On 11 June 2019, the US District Court for the Southern District of Texas, Laredo Division (the Court) found that Edward Flume willfully failed to disclose his interest in a Swiss bank account maintained at UBS in 2007 and 2008 on the required Foreign Bank Account Report form (FBAR). See United States v. Flume, 123 AFTR 2d 2019-2211 (S.D. Tex. 2019). In a case of first impression in the Fifth Circuit, the Court’s willfulness determination relied on its findings that Flume’s testimony lacked credibility and that the structure in place reflected a sophisticated tax-evasion scheme, as well as the fact that Flume disclosed a Mexican bank account on Schedule B, Interest and Ordinary Dividends, of his income tax returns.
Edward Flume is a US citizen who has lived and worked in Mexico since 1990. During the 1990s, Flume owned 42 fast food restaurants. To operate the restaurants, Flume and a business partnerformed a Mexican limited liability stock corporation, Franchise Food Service de Mexico S.A. de C.V. (FFS). Flume sold the restaurants in 1998, but left FFS intact, and has since focused on real estate development.
In 1999, Flume and his wife, who is also a US citizen, began using Leonard Purcell as their return preparers.
To manage the real estate business, Flume incorporated Wilshire Holdings, Inc. (Wilshire) in the Bahamas. In 2001, Wilshire was reincorporated in Belize. In 2005, Flume opened an account at UBS, identifying Wilshire as the account holder, with a stated purpose of managing retirement funds. Flume and his wife were the only individuals with signature authority over the account. The account opening documents also indicated that Flume and his wife were Wilshire’s sole shareholders. Flume claimed in a separate legal proceeding in the US Tax Court (which concerned the alleged failure to file certain information returns disclosing the ownership interests in FFS and Wilshire) that “amended” Articles of Incorporation were effective as of the day of the reincorporation and reduced the Flumes’ aggregate ownership interests in Wilshire to 18%. Flume eventually admitted the “amended” articles had been backdated. He also instructed UBS not to invest in US securities, an action generally viewed by the IRS and Department of Justice (DOJ) as an attempt to further conceal ownership in a foreign account.
In 2008, the Flumes began transferring funds from Switzerland to their accounts in the United States and Mexico. In the summer of that year, the IRS served a “John Doe” summons on UBS, and in early 2009, UBS entered into a deferred prosecution agreement (DPA) with the DOJ on charges of conspiring to evade US tax laws. Instead of entering into the IRS’s newly established Offshore Voluntary Disclosure Program in 2009, for which they were eligible, the Flumes waited until June 2010 and then only filed delinquent FBARs for the 2004 through 2008 tax years.
As required by the terms of its DPA, UBS turned over the account information of its US clients. Upon receipt of information concerning the Wilshire account, the IRS initiated an examination, one component of which related to the delinquent FBAR filings.
On 15 April 2014, the IRS assessed the maximum penalties permissible under 31 U.S.C. § 5321(a)(2) against Flume for his failure to file FBARs reporting his financial interest in the UBS account: $356,509 for 2007 and $100,000 for 2008. Flume did not pay the penalties, and DOJ filed suit to reduce the assessment to judgment.
The Court’s Willfulness Determination
To collect civil penalties for a willful violation of 31 U.S.C. § 5314, the DOJ had to prove that (1) Flume was a US citizen, (2) he had a financial interest in or signatory authority over the account at issue, (3) the account balance exceeded $10,000, (4) the account was in a foreign country, (5) he failed to disclose the account, (6) the failure was willful, and (7) the amount of the proposed penalty was proper. In the instant case, as with the vast majority of FBAR cases, only the willfulness element was in dispute.
Prior to trial, the DOJ filed a Motion for Summary Judgment asking the Court to hold as a matter of law that Flume willfully violated 31 U.S.C. § 5314. The Court denied the motion and acknowledged that Flume’s testimony created a genuine dispute as to whether he knowingly disregarded his FBAR filing obligations and that “courts [were] not permitted to make credibility determinations in ruling on summary judgment motions.” The Court also found that a genuine dispute existed as to whether Flume acted recklessly because there was evidence he relied on his return preparer. Further, the Court rejected the DOJ’s “constructive knowledge” theory, specifically refusing to accept the idea that “every taxpayer, merely by signing a tax return, is presumed to know of the need to file an FBAR” because it erases the distinction between willful and nonwillful violations, and declined to follow the holdings of United States v. Williams, 489 F. App’x 655 (4th Cir. 2012) and United States v. McBride, 908 F. Supp. 2d 1186 (D. Utah 2012). The courts in Williams and McBride both held that “constructive knowledge” of the contents of one’s tax returns are ascribed to the individual because they have signed the return declaring under penalties of perjury that they have “examined” the returns.
