Recently, a federal court case held that online poker accounts must be disclosed on an FBAR. In United States v. Hom, 2014 U.S. Dist. LEXIS 77489 (N.D. CA 2014), Mr. Hom was an online gambler who opened up accounts with two online poker websites in 2006: PokerStars and PartyPoker. Both websites allowed Mr. Hom to deposit and withdraw money. In 2007, Mr. Hom gambled online through his PokerStars account. He used his account at FirePay.com, an online financial organization that receives, holds, and pays funds on behalf of its customers, to bankroll his PokerStars and PartyPoker accounts.

Mr. Hom’s FirePay account was funded by cash transfers from his domestic Wells Fargo bank account or other online financial institutions, one of which was Western Union. In 2006, FirePay discontinued the practice of allowing United States customers to transfer funds from their FirePay accounts to offshore internet gambling sites. As a result, Mr. Hom began using Western Union and other online financial institutions to transfer money from his Wells Fargo bank account to his online poker accounts.

On June 4, 2014 in U.S. v. John C. Hom (113 AFTR 2d 2014-XXXX, (N.D. Cal, 06/04/2014)), the Federal District Court granted the government’s Motion for Summary Judgment. Is doing so, it held that the accounts at FirePay, PokerStars, and PartyPoker were foreign accounts reportable on a FBAR. As if that was not bad enough, the Court held that Mr. Hom was liable for penalties under 31 U.S.C. 5321.

THE PERFECT STORM: AN IRS EXAMINATION

The IRS became aware of irregularities with Mr. Hom’s 2006 and 2007 federal income tax returns as a result of an examination. That triggered a Foreign Bank and Financial Accounts Report (“FBAR”) examination. As previously discussed, U.S. taxpayers must file an FBAR when the maximum aggregate value of their foreign financial accounts exceeds $ 10,000 in a given tax year. It is due by June 30 of the year following the year that the taxpayer had such an account (Note: For due dates after December 31, 2015, it has been changed from June 30 of the year following the calendar year for which the account is being reported to April 15 of the year following the calendar year for which the account is being reported, with the possibility of a six-month extension). Mr. Hom did not file his 2006 or 2007 FBARs until June 26, 2010. In addition, his 2006 FBAR did not include his FirePay account.

Mr. Hom acknowledged that at various points in 2006 and 2007, the aggregate maximum balance in his FirePay, PokerStars, and PartyPoker accounts exceeded $10,000 (U.S.). The IRS assessed civil penalties under 31 U.S.C. 5321(a)(5) for Mr. Hom’s non-willful failure to file FBARs, as it related to his interest in his FirePay, PokerStars, and PartyPoker accounts. The IRS also assessed a $ 30,000 penalty for 2006. Breaking down that penalty, it included a $10,000 penalty for each of Mr. Hom’s three online accounts.

For 2007, the IRS asserted a $10,000 penalty, relating only to Mr. Hom’s PokerStars account. Interest and penalties continued to accrue.

INTEREST IN “A BANK, SECURITIES, OR OTHER FINANCIAL ACCOUNT”

The two issues decided by the court were as follows. First, whether the accounts with the three entities (FirePay, PokerStars, and PartyPoker) were “bank, securities or other financial account[s]” that had to be reported on an FBAR. And second, whether any, or all, of the accounts was in a foreign country. The Court answered both questions in the affirmative.

With respect to the first issue, the Court of Appeals for the Fourth Circuit previously held that an account with a financial agency was a financial account under Section 5314. Under Section 5312(a)(1), “financial agency” could be mean one of two things: (1) a “person acting for a person” as a “financial institution” or (2) a person who is “acting in a similar way related to money.” Section 5312(a)(2) lists 26 different types of entities that may qualify as a “financial institution.” Based on how broad this definition was, the Court of Appeals for the Ninth Circuit held that “the term ‘financial institution’ is to be given a broad definition.”

