Like the First Amphibian Crawling Out of the Swamp onto Land, the Flora Rule Emerges from Title 26 to Possibly Infest Title 31

The case of Bedrosian v. United States, No. 17-3525, __ F.3d __, 2018 U.S. App. LEXIS 36146 (3rd Cir. Dec. 21, 2018) marks the possible jurisdictional cross-over of the Flora rule from the tax code into the broader reaches of the United States Code. This is not good news for individuals seeking to contest the application of the FBAR penalty – the penalty at issue in this case – or other liabilities with ties to taxes. For a discussion of the case and links to several of the documents filed in the case, look at the blog post by Jack Townsend. In addition to Jack’s excellent post which you should read for a fuller understanding of the issue here, I wish to acknowledge the assistance of Carl Smith and Christine Speidel in writing this post. While we regularly circulate the posts prior to publication, I reached out with a special request for help on this one due to my lack of knowledge about the technical workings of the FBAR provisions.

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The FBAR penalty arises from 31 U.S.C. 5314 and the following sections. The Third Circuit described the penalty as follows:

The Secretary has implemented this statute through various regulations, including 31 C.F.R. § 1010.350, which specifies that certain United States persons must annually file a Report with the IRS. Covered persons must file it by June 30 each year for foreign accounts exceeding $10,000 in the prior calendar year. 31 C.F.R. § 1010.306(c). The authority to enforce the FBAR requirement has been delegated to the Commissioner of Internal Revenue. Id. § 1010.810(g); see also Internal Revenue Manual § 4.26.1, Ex. 4.26.1-3 (U.S. Dep’t of Treasury Memorandum of Agreement and 4 Delegation of Authority for Enforcement of FBAR Requirements).

The civil penalties for a FBAR violation are in 31 U.S.C. § 5321(a)(5). The maximum penalty for a non-willful violation is $10,000. Id. § 5321(a)(5)(B)(i). By contrast, the maximum penalty for a willful violation is the greater of $100,000 or 50% of the balance in the unreported foreign account at the time of the violation. Id. § 5321(a)(5)(C)(i).

The amount of the penalty imposed on individuals who the IRS determines willfully violated the provision makes the FBAR penalty potentially similar to the IRC 6707 penalty at issue in United States v. Larson, __ F.3d __ (2nd Cir. 2018) which we discussed here and here. The IRS assessed a willful FBAR violation penalty against Mr. Bedrosian of $975,789. While that is only a small fraction of the amount assessed against Mr. Larson and “only” 50% of the amount in the foreign bank account for the year he failed to report the account, this amount still presents a high bar for entry into court to litigate the correctness of the application of the penalty.

To understand how Mr. Bedrosian came to be in front of the Third Circuit, a short review of FBAR assessment and collection procedures may be helpful. When the IRS determines that someone has failed to properly report a foreign bank account, it does not send a notice of deficiency for this Title 31 violation. It makes a summary assessment. The “person” (not “taxpayer”) is given the opportunity to go to appeals before FBAR assessment. See IRM 4.26.17.4.6 (01-01-2007) Closing the FBAR Case Unagreed. See also IRM 4.26.17.4.7 (01-01-2007) Closing the FBAR Case Appealed, and IRM 8.11.6 FBAR Penalties (appeals procedures). There are also special procedures for FBAR examinations.

Not surprisingly, the IRM reflects in several ways the government’s position that FBAR penalties are not tax penalties subject to Title 26 requirements and norms. For example, Form 2848 can only be used to appoint a representative for an FBAR exam if there is a related income tax examination. If there is not, a representative must provide a general POA valid under state law. See IRM 4.26.8.2.

The collection process for FBAR cases does not follow the normal IRS practice for collection either. For a detailed discussion of collection of an FBAR penalty you might review the slide program to which Jack Townsend mentions. The program was presented at the May, 2018 ABA Tax Section meeting.

The FBAR regulation says that IRS has been delegated collection authority as well as assessment authority. 31 CFR 1010.810(g). However, the IRM on collection explains that while “authority to collect” has been delegated,

[IRS] Collection is not delegated any enforcement authority with respect to FBAR penalties. … The Bureau of Fiscal Service (BFS), formerly Financial Management Service (FMS), which is a bureau of the Department of the Treasury, is responsible for collecting all non-tax debts. This includes FBAR penalties.

IRM 5.21.6, Foreign Financial Account Reporting. There is nothing in the IRM about BFS collection procedures or requirements.

One might wonder if FBAR penalties can be compromised. The IRS position is that FBAR assessments cannot be compromised through the Offer in Compromise program “because the assessment is based on Title 31 violations and IRC § 7122 allows the IRS to compromise only Title 26 liabilities.” IRM 5.8.1.9.6 (05-05-2017). The Third Circuit, however, rejects this simple and clear distinction.

