Are FBAR Penalties Taxes for Purposes of the Flora Rule?

In Mendu v. United States, No. 1:17-cv-00738 (Ct. Fd. Claims April 7, 2021) the Court of Federal Claims held that FBAR penalties are not taxes for purposes of applying the Flora rule.  In arguing for the imposition of the Flora rule the taxpayer, in a twist of sides, sought to have the court require that the individual against whom the penalties were imposed to fully pay the penalties before being allowed to challenge the penalties in court.  The FBAR penalties are not imposed under title 26 of the United States Code which most of us shorthand into the Internal Revenue Code but rather are imposed under Title 31 as part of the Bank Secrecy Act.

The possibility that the Flora rule could apply to non-tax issues first arose sua sponte in a Third Circuit case in 2018 which I wrote about here (see also my article on Flora from last year).  That post also contains a link to an excellent post by Jack Towsend.

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I think the attorneys for Mendu may have read the prior blog post but if not they definitely read the Bedrosian opinion discussed in the blog post.  In Mendu, in a flip of the normal situation, the taxpayer argues that Flora applies and their case should be dismissed while DOJ argues on behalf of the IRS that Flora does not apply since this case does not involve a liability under the IRC.

The court picks up on why the plaintiff in this case would want the case dismissed and would make the Flora argument raised sua sponte in the Bedrosian case:

On November 8, 2019, the Federal Circuit issued its decision in Norman v. United States, 942 F.3d 1111 (Fed. Cir. 2019); as a result, the stay expired. In Norman, the Federal Circuit held that a now out-of-date Treasury Regulation did not cap FBAR penalties for willful violations at $100,000. The Federal Circuit’s ruling in Norman, which binds this Court, may have given Mr. Mendu pause about continuing litigation in this circuit because on January 20, 2020 — facing a counterclaim against him for potentially 700 times greater than the amount sought in his complaint — Mr. Mendu sought to dismiss his own complaint for lack of subject-matter jurisdiction, along with Defendant’s counterclaim. See generally Pl. Rule 7(b)(1) Mot. In his Rule 7(b)(1) Motion, filed in 2020, Plaintiff based his sudden change in course on a footnote in in a case decided two years earlier, Bedrosian v. United States, 912 F.3d 144, 149 n.1 (3d Cir. 2018). In that footnote, which appears to be dictum, the United States Court of Appeals for the Third Circuit (Third Circuit) commented, without substantive analysis, that it was “inclined to believe” that FBAR penalties are internal-revenue laws within the scope of 28 U.S.C. § 1346(a)(1), and are therefore subject to the full payment rule as articulated in Flora v. United States, 362 U.S. 145, 164 (1960). Pl. Rule 7(b)(1) Mot. at 4-5, 7-11. Accordingly, Plaintiff now believes that the Flora full payment rule requires this Court to dismiss Plaintiff’s claim for illegal exaction of his $1,000 partial payment because Plaintiff has not fully paid the FBAR penalty at issue. Pl. Rule 7(b)(1) Mot. at 3-4. Mr. Mendu notes that, because this Court does not have independent jurisdiction over the Defendant’s counterclaim for $752,920, this Court must dismiss the Defendant’s counterclaim as well. Pl. Rule 7(b)(1) Mot. at 2, 11-14; Pl. Resp. to Cross-Mot. at 12-15.

Because of the potential huge exposure in the Court of Federal Claims and the much smaller exposure that might exist in the Central District of California, one can hardly blame petitioner for trying to remove their case from this jurisdiction where the law has turned unfavorable and try to get to another location where the law might be much better.  Unfortunately for petitioner but fortunately for almost everyone else, petitioner’s Flora argument does not gain any traction.

The court sets the scene for its discussion of the application of Flora by stating:

The parties agree that the Flora full payment rule only applies if it is an “internal-revenue tax” as that term is used in section 1346(a)(1). See Pl. Rule 7(b)(1) Mot. at 7; Def. Resp. at 4. As noted, if FBAR penalties are considered internal-revenue taxes, then the Flora full payment rule applies, and this Court lacks jurisdiction over Plaintiff’s tax refund claim because the Plaintiff has not paid the assessed $752,920 FBAR penalties in full. Conversely, if FBAR penalties are not internal-revenue taxes then Flora full payment rule does not apply, and this Court has jurisdiction over Plaintiff’s $1,000 illegal exaction claim. See Ibrahim v. United States, 112 Fed. Cl. 333, 336 (2013) (finding that while tax refund claims are subject to the Flora full payment rule, the full payment rule does not apply to other illegal exaction claims).

