Most tax penalties follow a simple logic. The bigger the tax problem, the bigger the penalty.
For example, the civil fraud penalty is one of the most severe penalties in our tax code. This makes sense as fraud is the most severe thing that one can do wrong when it comes to taxes. The civil fraud penalty is 75% of the understated tax. This means it is effectively capped at about 26% of the underlying income (75% of the 35% maximum tax rate).
There are other penalties that are not tied to the tax loss to the government. Foreign Bank and Financial Accounts Report (“FBAR”) penalties are a prime example. FBAR penalties are based solely on unreported account balances. FBAR penalties can exceed 100% of the account value. This makes the FBAR penalties significantly larger than even the harshest traditional tax penalties. They can even greatly exceed the amount for the civil fraud penalty.
FBAR penalties often are excessive. Taxpayers have argued FBAR penalties are excessive. The courts have generally dismissed these challenges, however. This has recently changed with the United States v. Schwarzbaum, No. 22-14058 (11th Cir. Jan. 23, 2025) case.
Facts & Procedural History
The case involves a taxpayer who was born in Germany. He became a legal permanent resident of the U.S. in 1995 and obtained his U.S. citizenship in 2000. He then split his time between Costa Rica, Switzerland, and the United States.
The taxpayer’s wealth originated from his father’s successful textile and real estate ventures in Germany. In 2001, the father transferred an existing Swiss bank account to the taxpayer and continued making substantial gifts to the account through 2009. The funds were managed according to the father’s instructions by bankers, with the taxpayer never directing investments.
Between 2006 and 2009, the taxpayer maintained interests in 13 foreign accounts. This included 11 accounts in Switzerland and two in Costa Rica. The account balances were substantial:
- One UBS account held over $8.6 million
- Another UBS account contained more than $15 million
- Multiple other Swiss accounts held between $2.6 million and $4.5 million each
- One account (Aargauische) maintained a balance under $16,000
The taxpayer properly disclosed these accounts to his CPAs. However, the taxpayer’s CPAs incorrectly advised him that he had no duty to report these assets. Relying on this incorrect advice, the taxpayer filed incomplete FBARs. In 2007 he reported only one Scotiabank account. He filed no FBAR for 2008 until 2011. In 2009, he filed to disclose just three accounts out of the many he held.
In 2010, the taxpayer entered the IRS’s Offshore Voluntary Disclosure Initiative (“OVDI”). As part of this, the taxpayer disclosed 17 Swiss accounts and 4 Costa Rican accounts. The taxpayer later opted out of the program, which triggered an IRS audit.
The procedural history that followed was complex. The IRS initially calculated FBAR penalties at $35.4 million. This was reduced to $13.7 million after mitigation. The penalties were timely assessed in September 2016 under a tolling agreement.
In August 2018, the U.S. filed suit to collect the penalties. In March 2020, the district court found willful violations for 2007-2009. Multiple appeals followed regarding calculation methods. The IRS ultimately recalculated the penalties at $13.5 million. The government sought a final judgment of $12.5 million.
After an initial decision focusing on procedural issues, the Eleventh Circuit Court of Appeals granted a petition for rehearing, vacated its prior opinion, and addressed the constitutional question of whether FBAR penalties are so severe that they violate the Eighth Amendment’s prohibition on excessive fines.
About FBAR Penalties
U.S. citizens and residents have to file an FBAR to report financial interest in or signature authority over most foreign financial accounts.
The forms have to be filed if the accounts exceed $10,000 in total at any time during the calendar year. This is not an annual account balance test. If the combined accounts exceed $10,000 even for one day, the filing requirement is triggered.
The FBAR forms are not filed with the IRS. They are filed with the Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) through its BSA E-Filing System.
Unlike most tax penalties, FBAR penalties are not found in the tax code. They come from the Bank Secrecy Act of 1970, which was primarily designed to combat money laundering and other financial crimes. The IRS enforces these penalties even though they were not found in the tax law and not filed with the IRS.
Congress has created different tiers of penalties for FBAR violations. Non-willful violations are capped at $10,000 per violation. The courts have determined this is per account, not per year.
Willful violations trigger much steeper penalties. The IRS can assess the greater of $100,000, or 50% of the account balance at the time of the violation. This is the conjunctive “or” and not capped at $100,000.
