U.S. v. Schik
In U.S. v. Schik, the United States District Court for the Southern District of New York denied the government’s request for summary judgment that a taxpayer’s failure to file FBAR and disclose foreign accounts was willful rather than merely negligent, thereby incurring $9 million in penalties.
The taxpayer defendant in this matter is a 99-year-old Holocaust survivor named Walter Schik. Mr. Schik failed to file Form TD F 90-22.1 (FBAR) for the 2007 tax year to disclose his financial interest in foreign accounts. Thus, the IRS assessed a penalty against him for almost $9 million dollars, which Mr. Schik did not pay, thereby leading to this action against him.
During World War II, Mr. Schik, who was a young teenager, was forcibly separated from his family in Austria and sent to a concentration camp in Hungary. He was the sole member of his family to miraculously survive the concentration camp, and when the war ended he moved to the United States, where he later became a citizen. Around that time, Mr. Schik opened a bank account at UBS in Switzerland to deposit money recovered from his relatives who died in the war. Given Switzerland’s neutrality, Mr. Schik opened accounts there as a safety net in case of another Holocaust.
Over the years, Mr. Schik’s son and money manager managed the Swiss account on his behalf and opened additional accounts in his name. Mr. Schik did not manage or touch the money. In 2007, the two accounts at the center of this case contained a combined maximum balance of $17,243,971.
Mr. Schik’s accountant prepared his tax forms for 2007 but never inquired about foreign accounts nor asked Mr. Schik to complete a tax preparation questionnaire. Mr. Schik had an opportunity to review his 2007 tax return but did not do so before signing.
A few years later, Mr. Schik’s money manager was indicted for conspiring with U.S. taxpayers and foreign financial institutions to hide his client’s Swiss bank accounts from the IRS. Shortly thereafter, Mr. Schik voluntarily disclosed his foreign accounts to the IRS, which the IRS rejected due to timeliness and/or completeness. Mr. Schik then belatedly filed an FBAR for 2007 to report the holdings in the Swiss accounts. The IRS assessed penalties totaling $8,822,806 against Mr. Schik for willful failure to comply with the FBAR filing requirements, which Mr. Schik did not pay.
The FBAR must be filed with the U.S. Treasury Department to disclose that a filer has a financial interest in a foreign financial account with an aggregate value of $10,000 or more during the taxable year. The Bank Secrecy Act requires, “a person in, and doing business in, the United States, [to] keep records, file reports, or keep records and file reports, when the resident, citizen, or person makes a transaction or maintains a relation for any person with a foreign financial agency.” Willful failure to file an FBAR may result in a civil penalty ranging from $100,000 up to 50% of the balance in the account at the time of the violation.
Summary judgment is appropriate where “the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” In civil FBAR cases, the government bears the burden to prove by a preponderance of the evidence that it is entitled to judgment as a matter of law.
Here, the government seeks a civil FBAR penalty against Mr. Schik pursuant to 31 U.S.C. section 5321(a)(5), under which a penalty may be assessed against any person willfully violating any provision of Section 5314. The government must prove by a preponderance of the evidence that: (1) Mr. Schik is a United States citizen; (2) he had an interest in, or authority over a foreign financial account; (3) the account had a balance exceeding $10,000; and (4) he willfully failed to disclose the account and file an FBAR. The sole dispute among the parties is whether Mr. Schik’s failure to file the 2007 FBAR was a willful violation.
The Court held that a “willful violation” includes reckless violations for purposes of a civil FBAR penalty, and found that, drawing all reasonable inferences in favor of Mr. Schik, there are genuine issues of material fact regarding whether Mr. Schik’s failure to file the FBAR was willful rather than merely negligent. Mr. Schik did not manage the accounts himself, nor did he prepare the 2007 tax returns. It further found that he was not aware of his obligation to disclose the accounts nor was his failure to disclose due to a nefarious reason.
The U.S. District Court found that the evidence, taken in the light most favorable to Mr. Schik, creates a genuine dispute of material fact as to whether Mr. Schik willfully failed to disclose his foreign accounts. Accordingly, the Court found the government is not entitled to judgment as a matter of law.
Estate of Levine
In an estate tax case involving a decedent who entered into split-dollar life insurance arrangements, where her revocable trust paid for premiums on policies which were taken out on her daughter and son-in-law and which were owned by a separate irrevocable life insurance trust with an independent trustee that alone held the termination right, the Tax Court determined that the estate included the stipulated value of the split-dollar receivable, not the policies’ cash-surrender values as the IRS determined, finding that on the date of death, decedent possessed only that receivable.
In 2008, Marion Levine’s children and long-time business partner, as attorneys-in-fact for Levine, established an irrevocable life insurance trust (ILIT) for the benefit of Levine’s children and grandchildren. The trust named South Dakota Trust Company as the administrative trustee and Levine’s business partner as the sole member of the investment committee. In order to purchase policies on the lives of Levine’s daughter and son-in-law, Levine’s revocable trust agreed to pay the premiums on the policies, thus entering into a split-dollar arrangement. The ILIT assigned the insurance policies as collateral and agreed to pay to the revocable trust the greater of (i) the total amount of the premiums paid for these policies – $6.5 million – and (ii) either (a) the current cash-surrender values of the policies upon the death of the last surviving insured or (b) the cash-surrender values of the policies on the date that they were terminated, if they were terminated before both insureds died. Importantly, only Levine’s business partner, as sole member of the ILIT’s investment committee, could cancel or surrender the policies during the lifetime of either insured and thereby terminate the split dollar arrangement. Within just a year’s time, in 2009, Levine died.