The court then finds that the FBAR penalty is not a tax.  The fact that title 31 and not title 26 imposes the FBAR penalty is something the court describes as more than a mere technicality.  The court finds not only that the FBAR penalty derives from a separate statutory scheme, but that the reasoning behind the Flora decision does not apply in this context, since full payment of the penalty does not matter for this penalty the same way it matters for taxes and other penalties.  The court finds the footnote in the Third Circuit’s opinion suggesting, but not holding, that perhaps Flora should apply to the FBAR penalty does not provide a persuasive basis for bringing Flora into an entirely different statutory scheme.  After analyzing several different reasons why the footnote falls short of persuading, it concludes this section of the opinion by stating:

It may be accurate that every internal-revenue law is not necessarily contained in Title 26. However, Congress’s specific placement of the FBAR in Title 31, the stated purpose of the BSA, and the fact that Congress chose not to employ traditional tax collection procedures to recover FBAR penalties collectively demonstrate that Congress did not intend to subject FBAR penalty suits to the Flora full payment rule.

The case then turns on the rules of the Court of Federal Claims.  The court rules do not track the Tax Court rules that do not allow a petitioner out of a deficiency case once properly filed (see discussion here); however, the rules do provide that once the defendant files an answer asserting a counterclaim the petitioner cannot seek dismissal of the counterclaim would not stand on its own in the court.  Here, the huge counterclaim made by the government would not survive if the complaint were withdrawn.  So, Mr. Mendu remains stuck in the Court of Federal Claims instead of being allowed to beat a retreat to the possible friendlier confines of the Central District of California.  Perhaps, he will continue to make the Flora argument.  I hope the court will continue to knock it down.

I do note that occasional guest blogger, Lavar Taylor, just won a big FBAR case in the 9th Circuit.  So, maybe Mr. Mendu has a good reason for wanting a change of scenery to Southern California. In Boyd v. United States,___ (9th Cir. 2021) the court held that 

Examining the statutory and regulatory scheme for reporting a relationship with a foreign financial agency under § 5314, the panel held that § 5321(a)(5)(A) authorizes the IRS to impose only one non-willful penalty when an untimely, but accurate, FBAR is filed, no matter the number of accounts.  

Perhaps we will give a further discussion of Lavar’s case in a future post.

In FBAR Case Court Allows in to Evidence Newspaper Articles Despite Hearsay, Relevance, and Unfair Prejudice Objections

US v Briguet is a brief order out of the Eastern District of New York. Briguet is an FBAR case. The maximum penalty for a willful FBAR violation is the greater of $100,000 or 50% of the balance in the account at the time of the violation. Proving that a violation is willful is the key aspect of most of these cases. The order relates to a motion in limine that Briguet filed. That motion asked the court to preclude the admission at trial of 96 newspaper articles that concerned the government’s crackdown on US taxpayers who held offshore accounts and did not report their existence on US tax returns or the FinCEN Form 114. The defendant argued that the articles should be excluded on hearsay, relevancy and unfair prejudice grounds. The order rejects the motion and (mostly) allows the articles into evidence. 

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As to hearsay, the order held that the articles were not offered to prove the truth of the matter being asserted (i.e., that Mr Briguet willfully failed to file the FBAR form). Instead, the court held that the government was offering the articles as circumstantial evidence of the state of Briguet’s mind and general awareness of the FBAR filing requirement.

As to relevance, the court noted the fairly wide definition of relevance for admissibility purposes, i.e., an item is  “relevant when ‘it has any tendency to make a fact more or less probable than it would be without the evidence.’”  United States v. White, 692 F.3d 235, 246 (2d Cir. 2012), as amended (Sept. 28, 2012) (quoting Fed. R. Evid. 401. With that benchmark, the court held that the articles, which were in the NY Times and Wall Street Journal prior to the date of the filing deadline, easily met the standard. Drilling deeper, the court noted that a number of the headlines flagged efforts targeted at UBS clients (where Briguet had his account) and that Briguet had testified that he read the financial sections of the NY Times and the Journal “every day.” In addition the order flagged the customer logs from UBS itself, “one of which illustrates that he “closely followed the published events on the UBS business policy for US customers” and “consulted a lawyer, aware of [UBS’s] change of policy, and fearing for the confidentiality of his account.”

