FBAR Penalties and the Eighth Amendment: What a Circuit Split Means for Taxpayers

For U.S. taxpayers with foreign bank accounts, the tax filing season can contain additional compliance obstacles. Not only must these taxpayers file an income tax return, but they may also be required to file a Foreign Bank Account Report (FBAR). This information return is filed with the Treasury Department to report amounts held by U.S. taxpayers in foreign financial accounts and is used to prevent tax evasion. To enforce compliance, Congress has enacted steep penalties for a failure to file the FBAR. This has called into question the legitimacy of these penalties and whether they can pass constitutional muster. 

FBAR Penalties 

An inadvertent (or “non-willful”) failure to file the FBAR can result in fines of $10,000 per form. However, if the taxpayer’s failure to file is considered “willful,” the fine increases to a minimum of $100,000 per form. Unfortunately for taxpayers, the term “willful” is not defined in the law, and courts have not provided much clarity on when the failure to file rises to this level. To this end, the Taxpayer Advocate Service has recommended reforms to modify the definition of “willful” for purposes of the FBAR penalties. For many, these “willfulness” penalties can feel particularly draconian, which begs the question: Where is the line between enforcement and constitutional fairness? While the goal of the FBAR is to combat tax evasion, whether the fines imposed for willfully failing to file the FBAR are “excessive” has become the center of a constitutional debate. 

What is the Eighth Amendment? 

The Eighth Amendment lies within the Bill of the Rights and takes its roots from the English Bill of Rights of 1689. It was intended as a protection against excessive and partisan punishments. While most notable in the criminal context for providing guardrails against the imposition of “cruel and unusual punishment,” the Eighth Amendment also includes protections against the imposition of “excessive fines” by the federal government.  

What is the Standard: Analyzing Toth 

Courts have historically been reluctant to enforce Eighth Amendment protections on civil penalties imposed by the federal government. To determine whether penalties imposed by the government are excessive, courts first examine whether the penalty is considered a “fine.” In Austin v. United States, 509 U.S. 602, 113 (1993), the Supreme Court held that a penalty is a fine if its purpose is to serve as punishment for an act (or lack thereof) or as a remedy to the government in compensation for losses resulting from the taxpayer’s action.   

The First Circuit in Toth followed this standard, holding that penalties imposed on a taxpayer for failing to disclose Swiss bank accounts on her FBAR were not solely punitive and therefore not excessive. The First Circuit held that the penalties imposed on Ms. Toth were assessed to recoup costs associated with preventing tax evasion, all of which would have been discovered if an accurate FBAR was filed. Thus, according to the First Circuit, willful FBAR penalties imposed on taxpayers do not violate the Eighth Amendment because the imputation of the penalty itself is not considered a “fine.” Ms. Toth petitioned the Supreme Court to hear her case, which they declined to do. Justice Gorsuch dissented.   

Schwarzbaum’s Defection 

As Toth shows, taxpayers have tried, and often failed, to argue certain civil penalties constitute excessive fines under the Eighth Amendment. Enter Isac Schwarzbaum, a U.S. citizen who failed to file FBARs for three consecutive years. While many of Mr. Schwarzbaum’s accounts were worth millions, one account never exceeded $16,000 during the years in question. The Eleventh Circuit expressly rejected the analysis of the First Circuit in Toth, holding not only that willful FBAR penalties are subject to Eighth Amendment scrutiny but that its application as to the $16,000 account was excessive. The Eleventh Circuit focused its analysis on whether the FBAR willfulness penalties were imposed as a means of punishing conduct or as a remedy for damages incurred by the Treasury for his failure to file. 

Given that Congress itself, when drafting the law, sought these steep penalties to enforce taxpayer “compliance,” the Eleventh Circuit held such penalties to be considered “fines” and thus subject to Eighth Amendment protections. The Court further held that these fines were unconstitutionally excessive as they amounted to over six times the highest account value during the affected years. It should be noted that the Court only found that the penalties were excessive as assessed against the smaller account and upheld the other hefty penalties that were assessed. 

Impacts on Taxpayers  

Schwarzbaum likely won’t be the last time this issue is litigated in court. However, it does provide taxpayers with persuasive arguments if the matter is argued in another Circuit. For now, taxpayers in the Eleventh Circuit have precedent to argue against the imposition of willful FBAR penalties as “excessive fines.” Meanwhile, taxpayers in the First Circuit will continue to operate under the precedent of Toth. With the rulings of the First and Eleventh Circuits at odds now, this matter may end up being decided by the Supreme Court. Until that point, the Treasury will continue operating under the ruling put forth in Toth in all circuits other than the Eleventh. 

Taxpayers should engage trusted advisors to keep up to date on any developments in this or other cases involving the legality of penalties and to remain in compliance.