Commenting on Regulations

A recent paper shines a light on the fascinating process of commenting on regulations. This year Tax Notes recognized the regulation writers at the IRS Office of Chief Counsel and the Treasury Department as the most significant tax players. Because of the 2017 legislation and the downsizing of Chief Counsel’s office due to the budget reductions over the past eight year, the attorneys there did a tremendous job under very difficult circumstances. They are very deserving of the recognition given by Tax Notes.

The recent paper, entitled “Beyond Notice-and-Comment: The Making of the § 199A Regulations” was written by Shu-Yi Oei of Boston College Law School and Leigh Osofsky of the University of North Carolina at Chapel Hill. The authors focus on the comments made to Treasury and the IRS regarding just one provision of the 2017 legislation. This provision resulted in a high volume of comments because of its nature. The paper not only looks at the volume and the substance of the comments but takes a hard look at the timing and how the timing of comments plays into the final product.

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Although I have limited experience in writing regulations and in commenting on regulations, the article was eye opening in its detail of the process of submissions. In addition to formal submission, the article also comments on the informal ways that parties can influence regulations through the scholarly and popular press, including blogs.

The authors spent a fair segment of the article chronicling the comments on section 199A made prior to the call for formal comments. They detail their effort to find the early comments. These comments do not have the same type of recordkeeping that attaches to formal comments made during the notice and comment period. Their efforts to find these comments is interesting in itself. Also interesting is the impact the early comments had on the proposed regulation. The authors note the number of times the proposed regulations refer to the comments receiving during the period prior to the call for notice and comments. This section had the greatest impact on me because it told me that players with early access have influence at the most critical time. Certainly, parties making comments on the proposed regulation have an influence but having an influence in the formation of the regulation seems even more meaningful.

Because low income taxpayers have no ability to hire lobbyists or attorneys to make their case during the process of creation of a regulation, the Pro Bono and Tax Clinic Committee of the ABA Tax Section tries to comment on legislation and other notices when the IRS puts out a call for comments. At some low income taxpayer clinics around the country, there is also an effort to comment. The article makes me wonder if we are missing an opportunity to more proactively provide our voice on the formation of rules because we generally wait for the IRS to make a request.

If you have ever participated in making comments or wondered about the process, this article will open your eyes. Thanks to the authors for great work.

Bankruptcy Decisions Impacting Taxes in 2018

We provided a year in review look at the Collection Due Process cases decided in 2018 on which we wrote. Here is a similar year in review for bankruptcy cases involving tax issues. We wrote 18 posts on bankruptcy issues involving a wide range of issues. For the most part 2018 was not a year of groundbreaking jurisprudence in the intersection of bankruptcy and taxes but cases continue to clarify certain areas not previously addressed or to supplement prior decisional law. Because it is possible to litigate the merits of a tax liability in bankruptcy as well as to eliminate the liability completely under the right circumstances, it is not possible to fully discuss tax procedure without examining the law and the case in the bankruptcy area.

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  • What is the effect of BC 523(a)(7) on the fraud penalty and how does bankruptcy impact the statute of limitations on collection?

In the case of United States v. Joel No. 3:13-cv-01102 (W.D. Ky. Oct. 18, 2018) the taxpayer committed fraud on the bankruptcy court. His bankruptcy case was reopened once the fraud was uncovered. At issue in this case is the impact of his bankruptcy case on the statute of limitations for collection.

https://procedurallytaxing.com/effect-of-a-revoked-discharge-on-the-suspension-of-the-collection-statute-of-limitations/

  • Interplay between the Federal Tax Lien and the Homestead exemption.

The bankruptcy trustee tries to use the federal tax lien to his advantage to bring property into the estate. The bankruptcy court holds that the trustee cannot step into the shoes of the IRS for the purpose of reaching property that he could not otherwise reach.

https://procedurallytaxing.com/the-federal-tax-lien-and-the-homestead-exemption/

  • Excluding pension plan from property of the estate.