Mr. Bedrosian decided to pay 1% of the assessed liability, or $9,757, and bring a suit for recovery of that amount in district court under the Little Tucker Act.  The Tucker Act (28 U.S.C. sec. 1491(a)(1)) allows the Court of Federal Claims to hear suits against the United States founded upon a contract, the constitution, or a statute, without limitation as to amount.  The Little Tucker Act (28 U.S.C. sec. 1346(a)(2)) allows similar suits in district court, but only where the amount involved does not exceed $10,000.  Flora held that a tax refund suit under 28 U.S.C. sec. 1346(a)(1) (i.e., not the Little Tucker Act) can only be brought in the district court or the Court of Federal Claims after full payment of the tax in dispute.  Section 1346(a)(1) applies to suits brought for refund “under the internal -revenue laws”.  Neither party brought up the Flora rule as a jurisdictional hurdle here.  The Department of Justice counterclaimed for the balance of the liability rather than moving to dismiss the case for lack of jurisdiction, as it did in Larson, because it believed that the district court had jurisdiction to hear the case under the Little Tucker Act.  The district court did not raise Flora as a possible jurisdictional bar to the litigation.  The Flora issue emerged, sua sponte, from the Third Circuit at oral argument.  The court asked the parties to submit letter memoranda on the district court jurisdictional issue after the oral argument occurred. Jack Townsend’s post linked in the first paragraph above provides the links to the memoranda submitted to the Third Circuit on this issue.

Here is what the Third Circuit says in a footnote about the Flora issue:

The parties’ argument that Bedrosian’s claim is not within the tax refund statute is premised on the notion that the phrase “internal-revenue laws” in 28 U.S.C. § 1346(a)(1) refers only to laws codified in Title 26 of the U.S. Code. But that argument does not follow the statutory history of the tax refund statute, which suggests that “internal-revenue laws” are defined by their function and not their placement in the U.S. Code. See Wyodak Res. Dev. Corp. v. United States, 637 F.3d 1127, 1134 (10th Cir. 2011). The argument also ignores the Tax Court’s rejection of the proposition that “internal revenue laws are limited to laws codified in [T]itle 26.” See Whistleblower 21276–13W v. Comm’r, 147 T.C. 121, 130 & n.13 (2016) (noting that “the IRS itself acknowledges that tax laws may be found outside title 26”). We also observe, by analogy, that claims brought by taxpayers to recover penalties assessed under 26 U.S.C. § 6038(b) for failing to report holdings of foreign companies—a statute nearly identical to the FBAR statute, except addressing foreign business holdings rather than foreign bank accounts—are brought under the tax refund statute, 28 U.S.C. § 1346(a)(1). See Dewees v. United States, 2017 WL 8185850, at *1 (Fed. Cir. Nov. 3, 2017). Also, allowing a taxpayer to seek recovery of a FBAR penalty under the Little Tucker Act permits that person to seek a ruling on that penalty in federal district court without first paying the entire penalty, as Bedrosian did here by paying just under the $10,000 Little Tucker Act threshold. This violates a first principle of tax litigation in federal district court—“pay first and litigate later.” Flora v. United States, 362 U.S. 145, 164 (1960). We are inclined to believe the initial claim of Bedrosian was within the scope of 28 U.S.C. § 1346(a)(1) and thus did not supply the District Court with jurisdiction at all because he did not pay the full penalty before filing suit, as would be required to establish jurisdiction under subsection (a)(1). See Flora, 362 U.S. at 176–77. But given the procedural posture of this case, we leave a definitive holding on this issue for another day.

Having raised Flora as a possible jurisdictional defect to the suit, the Third Circuit decides that because the IRS filed a counterclaim the district court (and it) clearly have jurisdiction to hear the case. It decides not to make a definitive ruling on the application of Flora to FBAR cases. Maybe no other court will take the bait and after a few faltering footsteps on land the idea of applying Flora to provisions outside of Title 26 will head back to the swamp not to emerge again. Still, Bedrosian raises the specter of the extension of Flora yet again to matters never intended by the Supreme Court or anyone else when that Court ruled 5-4 on the shaky legal basis presented 60 years ago. Let’s hope that Bedrosian does not signal a new expansion of a doctrine that needs to be contracted and not expanded.

Bedrosian also presents a case involving the appropriate standard for review and the appropriate standard for willfulness in an FBAR case. The appeals court decides that the appropriate standard of review of the factual finding from the bench trial (that Mr. Bedrosian’s conduct was not willful) is to review the determination for clear error. However, the court must still correct any errors in the district court’s legal analysis. It decides that the appropriate standard for willfulness in an FBAR case mirrors willfulness in other contexts:

In assessing the inquiry performed by the District Court, we first consider its holding that the proper standard for willfulness is “the one used in other civil contexts—that is, a defendant has willfully violated [31 U.S.C. § 5314] when he either knowingly or recklessly fails to file [a] FBAR.” (Op. at 7.) We agree. Though “willfulness” may have many meanings, general consensus among courts is that, in the civil context, the term “often denotes that which is intentional, or knowing, or voluntary, as distinguished from accidental, and that it is employed to characterize conduct marked by careless disregard whether or not one has the right so to act.” Wehr v. Burroughs Corp., 619 F.2d 276, 281 (3d Cir. 1980) (quoting United States v. Illinois Central R.R., 303 U.S. 239, 242–43 (1938)) (internal quotation marks omitted). In particular, where “willfulness” is an element of civil liability, “we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well.” Fuges v. Sw. Fin. Servs., Ltd., 707 F.3d 241, 248 (3d Cir. 2012) (quoting Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 57 (2007)). We thus join our District Court colleague in holding that the usual civil standard of willfulness applies for civil penalties under the FBAR statute.

