FBAR Penalties Are Unconstitutionally Excessive – Houston Tax Attorneys

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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Stephan Dorsey

Stephan is the sports journalist for the Maple Grove Report.

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Conduct During IRS Audit Evidence of Tax Return Fraud – Houston Tax Attorneys

The courts have taken an expansive view as to what counts as fraud for tax matters. Some courts have even said taxpayers can be held accountable for fraud committed by their tax return preparers.

When considering fraud, there is a question as to what activities are considered. Take for example the civil tax fraud penalty. This civil penalty applies to understatements of tax. This means that the relevant timeframe would seem to be the time leading up to and culminating with the filing of the tax return. Once the tax return is filed, the fraudulent has been completed.

What about additional actions by the taxpayer to further the fraud? For example, submitting false or altered documents to the IRS auditor who is examining the fraudulent tax return? Can those actions be considered evidence of fraud for the understatement of tax? The court recently answered this question Chopra v. Commissioner, T.C. Memo. 2025-2.

Facts & Procedural History

The taxpayer in this case is a healthcare consultant. She has several advanced college degrees.

The case involves her 2019 individual income tax return. The taxpayer filed her tax return and reported substantial business expense deductions and itemized deductions. This included more than $68,000 in medical expenses and nearly $90,000 in business expenses.

The IRS pulled her tax return for audit and requested documentation to substantiate the claimed deductions. The IRS auditor proposed adjustments for the larger items on the tax return and also proposed a civil fraud penalty.

The civil fraud penalty was due to the taxpayer’s failure to cooperate. This continued during the litigation in the tax court. The court described the conduct by the taxpayer as follows:

She provided only partial credit card statements to the IRS auditor (5 months out of 12)
She refused to produce partnership tax returns and agreements for the flow through income
She made false representations to the court about discussing matters with opposing counsel
She provided documents that appeared to be digitally altered
She offered implausible explanations when questioned about inconsistencies

The tax court ultimately upheld both the underlying tax deficiency and a civil fraud penalty. This article focuses on the fraud penalty.

Traditional Badges of Fraud vs. Procedural Conduct

The civil tax fraud penalty is found in Section 6663 of the tax code. It is a very short statute that just says that the taxpayer can be liable for a 75 percent penalty for any underpayment of tax that is attributable to fraud.

The IRS has the burden to prove that there was tax fraud. To do this, the IRS has to show that the taxpayer engaged in conduct with the intent to evade taxes that he knew or believed to be owing. The IRS also has to prove that the understatement of tax was due to the fraud.

There are several prerequisites implicit in these rules. For example, the taxpayer has to actually file a tax return. This provides one “out” for this penalty. For example, a document that is filed that does not qualify as a “tax return” cannot trigger this penalty. The tax return may not have to be signed for there to be fraud, but it does have to be intended to be a valid tax return and it has to be filed. Those who file a frivolous tax return or those do not file a tax return cannot be subject to this penalty.

As a separate note, it is often advisable to file a tax return, even if the tax return is being filed late, to get the statute of limitations for the IRS to audit and make an assessment. However, the tax return has to be an honest and truthful return to avoid for this to work and to avoid the fraud penalty. The taxpayer then has to contend with the late filing penalty.

Also, those who do not believe that intentionally file a false return under a genuine belief that they are complying with the law do not trigger this penalty. These concepts are not set out in the tax code. They are found in various court cases involving this penalty.

The Badges of Fraud

Section 6663 also does not provide a definition for the term “fraud.” The courts have developed factors that are used to establish fraud. These so-called “badges of fraud” typically focus on the taxpayer’s conduct at or before the time of filing of the tax return, such as:

Maintaining false books and records
Creating fictitious documents
Concealing income or assets
Making false statements to investigators
Dealing extensively in cash
Filing false documents

There are quite a few court cases that apply factors like these. The courts have largely said that no one factor is determinative, and then they essentially pick the set of factors that are relevant to the case. In many cases there is one fact triggers several of these factors, such as in cases where a fictitious business is reported on a tax return for a tax loss. The business is reported on the return, but the taxpayer may maintain false books and records or create false or fictitious documents to support it–as the court suggested that the taxpayer did in this case.

The tax court cases that address fraud penalties are largely sustained in the IRS’s favor. Even in those cases where the taxpayers prevail on the fraud penalty, the tax court still usually imposes the lesser 20 percent accuracy or negligence penalty.

Conduct After the Tax Return is Filed

This brings us to the question posed by this article. Can conduct after the tax return is filed be considered as one of the “badges of fraud” for the understatement of tax on the tax return?

The understatement of tax happened at the time the tax return was filed. By the time the IRS audits the tax return, several years have usually passed. By the time the case gets to tax court, several more years have passed.

This Chopra case is a prime example. It is a tax court case with an opinion issued in 2025 for a 2019 income tax return. The court in Chopra did in fact find that the taxpayer’s post-tax return filing conduct supports a finding of fraud for the civil tax fraud penalty.

The tax court specifically identified several aspects of the taxpayer’s procedural conduct as badges of fraud:

Failure to cooperate with tax authorities
Providing implausible or inconsistent explanations
Offering testimony lacking credibility
Refusing to produce relevant documents
Making false representations to the court

The tax court even noted that the taxpayer’s “duplicitous and obstructive behavior throughout this [court] case is a badge of fraud” for the Section 6663 penalty.

The court made this ruling even though it has its own separate penalty for fraudulent conduct during tax litigation which is found in Section 6673. The Section 6673 penalty is limited to $25,000, which the Section 6663 fraud penalty is not. The opinion does not address the Section 6673 penalty so, presumably, the court did not impose this additional penalty.

The Takeaway

This case shows that conduct during tax audit and litigation matters as it can be additional evidence of fraudulent intent for any understatement on the tax return. Producing fraudulent documents to the IRS auditors and making false statements to the court can be evidence of fraudulent intent. While taxpayers retain their rights to challenge IRS positions and limit document production, they should exercise these rights in a way that doesn’t create additional evidence of fraud.