In the case of United States of America v. Ali Mahyari and Roza Malekzadeh, the government sought civil money penalties from Ali Mahyari and Roza Malekzadeh (collectively referred to as the “Defendants”) under 31 United States Code section 5321(a)(5) after concluding that the Defendants willfully failed to report their interests in foreign bank accounts. The United States District Court for the District of Oregon was tasked with evaluating whether the Defendants willfully failed to file Reports of Foreign Bank and Financial Accounts (FBARs) for tax years 2011, 2012, and 2013 and, thus, are subject to the penalties imposed under 31 U.S.C. section 5321(a)(5).
Facts
The Defendants were a married couple with origins in Iran. They moved to the United States in the early 2000s but still owned their previous residence in Tehran. After selling their residence in Tehran in early 2011, the Defendants utilized bank accounts in Canada and Iran to transfer proceeds from the sale to themselves in the United States. Despite obligations under 31 C.F.R. section 1010.350(a), the Defendants failed to file the necessary FBARs timely.
Consequently, on November 2, 2020, the government filed a complaint against the Defendants seeking civil penalties for willful non-compliance for failing to report their interests in the foreign bank accounts in Canada and Iran for the tax years 2011, 2012, and 2013.
At summary judgment, the court found the Defendants willfully failed to file FBARs for their accounts in Canada for the years 2011 through 2013 and their accounts in Iran for 2012 and 2013. A jury found the failure to file for the Iranian accounts in 2011 was not willful. The court remanded the case to the Internal Revenue Service (“IRS”) to incorporate the jury’s finding and recalculate the FBAR penalty. As a result, the government moved the court to enter judgment against the Defendants, requesting penalties of $198,683 against each defendant, plus statutory accruals.
Analysis
31 C.F.R. sections 1010.350(a) and (c) set forth the requirements for U.S. citizens to report foreign financial accounts exceeding $10,000 at any time during the calendar year. Willful failure to comply with these reporting requirements can result in severe penalties, including the greater of $100,000 or 50% of the account balances at the time of the violation. This FBAR statute gives the IRS discretion to impose any penalty below the maximum provided by the FBAR statute. A court will set aside a penalty assessment only if it was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law” under the Administrative Procedure Act. Under the Administrative Procedure Act standard, an agency must “examine the relevant data and articulate a satisfactory explanation for its action, including a rational connection between the facts found and the choice made.”
The court’s analysis focused on the standard of “willfulness” in failing to file FBARs. The distinction between non-willful and willful violations carries implications for the severity of penalties. The Defendants contended the IRS’s penalty calculation was arbitrary and capricious because the IRS failed to apply mitigation guidelines and used an inaccurate exchange rate for converting Iranian rials to U.S. dollars.
The court first addressed the Defendants’ argument regarding the IRS’s refusal to apply FBAR penalty mitigation guidelines. According to the Internal Revenue Manual (IRM) section 4.26.16.5.5.3, mitigation is contingent upon meeting specific criteria, including no history of criminal tax evasion or previous FBAR penalties, the legality of funds, cooperation during the examination, and no determination of a civil fraud penalty for the year in question. The government argued that the Defendants failed to cooperate during the examination because they
- (1) failed to disclose all their foreign bank accounts to the IRS on multiple occasions,
- (2) failed to back file FBARs for one bank account for 2012 and 2013, and
- (3) failed to provide bank statements for all their foreign accounts.
Considering these failures, the court found the IRS’s determination that the Defendants did not qualify for mitigation was not arbitrary or capricious due to the Defendants’ lack of cooperation and incomplete disclosure of foreign accounts.
The use of International Monetary Fund (IMF) exchange rates to convert Iranian rials to U.S. dollars was also contested. The defendants argued that the unique economic environment of Iran rendered the IMF rate inaccurate, advocating for the use of a “black market” rate. However, the court deferred to the IRS’s discretion in using the IMF rate, finding the agency had articulated a rational basis for its decision, including consistency with actual exchange rates and lower penalty calculation compared to Treasury rates.
The court’s analysis was guided by the standards under the Administrative Procedure Act, which mandates that agency actions must not be arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. The review is deferential, assuming a presumption of regularity in agency decisions. The court found the IRS’s actions in calculating penalties and choosing exchange rates met these standards, providing reasoned explanations for their decisions.
Comment
The court found that neither the IRS’s refusal to apply FBAR mitigation nor the IRS’s conversion of Defendants’ Iranian Rials into U.S. Dollars using IMF Exchange Rates was arbitrary and capricious. Accordingly, the court granted the government’s motion for entry of judgment after remand, ordering the imposition of the recalculated civil penalties against the Defendants.
Frank Baldino is an estates and trusts attorney who helps people throughout the greater Washington, DC area protect assets for their families and future generations through careful estate tax planning. For more information, contact Frank at (301) 657-0175 or fsbaldino@lerchearly.com.