This is an important case for those practicing in the FBAR area. The Flora issue raises the possibility of expansion in a way that could make it much more difficult for individuals challenging an FBAR assessment. The discussion of willfulness provides some clarity that litigants may find useful.

 

Jurisdiction in the Court of Federal Claims and FBAR Cases

Yesterday, in Paying the Full FBAR Penalty, Keith discussed the Court of Claims opinion in Norman v US, which upheld an FBAR penalty and disagreed with district court opinions in Colliot and Wadhan concerning the intersection of the FBAR regs and the statute.  Keith’s post flags an important split in views concerning the intersection of regs, which cap the penalty at $100,000, and the later-enacted statute, which provides that the maximum penalty “shall be increased” to the greater of $100,000 or 50% of the account.

Keith notes that the case was tried in the Court of Federal Claims; most of the cases concerning FBAR penalties have arisen in federal district courts. There is a side jurisdictional issue in the case, and one of the reasons for the delay between the complaint being filed and the outcome Keith discussed is that the government initially argued in Norman that only federal district courts could hear FBAR cases.

Here is the statutory context of the dispute.

Title 28 Section 1355 states that “district courts shall have original jurisdiction, exclusive of the courts of the States, of any action or proceeding for the recovery or enforcement of any fine, penalty, or forfeiture, pecuniary or otherwise, incurred under any Act of Congress, except matters within the jurisdiction of the Court of International Trade under section 1582 of this title.”

The Tucker Act is also found within Title 28 and waives the federal government’s sovereign immunity from suit and authorizes monetary claims “founded either upon the Constitution, or any Act of Congress, or any regulation of an executive department, or upon any express or implied contract with the United States, or for liquidated or unliquidated damages in cases not sounding in tort.”  The Court of Federal Claims has trial court jurisdiction over “Big” Tucker Act claims against the United States; district court and the Court of Federal Claims have concurrent jurisdiction over claims for $10,000 (so-called Little Tucker Act claims)

In 2016, the government argued in effect that the Tucker Act was preempted by Section 1355 and sought to dismiss Norman’s complaint; the Court of Federal Claims disagreed, finding that 1355 was not meant to give district courts jurisdiction in all penalty cases and also finding that the FBAR penalties in Title 31 did not reflect a “specific and comprehensive scheme for administrative and judicial review” which could also displace its jurisdiction under the Tucker Act.

The 2016 Norman opinion discusses a handful of cases applying 1355 that limit the Court of Federal Claims’ jurisdiction; ultimately it distinguished those cases from Norman as relating to either forfeiture cases or criminal cases.  There is a bit more to the issue, including a 9thCircuit case that suggests that 1355 is only meant to apply when the government is reducing a penalty to judgment. The 2016 Norman opinion did note that there was tension between Section 1355 and the Tucker Act, and substantial ground for difference of opinion in its view that the CFC had jurisdiction, leading it to conclude that the government could file an interlocutory appeal on the jurisdictional issue, which would have allowed for an appellate opinion on that issue before a trial on the merits.

That appeal never came, as the government abandoned its jurisdictional defense. While the government lost the battle in 2016, as Keith discussed, it won the war of the case—at least for now. One expects that Mrs. Norman may try her luck for an appellate review on the merits of the penalty, and see if the panel agrees with the two district court judges that have capped the penalty in line with the regulations. In addition, if Norman appeals one suspects that the circuit court may take a fresh look at the jurisdictional issue.

 

Paying the Full FBAR Penalty

Few penalties have the bite of the FBAR penalty. As the IRS obtained more information and more sophistication in locating foreign bank accounts, it offered taxpayers who had used such accounts the opportunity to limit their civil and criminal exposure through a series of Offshore Voluntary Disclosure Initiatives (OVDI and its cousin OVDP). We have discussed OVDI and OVDP in previous posts here and here. Les wrote about a non-wilful FBAR case here.

The Court of Federal Claims recently rendered an opinion in Norman v. United States, No. 1:15-cv-00872 (July 31, 2018) finding the taxpayer liable for the 50% penalty imposed by 31 U.S.C. 5314. The 50% penalty means that Ms. Norman owes the IRS half of the money in her foreign bank account which makes the FBAR penalty one with an enormous bite. Jack Townsend’s blog covers FBAR issues extensively and is a much better source than PT on this issue. As usual, he wrote about this case the day after it came out and his post can be found here. The Norman case has importance not only because the court finds her conduct willful but also because the court addresses the application of the regulations. For that reason, it deserves mention in PT where we spend relatively little time writing about foreign bank accounts.

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In October, 2013, the IRS assessed an FBAR penalty against Ms. Norman in the amount of $803,530 for willfully failing to report her foreign bank account. After unsuccessfully contesting the penalty administratively, she paid it and brought a suit for refund. The IRS tried to win the case on summary judgment but the court found that the issue of willfulness required the gathering of facts in a manner not possible through summary judgment. So, a three hour trial took place in Brooklyn on May 10, 2018.