A gift tax return was filed that reported the gift from the revocable trust to the ILIT as $2,644. The revocable trust was promised a payment by the ILIT of some amount in the future, and as such was reported as a receivable by the estate, valued on Levine’s estate tax return at around $2.1 million. The IRS audited Levine’s estate and issued a notice of deficiency for more than $3 million, with the biggest adjustment to the value of Levine’s rights under the split-dollar arrangement. The IRS also issued a 40% gross-misvaluation penalty under Section 6662(h), because the value of the receivable was, according to the IRS, far too low. The estate disagreed with the penalty and the IRS’s determination that the value of the split-dollar receivable in Levine’s estate was the policies’ cash surrender value of over $6 million to the Tax Court.
The Tax Court first looked to Treas. Reg. 1.61-22 to determine whether the “loan regime” or “economic benefit regime” applied to the split-dollar arrangement. Which regime the arrangement falls under generally depends on who owns the policy, and in this case, the ILIT owned the policy, which would mandate a loan regime, unless the only right or economic benefit provided to the donee under the arrangement was an interest in current life insurance protection, in which case the donor is deemed the owner and the economic benefit regime applies. The Tax Court noted that the split-dollar regulations do not address the estate tax consequences of such arrangements other than pointing to Section 2042, which governs the estate tax consequences of policies on a decedent’s own life, not arrangements where policies were taken out on the lives of others. This leaves the Tax Court to look to general estate tax provisions, including Sections 2036 and 2038, to determine the value of the arrangement.
The IRS argued that the estate should have reported the cash surrender values of the life insurance policies, not the value of the receivable, reasoning that under Section 2036, Levine retained the right to income, or the right to designate who would possess the income, from the split dollar arrangement, and that she maintained the power to alter, amend, revoke, or terminate the enjoyment of aspects of the arrangement, causing inclusion under Section 2038. The Tax Court looked first at what rights the estate, through the revocable trust, transferred and what rights it retained. The Court determined that the life insurance policies were always owned by the ILIT, so those policies cannot be the property that was transferred, since they were never owned by the revocable trust. Instead, the only transfer that occurred was the $6.5 million Levine sent to the ILIT from her assets that the ILIT used to pay for the policies. In asking whether, under Section 2036, Levine retained any rights or interest in the cash she transferred, including the receivable that gave her the right to the greater of $6.5 million or the cash-surrender values of the policies, the Tax Court held that Levine did not have an immediate right to the cash-surrender value, because she or her estate had to wait until either the deaths of her daughter and son-in-law, or the termination of the policies according to their terms. Distinguishing this case from Estate of Cahill and Morrissette II, where the donor and donee in each case jointly held termination rights, the Tax Court noted that the split-dollar arrangement at issue here allowed only the ILIT to terminate the policies, not Levine. This meant that Levine herself had no unilateral power to terminate the policies, nor could she terminate the arrangement in conjunction with the ILIT. Therefore, the Court held that Levine had no right to or possession of the cash-surrender values.
The IRS attempted to build on the precedents of Estate of Strangi and Estate of Powell, arguing that Levine, through her attorneys-in-fact, stood on both sides of these transactions and could unwind the split-dollar arrangement by surrendering the policies for their cash surrender values, thereby retaining the right to possession and enjoyment of the split-dollar receivable under Section 2036. However, unlike the precedent cases cited, here the only person who stood on both sides of the transaction was Levine’s business partner, who was one of the attorneys-in-fact and the sole member of the ILIT’s investment committee. As attorney-in-fact, the business partner had only the powers of Levine, who could not, by the arrangement’s terms, terminate the policies; instead, they could be terminated only by the business partner in his role as the ILIT’s sole investment committee member, where his fiduciary duties owed to the beneficiaries of the ILIT would prevent him from surrendering the policies. Unlike the precedent cases, these were not duties he essentially owed to himself. Thus, the cash-surrender values of the life insurance policies were not includible under Section 2036(a)(2) or Section 2038.
Finally, the Tax Court ruled that Section 2703 was inapposite, since that section deals with property in an estate, not property belonging to some other entity, such as the ILIT in this instance. There were no restrictions on the split-dollar receivable held by Levine’s estate which would otherwise invoke Section 2703.
This case will likely serve as a roadmap for those looking to set up similar split-dollar arrangements. The transaction was preserved and kept out of the estate because Levine herself, either alone or in conjunction with someone else, could not terminate the agreement. Though it was not at issue in this case, the Tax Court noted in dicta that a weakness of the transaction involved the calculation of the value of the gift between Levine and the ILITs, so practitioners should be careful in what comfort they take from this case from a gift tax standpoint.
This article first appeared in the September 2022 Edition of the Estate Planning Journal.
Authors: FRANK S. BALDINO, SCOTT A. BOWMAN, and BRAD DILLON
FRANK S. BALDINO is a principal in the law firm of Lerch, Early & Brewer, Chartered, in Bethesda, Maryland. He is a member of the Maryland, District of Columbia, New York, and New Jersey Bars. SCOTT A. BOWMAN is a partner in the law firm of McDermott Will & Emery LLP in Washington, D.C. He is a member of the Florida, New York, California, and Connecticut Bars. BRAD DILLON is a Senior Wealth Strategist in the Advanced Planning Group at UBS Financial Services, Inc. in New York City and an adjunct professor at Fordham Law School. He is a member of the New York Bar.