Even though the Supreme Court ruled a couple of decades ago that pension plans are not included in property of the estate under BC 541, the issue of what is a pension plan remains and was addressed in this case. Here, the court holds that the taxpayers retirement plan did not qualify under ERISA and therefore the assets in the retirement account came into the bankruptcy estate for the creditors to use to satisfy their claims.

https://procedurallytaxing.com/bankruptcy-court-declines-to-exclude-retirement-plan-from-estate/

  • Tolling the Period for the IRS to obtain priority status for its claim

If the taxpayer files a prior bankruptcy case or submits an offer in compromise, the act can extend the period in which the IRS can file its claim as a priority claim. A pair of cases discuss how actions taken prior to bankruptcy can extend the statute. In the Clothier case the Assistant United States Attorney arguing the case initially, failed to fully apprise the bankruptcy court of the scope of the statute extension available which caused a motion for reconsideration and a revised opinion from the court once it understood the reach of the statute.

https://procedurallytaxing.com/suspending-the-priority-claim-period-and-an-update-on-clothier-v-irs/

https://procedurallytaxing.com/bankruptcy-court-limits-prior-supreme-court-decision-on-equitable-tolling/

  • Proper treatment of the EITC as source of funds for trustee vs taxpayer

Bankruptcy trustees regularly seek a chapter 13 debtors tax refund during the time the case is pending. The Seventh Circuit holds that the trustee does not have a right to a refund caused by the EITC if the taxpayer can show that the amount received by the taxpayer is needed for necessary expenses. Here there was evidence that the money the debtor received through the EITC tax refund allowed her to pay necessary expenses. Under these circumstances, the court did not order the debtor to pay over to the trustee the amount of the refund related to the EITC.

https://procedurallytaxing.com/proper-treatment-of-earned-income-tax-credit-in-calculating-disposable-income/

  • Who owns the refund in consolidated return cases

When some but not all members of a consolidated group go into bankruptcy the issue arises of who is entitled to refunds of the consolidated group and whether the refunds become property of the estate.

https://procedurallytaxing.com/who-owns-a-refund-consolidated-returns-and-bankruptcy-add-wrinkles-to-refund-dispute/

  • When can the bankruptcy court clawback money paid to the IRS by a fraudster

Cases regularly arise in which a party perpetrating a fraud pays taxes on the money gained by the fraud with the money fraudulent acquired. A circuit split exists on whether the bankruptcy court can clawback the money paid for the taxes in order to use it to repay the parties who lost it due to the fraudulent scheme.

https://procedurallytaxing.com/another-clawback-of-money-paid-to-the-irs/

  • The application of the voluntary payment rule in bankruptcy cases

The IRS allows taxpayers to designate the liability to which their payment will be posted if they make a voluntary payment. If the IRS levies to obtain money or otherwise obtains it involuntarily, it does not allow the taxpayer to designate how the payment will be applied. How does a bankruptcy payment fit into this scheme?

https://procedurallytaxing.com/bankruptcy-and-the-voluntary-payment-rule/

  • What happens when the IRS wrongly tells the taxpayer a debt was discharged by a bankruptcy case

Following bankruptcy many taxpayers have not spoken to their bankruptcy lawyer in a long time and rely upon the IRS determination regarding discharge. Sometimes the IRS person to whom they speak may give them wrong advice. What then?

https://procedurallytaxing.com/detrimental-reliance-on-the-irs/

  • Filing the notice of federal tax lien during the automatic stay

The stay prohibits collection action including filing the NFTL. In this case the IRS asked the bankruptcy court to lift the stay to allow it to file the NFTL and the bankruptcy court agreed to do so.

https://procedurallytaxing.com/filing-the-notice-of-federal-tax-lien-during-the-automatic-stay/

  • Must the IRS affirmatively obtain permission of the bankruptcy court before pursing post discharge collection from a taxpayer.

The IRS makes a discharge determination in each bankruptcy case in which it is listed as a creditor. When it makes the decision that a debt is excepted from discharge, it sends the case back into the collection stream. It does not seek a ruling from the bankruptcy court before doing so. One bankruptcy court challenged this practice. If the IRS must seek a ruling from the bankruptcy court in every case in which it makes a discharge determination and determines that the bankruptcy case did not discharge the taxes, the bankruptcy courts will see a definite rise in the cases on their dockets since it is common for some taxes to pass through bankruptcy without being discharged.

https://procedurallytaxing.com/does-irs-bear-the-responsibility-to-affirmatively-obtain-a-ruling-from-the-bankruptcy-court-before-pursuing-collection-after-discharge/