A couple of things about the trial deserve note. First, the location of the trial shows that the Court of Federal Claims regularly travels around the country for its trials to a site near the taxpayer. This is not news for those familiar with the Court of Federal Claims but for those not familiar with this court it may come as a surprise.   Second, the timing of the decision in this case vis a vis the trial stands in stark contrast to the normal time for a decision from the Tax Court. Unless decided by a bench opinion, I would not expect a Tax Court decision following a trial of this type for about a year instead of less than three months; however, it did take almost three years after the filing of the complaint in the Court of Federal Claims before the case came to trial.

In short, the court did not believe the testimony of Ms. Norman. It found her memory quite selective. It went through the elements necessary to prove a willful failure to report a foreign bank account, then through the facts she did and did not prove in order to reach the conclusion without much difficulty that Ms. Norman knew about the account and knew she should have reported it. It’s not worth going through all of the factual findings here but for those representing individuals with foreign accounts the details might matter. As Les mentioned in his post, the number of opinions coming out on this issue is relatively low. The IRS settlement initiative doubtless has resolved the vast majority of cases without litigation.

Having found a willful violation, the court then had to deal with the amount of the penalty. The taxpayer argued that the court should cap her penalty based on regulation 31 C.F.R. 1010.820 which was written under the previous version of the Bank Secrecy Act and which capped the penalty at $100,000 which would be quite a reduction from the assessment here. Taxpayer requested that the court adopt the reasoning set forth in Colliot v. United States, 2018 U.S. Dist. LEXIS 83159 (W.D. Tex. 2018), and in Wadhan v. United States, 122 AFTR2d 2018-5208 (D. Colo. 2018). In 2004 Congress amended the law to increase the penalty. Colliot and Wadhan held that the new law did not supersede the regulation promulgated under the prior statute. The Colliot district court reasoned that:

[The amendment] sets a ceiling for penalties assessable for willful FBAR violations, but it does not set a floor. Instead, 5321(a)(5) vests the Secretary of the Treasury with discretion to determine the amount of the penalty to be assessed so long as that penalty does not exceed the ceiling set by 5321(a)(5)(C).

The Court of Federal Claims found that the statement in Colliot “mischaracterizes the language of 5321(a)(5)(C), by ignoring the mandate created by the amendment in 2004.” The revised statute provided that the maximum penalty “shall be increased” to the greater of $100,000 or 50% of the account. Because Congress used the imperative, the amendment did not merely permit a higher ceiling on penalties based on the decision of the Secretary it “removed the Treasury Secretary’s discretion to regulate any other maximum.” It found Congress superseded the regulations.

In invalidating the regulations the Court of Federal Claims refused to follow precedent that could have damaged the IRS not just in FBAR cases but in other similar situations in which a revised statute did not immediately trigger a withdrawal or revision of a regulation by the IRS. Of course, the Colliot decision turned on an interpretation of the intent of Treasury in leaving the regulations on the books but it had potentially far reaching consequences for the IRS. The Norman decision does not mean the IRS has won this issue but it does mean that a court of nationwide jurisdiction has not signed on to the interpretation of one district court.  While I agree with the decision in Norman, the IRS could do itself a favor by addressing the regulation.  It seems that it has the power to avoid having to litigate this issue repeatedly.

 

 

Court Grants Government’s Motion in Limine in FBAR Penalty Trial

Last week’s order in Bedrosian v US concerns an evidentiary dispute in an FBAR case. Bedrosian is CEO of pharmaceutical company Lannett. The dispute centered around the government’s motion in limine to exclude any evidence pertaining to its administrative determination to impose penalties for willfully failing to file an annual FBAR form. The government filed its motion, arguing that the evidence pertaining to its the administrative determination was irrelevant in the court proceeding, as the court would be making a de novo review on the merits of the penalty. The court agreed with the government.

I will describe the order and give some context.

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FBAR penalties are steep, especially if the failure to file the report is willful. A willful failure to file carries a penalty of up to the greater of $100,000 or 50% of the account balance.

In Bedrosian, the penalty at issue is about $1 million for willfully failing to disclose an interest in one of two UBS Swiss bank accounts.

Bedrosian had a Swiss account for many years, which he failed to disclose to the IRS. For many years he also did not report the income from the account on his federal income tax returns. He had another more recently opened smaller UBS account, which he began disclosing on an FBAR in the 2007 tax year, though when he filed the FBAR for that smaller account he did not report its income on his 2007 federal tax return.

The account he disclosed had a value of about $230,000; the other undisclosed account was worth about ten times that. In 2008 UBS told Bedrosian that it would be turning over all account information to the IRS. In 2010, Bedrosian amended the earlier FBAR filing and filed a new FBAR showing his interest in both accounts. He also amended his income tax return to reflect the income from the accounts.

The order from earlier this year on the cross summary judgment motions discusses how Bedrosian cooperated with IRS after it began investigating him in 2011. (See Jack Townsend’s Federal Tax Crimes blog post for an excellent discussion of the earlier order and the court’s discussion of the willfulness standard; hard working Jack also beat us to this punch with a post yesterday on last week’s order here). Initially the IRS proposed to only impose nonwillful FBAR penalties; however, for reasons that are not clear the IRS reassigned the matter to another IRS agent, and that agent recommended imposing the willful FBAR penalty. IRS went ahead and proposed to impose the largest willful penalty allowed under the regs; that was just under $1M.

