Can a Foreign Bank Account Reporting (FBAR) Penalty be Unconstitutional?  

The Bank Secrecy Act (“BSA”) requires all U.S. persons to report their financial interests in foreign accounts that exceed $10,000 at anytime during the calendar year.  Failing to report foreign accounts can lead to significant penalties.  Non-willful violations of the BSA can result in penalties up to $10,00 per violation.  Penalties increase to the greater of $100,000 or fifty percent of the account balance at the time of the violation for willful violations of the BSA.

Since there is no cap on the penalties that the Internal Revenue Service (“IRS”) can assert in relation to willful violations of the BSA, an important question is raised – Can a FBAR penalty be unconstitutional?  The answer to this question may hinge on which Circuit Court of Appeals has jurisdiction over a taxpayer’s case.

In addition to prohibiting “cruel and unusual” punishments, the Eighth Amendment also outlaws the imposition of excessive fines.  While the words of the Eight Amendment are crystal clear, how courts apply them is anything but clear.  Currently, only two U.S. Courts of Appeals have addressed the application of the Eighth Amendment in the context of FBAR penalties asserted by the IRS.  In United States v. Toth, the U.S. Court of Appeals for the First Circuit held a civil penalty imposed pursuant to the BSA is not a “fine” and thus the Eighth Amendment does not apply to it.  The court arrived at this conclusion because the IRS’s assessment was not tied to any criminal sanction and it served a remedial purpose. 

However, the U.S. Court of Appeals for the Eleventh Circuit declined to “repeat [Toth’s] mistakes.”  In United States v. Schwarzbaum, the Eleventh Circuit held that three separate FBAR penalties, each in the amount of $100,000 (for the three tax years at issue), violated the Eighth Amendment when the foreign account never exceeding $16,000.  The court reasoned that the FBAR penalties were punitive in nature and that $300,000 in penalties was grossly disproportionate and constitutionally excessive.  

The legal arguments around the applicability of the Eighth Amendment to FBAR penalties are very nuanced and litigation will all but certainly continue.  Courts will have to wade through the murky waters balancing enforcement measures with constitutional protections.  Accordingly, it will be imperative for taxpayers and tax practitioners to remain abreast of developments in this area.