  • Can a taxpayer obtain a discharge on a late filed tax return

There is a serious circuit split on the meaning on the language at the end of BC 523(a) regarding late filed tax returns. These cases continue to bubble up although the pace has slowed and the tide has turned against the per se one day late rule adopted by three circuits. 2018 did not produce any groundbreaking decisional law in this area but an opinion from the 9th Circuit continued to provide a basis for court opinions on the subject of late returns.

https://procedurallytaxing.com/mr-smith-continues-to-suffer-from-his-failure-to-file-and-other-updates-on-late-filed-returns/

  • Validity of IRS claims in bankruptcy

A pair of cases examines how and when to attack IRS claims in bankruptcy. One deals with who is authorized to file the claim while the other deals with the amount of the claim.

https://procedurallytaxing.com/irs-claims-in-bankruptcy/

  • Priority claim status of unpaid individual mandate tax (penalty)

Several liabilities imposed by the IRC carry the label tax but walk like a penalty and talk like a penalty. Bankruptcy courts have determined that several such liabilities cannot result in priority status claims. It recently applied the same logic to the liability imposed by the individual mandate of the ACA.

https://procedurallytaxing.com/priority-status-of-individual-mandate-tax-obligation/

  • Dischargeability of the first time homebuyer credit

In an issue similar to the priority provision for the individual mandate, a bankruptcy court addresses the dischargeability of the credit. The similarity between to two situations is the need for the bankruptcy court to examine what type of debt is really present and whether the debt created when someone does not fulfill their obligation under the homebuyer credit provisions is tax debt or some other type of debt.

https://procedurallytaxing.com/dischargeability-of-the-first-time-homebuyer-recapture-liability/

  • Cases raising the issue of excepting a liability from discharge due to the fraud exception

Taxpayers who fraudulently evade their liability cannot obtain a discharge. A pair of cases are discussed.

https://procedurallytaxing.com/bankruptcy-cases-involving-evasion-of-payment-and-classification-of-the-failure-to-file-penalty/

  • Who can avoid the federal tax lien in a bankruptcy case

A debtor tries to avoid the federal tax lien and fails in a situation in which the trustee would have succeeded.

https://procedurallytaxing.com/avoiding-the-federal-tax-lien-securing-penalties-in-a-bankruptcy-case/

 

Ponzi Scheme Victims Seek to Defeat the Federal Tax Lien with Constructive Trust Argument

All too often a person cheating others ends up pitting the defrauded individuals against the IRS in a battle over the remaining assets of the cheater. The most recent version of this longstanding problem exists now in the Ninth Circuit case of Wadsworth v. Talmage, 123 AFTR 2d 2019-305 (911 F.3d 994), (9th Cir. 2018) (order certifying question to the Supreme Court of Oregon). On December 27, 2018, the Ninth Circuit declined to sustain the dismissal of the action by the district court and certified the issue of the meaning of a constructive trust in Oregon to the Oregon Supreme Court. Presumably, the Oregon Supreme Court’s decision on the application of constructive trusts in that state will allow the Ninth Circuit to reach a decision on whether property existed to which the federal tax lien could attach.

These types of cases put the IRS in the awkward position of taking the assets of the thief to satisfy outstanding tax debts resulting from the theft. By taking those assets, the IRS prevents the actual victims of the theft from receiving restitution. I am always pulling for the victims in these cases because it does not seem right to me that the tax authority should take the money instead of the actual victims of the theft. I have written about these types of situations previously in the bankruptcy context, here and here, in circumstances in which the issue was whether the court could order a clawback of the money from the IRS.

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The Ninth Circuit describes the basic facts regarding the use of the money fraudulently obtained from investors:

John Wadsworth and other members of the RBT Victim Recovery Trust (collectively, “the Trust”) allege that Ronald Talmage, an investment manager, began fraudulently diverting his clients’ funds in the 1990s as part of a Ponzi scheme. Members of the Trust entrusted Talmage with “over $55 million” between 2002 and 2015.

In 1997, Talmage and his first wife purchased RiverCliff for almost $1 million. The property was purchased with the proceeds of Talmage’s Ponzi scheme. From 1998 to 2008, Talmage spent over $12.5 million of entirely stolen funds to improve the property. Talmage paid his first wife $1.5 million dollars in 2005 using money “stolen . . . from . . . Trust beneficiaries” to purchase her half-interest in RiverCliff after the couple divorced. Throughout this time, Talmage resided at RiverCliff.