Bedrosian sued claiming that the penalty amounted to an illegal exaction, leading both parties to file summary judgment motions.

After denying both parties’ summary judgment motions, and with the case heading to trial, the government sought to exclude from trial the evidence pertaining to the IRS’s flip flop on its penalty determination. Last week’s order agreed with the government. In so doing the court looked to analogous case law that provides that the “thoughts and analysis, application of facts to law at the administrative level with respect to willfulness have no place in the Court’s de novo review of whether Bedrosian willfully failed to comply with the FBAR requirements.”

Bedrosian cited case law interpreting the Individuals with Disabilities Education Act (IDEA), which also has de novo review of administrative proceedings but has mandated that the earlier proceedings become part of the record in court challenges. The Bedrosian order distinguished that line of cases, as the IDEA statute specifically requires that the courts should receive records of the earlier administrative proceedings.

The key, from the court’s perspective, was that the government’s documents on its FBAR penalty determination were not relevant to its task of making an independent determination on whether Bedrosian acted willfully in failing to file the FBAR. The matter now proceeds to a trial on the merits. As there are many FBAR cases in the pipeline, and only a handful of court opinions and orders, this is an important victory for the government.

 

 

Challenging an FBAR Penalty: District Court Says APA Not the Ticket

Can a taxpayer facing an assessment stemming from a Foreign Bank Account Reporting (FBAR) penalty use the Administrative Procedure Act (APA) as a basis to challenge the penalty assessment and raise a defense like reasonable cause? A couple of years ago I discussed in District Court Punishes IRS for Failing to Justify or Explain Itself in FBAR Case, Moore v US, where a taxpayer was able to rely on the APA as a lever to expose and punish sloppy IRS conduct in assessing an FBAR penalty, including failing to explain the basis for IRS imposition of the penalty.

IRS is fighting back on allowing courts to use the APA to review (and sanction) IRS administration of the FBAR penalty. In Kentera v US a district court in Wisconsin agreed with the IRS’s sovereign immunity defense as a basis to dismiss a taxpayer claim that he and his wife were not subject to an FBAR penalty.

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The Kenteras had inherited money located in a bank account in Montenegro. The opinion states that the husband and wife disclosed the existence of the account on their income tax returns but did not file the annually-required FBAR forms. They entered the Offshore Voluntary Disclosure Initiative and amended returns to include the income from the accounts and also delinquently filed the FBARs. IRS proposed assessments of non-willful FBAR penalties on them individually for five years, with her total penalties at $10,500; and his at $40,500.

The Kenteras disagreed with the proposed penalty assessments, essentially arguing that they had reasonable cause for their failure to file due to their reliance on a tax advisor. Appeals sustained the penalties.

After Appeals sustained the penalties, they then sued in district court, arguing that because IRS wrongfully rejected their reasonable cause defense the IRS’s actions were arbitrary and capricious and thus in violation of the APA as per 5 U.S.C. § 706(2)(A).

Jack Townsend has written about Kentera at the Federal Tax Crimes blog, and he includes links to the relevant documents, including the government’s memo in support of its motion to dismiss. I suggest interested readers wanting more on this look there, but I highlight the main takeaway from the opinion: the APA does not confer jurisdiction unless there is no “adequate remedy” in another court; you get to the adequate remedy issue after final agency (IRS) action and a substantive statute (the BSA) that authorizes review. In Moore, IRS did not I recall raise the adequate remedy defense and the opinion proceeded to get to the merits of Moore’s claims that were brought under the APA (note 4 of Kentera states that the government apparently did not raise the defense in Moore).

In Kentera, the district court held that the Tucker Act, codified at 28 USC § 1491(a)(1), provided the means for a remedy in the Court of Federal Claims. That statute provides that Court of Federal Claims has “jurisdiction to render judgment upon any claim against the United States, founded either upon the Constitution, or any Act of Congress or any regulation of an executive department, or upon any express or implied contract with the United States, or for liquidated or unliquidated damages in cases not sounding in tort.”

The existence of the Tucker Act alone was not sufficient to grant the government’s motion, as Tucker does not independently grant plaintiffs like Kentera substantive rights. Taxpayers seeking to sue the government need an additional hook: a substantive source of law that provides for a monetary remedy.

The opinion concluded that the Kenteras had that monetary remedy hook in the Bank Secrecy Act itself, though not due to any explicit language but by implication:

The statute authorizes the government to impose a penalty for failure to file an FBAR, unless the failure was due to reasonable cause. 31 U.S.C. § 5321(a)(5)(B)(ii)(I). If there was no failure to file or if the failure was due to reasonable cause, there should be no penalty and any money the government receives as payment of the penalty was illegally exacted in violation of the statute. Though the BSA admittedly lacks money-mandating language, it is by necessary implication that the taxpayer has a monetary remedy—the return of his illegally exacted funds—when the statute is violated. Norman, 429 F.3d at 1095; N. California Power Agency, 122 Fed. Cl. at 116; White Mountain Apache Tribe , 537 U.S. at 477. As a result, Plaintiffs could bring their statutory and constitutional claims in the Court of Federal Claims pursuant to the Tucker Act. This, in turn, compels the Court to conclude that APA review is unavailable here, since Plaintiffs have an adequate remedy to replace it.

