, taking up this case would have been well worth our time. As things stand, one can only hope that other lower courts will not repeat its mistakes.”⁴

This language sends a positive signal to anyone litigating an FBAR penalty case outside of the First Circuit. There’s at least one Supreme Court justice who believes Toth should be revisited. From the government’s perspective, it’s unhelpful when Gorsuch alludes to the “mistakes” of Toth; it hopes Toth becomes the law of the land.

OK, so why are we obsessing over nonbinding verbiage from a case the Supreme Court declined to hear almost two years ago?

That’s because of something that happened more recently. On August 30 the Eleventh Circuit delivered its opinion in Schwarzbaum, reaching a contradictory decision on an identical FBAR issue.⁵ The Eleventh Circuit squarely rejected the First Circuit’s reasoning in Toth. In doing so, it riffed on Gorsuch’s language: “We respectfully decline to ‘repeat [Toth’s] mistakes.’”⁶

Gorsuch lost the battle in Toth, but he may yet win the war in Schwarzbaum or some future FBAR dispute. That depends on what happens next. We now have a split among circuits on whether FBAR penalties are kosher under the Bill of Rights.⁷

The answers to constitutional inquiries should be uniform across the nation, not hinging on flukes of geography. The application of any federal statute (here, key sections of the Bank Secrecy Act)⁸ should require the same things of taxpayers whether they reside in Boston or Miami. Currently, that’s not so.

This column reviews Toth, and a subsequent article will review Schwarzbaum. Through these pieces I hope to present a cohesive argument as to why civil FBAR penalties should conform to the Eighth Amendment’s protections. That outcome would leave the IRS with plenty of room to effectively enforce the Bank Secrecy Act.

The Tale of Toth

The taxpayer, Monica Toth, is in her 80s. She is a naturalized U.S. citizen; she was born in South America in 1940, where her father had resettled after fleeing Germany in the mid-1930s.

In the years that followed, her father became a successful businessman in Buenos Aires. Though he left Europe behind, he maintained at least one vital connection to the continent: an undisclosed Swiss bank account — a sort of reserve fund that could be accessed in the event of crisis or turmoil.

This part of the discussion calls for some sensitivity. If ever there were a good reason for establishing an offshore financial account and being reluctant to mention it, this — being forced to escape Nazi aggression — is it. The Gestapo cannot confiscate what it doesn’t know about. The instinct to conceal is understandable, but not exculpatory for affairs of the present day.

During his final years, it seems that Toth’s father encouraged her to do the same — keep some money hidden away, just in case. It’s the kind of advice a well-meaning father might offer to his children, given his life experiences. That said, this advice may clash with the financial disclosure rules that those sons and daughters would face during their lives. Argentina did not have a FBAR regime, but the United States does. The United States also has section 61(a) of the IRC, which defines gross income as income from “whatever source derived.” There’s a bottom line here: Nobody gets a pass with the IRS, regardless of family narratives.

Sometime in the 1960s, while Toth was still in her mid-20s, she emigrated to the United States. Congress enacted the Bank Secrecy Act a few years later, in 1970. From that point on, her father’s advice about keeping certain things hush-hush was on a collision course with the dictates of federal law.

Shortly before he died, Toth’s father gifted her funds held in a financial account with Union Bank of Switzerland (UBS), which amounted to several million dollars. According to court documents, Toth became the beneficial owner of the UBS account in 1999. She was responsible for annual FBAR filings, provided that the account balance exceeded the $10,000 threshold. Toth was initially unaware of her FBAR obligations. As everyone reading Tax Notes should know, ignorance of the law is not an excuse for noncompliance — although it can provide the basis for distinguishing willful from non-willful behavior.

Toth filed her first FBAR in 2010. She claims that she also submitted delinquent FBARs covering the period from 2005 through 2009. This is a point of contention: The IRS was aware of her 2010 filing but has no internal record or supporting evidence of the belated filings for the five years prior. A footnote in the First Circuit’s opinion suggests that Toth might have mailed the batch of tardy FBARs to the wrong address or the wrong federal agency.⁹ Where they went, or whether they existed at all, remains a mystery.

The following year, in 2011, the IRS audited Toth and found her to have violated her FBAR requirements for the years before 2010. The IRS filed late FBARs on her behalf for the period from 2005 to 2009. The years before 2005 are not at issue.