The government argued that FirePay, PokerStars, and PartyPoker were all financial institutions because they were the functional equivalent of “commercial bank[s].” The Federal District Court agreed. In doing so, it relied on the case of United States v. Clines, 958 F.2d 578, 581 (4th Cir. 1992) as persuasive precedent. In Clines, the fourth circuit court of appeals reasoned that “[b]y holding funds for third parties and disbursing them at their direction, [the organization at issue] functioned as a bank [under Section 5314].”

In the same way that the organization in Clines functioned as a bank by holding funds for its clients and distributing them at their direction, the Federal District Court in Hom reasoned that FirePay, PokerStars, and PartyPoker functioned as banks. Therefore, Mr. Hom should have filed an FBAR to report all three online accounts.

THE FINANCIAL ACCOUNT IS IN A FOREIGN COUNTRY

Both the government and Mr. Hom had radically different interpretations for the term, “located in.” The government, taking an expansive view, argued that “located in” meant the location of the financial institution that created and managed the account. Mr. Hom argued that “located in” referred to where the funds were physically located. In other words, if the funds sat in an account in a bank located in the U.S., they were domestic. But if they sat in an account in Sri Lanka, they were offshore. Evidence that PokerStars had dozens of bank accounts in the United States allowed Mr. Hom to argue that “there is a real possibility that [his] funds are in an American bank.”

Unfortunately for Mr. Hom, the Court adopted the government’s interpretation. At the same time, it held that where PokerStars, FirePay, or PartyPoker opened their bank accounts was meaningless. Why? The Court reasoned that the accounts belonged to the online poker websites, and not to Mr. Hom. Rather, Mr. Hom’s accounts were “digital constructs that these financial institutions, all located outside of the United States, created and maintained on his behalf.”xix

For example, FirePay was “located in and regulated by the United Kingdom.”xx PokerStars and its parent company, Rational Entertainment Enterprises Ltd., were “licensed and regulated by the government of the Isle of Man.”xxi And PartyPoker and its parent company, PartyGaming, were “licensed, regulated, and headquartered in Gibraltar.”xxii The Court held that these were the locations of Mr. Hom’s electronic accounts — and not where these companies happened to “place their own funds.”xxiii

To summarize, the Court reasoned that since PokerStars, FirePay, and PartyPoker were all licensed and operated in foreign countries, Hom’s online accounts were created and maintained in these foreign countries. Therefore, the Court held that the accounts in which John Hom “held an interest were all located in foreign countries.”xxiv

A deeper look into the first issue reveals an interesting discovery. The court based its holding upon a fair interpretation of the statute. While most people would not think of an online poker company as being a financial institution, it is not outside the realm of possibility to believe that it could function in that way. Ironically, for as deep an analysis as the court engaged in, it can be summed up in a one-sentence idiom: “If it looks like a duck, swims like a duck, and quacks like a duck, then it’s probably a duck.”

So, at a primitive level, the Court employed the “duck test” to reject Mr. Hom’s argument that his online poker account was not a financial account under 31 C.F.R. 103.24 that triggered an FBAR reporting requirement.

In fairness, it would be impossible to overlook at least one glaring difference between online gambling accounts and financial accounts. And that has to do with the way in which online gambling accounts are marketed. Specifically, they are not marketed as the equivalent of financial accounts – such as a run-of-the-mill savings or checking account – where the main goal is to invest and protect assets.

On the contrary, online gambling accounts exist to facilitate gambling. Nonetheless, as the court reasoned, they had attributes that resembled financial accounts – namely, they accepted deposits and allowed customers to withdraw money.

This raises a number of interesting questions.  For example, when is an insurance policy issued by a foreign insurer a financial account When is a lawyer’s trust account in an offshore location a financial account?

Endnotes:

xix FBAR Penalty Applies To Offshore Poker Account, Forbes, Rettig, Charles, 6/19/2014, available at http://www.forbes.com/sites/irswatch/2014/06/19/fbar-penalty-applies-to-offshore-poker-account/

xx Id.

xxi Id.

xxii Id.

xxiii Id.

xxiv Id.