Unlike the debtors in the bankruptcy cases linked above in which the issue was a clawback of money paid to the IRS, here the perpetrator of the scheme also failed to pay his taxes. Because he failed to pay his federal taxes, the IRS filed a notice of federal tax lien. The lien attached to RiverCliff and all of the property owned by Mr. Talmage. The IRS brought suit to foreclose its lien on the property. The Recovery Trust sought to intervene in that action and was denied. The Recovery Trust then brought this action seeking to quiet title to the property. At the district court level the IRS succeeded in having the suit dismissed. The referral to the Oregon Supreme Court comes because the Ninth Circuit sees the possibility that under Oregon law the Recovery Trust may have a superior property interest to the lien of the IRS.

Although the priority of the federal tax lien is determined under federal law, whether the taxpayer has a property interest to which the lien can attach is a question of state law. Looking at Oregon law, the Ninth Circuit found that opinions existed supporting both the majority and minority views of constructive trust:

The rights of the legal title-holder, and of lienors such as the Government, depend on when the constructive trust arises. Under the laws of the several states, a constructive trust can arise either at the moment a purchase is made with the fraudulently-obtained funds, or at the moment a court imposes the trust as an equitable remedy. Under the majority rule, a trust arises automatically at the moment of purchase. See In re Leitner, 236 B.R. 420, 424 (Bankr. D. Kan. 1999) (“[U]nder the majority state law rule, a constructive trust arises at the time of the occurrence of the events giving rise to the duty to reconvey the property, not at the date of final judgment declaring the trust . . .”); see also RESTATEMENT (THIRD) OF RESTITUTION AND UNJUST ENRICHMENT § 55 cmt. e (2011). In states following this rule, the legal title-holder is a constructive trustee who holds no rights beyond bare legal title. For purposes of the federal tax lien statute, 26 U.S.C. §6321, property held in a constructive trustee-taxpayer’s name therefore does not “belong” to the taxpayer, and tax liens cannot attach. See, e.g., FTC v. Crittenden, 823 F. Supp. 699, 704 (C.D. Cal. 1993) (finding that an “IRS lien does not attach” to business funds that are subject to a constructive trust under California law); Mervis Indus., Inc. v. Sams, 866 F. Supp. 1143, 1147 (S.D. Ind. 1994) (finding tax liens could not attach to property whose title is held by an embezzler because Indiana law “is clear” that “an embezzler, from the beginning, acquires no beneficial ownership in property purchased with stolen funds”).

Under the minority rule, a constructive trust arises only once it is imposed as a judicial remedy. In that case, the legal title-holder retains all the rights of a property owner until such a remedy is imposed by a court. Until that time, the property “belongs” to the title-holder for purposes of 26 U.S.C. § 6321 and federal tax liens against the title-holder can attach. If no court has imposed a trust when the tax liens attach, the beneficiaries of a potential constructive trust hold at most an inchoate claim to the property. For example, in Blachy v. Butcher, 221 F.3d 896, 905 (6th Cir. 2000) (quoting Soo Sand & Gravel Co. v. M. Sullivan Dredging Co., 244 N.W. 138, 140 (Mich. 1932)), the Sixth Circuit found that “[u]nder Michigan law, a ‘constructive trust is strictly not a trust at all, but merely a remedy administered in certain fraudulent breaches of trusts.’” Because “a constructive trust does not arise until a judicial decision imposes such a trust under Michigan law,” beneficiaries of the trust alleged in that case held only an inchoate state-created lien, over which an attached federal tax lien takes priority. Id.

Because state law controls a critical question concerning the competition between the parties due to the issue of what property interest in the taxpayer held, the Ninth Circuit correctly certified the question to the Oregon Supreme Court. The specifics of Oregon law may impact few readers but the issue of constructive trust and the ways that states have construed ownership in these situations has broad application. The lawyers for the trust have done a great job of keeping the case going in the face of significant adversity after being rebuffed in their effort to intervene and being dismissed in the quiet title action. They have one more hurdle to leap before the defrauded investors (and probably the lawyers themselves) have a chance at using the value of the property purchased by Talmage to satisfy their claims.

