Reyes and the Objective Standard of Recklessness

For all U.S. Investors in Golden Visa funds: In January 2026, the Second Circuit decision in United States v. Reyes affirmed that reckless conduct satisfies the civil willfulness standard for FBAR penalties. This ruling aligns the Second Circuit with the established circuit consensus on that issue.

The court adopted a standard based on what a reasonable person should have known. Where a reasonable person should have recognized a high risk of a foreign account reporting requirement, including from the Schedule B foreign account question and surrounding facts, failure to investigate can constitute recklessness. In FBAR cases, that makes an "I didn't know" defense much weaker where the return and facts clearly signaled a foreign reporting issue.

The Shift from Subjective to Objective Willfulness

Historically, taxpayers often argued that they "innocently" or "negligently" missed a filing requirement because they were unaware of the specific law. Reyes reinforces a trend toward an objective standard of recklessness.

• The Objective Standard: Under this logic, the government does not need to prove you subjectively intended to break the law. Instead, 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.

• Red Flags as Evidence: If a taxpayer is sophisticated, has a history of tax compliance (which demonstrates a historical understanding filing obligations), or checked "No" on Schedule B of their 1040 regarding foreign accounts, the court may view these as "red flags." Ignoring them is increasingly classified as reckless disregard, which meets the legal threshold for willfulness.

Application to CFCs and PFICs

Reyes is an FBAR case under Title 31 (Money and Finance), but its logic gives the government a stronger basis to argue in Title 26 (Internal Revenue Code) cases that taxpayers who ignored obvious foreign reporting red flags acted recklessly rather than innocently.

• Willful Neglect and Reasonable Cause: In Title 26 cases, such as those including CFCs and PFICs, the government can argue that objectively reckless conduct undermines claims of reasonable cause, good faith, or lack of willful neglect. That argument is especially dangerous where a taxpayer ignored obvious foreign reporting red flags.

• Duty of Inquiry: Passive reliance on a fund's internal reporting is becoming harder to defend. If the information provided is incomplete, internally inconsistent, or contradicts the red flags reflected on a U.S. return, a taxpayer's failure to investigate further can be characterized as reckless disregard.

The 40% Underpayment Penalty, Section 6662(j)

Section 6662(j) increases the standard 20% accuracy related penalty to 40% for the portion of an underpayment attributable to an undisclosed foreign financial asset. The statute expressly reaches failures under provisions including Section 6038 and Section 6038D.

For CFC cases, that can matter directly through Section 6038 and Form 5471. For PFIC cases, Form 8621 is not explicitly listed in Section 6662(j), but PFIC holdings may also be reportable on Form 8938 which is listed. In cases involving an underpayment attributable to an undisclosed foreign financial asset, that overlap can create exposure to the 40% rate.

Once a court concludes that the taxpayer ignored obvious foreign reporting red flags, establishing reasonable cause or good faith under Section 6664(c) becomes materially harder.

Foreign Trust Penalties, Form 3520

Foreign trust reporting failures trigger a separate penalty regime. For transfers to a foreign trust, failure to report on Form 3520 can trigger a penalty equal to the greater of $10,000 or 35% of the gross value of the property transferred. For unreported distributions, the penalty is the greater of $10,000 or 35% of the gross value of the distribution. For a U.S. owner of a foreign trust, failure to ensure proper foreign trust reporting can trigger a penalty equal to the greater of $10,000 or 5% of the gross value of the portion of the trust's assets treated as owned by the U.S. person.

If the same facts also produce an underpayment attributable to an undisclosed foreign financial asset within Section 6662(j), a separate 40% accuracy related penalty can apply to that portion of the tax.

Reyes strengthens the government's argument that obvious foreign reporting red flags cannot be ignored and later dismissed as innocent mistake.

Why This Matters for Taxpayers

Reyes and Horowitz give the government stronger language to argue that a taxpayer who ignored obvious foreign reporting red flags acted recklessly rather than innocently. If a taxpayer has offshore interests, the government can argue that obvious foreign reporting indicators triggered a higher duty to inquire about those reporting obligations.

Reyes does not by itself rewrite every foreign information return penalty statute. It does, however, reinforce a government-friendly principle that may be dangerous for taxpayers: a taxpayer who ignores obvious foreign reporting red flags may be treated as reckless, not merely careless. For cross-border investors, failing to investigate is becoming far more expensive.