In concluding that the pre-filing articles were relevant the order concluded that “a reasonable jury might readily conclude Defendant read the newspaper articles in the financial sections of the New York Times and Wall Street Journal, and such an inference seriously undermines any claim that he was unaware of the FBAR filing requirement.”

It was not a complete government victory, however. The motion also opposed admission of articles that appeared after the FBAR filing date. While the court declined to exclude the articles it reserved judgment and stated it would resolve that issue later. While the articles are not relevant to the state of mind at the time of the FBAR deadline the court noted that they may prove relevant as to when Briguet became aware of the deadline.

As a final objection to admissibility Briguet’s motion claimed that the articles would unfairly prejudice him because  “the jury may be left with the impression that the UBS case, DOJ’s Swiss bank crackdown, and the IRS’s offshore voluntary disclosure program were ‘hot issues’ to investors who read the New York Times and Wall Street Journal and … infer … that Mr. Briguet probably read some of the articles at issue.” While noting that the observation was “valid” the court sided with the government noting that “[e]vidence is prejudicial, but in this instance any prejudicial effect is entirely coextensive with the probative value of the articles and therefore not unduly prejudicial.” 

Circuit Court Weighs in on Meaning of Willfulness, Maximum Penalty and SOL Issues in Important FBAR Case

In US v Horowitz  the Fourth Circuit issued a published opinion addressing a number of issues relating to the willful penalty for failing to file an annual Report of Foreign Bank and Financial Accounts, commonly referred to as an FBAR. 

The opinion addresses 1) the meaning of willful, holding that willful encompasses recklessness and that the term has different meanings for civil and criminal law purposes, 2) the maximum penalty for willful violations when a 1987 regulation that capped the willful penalty at $100,000 is inconsistent with a 2004 statutory change that boosted the “maximum penalty” for a willful violation to the greater of $100,000, or 50 percent of the account balance, holding that the statutory change effectively abrogated the $100,000 regulatory cap, and 3) the meaning of the term assessment when during the course of a post-assessment administrative appeal of the penalty there was uncertainty as to whether the IRS had abated the assessment.

In this post, I will discuss the third issue, focusing on the SOL argument the taxpayers raised. 

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As background, the Horowitzes had lived and worked in Saudi Arabia since 1984. While there, they initially had a bank account in a Saudi Arabian bank, but they eventually transferred the funds to FOCO, a Swiss bank. When FOCO was bought by an Italian bank, the Horowitzes moved the funds to another Swiss bank, UBS. By the time they moved back to the US in 2001 the account had grown to approximately $1.6 million. All the while they did not report income earned on the account on their US tax returns, and they never provided UBS with their US address.  By 2008, after UBS experienced financial setbacks, Mr. Horowitz traveled to Switzerland and withdrew the funds, depositing the proceeds in Finter Bank, another Swiss bank, this time in his name only. For an additional fee, Finter created the account as a “numbered” account with “hold mail” service, which meant that there was only a number associated with the account and that the bank would hold all correspondence associated with the secret account.

By 2009, there was widespread attention around the IRS crackdown on offshore accounts. The opinion discusses its impact on the Horowitzes:

In January 2010, the Horowitzes submitted a letter to the IRS disclosing the FOCO, UBS, and Finter Bank accounts and requesting that they be accepted into the Department of Treasury’s Offshore Voluntary Disclosure Program. This program provided potential protection from criminal prosecution and reduced penalties in exchange for cooperation. After entering the program, the Horowitzes filed FBARs, as well as amended income tax returns, for 2003 through 2008. As part of that process, they reported additional income of $215,126 and paid more than $100,000 in back taxes. In 2012, however, the Horowitzes opted out of the program.

In May of 2014 IRS sent letters to the Horowitzes proposing FBAR penalties for the undisclosed UBS accounts that they owned in 2007 and 2008. The letters proposed enhanced penalties based on an IRS determination that their conduct was willful and gave them about a month to respond. 

The Horowitzes, through their counsel, did respond to the May letter proposing penalties. In a June 3, 2014 letter they requested an administrative appeal of the still yet to be assessed penalties. The letter included a consent to extend the SOL on assessment of the penalties to December 31, 2015.