Ninth Circuit Affirms Earlier Decisions Denying Debtor Right to Alter IRS Lien after Bankruptcy

On November 7, 2017, I posted on the case of In re Nomillini in which the debtor sought to limit the secured claim of the IRS based on the confirmation of his chapter 13 plan. The Ninth Circuit, in an unpublished opinion dated December 18, 2018, denied the debtor’s motion to cut off the rights of the IRS lien in debtor’s property. Here, the debtor’s plan did not seek to limit the rights of the IRS as a secured creditor. The court relied on the normal rule that a lien against a debtor passes through the bankruptcy unaltered absent a specific attack on the lien as a part of the bankruptcy proceeding.

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The Ninth Circuit stated the general rule as follows:

For a debtor to avoid a creditor’s lien or otherwise modify the creditor’s in rem rights, the debtor’s confirmed plan must do so explicitly and provide the creditor with adequate notice that its interests may be impacted. Id. at 873. Any ambiguity in the plan will be interpreted against the debtor. Id. at 867.

Mr. Nomillini did not mention the IRS lien in his chapter 13 plan. He gave no notice to the IRS during his bankruptcy proceeding that he sought to reduce or eliminate its lien on his property. He sold his home. He entered into an agreement with the IRS that its lien would attach to the proceeds. The sale of the home brought a greater price than anticipated by the IRS when it filed its original lien. Based on the sale price, the IRS amended its claim to increase the amount of its lien claim to match the proceeds. Mr. Nomillini sought to limit the IRS lien claim to the amount of the original claim. He then brought an action seeking to avoid the IRS lien to the extent that it exceeded the original claim. The lower courts dismissed the case and the 9th Circuit affirmed.

Lien claims not only pass through bankruptcy unimpacted (absent a specific challenge) but the amount of a lien claim can change during or after a bankruptcy as the value of the property increases or decreases. When the IRS filed its original claim in this case, it had to value its lien claim and claim any portion not covered by equity in Mr. Nomillini’s property as an unsecured claim. Here, the value of the secured property turned out to be low either because the IRS made a wrong determination at the outset or because the property continued to increase in value. In either event the debtor does not receive a windfall because of the low value in the initial claim.

Once the property was sold, the value of the property was set and the IRS amended its claim up to the amount of the sales proceeds. The Ninth Circuit joins the lower courts in determining that the IRS has the right to do this. Had the property sold for less than the amount of the lien claim that the IRS made, the value of the lien claim would have decreased rather than increased. For this reason creditors often seek to protect themselves from a downward movement of value in secured property by seeking adequate protection. The IRS does not do this often because of the time involved to seek adequate protection and, in cases in which its lien is secured by real property, because of the difficulty in proving that the property will decrease in value.

The case resolves the issue in a manner consistent with existing law. The lesson here is that the value of a lien claim is not fixed at the time of filing bankruptcy.

FOIA Suit Seeking Trump’s Returns Fails

Over the past two plus years we have written four posts about Mr. Trump’s returns here, here, here and here. A good argument could be made that this is four posts too many; however, the recent decision of the DC Circuit in a FOIA case seeking those returns brought by the Electronic Privacy Information Center (EPIC) provides an opportunity to go beyond speculation about obtaining those returns and focus on how, in the interaction between FOIA and IRC 6103, the law does not permit third parties to use FOIA as a means of obtaining the returns or return information of others. In the course of ruling on this case the DC Circuit sets the IRS straight on the appropriate standard to apply to those making a FOIA request.

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Shortly after the 2016 election EPIC submitted a FOIA request to the IRS seeking the tax returns of Donald Trump for the years 2010 and forward. It also sought “any other indications of financial relations with the Russian government or Russian businesses.” Not surprisingly, the IRS declined to comply with the request. In declining the IRS provided two reasons: 1) the requested “documents, to the extent that any exists, consist of, or contain the tax returns or return information of a third party,” which “may not be disclosed unless specifically authorized by law” and 2) the IRS rules require consent of the third party when a request is made for their tax return. Because the IRS rules require the consent of the third party when a return is requested, the IRS did not even process the FOIA request.

EPIC submitted a second request trying a slightly different tack by citing to IRC 6103(k)(3). This provision allows the IRS to disclose return information to correct a misstatement of fact if correcting the misstatement is necessary to a tax administration purpose. This provision also requires that the IRS obtain the approval of the Joint Committee on Taxation before making a disclosure. The IRS responded to EPIC’s second request by notifying it that the second request also did not cite a basis for turning over to it the returns of President Trump. The IRS concluded this letter by notifying EPIC that it would not process any further requests from it on this topic.