At the close of the audit, the IRS determined that Toth’s FBAR violation for 2007 had been willful.¹⁰ It assessed her a civil penalty for the maximum amount permitted by statute: half the account value at the time of the violation. That penalty came to $2,173,703. With late charges and interest, the combined assessment exceeds $3 million.¹¹ Note that the government’s assessment of willfulness is at odds with Toth’s assertion that she didn’t know about FBAR before 2010. We can only assume that the audit turned up documentary evidence (perhaps written correspondence between her and UBS) indicating that she possessed some degree of knowledge about the FBAR regime and her requirements as accountholder.

The audit separately found that Toth had an outstanding income tax liability and assessed a separate tax fraud penalty against her. In this article, we’re concerned solely with the FBAR penalties under the Bank Secrecy Act, which is not part of the IRC. Technically speaking, Toth is not a tax case. As we shall see, that’s not a trivial observation.

See You in Court

Despite the audit results, Toth did not pay her FBAR penalty. She basically ignored the assessment for as long as she could. The inaction prompted the government to bring a civil collection suit in district court in 2015.

Service of process was problematic. Two process servers tried unsuccessfully to serve her in person. Service of process was eventually accomplished by leaving a copy of the government’s complaint at Toth’s residence, as permitted by the Federal Rules of Civil Procedure and the Massachusetts Rules of Civil Procedure. Toth apparently made no response to the complaint, and the government moved for default judgment, which was granted in 2016. After learning of the default judgment against her, she took steps to challenge it. That resulted in a court hearing at which Toth (who is not a lawyer) appeared pro se. The court agreed to reconsider the default motion if Toth obtained counsel. She resisted, moving to set aside the default judgment without hiring a lawyer.

The court granted Toth’s motion to set aside the default judgment, citing two factors — the sheer size of the penalty and a desire that its validity be settled on the merits. Toth then moved to dismiss the complaint, raising several procedural objections including untimely service, lack of personal jurisdiction, and failure to state a claim. The first of these contentions is the most interesting.

At the time the complaint was brought, the Federal Rules of Civil Procedure (Rule 4(m)) required that process be served within 120 days of filing. The rule was later changed, with the service period being shortened to 90 days. The amendment took effect before Toth was served. The parties stipulate that Toth was served 118 days after the complaint was filed. The question was whether the complaint was subject to the original version of Rule 4(m).

The district court held that the original 120-day service period was applicable, allowing the government’s case to continue. The First Circuit would later agree. The courts noted that Toth had been aware that a process server was attempting to locate her and that she took deliberate steps to avoid detection. They reasoned that to apply the shorter service period (forcing a dismissal of the complaint) would reward an uncooperative litigant for evading service. That sounds like an estoppel argument. Whether this is justice I leave for others to decide because it doesn’t directly concern the FBAR issue.

In the words of Gorsuch, Toth’s efforts to represent herself “did not go well.” They seldom do. The First Circuit commented that she was uncooperative with the government’s attempts to conduct discovery and failed to confer with counsel as required by court rules. She faced multiple sanctions motions under Rule 37 (failure to make or cooperate with discovery). One of the government’s sanction motions was eventually granted in October 2018. The court noted her “severe, repeated, and deliberate” violations of discovery orders and “a pattern of stonewalling.”¹² The sanctions order included a provision stating that certain key facts were to be taken as established, including a finding that her FBAR violation would be taken as willful.

Toth eventually hired a lawyer (years after she should have). My thinking is that any smart lawyer, upon being inserted into such a contest, would soon realize that reducing the FBAR penalties to the non-willful variety would be an excellent result for the client. In dollar terms, the designation was the difference between a penalty of $10,000 and an assessment exceeding $3 million. That would have been a huge win for Toth. The obstacle, however, was that the sanctions order had already declared that her violation was willful.

Toth’s lawyer set out to vacate the sanctions order. That was the right idea, but it proved unsuccessful. The government then moved for summary judgment, which the district court granted in September 2020. In granting the motion, the court reaffirmed the earlier determination that Toth’s behavior was willful.