While the Horowitzes’ counsel letter began the process of an administrative appeal of the penalties, and had hoped that the extension would put off any possible assessment, on June 13, 2014 the IRS assessed the penalties. The opinion goes into some detail about the assessment process for FBAR penalties, including the work of the FBAR Penalty Coordinator at the Department of Treasury, and how she prepared four Form 13448 Penalty Assessment Certifications that a supervisor signed.

Here is where we get to the SOL issue.  The failure to file the annual FBAR gives the IRS six years to assess penalties, as per 31 USC § 5321(b)(1). At the time the FBAR had to be filed by June 30, so the SOL for assessing the 2007 FBAR penalty was June 30, 2014.  (Note that Title 31 gives the US two-years post-assessment to commence enforcement. 31 USC § 5321(b)(2)). 

There was no dispute that the penalty for 2007 was assessed prior to June 30, 2014, but the Horowitzes contended that the IRS’s actions after they protested the penalty amounted to an abatement of the assessment. 

In October of 2014, the Appeals Officer sent an email to the Appeals FBAR coordinator (with the very cool last name Batman) requesting that the assessments be “removed.” Internal emails between Appeals and the FBAR penalty coordinator suggested that the June 2014 assessment was “assessed prematurely.” In light of the protest and extension, Treasury’s FBAR penalty coordinator “simply deleted “6/13/2014” (the assessment date) from the “date penalty input” field in the assessment database.”

When the appeals process culminated in 2016 with no resolution, the Horowitzes argued that the IRS post-Appeals actions amounted to a reassessment of the penalty—this time beyond the six-year SOL for both 2007 and 2008 as per 31 USC § 5321(b)(1). 

The Fourth Circuit disagreed. In so holding, the opinion discussed the internal IRS procedures that allowed Appeals to hear the matter. Importantly, the opinion notes that the coordinator’s entry in the database was not accompanied by any more formal action:

But she did nothing more. Significantly, she generated no document, and her supervisor, Calamas, did not sign any document reversing the assessment certifications he had executed on June 13, 2014. Moreover, the Horowitzes were never informed that the penalties against them had been placed back into an unassessed status.

As the opinion discusses, the administrative appeals process continued for a couple of years. By May of 2016, Appeals informed the Horowitzes that there was insufficient time to reach resolution, in light of the two-year deadline to commence enforcement action “given that the government’s time for filing suit was set to expire in June 2016 (i.e., two years after the penalties were assessed in June 2014).”

Prior to closing the case at Appeals, the Appeals FBAR coordinator and the Treasury FBAR Penalty coordinator spoke about the legal effect of the database entry. That exchange, as well as its decision to end the Appeals process, highlighted that the government did not believe its actions amounted to an unwinding of the original assessment.

The Fourth Circuit emphasized that even if there were any subjective misunderstanding surrounding the legal effect of its data base deletion it concluded as a “matter of law” that the “mere act of deleting that date did not have the legal effect of reversing the assessments that had been formally certified … on June 13, 2014. Accordingly, the civil penalties against the Horowitzes were timely assessed, and the enforcement action was timely filed.”

Conclusion

The Horowitz opinion highlights the importance of the legal effect of an assessment. The opinion suggests that there were few formal mechanisms in place to allow Appeals to consider a post-assessment challenge to the penalty. The workaround that Appeals facilitated, which temporarily delayed the practical effect of an assessment, did not unwind its legal effect.

UPDATE

There are some excellent discussions in other blogs about the opinion. See Jack Townsend in his Federal Tax Crimes blog, discussing all aspects of the case, as well as Carolyn Kendall of Post & Schell who blogged the case in the firm’s White Collar blog with a focus on the opinion’s discussion of willfulness.

Affidavits in Summary Judgment – Designated Orders: September 16 – 21, 2019

Only one order this week, but it’s a meaty one. Judge Halpern disposed of three pending motions from Petitioner in Martinelli v. Commissioner, a deficiency case. Let’s jump right in.

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Docket  No. 4122-18, Martinelli v. C.I.R. (Order Here)

So begins the tale of the brothers Martinelli: Giorgio, the Petitioner in this Tax Court case, and Maurizio, the generous yet problem-causing sibling who—according to Giorgio—created an Italian bank account in Giorgio’s name in 2011. Giorgio argues that he never had knowledge of or control over the Italian bank account; he was a mere “nominee” on the account. He first learned of the account in September 2012.