Parting Thoughts

The opinion also discusses the Little Tucker Act and its granting of concurrent jurisdiction to hear cases in district courts over suits against the United States for $10,000 or less founded upon “the Constitution, or any Act of Congress,…or upon any express or implied contract with the United States” and waives sovereign immunity for those claims.” That $10,000 limit is computed on a per claim basis, and since none of the separate penalty assessments exceeded $10,000, it too provided an avenue for court review separate from APA.

While the district court dismissed the case, it was without prejudice, meaning that the Kenteras still can challenge the assessments in federal court, though must pay some of the proposed penalty (illegal exaction claims do not require full payment, according to the opinion, an issue I did not separately research).

You may recall in Moore  the judge criticized IRS for its “arbitrary and capricious conduct in imposing that penalty” and prevented IRS from imposing interest on the assessment. The Kentera opinion at note 4 states that the government apparently did not raise the sovereign immunity defense in Moore. I guess (though am only speculating) that the government’s fight in Kentera to push the case away from APA may be a reaction to Moore where the district court judge relied in part on the APA to punish IRS for the way it administered the FBAR penalty.

 

Dean Zerbe Adds Insights to Whistleblower “Collected Proceeds” Tax Court Case

On August 4th, I wrote about the Tax Court’s second holding in Whistleblower 21276-13W v. Commissioner, and how the Court held that “collected proceeds” included criminal fines and civil forfeitures.   That post can be found here.  In the post, we noted that Dean Zerbe was the attorney on the prior case who successfully obtained the whistleblower award, and we assumed he was the lead attorney on this case, but the attorney of record was sealed.

Dean was one of the primary architects of the whistleblower statute, and one of the leading practitioners in this area, so it is not surprising to see him attached to these important cases.  Dean reached out to me last week and confirmed he was the lead attorney on this case also.  He also provided some feedback on the post and some of the issues we highlighted.  I’ve recreated some of Dean’s insightful comments below.  It probably goes without saying, any errors and coarse language are assuredly mine .

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I will not recreate my prior post, but will add a few excerpts to provide context to Dean’s comments.  The key issue was:

Under Section 7623(b), certain whistleblowers are entitled to mandatory awards if certain requirements are met.  That amount can be between 15% and 30% of the “collected proceeds” under (b)(1), which has a parenthetical indicating that is “(including penalties, interest, additions to tax, and additional amounts),” and the sentence further states these amounts can be “resulting from the action (including any related actions) or from any settlement in response to such action.”

As stated above, the Service took the position collected proceeds did not include criminal penalties and civil forfeitures.  The Service based this on the claim that Section 7623 should only apply to proceeds assessed and collected under the federal tax laws found in Title 26 of the United States Code.  As the fines and forfeitures here were imposed under Chapter 18, they could then not be “collected proceeds” subject to the statute; unlike the restitution, which as per 2010 law can be assessed and collected in the same manner as tax.

The Court held “internal revenue laws” were not simply those under Title 26, and included the fines and forfeitures.  This implicates FBAR penalties also, although not explicitly stated in the holding.  Dean’s thoughts on the holding generally were as follows:

I read  the case as the Court seeking to get rid of any shadows or dark corners about what is included in “collected proceeds” and not wanting to see this litigated again and again (there are a lot of these cases in the pipeline).  [My impression] is the Tax Court will not engage in hair splitting.  See page 26, “In sum, we herein hold that the phrase “collected proceeds” is sweeping in scope and is not limited to amounts assessed and collected under Title 26.”    And again on page 29, “We have already explained that ‘collected proceeds’ is a broadly defined term:  It encompasses ‘the total amount brought in’ by the Government.”   And then again, of course, the language in first paragraph of page 32.  There is nowhere to hide with those statements.

I think one of the more interesting points in this opinion (which deserves a lot of rereading) is on page 30, where the Court correctly states that the “forfeitures resulted from an administrative action with respect to the laundering of proceeds, which in turn, arose from a conspiracy to violate Section 7601 and 7206…”   Encompassing, properly, a broad linkage and again speaks to FBAR.

As to FBAR, Dean stated:

[I]t seems clear that FBAR [penalties are] encompassed by the Court’s sweeping ruling (particularly as [the holding]  fits with the discussion in the previous Section 7623(b)(5) case, as well as the reference in footnote 15 in this case to Hom – and citing that FBAR is “tax administration”).

Our readers and tax procedure enthusiasts are likely familiar with Mr. Hom.  His cases have graced our pages somewhat frequently, most recently in late July with the Ninth Circuit holding online gambling site accounts were not subject to FBAR disclosure (well done Joe DiRuzzo).  Les had a brief write up on that found here. The footnote Dean references cites to a different Hom case in the Ninth Circuit from this year, and the note states:

Ours is not the only court to note that tax laws and related laws may be found beyond those codified in title 26. The District Court for the Northern District of California in Hom v. United States, 2013 WL 5442960 … aff’d, … 2016 WL 1161577 (9th Cir. Mar. 24, 2016), stated: “[T]he issue here is whether [31 U.S.C.] Section 5314 is either an internal revenue law or related statute (either designation would make the disclosure [of taxpayer information under sec. 6103] permissible). The United States argues that [31 U.S.C.] Section 5314 is a ‘related statute’ under Section 6103 (Dkt. No. 13 at 6). This is correct. Congress intended for [31 U.S.C.] Section 5314 to fall under ‘tax administration.’”