EPIC brought suit seeking relief under both FOIA and the Administrative Procedure Act. The district court dismissed the suit and the DC Circuit affirmed the dismissal but in doing so provided some clarity regarding the reason for denying the request. The circuit court explained the interplay between FOIA and the IRC. It provided an explanation for how and when tax records stand outside the type of government record that can be obtained through a FOIA request. It noted, however, that the district court denied the request for failure to exhaust administrative remedies. That basis for dismissal was wrong but even though it was wrong other reasons for dismissing the case existed making the decision to deny the requested relief correct.

The court points out that this is not an ordinary exhaustion of remedies case where the litigant rushes to court without giving the agency the chance to consider the argument. Here, EPIC tried to get the IRS’ attention and got pushed away. The IRS argues that because EPIC’s request violated its published rules for considering a FOIA request by not obtaining President Trump’s permission to seek his tax returns EPIC did not exhaust the available administrative remedies. This is an interesting interpretation of the exhaustion doctrine which views the requester’s failure to do the impossible, obtain permission from a party who does not want to consent, as a failure to exhaust remedies.

According to the DC Circuit, the IRS “misunderstands its FOIA disclosure obligations. FOIA unambiguously places on an agency the burden of establishing that records are exempt.” To prevail, the IRS cannot rely on a perceived failure by the requester but must show that the information sought is subject to the IRC 6103(a) bar on disclosure. Although the Court agrees with the IRS that it can create published rules regarding the procedures to follow in making a request, the Court disagrees with the IRS that those rules can substantively shift the burden from the agency to the requester regarding the basis for denying the request. Here, “[n]one of the purposes of exhaustion supports barring judicial review of EPIC’s claims.” Still, the IRS has the ability to show that EPIC should not receive the requested documents by making a showing on the merits of the applicable statutes – which it does.

The scope of IRC 6103 in protecting taxpayer records is broad but is still limited in scope. The court notes that “[n]ot all IRS records constitute tax returns or return information.” It cites as an example of material not covered by those definitions the legal analysis contained in IRS Field Service Advice Memoranda. Here, the first part of EPIC’s request, the request for President Trump’s tax returns, clearly falls within the scope of tax returns and return information and “is plainly covered by section 6103(a)’s bar.”

With respect to the requested information concerning financial relations with Russia, the court finds that the request is framed in such a way that answering it reveals the fact that tax returns were filed, making any response one which would disclose tax returns or return information. Therefore, the court denies this request as well.

Moving on to EPIC’s revised request citing to 6103(k)(3), the court finds that this provision was not designed as a provision for parties to make a request to the IRS but rather for the IRS to make a decision to disclose information to avoid problems with tax administration. The court finds “Congress’s omission of any public right to ‘request’ disclosure under section 6103(k)(3) is intentional.” So, this provision affords the requestor no disclosure right. EPIC’s claim based on this provision fails.

Lastly, the court looks at the APA as a basis to disclose the returns. It finds that the APA claim should be dismissed because FOIA, not the APA, provides the basis for the remedy sought by the requestor. The fact that FOIA does not allow disclosure under this circumstance does not mean that the APA provides a separate remedy.

No doubt we have not heard the last of attempts to obtain President Trump’s returns. The harder people try to obtain the returns without success, the more respect I have for the IRS and the states in their administration of the disclosure laws. Maybe one day we will see the returns and learn great secrets. In the meantime we should appreciate that the disclosure laws which were tightened significantly in response to President Nixon’s attempts to misuse the IRS seem to be working well.

 

 

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.

 

Don’t Forget Guralnik and Parkinson during Tax Court’s Indefinite Closure

The government shutdown and last Friday’s closure of the Tax Court, as discussed here, provides an opportunity for taxpayers who would otherwise have missed the jurisdictional deadline for filing a Tax Court petition. Since the last government shutdown of any length the Tax Court’s precedent on jurisdiction has changed. A reminder of the Tax Court precedent regarding the impact of the closure of the Tax Court clerk’s office on the timeliness of filing a petition (and other documents?) is worth a visit. Carl Smith assisted me in the preparation of this post.

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Long time readers of this blog know that we paid a fair amount of attention to the Guralnik case a few years ago perhaps because the tax clinic at Harvard filed an amicus brief in that case. See our posts here, here and here. While the tax clinic argued that the Tax Court had the power to open its doors based on equitable tolling, the court rejected the clinic’s argument in favor of a non-equitable remedy that has both broader implications as discussed below and narrower ones for other petitioners.

