APA Offers No Avenue For Relief For Challenge to Offshore Transition Rules Penalty Regime

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Harrison v IRS, a recent opinion from the federal district court for the District of Columbia, nicely explains the relationship between the tax refund process, the Anti Injunction Act (AIA) and the Administrative Procedure Act (APA). For good measure it also illustrates the uphill battle facing challenges based on violations of procedural due process. 

Harrison and spouse Sprinkle had lived abroad and maintained an undisclosed Swiss bank account. Like many with undisclosed assets and income they entered the Offshore Voluntary Disclosure Program (OVDP).  IRS established OVDP in 2009, which allowed for the payment of a single miscellaneous penalty. In 2014, IRS implemented “Streamlined Domestic Procedures” (SDP) for individuals with unreported foreign accounts who were not in the OVDP plan and who certified that the failure to previously report their accounts was “non-willful. The SDP allowed for a lesser penalty rate than OVDP. IRS, through a FAQ, also established transition rules for people, like Harrison and Sprinkle, who were in OVDP but who wanted to transition to SDP. Unfortunately for Harrison and Sprinkle, IRS determined that their conduct was willful and thus they were not eligible for SDP. Following the denial of their application to SDP, they paid over $500,000 in back taxes and penalties as part of the OVDP. This led to their executing a closing agreement where they agreed that they would not file a refund suit. 

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About two years after signing the closing agreement and paying the penalty and back taxes, they filed a suit challenging the IRS’s transition rules, claiming 1) that their promulgation without notice and comment violated the APA, 2) that the application of the transition rules to their circumstances violated the APA because it was arbitrary and capricious, 3) that the absence of procedural protections in the transition rules violated due process, and 4) that the closing agreement should be voided because they signed it under duress.

The government filed a motion to dismiss the suit. 

The opinion dealt with the APA claims first. The government argued that the court did not have jurisdiction to hear those claims because the FAQ was not final agency action and in any event the taxpayers had an alternative path to challenge the rules. The opinion did not reach the final agency action issue as it held that they had an alternate remedy via a refund suit. (Side note: in Scholl v Mnuchin, involving a similar APA challenge to the IRS’s illegal use of FAQs to bar the incarcerated from receiving pandemic relief/EIPs, a district court in CA held that the FAQ in that instance was final agency action, a conclusion buttressed by statements from Chief Counsel that the FAQs were all the guidance IRS would issue on the topic; see a post from Keith with a link to the district court’s order here).

One of the requirements for a court’s subject matter jurisdiction under the APA is that there is no adequate other remedy at law. The DC Circuit, like other courts, has held that a refund proceeding provides a cause of action for the recovery of taxes (and penalties) allegedly unlawfully or illegally collected.  As such, absent the closing agreement, Harrison and Sprinkle could have brought their APA claims in a refund proceeding.  But that that they entered into a closing agreement forbidding the filing of a refund suit did not mean that they had no other adequate remedy. As the court explained at note 4 “that Harrison and Sprinkle relinquished their right to file a refund suit by entering the Closing Agreement does not affect whether “no other remedy exists…. Parties cannot waive their way into federal jurisdiction where Congress has not granted it.” In other words, the closing agreement’s terms preventing them from filing a refund suit did not mean that that there was no adequate remedy at law. They could have brought their APA claims in a refund proceeding if they chose to not participate in the OVDP and agreed to pay whatever tax and penalty that awaited them following examination. They then could have filed a refund suit for the difference between the liability determined and what would have been owing under the streamlined procedures.

In finding that the refund procedures were an adequate remedy, the opinion notes that while Harrison and Sprinkle were asking the court to provide declaratory relief they were effectively asking for a refund.  Longtime readers of PT and other tax procedure nerds at this point might wonder why the government did not raise the AIA and Declaratory Judgment Act (DJA) as separate grounds for a bar to the suit. In fact, in Maze v IRS, a case I discussed in Important DC Circuit Opinion on Anti-Injunction Act and Offshore Disclosure Regime, the DC Circuit relied on the AIA and DJA to dismiss a similar challenge to the transition rules. The difference in this case, however, is that the taxpayers had fully paid the taxes and penalty, whereas in Maze the taxpayers had not fully paid the taxes and penalties. Yet the AIA analysis is instructive, because the AIA does not bar a suit if there is no adequate remedy at law, a similar inquiry under the APA. As the DC Circuit in Maze held that the refund procedures were adequate for AIA purposes, it was an easy leap for the district court to consider the same procedures adequate for APA purposes.

The opinion gave relatively short shrift to the argument that the closing agreement should be invalidated due to duress. The argument that Harrison and Sprinkle made was that the IRS’s denial of their request to use the transition rules amounted to their holding a sword of Damocles over their heads: 

The couple argues that their execution of the Closing Agreement was the improper product of duress because the “alternative [to signing] would be to face an examination with the prospect of devastating penalties by the same agency that already found [that they] willfully violated the law.”

That was not enough to rise to the level of duress. Informing a party about the possibility of legislatively mandated penalties is “no more coercive than informing a counterparty of the potential outcomes of litigation.”  While the IRS had rejected the couples’ non-willful certification if they had opted out of the OVDP and succeeded in later convincing the IRS or a court that their conduct was non-willful they would have paid substantially less. 

The opinion also rejected the claim that the transition procedures violated their procedural due process rights. The argument that the taxpayers made was that the same procedural infirmities that were underlying the claim that the rules violated the APA amounted to a constitutional infirmity under procedural due process principles. In rejecting that argument, the court acknowledged that under cases like Mathews v Eldridge, courts traditionally employ a test that weighs (1) “the private interest that will be affected by the official action;” (2) “the risk of an erroneous deprivation of such interest through the procedures used, and the probable value, if any, of additional or substitute procedural safeguards;” and (3) “the Government’s interest, including the function involved and the fiscal and administrative burdens that the additional or substitute procedural requirement would entail.” Usually, as the court notes, this requires a right to a pre-deprivation hearing. Pointing to cases that have treated tax as exceptional in procedural due process claims (a line of cases I discuss in a recent essay published in the Pittsburgh Tax Review issue highlighting Nina’s time as NTA), the court held that the ability to access post deprivation refund proceedings was constitutionally sufficient, and not a denial of due process.

Conclusion 

The upshot of this case is that the IRS’s actions and rules that it published in the FAQ are immune from judicial challenge under the APA. The needle can still be thread: if someone else  has fully paid and is not subject to a closing agreement they could bring a refund suit in federal court and get a court to consider the merits of the APA challenge. 

It of course is somewhat odd to think of an FAQ as a rule for APA purposes. Yet a “rule,” is defined rather broadly to include any “agency statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy or describing the organization, procedure, or practice requirements of an agency.”  Whether the rule is subject to notice and comment requirements, as Harrison and Sprinkle claimed, will have to wait another litigant. 

The case also highlights one of the big policy issues at play in the upcoming CIC Services v IRS case in the Supreme Court.  Will CIC Services, as some have argued, open the door for pre-enforcement challenges to rulemaking? Or will litigants like Harrison and Sprinkle continue to have to shoehorn APA claims into existing tax enforcement proceedings?

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

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