Hammering home that FBAR penalties are likely included in “collected proceeds”.

Dean also addressed the Chevron comment from my post regarding the regulations that were not before the Tax Court case.  I highlighted (because Les pointed it out to me) that the Tax Court’s language was akin to language used when tossing a regulation under Chevron.  Dean agreed, and provided additional insight:

The language used by the Tax Court – plain language and enforce the terms – is, as you know, right in step with the language we see from Courts when they are rejecting agency regulations under Chevron.    While the Regulations are not at issue here – see footnote 9 – it is difficult to imagine the Regulations withstanding a challenge given this holding.  However, the real hope is that the administration will not appeal the decision and seize the ruling as a chance to make the correct policy decision (as you note) and embrace the commonsense decision by the Court on defining collected proceeds broadly.

Footnote 9, for those of you interested, states both parties agree the regulations are not at issue, as the decision regarding the award was rendered prior to the effective date of the regulations.

Many thanks to Dean for his comments on the case, and congratulations on a great result.

Grab Bag: FBAR and Offshore Cases Worth Highlighting

While Stephen, Keith and I are traveling, important and interesting tax procedure developments keep coming. For those who are missing their tax procedure fix, I point to two cases and other nice write ups that will give some good context.

The first is the Hom case; Mr. Hom has filled a few PT posts with varied and important tax procedure issues. In the development this week, in a nonprecedential and unpublished (but freely available) opinion the Ninth Circuit reversed in part the district court in a case involving whether online gambling sites were accounts that were required to be reported under the FBAR rules.

Jack Townsend at Federal Tax Crimes and Ed Zollars at Current Federal Tax Developments both discuss the case.

The other case that caught my eye and is one that I will be returning too is the Maze v IRS case out of the federal district court in DC. It contains an important discussion of the Anti-Injunction Act. In particular, the opinion considers whether the AIA is a bar to preventing the court from considering the taxpayer’s argument that the IRS should have used streamlined procedures rather than transition streamlined procedures.

Not surprisingly, Jack’s blog, which is the place to turn for developments generally relating to criminal tax but in particular on all offshore issues, hits the opinion hard here.

What caught my eye in the opinion is the extensive discussion of Florida Bankers and other important AIA cases, including Cohen v US, Foodservice and Lodging Inst. v Regan, and Seven-Sky v Holder. We have discussed some of those issues in PT previously. The opinion is careful to limit the openings in the AIA that some cases have revealed.

Legitimate Claim of 5th Amendment on Tax Return Should not Result in Frivolous Return Penalty

Tax Court Judge Holmes issued an order on November 6, 2015, holding that a petitioner’s claim of privilege under the 5th Amendment does not form the basis for assertion of the frivolous return penalty.  I have written before on this penalty which is imposed under IRC 6702(a)(1).  As required to implement this statute, the IRS publishes a list of frivolous positions but may assert the penalty for reasons that go beyond its own list.  Here it asserted the penalty based on one of the items on the list.  Citing the 5th amendment on a tax return is something that a tax protestor might do which is why such an assertion makes the list, but it is also something that someone with a legitimate fear of prosecution should do.  The employees at the Service Center will have a difficult time distinguishing between legitimate and frivolous assertions of the 5th amendment just looking at the return.  I suspect they generally default to presuming every assertion of the 5th amendment is a tax protestor tactic.   The Youssefzadeh case provides an example of the appropriate use of the 5th amendment privilege and the inappropriate use of this penalty.  The issue comes up in a collection due process (CDP) case which is also interesting because of the many posts we have had on when taxpayers can raise the merits of an assessable penalty in a CDP case or whether the opportunity to go to Appeals to contest the penalty bars the taxpayer from raising it in the CDP context.  For those with a subscription to Tax Notes, see Ajay Gupta’s excellent post on this case on November 17, 2015, which focuses much more on the background of the FBAR civil and criminal penalties.   Jack Townsend discusses this case as well in a good post summarizing the order in his Federal Tax Crimes blog.

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On Schedule B of his 2011 return Mr. Youssefzadeh asserted his 5th amendment right not to incriminate himself.  After the IRS assessed the frivolous return penalty, it began sending the collection notices including the notice of intent to levy.  He sent the IRS a request for a CDP hearing and raised the correctness of the assertion of the penalty in his circumstances.  The appeals officer upheld the imposition of the penalty in the determination letter and Mr. Youssefzadeh filed a Tax Court petition.  As frequently happens in CDP cases, the IRS filed a motion for summary judgment.  In a much less frequent occurrence, petitioner filed a cross motion for summary judgment.  Petitioner here had sophisticated representation from the Beverly Hills firm of Hochman, Salkin, Rettig Toscher & Perez, which many CDP petitioners do not.  Because the Court decides the case on the basis of the motions for summary judgment, the decision comes out in the form of an order rather than in the form of an opinion.