The IRS, as one might expect, alleged that Giorgio didn’t report the income from the account on his federal income tax returns for 2011 through 2016. To boot, the IRS assessed a penalty under section 6038D(d) for failure to disclose information regarding a foreign financial assets where an individual holds foreign financial assets exceeding $50,000 in value. (NB: This penalty is distinct from the Foreign Bank Account Reporting, or FBAR, penalty found at 31 U.S.C. § 5321. Unlike the FBAR penalty, the IRS may collect the section 6038D(d) penalty using its ordinary collection mechanisms, including the federal tax lien).

Petitioner filed three motions: first, a motion for partial summary judgment to determine that the Tax Court has jurisdiction regarding the section 6038D(d) penalty; second, a motion to restrain assessment and collection of the penalty while the Tax Court case is pending; and third, a motion for partial summary judgment regarding the underlying income tax deficiency.

Jurisdictional Motion

The Court rightly held that it lacks jurisdiction as to the 6038D(d) penalty. As the Tax Court likes to repeat, it is a court of limited jurisdiction. Congress must provide the Tax Court with the authority to hear particular cases. While certain penalties fit into Congress’ grant of authority under the Tax Court’s general deficiency jurisdiction under section 6211(a) and section 6214, this penalty simply doesn’t.  

Judge Halpern reviews the Court’s jurisdiction under section 6211(a). It includes taxes imposed under subtitle A or B, or under chapters 41, 42, 43, or 44. But section 6038D is in Chapter 61 of subtitle F. So no luck there.

Likewise, the penalty isn’t an “additional amount” under section 6214. Tax Court precedent has confined this jurisdictional grant to penalties under subchapter A of chapter 68. See Whistleblower 22716-13W v. Commissioner, 146 TC 84, 93-95 (2016). Failing to find a jurisdictional hook, the Court denies summary judgment on this matter, holding that the Court does not have jurisdiction with respect to this penalty.

Is this the right result as a policy matter? I think not. The IRS likely assessed this penalty during the audit of Mr. Martinelli’s tax return, in addition to the deficiency it proposed. One result of the audit is subject to challenge in the U.S. Tax Court; the other isn’t. Yet a challenge to both may rely on the same set of facts. Why require a taxpayer to litigate twice?

Motion to Restrain Assessment & Collection

The Court’s disposition of the first motion makes the second easy. If the Court can’t determine the amount of the penalty, it certainly can’t tell the IRS not to collect the penalty. This motion is likewise denied.

The Deficiency

Giorgio alleges that he was a mere “nominee” of the account, and that in fact, his brother Maurizio controlled the account. Thus, Giorgio shouldn’t be subject to tax on the interest and dividend income from the account.

Judge Halpern takes issue with the nominee argument. He notes that a nominee analysis doesn’t really fit here; that analysis is usually used to determine whether a transferor of property remains its beneficial owner. Here, the parties disagree on whether Maurizio used his own assets to fund account and then listed Giorgio as the nominee owner. This analysis would allow the Court to determine whether Maurizio had an income tax liability, but would only allow a negative implication as to Giorgio.

Instead, the Court focuses on whether Giorgio exercised sufficient dominion and control over the account. The Court asks whether Giorgio had freedom to use funds at his will. While Petitioner did submit affidavits from himself and Maurizio, there was no other evidence to show that Petitioner didn’t enjoy the typical rights of an account owner (i.e., the right to access funds in the account). So, it appears there’s still a genuine dispute of material fact regarding Giorgio’s ability to access these funds.  

Judge Halpern did, however, allow for the possibility that Giorgio didn’t have any knowledge of the account until after 2011. After all, one can’t withdraw funds from an account that remains secret from the nominal owner. Giorgio says that he didn’t have knowledge until September 2012.

Here’s where we enter a problem for the typical analysis of a motion for summary judgment. Petitioner provided an affidavit that he had no knowledge of the account until September 2012. Respondent denied this, but didn’t provide any other evidence showing that Giorgio did, in fact, have this knowledge. Under Rule 121(d), Respondent can’t rest on mere denials in response to a motion for summary judgment; instead, a party “must set forth specific facts showing that there is a genuine dispute for trial.”  

What’s Respondent to do? There may be no evidence demonstrably showing that Giorgio knew about the account. The only evidence is Giorgio and Maurizio’s affidavit.