I do not mean to make light of Toth’s uncooperativeness. Her conduct was not that of a model litigant. Yet I’m somewhat bothered that the finding of willfulness stemmed not from any fair presentation of evidence, but from a sanctions motion. Again, the sanctions under Rule 37 may have been entirely appropriate (the stonewalling seems evident), but should the resulting order have included a presumption of willfulness? Moreover, was the presumption irrebuttable? Let’s recall that the standard for granting summary judgment typically assumes factual matters to be most favorable to the opposing side. Arguably that didn’t occur here.

Next, Toth argued that an assessment of an FBAR penalty exceeding $100,000 should be blocked by a Treasury regulation. This argument went nowhere. The regulation¹³ in question was promulgated in 1987 and refers to the maximum FBAR penalty permitted under prior law (see discussion below). There is no statutory provision authorizing Treasury to set a regulatory cap on FBAR penalties lower than the one established by Congress. The regulation was superseded by subsequent legislation permitting a much higher penalty. Toth harped on the fact that Treasury didn’t get around to withdrawing or amending the regulation for 12 years after Congress revised the FBAR regime to allow for higher maximum penalties, meaning the reg was unaltered during the years relevant to her ownership of the UBS account, including the one year (2007) for which the IRS assessed the large FBAR penalty at issue.

Both the district court and the First Circuit rejected this argument, holding that Treasury’s failure to more promptly withdraw the 1987 regs reflected its administrative “inattention” and did not confer broader significance. At any rate, Treasury can’t override the penalty framework set by statute. Here, Treasury wasn’t trying to do that. The regulation was merely parroting the statutory cap.

At that point Toth’s lawyer raised the constitutional argument that a penalty of that magnitude was excessive (relative to the size of the UBS account) and should be barred by the Eighth Amendment, which provides that “excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.”¹⁴

The court rejected that argument, holding that the protection against excessive fines was inapplicable because FBAR penalties are not punitive in nature (that is, they aren’t fines at all). It reckoned that FBAR penalties are remedial in nature, evidenced by the fact that the IRS loses out on tax revenue each year by being unable to detect income-producing assets placed in offshore bank accounts.

Following that line of reasoning, the court wants us to believe that the purpose of the FBAR penalty is not to punish the individual for botching their financial reporting requirements, but to compensate the public fisc for the conceptual bundle of tax dollars that should have been collected but weren’t because of concealment by taxpayers. That’s deeply flawed when you think about it.

Yes, it’s part of the IRS’s job to ferret out undisclosed bank accounts that generate taxable income for U.S. taxpayers. Yes, mandatory reporting requirements are a gateway that often leads to subsequent collection actions by the IRS. But no, the reporting obligation itself is not that collection mechanism. FBAR is not a taxing provision. It never was; it never will be. The amount of an FBAR penalty has nothing to do with the amount of income that went untaxed. How, then, are FBAR penalties deemed to be remedial as opposed to punitive? Toth appealed.

The thing that bothers me about the court’s analysis is that it conflates the role of a financial reporting requirement with the role of income taxes. Recall that Toth’s audit separately resulted in her being hit with an income tax assessment. It seems to me that enforcement of the IRC is the better way for the government to pursue its remedial claims, while enforcement of the Bank Secrecy Act is about something else altogether. FBAR is not about chasing tax revenue or other compensatory remedies; it’s about information gathering, plain and simple. The penalty for an information reporting violation is not interchangeable with an income tax deficiency.

Remedy vs. Deterrent

To better appreciate the constitutional issue, it helps to briefly review the history of FBAR penalties since their inception over 50 years ago.

Originally, the statutory penalty for a willful FBAR violation was set at $1,000. That’s one-tenth of the current penalty for a non-willful violation, and it was assessed against the financial institution, not the accountholder. Few observers at the time would have anticipated that FBAR litigation would become a thing that crowds federal court dockets. The penalty was so small that it wasn’t worth fighting.

Banks would just pay the penalty to the IRS without the slightest bit of fuss, knowing that the terms of their banking relationship with accountholders permitted them to pass along the costs. A charge corresponding to the FBAR penalty would then appear on the accountholder’s next bank statement, sent by snail mail. Those were the primitive days before the internet, when people sat down at the kitchen table once a month to catch up on their bank balance and reconcile the log for their checking account. By the time people realized their account had been debited, reflecting the FBAR penalty, the IRS had already collected the funds, and the bank had already been fully reimbursed. There wasn’t much drama to the process, apart from accountholders feeling disgruntled once they did the math and realized their balance was lower than expected. Direct interactions between accountholders and the IRS were minimal (or nonexistent), which was remarkably efficient when you think about it.