A few interesting aspects of the CDP case cause me to stop before going further with the case to comment on the proceeding.  Mr. Youssefzadeh filed his petition on June 25, 2014.  On May 27, 2015, the Court sent the notice of trial setting the trial on October 26, 2015.  The IRS did not file its motion for summary judgment until 14 months later on August 27, 2015, the last day to file a motion for summary judgment under the Tax Court Rule 121 which was revised in 2011 to prevent summary judgement motions at the last minute.  Because the case went through Appeals before the petition, the case was with Chief Counsel’s office for over 14 months before it decided to file the motion for summary judgment.  The staffing problems within Chief Counsel’s office undoubtedly contributed to the delay but this points out why CDP cases take so long to resolve.  Even though Congress seemed to expect an expedited process by giving the taxpayer only 30 days to request a CDP hearing and only 30 days to petition the Tax Court, as a practical matter those two points where the taxpayer must act quickly remain the only points during which the CDP process receives expedited treatment.  Carl Smith and I wrote about this several years ago detailing the time these cases spend in Appeals and the Court and the system does not seem to have changed.

Because petitioner lived in California at the time of filing the petition and because he contested the merits of the liability, venue for appeal in this CDP case is the 9th Circuit.  The 9th Circuit, in the case of Keller v. Commissioner is one of the Circuits that has limited the Tax Court to the administrative record in CDP cases.  Since the Tax Court is limited to the administrative record pursuant to the application of the Golsen rule, Judge Holmes issued an order on July 27, 2015, ordering the parties to stipulate to the administrative record by September 25, 2015.  I had not seen an order like this before because I do not practice in a circuit that has limited the Tax Court to the administrative record.  The order seems like a great way to cause the parties to prepare for the hearing.  I would be interested to hear how the order works.

Here the joint motions for summary judgment eliminated the need for a trial of the case.  The petitioner filed the 2011 return filling out “most of the lines in a normal fashion.”  On Schedule B where he had to report dividends and interest he did not answer some of the questions and instead invoked his 5th amendment privilege against self incrimination.  The opinion states that “the IRS warned that it would assess a frivolous return penalty against him unless he filed a return with all of the required information.”  I imagine that this warning came from the Service Center as it processed the return but that is not clear.  Whatever part of the IRS that made the request, petitioner refused to fill in the lines where he had invoked the 5th amendment.  The case sets up the issue in simple fashion because Mr. Youssefzadeh’s argument was simply that he had a valid 5th Amendment claim, he had no desire to waste the time of the IRS but also no desire to incriminate himself by putting the missing information on the return.  Does a valid assertion of the 5th amendment on the return allow the IRS to assert a frivolous return penalty or is a valid assertion of the right to not incriminate oneself also a basis for the IRS to assess a civil penalty.

To successfully assess a frivolous return penalty, the IRS must show three things: (1) the document purports to be a return; (2) the return omits enough information to keep the IRS from judging the substantial correctness of the return or appears substantially incorrect and (3) taxpayer’s position must be frivolous or demonstrate a desire to impede the IRS.  The Court quickly found the document purported by be a return.  It decided on a closer question that the return contained sufficient information.  The IRS fought over this factor arguing that the missing information was needed to determine if the tax shown on the return was correct.  The Court, however, determined that the test was not complete correctness but substantial correctness and the return met that standard.

On the third factor the IRS relied on its Notice 2010-33 implementing section 6702.  The Court acknowledged that the notice lists use of the 5th Amendment on a return as a basis for assertion of the penalty but found that the notice does not discuss the legitimate use of the 5th Amendment.  Because the tactic of using the 5th Amendment in inappropriate circumstances has been adopted over the years by tax protestors, the legitimate use of the 5th Amendment has out due to so much inappropriate use.  Relevant IRS provisions (See IRM 4.10.12.1.1(10) and 4.10.12.1.2(6)) talk about “blanket assertion of the 5th amendment.  Here, the return made a precise use of the 5th amendment with respect to certain questions but not a blanket assertion.  In Garner v. United States the Supreme Court has held that taxpayers may make a legitimate assertion of the 5th Amendment on a tax return.

Mr. Youssefzadeh argued that 31 USC 5314 and 5322 make it a crime to willfully fail to file a Report of Foreign Bank and Financial Accounts (FBAR).  The IRS could have easily used his answers to the questions he failed to answer to determine that should have filed an FBAR. The Court found that “because the lines that Youssefzadeh redacted ask for information that triggers the duty to file an FBAR and because willful failure to file an FBAR is a crime, we hold that Youssefzadeh has shown us a real and appreciable danger of self-incrimination…”  The Court, therefore, held that the penalty should not apply in his case.  This seems like the only result that does not penalize a taxpayer for the proper use of the right against self-incrimination.  Of course, Mr. Youssefzadeh has brought a lot of attention upon himself.  He may need to continue to employ his lawyers because his problems may not be over with the removal of the penalty if the IRS can identify his FBAR failure (assuming there was such a failure.)

Here the Court and the IRS allowed Mr. Youssefzadeh to raise the merits of the penalty without discussion of the Perkins case or the CDP regulation denying taxpayers the right to raise arguments where the taxpayer previously had an opportunity to go to Appeals.