Reyes, Willfulness, and Procedural Defense
What is the Reyes FBAR decision and why should it matter to me?
In January 2026, the Second Circuit ruled in United States v. Reyes that reckless conduct satisfies the civil willfulness standard for FBAR penalties. The court adopted an objective standard: the government does not need to prove you intended to break the law. They only need to show that you ignored an unjustifiably high risk of a legal violation that was either known or so obvious it should have been known.
Reyes is an FBAR case, but its logic extends to other foreign information return penalties. If a taxpayer ignores obvious foreign reporting red flags, such as investing in a fund that does not comply with U.S. securities law and then accepting its tax reporting without independent verification, the government can argue that this constitutes reckless disregard.
What is the legal chain from Safeco to Horowitz to Reyes?
The willfulness standard threatening offshore fund investors was built across three cases. In Safeco Insurance Co. v. Burr (2007), the Supreme Court established that "willfulness" includes not only intentional violations but also reckless disregard of a known or obvious risk. In United States v. Horowitz (4th Cir. 2020), the court applied this to FBAR penalties. In United States v. Reyes (2d Cir. 2026), the Second Circuit adopted an objective standard: the question is not whether you personally knew you were violating the law, but whether a reasonable person in your position should have recognized the risk. Subjective good faith is no longer a reliable defense in FBAR failures. This logic could extend to other foreign reporting obligations.
How does the Forensic Exposure Diagnostic help with a willfulness defense?
The Forensic Exposure Diagnostic documents your independent verification of your fund's reporting, which is the heightened duty of inquiry that Reyes and Horowitz demand. By commissioning independent forensic analysis, you are demonstrating that you did not passively rely on the fund's internal reporting. This is the factual record that can support a reasonable cause defense against findings of willfulness for U.S. reporting failures.
If I'm a victim of securities fraud, doesn't that protect me from tax penalties?
No. The SEC and the IRS coordinate in one direction: when the SEC finds fraud, the IRS receives audit triggers. There is no reverse coordination: the SEC declaring you a victim does not trigger any penalty relief from the IRS.
Under the Reyes objective recklessness standard, your victimhood can actually become evidence against you. If the fund was conducting an illegal offering, a reasonable person should have recognized the red flags. Your investment becomes proof of reckless disregard, not evidence of innocence.
The SEC says you deserve protection. The IRS says your victimhood proves you should have known better. Same investor, same fund, same facts, opposite conclusions. There is currently no statutory safe harbor for investors defrauded by illegal offshore offerings.
What happens if the SEC takes enforcement action against my fund?
SEC enforcement action is a discovery event that starts multiple clocks simultaneously. Under Rule 10b-5, you have two years from discovery to file a damages claim. On the tax side, enforcement creates an audit trigger. The action generates a paper trail listing every U.S. investor, which flows to the IRS. Once the IRS has it, every U.S. investor's tax returns become candidates for examination.
SEC enforcement also crystallizes the Reyes problem: once a federal agency has formally found that the fund was conducting an illegal offering, the argument that you "didn't know" becomes significantly harder to make.
If you believe your fund may be subject to SEC scrutiny, documenting your own diligence before enforcement action is announced is materially stronger than documenting it after.
Is there any procedural relief available for investors facing these penalties?
There are emerging legal developments that may provide limited relief, though none are settled.
In Farhy v. Commissioner (T.C. 2023), the Tax Court held that the IRS lacks authority to administratively assess certain international information return penalties. The D.C. Circuit reversed this in 2024, but the Tax Court reaffirmed its reasoning in Mukhi (2024). Outside the D.C. Circuit, the IRS may still be required to refer these penalties to the DOJ for collection, and a five-year statute of limitations under 28 U.S.C. section 2462 may apply.
Separately, in SEC v. Jarkesy (2024), the Supreme Court held that the SEC cannot impose civil fraud penalties without a jury trial. At least one federal court has extended this reasoning to FBAR penalties. If this line develops, some IRS penalty proceedings may require jury trials, providing procedural protections that do not currently exist in Tax Court.
These developments offer procedural defenses, not substantive relief. The legal landscape is evolving. The strongest position remains documenting your diligence independently before any enforcement action or audit begins.
U.S. investors deserve clarity, competence, care, and compliance.
You didn’t create this problem. Misleading marketing practices, fund structure, gaps in reporting, and the professional infrastructure around it created this problem. But under U.S. tax law, the consequences land on you unless you act. The window to mitigate them is limited.