Mr. Guralnik’s attorney sent a petition to the Tax Court in a Collection Due Process (CDP) case via Fed Ex on the 28th day after the issuance of the CDP Notice. Unfortunately, the Fed Ex delivery service selected (the best one offered) was not on the IRS list of approved delivery services because the IRS had not updated its list in the 11 years prior to Friday, February 13, 2015 when the petition was given to Fed Ex. Because the chosen delivery service was not on the IRS list, the IRS argued and the Tax Court agreed that the mailbox rule of IRC 7502 did not apply.

Petitioner needed the mailbox rule to apply, or an expanded reading of the “weekend and holiday” rule of IRC 7503, because the petition did not arrive in the Tax Court until Wednesday, February 18. Before you conclude that Fed Ex fell down on the job of delivering the petition, it is important to understand what happened in the intervening days during which the Tax Court was closed – Saturday, Sunday, Monday (President’s Day) and Tuesday (Snow closure). The petition arrived at the Court on the first day it opened after petitioner’s attorney delivered the petition to Fed Ex.

Prior law

Among the reasons that the IRS argued that the Tax Court lacked jurisdiction in Guralnik was that there were prior orders of the Tax Court in similar cases of the Clerk’s office being closed, and one of those cases involved a government shutdown.  Government shutdowns formed the basis for dismissals in the pre-Guralnik era. One of the cases forming the body of pre-Guralnik jurisdictional law in the Tax Court, McCoy v. Commissioner, Dk. No. 25941-13S, involved the dismissal of a case in which the taxpayer tried and failed to file the petition prior to the reopening of the Tax Court following the government shutdown.  In McCoy, hand delivery was made at the Tax Court the first date the Clerk’s Office was open after a 2013 government shutdown. The order in McCoy reads differently than the order that the Court posted for this shutdown. The difference might be attributable to the Guralnik case.

Current law

In a fully reviewed, precedential opinion, the Tax Court concluded that because it had no rule regarding days when its clerk’s office was closed it could borrow from the Federal Rules of Civil Procedure and treat filings received on the next day after closure as timely. The IRS argued vigorously against this result; however, as we posted here, the IRS appears to have accepted the result when the issue of the closure of the clerk’s office came up in a subsequent case, Parkinson v. Commissioner, Dk. No. 296-15. In Parkinson the Tax Court asked the parties to address the issue of the Court’s jurisdiction of a case in which the petition was filed after the last date to file unless one considered the Court’s extra holiday closure on January 2, 2015. After both parties filed responses indicating that the Guralnik opinion would apply to the court closure situation, the Tax Court seems to have accepted their arguments without further elaboration in its order.

Given the precedent set by Guralnik and the non-precedential acceptance of that precedent for the situation of the Court closing down to allow its employees off on the Friday after New Year’s Day, it appears almost certain that starting on December 30, 2018, the time for filing a petition in the Tax Court is extended until the government shutdown ends and the Tax Court clerk’s office reopens. Perhaps no taxpayers will benefit from this additional time within which to file their Tax Court petitions but knowing the rule could assist someone who might otherwise have missed the deadline.

Following on the logic of filing documents late when the clerk’s office is closed, it would also seem that brief and other responses due to the Tax Court during the period of the clerk’s office closure can also be filed when the court reopens. For veteran procrastinators this may seem like an opportunity to sit back and wait; however, government shutdowns can end as quickly as they begin. A late night agreement among the parties could restart the government unexpectedly. While we do not recommend delaying a filing because of the shutdown, perhaps an opportunity exists for those who prefer not to file before the absolute last minute. Another reason for not waiting is discussed below; however, if you have a client appear in a situation that would otherwise be too late to file the petition, perhaps Guralnik will provide some magic for your client.

Tax Court action prior to shutdown

In addition to posting the notice on its website that we discussed in a prior post, the court issued nearly 300 orders on Thursday and Friday before it shutdown to the parties involved in the cases set for trial in the first two weeks of trial session in January. The orders generally contain the following language:

The parties are notified that the cases set for trial and/or hearing during the trial session scheduled to begin in New York, New York, on January 14, 2019, shall proceed as scheduled. To avoid potential complications caused by the partial government shutdown, it is

ORDERED that a paper copy of any document submitted to the Court for filing, either electronically or in paper, between the date of this Order and the date of the above-referenced trial session, shall be made available at the trial session by the party who submitted the document.