The standard for “willful” violations in FBAR cases is surprisingly low. While criminal tax cases require proof that a taxpayer intentionally violated a known legal duty, civil FBAR cases only require recklessness. The courts have held that simply checking “no” on Schedule B of a tax return (which asks about foreign accounts) can be evidence of willfulness if the taxpayer has significant foreign accounts. Even failing to review tax returns carefully before signing them can constitute reckless conduct that triggers the larger willful FBAR penalties.
For willful violations, the penalties can stack year after year. Since the penalty is based on the account balance on the FBAR due date in each year, an account could theoretically be wiped out in just two years of penalties.
The Constitutional Framework
The Constitution gives Congress broad powers when it comes to taxes. Article I, Section 8 grants Congress the power to “lay and collect taxes.” The Sixteenth Amendment explicitly authorizes income taxes. Constitutional challenges to tax laws often focus on whether Congress acted within these enumerated powers, whether taxes are uniformly applied, or whether taxpayers received proper notice and hearings, or the taxpayer’s right to choose their own tax attorney.
FBAR penalties present a different constitutional question. Since these penalties originated in banking law rather than tax law, they raise issues under the Eighth Amendment’s Excessive Fines Clause. This clause states that “excessive fines shall not be imposed.”
While the Excessive Fines Clause originally targeted criminal penalties, the Supreme Court has extended it to civil penalties that serve punitive purposes. The key question is whether a penalty is solely remedial or serves even partly as punishment. If the penalty has any punitive aspect, it must not be “excessive” under the Eighth Amendment.
This creates an unusual situation. Congress has nearly unlimited power to impose taxes and traditional tax penalties. But when Congress creates penalties outside the tax code–like FBAR penalties–those penalties face constitutional scrutiny under the Excessive Fines Clause.
The Court’s Constitutional Analysis
The Eleventh Circuit had to first consider how FBAR penalties compare to traditional tax penalties. Most tax penalties are limited by being tied to the tax loss. The civil fraud penalty–one of the most severe penalties–is 75% of the understated tax. With our maximum tax rate of 35%, this means the civil fraud penalty cannot exceed 26% of the underlying income. FBAR penalties, by contrast, can exceed the entire value of the account.
With this context, the court found that FBAR penalties are subject to Eighth Amendment review because they serve punitive, not merely remedial, purposes. The court pointed to several factors for this:
- The penalties are calculated without regard to government costs
- The penalty structure focuses on culpability (higher for willful violations)
- Congress explicitly designed the penalties for deterrence
- The penalties can far exceed typical tax penalties
Applying this framework, the court found that $100,000 penalties on accounts holding less than $16,000 were “grossly disproportional” and thus unconstitutional. However, the court upheld larger penalties for the foreign accounts that held millions of dollars. This decision is particularly important as there are no administrative collection due process rights for FBAR penalties.
The court’s analysis raises fundamental questions about penalty proportionality. Most tax penalties are tied to the tax loss to the government. They are capped based on the tax rate. For example, the civil fraud penalty is 75% of the understated tax. With a maximum tax rate of 35%, this means the penalty cannot exceed 26% of the underlying income (75% x 35%).
As noted above, FBAR penalties work differently. They are based on account balances, not tax loss. They can exceed 100% of the account value. This leads to situations where the penalty amount may be thousands of times larger than any potential tax loss. The court acknowledged this disparity but concluded that hiding foreign accounts creates unique harms that justify larger penalties–at least for substantial accounts.
Differing Opinions for Now
This case marks a significant shift in how courts view FBAR penalties. In United States v. Toth, 33 F.4th 1 (1st Cir. 2022), the First Circuit had previously held that FBAR penalties entirely escape Eighth Amendment scrutiny. That court viewed these penalties as purely remedial, merely compensating the government for the costs of investigating foreign accounts.
The Eleventh Circuit explicitly rejected this view. It found that even if FBAR penalties serve some remedial purpose, they are at least partly punitive and thus subject to constitutional review. This creates a direct split between circuits on a fundamental question: whether there are any constitutional limits on FBAR penalties. Given the stakes involved and the frequency of FBAR cases, the Supreme Court may need to resolve this issue.
The Takeaway
This case preserved the IRS’s ability to impose significant FBAR penalties on larger foreign accounts. However, the case provides some grounds for taxpayers to make this type of constitutional argument when trying to defend against FBAR penalties. It suggests that penalties grossly disproportionate to account balances–like a $100,000 penalty on a $16,000 account–may be successfully challenged as unconstitutional.
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