There was one downside to this configuration of the FBAR regime: The penalty for a willful violation wasn’t painful enough to discourage noncompliance. The desired behavioral response wasn’t achieved. Congress was made aware of the shortcoming through a series of hearings held in the mid-1980s, as was referenced in the recent Bittner litigation.¹⁵ Lawmakers responded by amending the FBAR penalty regime in 1986. The legislative history reflects an orientation that the FBAR penalty functioned as a tool for deterrence, not as a compensatory measure.

Three new features were added. First, the penalties were assessed directly against individual accountholders, bypassing the banks. Second, Congress clarified that the penalties were to apply on a per-account basis (creating an interpretive issue that wouldn’t be resolved for another 37 years). Third, it raised the cap for willful violations to 100 percent of the account balance at the time of the violation (never to exceed $100,000) or $25,000, whichever was greater.

Let’s put the statutory reform into perspective. Under the original FBAR rules, in place between 1970 and 1986, Toth’s penalty would have been a mere $1,000. It would have been assessed to UBS and passed on to Toth by debiting her account. Under the amended version of the regime, in place between 1986 and 2004, her penalty would have been capped at $100,000. UBS would not have been involved in the assessment, which would have been directed at Toth individually. That necessitates a collection action if the accountholder doesn’t pay voluntarily. The main difference, of course, is that the 1986 amendments allow for a penalty that’s 100 times greater.

That wasn’t enough. A generation later, lawmakers decided the regime’s deterrent effect was still lacking. In 2002 the Treasury Department informed lawmakers that it was possible that fewer than 20 percent of U.S. citizens subject to FBAR rules were complying with the regime. The precise compliance rate was almost impossible to gauge, but it wasn’t good.¹⁶

Congress again tweaked the FBAR rules in 2004, setting the penalty for a willful violation at $100,000 or 50 percent of the account balance at the time of the violation, whichever is greater. Note that lawmakers ditched the concept of a statutory cap. Previously, the amount of the penalty ranged between a floor ($25,000) and a ceiling ($100,000). As of 2004, the former ceiling became the new floor, allowing for a maximum penalty that is as high as you can imagine. The sky is the limit! This explains Toth’s penalty of $2.1 million for a single UBS account for a single year (2007), which gets bumped to more than $3 million with interest and late charges.

Toth’s combined assessment is 30 times greater than the maximum penalty before the 2004 reforms, and 3,000 times greater than the maximum penalty before the 1986 reforms. The difference in scope is so vast, so astronomical, that these penalties are unrecognizable from their prior incarnations. You’d think we were talking about an entirely different statutory scheme.

The purpose of this commentary is not to second-guess Congress for elevating FBAR penalties over the course of several decades, but to emphasize that the sole rationale behind those reforms was the need for heightened deterrence. Lawmakers were responding to FBAR compliance rates that were unacceptably low. That points to a punitive objective, not a remedial one.

The Eighth Amendment has been around for a long time, so surely other federal courts have had the opportunity to examine these issues. In Austin v. United States¹⁷ the Supreme Court held that an in rem civil forfeiture action following the successful prosecution of state drug laws was a fine subject to the excessive fines clause. Similarly, in United States v. Bajakajian¹⁸ the Court held that an in personam civil forfeiture action was a fine subject to the excessive fines clause.

There’s no doubt that the protections of the Eighth Amendment can apply to civil sanctions. The Supreme Court has made that clear. In Toth, however, the First Circuit distinguished cases like Austin and Bajakajian by noting their link to related criminal proceedings. They involved civil forfeitures that came at the culmination of criminal prosecutions. That’s unlike FBAR penalties, which come from an IRS audit. Because the facts in Toth didn’t follow from underlying criminal activity, the court concluded that FBAR penalties could not have been punitive.

See what the court did there? It layered a precondition of its own making onto a constitutional protection: For the excessive fines clause to apply to a civil penalty, there must by a predicate criminal offense. That’s pure invention.

To say that the essence of the FBAR penalty regime is all about deterrence is to state the obvious. That is what Gorsuch means when he speaks of the mistakes of Toth.