The DOJ did not pursue the “constructive knowledge” theory at trial, so the Court did not elaborate on this theory. But in a footnote to its Findings of Fact & Conclusions of Law, the Court reiterated its position that “‘[t]he constructive knowledge theory was unpersuasive’ as a justification for penalties based on knowing conduct.” Following the Third Circuit’s decision in Bedrosian v. United States, 912 F.3d 144 (3d Cir. 2018), the Court noted that a willful FBAR violation occurs when a defendant knowingly or recklessly fails to file an FBAR.
While credibility determinations were impermissible at the summary judgment phase, the Court was not shy in making such determinations after a two-day trial. At trial, Flume testified that he opened the UBS account to avoid the consequences of bank failures, citing the collapse of Lehman Brothers as the primary cause for his concern. Yet, the UBS account was opened in 2005 whereas Lehman Brothers did not collapse until 2008. Flume also gave conflicting accounts of when and how he first became aware of the FBAR requirement, whether it was in 2008 or 2009, or through Purcell in 2010, or at a financial seminar in 2010. Purcell, by contrast, testified that he sent Flume annual reminders of the FBAR requirements and that Flume did not disclose the UBS account to him until after it was closed. Purcell was, however, aware of Flume’s account in Mexico and completed Part III of Schedule B accordingly. No FBAR was prepared or filed disclosing this account because Flume never requested Purcell to provide this service. Purcell assumed, therefore, that Flume prepared and filed his own FBAR each year, as was the case for a number of his other clients. Additional inconsistencies in Flume’s statements were noted by the Court, and the number of inconsistencies plus the credible testimony of the other witnesses led the Court to find Flume’s testimony unreliable.
Flume’s familiarity with international tax laws was also a factor in the Court’s willfulness determination. The Court noted that Flume’s instruction to UBS not to invest in US securities suggested that he was aware of and wanted to avoid the withholding and disclosure requirements that accompany US investments. Additionally, the Court found that moving Wilshire to Belize was an attempt to avoid government oversight, given certain restrictions put in place in the Bahamas. Furthermore, Flume continued to use FFS, the Mexican corporation that remained intact after Flume exited the fast food business, to pay his salary from Wilshire because it was better under Mexican law to receive income from a Mexican corporation than an offshore corporation. These facts, coupled with Flume’s lack of credibility, painted a picture of a sophisticated tax-evasion scheme for the Court.
The Court viewed Flume’s listing of his Mexican account on Schedule B as an indication that he was aware of the requirement to report foreign accounts and yet made a conscious decision not to include the Swiss account. The Court also noted that Flume took no action and made no attempts to review his compliance with respect to the UBS account until it became clear that his account information would be produced to the IRS—even though he had been aware of the UBS investigation since 2008.
The Court went on to note that even if it were to accept Flume’s claim that he had no knowledge of the FBAR requirement before 2010, the trial clearly established that, in light of Flume’s financial literacy, he acted in an extremely reckless manner by failing to review his tax returns before signing them, because even a cursory review would have alerted him to his obligation. Additionally, Flume’s supposed reliance on Purcell was misplaced and reckless on its own, because Purcell was not a CPA and Flume had conducted no research into Purcell’s education or credentials. Given Flume’s international holdings and the complexity of his investments and arrangements, the Court found Flume acted recklessly when entrusting Purcell with his filings having not investigated his credentials.
The Court concluded that Flume willfully failed to disclose his interest in the UBS account, and on 9 July 2019, it entered a judgment against Flume totaling $622,586.63 for the 2007 and 2008 tax years, reflecting the IRS’s original willful penalties, plus accrued interest on the assessment, late payment penalties, and associated fees.
Where Does Flume Fit in the Willfulness Discussion?
While the ultimate result for Flume himself was not favorable, all is not lost for other taxpayers coming before the Court. In its denial of DOJ’s request for summary judgment, the Court bucked earlier FBAR cases and determined that the government cannot use the “constructive knowledge” theory to prove willfulness. A few months after the Court filed its Memorandum and Order, however, the Court of Federal Claims relied on the “constructive knowledge” theory in granting the DOJ’s Motion for Summary Judgment in another case, in line with the courts in Williams and McBride, thus setting the Court in Flume apart as an outlier.
The Court also determined that recklessness must exceed mere carelessness and followed Bedrosian in suggesting that for conduct to be deemed reckless, a “high bar” must be met. For example, the Court noted that it “might be more lenient with an unsophisticated defendant who genuinely could not understand the language of his tax return” but treated Flume in accordance with his financial literacy and decades of project management experience. More guidance is needed in this area to allow taxpayers to distinguish between recklessness, which has become intertwined with willfulness over the years, and negligence.