For a case containing the sample language see the order in Gross v. Commissioner (Docket No. 2010-18S). The fact that the Tax Court had to issue nearly 300 orders is just another example of the colossal waste of resources when the government shuts down. This one is probably small in comparison to others but provides a very tangible example.

Caveat

One caveat should be noted before relying on a government closure to make a petition filing’s timely: The Tax Court’s Guralnik ruling was never appealed, and no court of appeals has yet considered whether the Tax Court may import rules from the Federal Rules of Civil Procedure to extend Tax Court filing deadlines that have been in the past held jurisdictional. But, there are currently before the Ninth Circuit two companion cases of petitions sent in around the same time as Guralnik, also by FedEx First Overnight, that arrived a day late. In these cases, Organic Cannabis Foundation LLC v. Commissioner, Ninth Cir. Docket No. 17-72874, and Northern California Small Business Assistants, Inc. v. Commissioner, Ninth Circuit Docket No. 17-72877, it is not clear why the petitions were filed late, but it appears that the Federal Express driver could not access the open Tax Court Clerk’s Office on the last day – either because of construction work, police activity, or some other reason – so the driver returned the following day (one day too late if section 7502 can’t be used). In unpublished orders issued on July 25, 2017 (here and here), the Tax Court declined to extend Guranik to cover situations where the Clerk’s Office was in fact open.

In the Ninth Circuit, the taxpayers not only seek to extend Guralnik, but also argue (as the tax clinic at Harvard did in Guralnik) that the deficiency petition filing deadline is not jurisdictional and is subject to equitable tolling. The DOJ relies on the holding in Guralnik, but argues that Guralnik cannot be stretched to cover the situation where the Clerk’s office is actually open. Since the parties cannot confer jurisdiction in a case merely by not making certain arguments, it would not be impossible for the Ninth Circuit to eventually rule both in these cases that the filing deadline is jurisdictional and that the Tax Court cannot import into its own rules any rule from the Federal Rules of Civil Procedure that extends the filing deadline when the Clerk’s Office is formally closed. That is, nothing stops the Ninth Circuit from rejecting the latter holding in Guralnik. Thus, until there are some court of appeals rulings on this fact pattern, it may be wise not to try to rely on the closure of the government as a reason for not mailing a Tax Court petition on time or attempting hand delivery to the court on the first date it reopens. The cases before the Ninth Circuit are fully briefed, but a date for oral argument therein has not yet been set. Among the briefs there are amicus briefs from the Harvard tax clinic arguing that the filing deadline is not jurisdictional and is subject to equitable tolling.

 

Tax Court Operations During Federal Government Shutdown

The message below is posted on the Tax Court’s web site. The Tax Court was able to operate on a normal schedule after other parts of the government impacted by the government shutdown because it has a reserve of funds from the fees it collects. Even though the court itself shut down yesterday, it will continue to hold trial calendars for the first two weeks of scheduled calendars in January.   The IRS attorneys who represent the government in the cases on those calendars will undoubtedly be deemed essential for the period of the calendar and for some time before the calendar.   Still, it may be a little tricky for those with cases on these calendars.

The United States Tax Court is shut down starting Friday, December 28, 2018, at 11:59 p.m. and will remain closed until further notice.

The trial sessions scheduled for the weeks of January 7 and 14, 2019, will proceed as scheduled.

  January 7, 2019

  • Birmingham, Alabama – Judge Joseph Robert Goeke
  • Los Angeles, California -Judge Albert G. Lauber
  • San Antonio, Texas – Judge Mary Ann Cohen

January 14, 2019

  • Los Angeles, California – Chief Special Trial Judge Lewis R. Carluzzo
  • New York, New York – Special Trial Judge Daniel A. Guy, Jr.
  • Phoenix, Arizona – Judge Ronald L. Buch
eFiling and eAccess will be available. Taxpayers may comply with statutory deadlines for filing petitions or notices of appeal by timely mailing a petition or notice of appeal to the Court. Timeliness of mailing of the petition or notice of appeal is determined by the United States Postal Service’s postmark or the delivery certificate of a designated private delivery service.

Please monitor this website for information regarding the Court’s operating status.