Rule 121(e) provides a safety valve: if a “party’s only legally available method of contravening the facts set forth in the affidavits or declarations of the moving party is through cross-examination of such affiants or declarants . . . then such a showing may be deemed sufficient to establish that the facts set forth in such supporting affidavits or declarations are genuinely disputed.” In other words, Petitioner can’t simply provide an affidavit and rest on his laurels. Respondent must have an opportunity to cross-examine the affiant—in this case, Petitioner and his brother.

Thus, because Respondent showed under Rule 121(e) that they had no other way to refute the facts alleged in Petitioner’s affidavits, the knowledge issue is a genuinely disputed material fact for 2011. Whether petitioner controlled and could withdraw funds from the account is likewise a genuinely disputed material fact for the other tax years. As such, Judge Halpern denies Petitioner’s motion for summary judgment.

The case is now set for trial on February 10, 2020 in New York.  

Notes from the Fall 2019 ABA Tax Section Meeting

From October 3 to 5 Les, Christine and I attended the tax section meeting in San Francisco.  We were each on different panels and we each enjoyed a delightful dinner cruise on the bay Friday night courtesy of tax procedure guru, Frank Agostino.  During the cruise the three of us had an in depth discussion with Frank about his latest ground-breaking tax procedure initiatives which we hope to highlight in coming posts.

For this post I intend to provide some of the information passed out during the update sessions in the Administrative Practice and Court Procedure Committees.  For anyone interested in more depth or more precision, it is possible to purchase audio tapes of the committee meetings from the tax section.

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Administrative Practice Committee

The discussion initially focused on Appeals and the Taxpayer First legislation seeking to create a more independent Appeals.  Apart from the legislation, Appeals issued a new conferencing initiative on September 19, 2019.  A request for comments on the new process went out. 

The presenter discussed the change to IRC 7803(e)(5)(A) and the right to a hearing in Appeals.  This change resulted from the Facebook case discussed here.  For those who do not remember the Facebook litigation, Chief Counsel denied Facebook the opportunity for a conference with Appeals after Facebook filed its Tax Court petition — even though Facebook had not met with Appeals prior to filing the petition.  The new provision will make it more difficult to deny a taxpayer the opportunity to meet with Appeals in this circumstance.

Another provision of the Taxpayer First Act, IRC 7803(e)(7)(A), grants taxpayers the right to their file 10 days in advance of a meeting with Appeals.  This provision has some income limitations but will generally benefit the vast majority of individual taxpayers.  It seems like a good step forward, though I would like the file much earlier than 10 days before the meeting, and I have had trouble getting it from Appeals in the past.  Some Appeals Officers (AOs) have denied my request for information in the administrative file, even though taxpayers have always had the right to this information.  If the case is in Tax Court, a Branerton letter to the Chief Counsel attorney will almost always result in that attorney calling the AO to tell the AO to send the material.  If you go to Appeals prior to Tax Court and have no Chief Counsel attorney to make this call, I wonder if the legislation will cause Appeals to take the position that a taxpayer cannot receive the material until 10 days prior to the meeting.  This would be a shame, because meetings are much more productive when parties can properly prepare.

The Taxpayer First Act also made changes to the ex parte provisions, set out in 7803(e)(6)(B), first enacted in 1998 as a means of insulating Appeals from the corrupting influence of other parts of the IRS.  The ex parte provisions were previously off-code but picked up by the IRS in a pair of Revenue Procedures describing how they would work.  The new provision allows Appeals to communicate with Chief Counsel’s office in order to obtain a legal opinion as it considers a matter, as long as the Chief Counsel attorney providing the advice was not previously involved in the case.  I don’t think this changes much.  Rev. Proc. 201218 already allowed attorneys in Chief Counsel to provide legal advice to Appeals.  Maybe this makes it clear that Appeals is not so independent that it cannot receive legal advice when it needs it, but it seemed that Chief Counsel and Appeals had already figured that out — even if some taxpayers criticized Appeals for obtaining legal advice.  Of course, when obtaining advice Appeals needs to seek out someone other than the attorney who was providing advice to Examination, in order to avoid having the attorney be the Trojan horse improperly influencing Appeals.

The panel mentioned Amazon v. Commissioner, 2019 U.S. App. Lexis 24453 (9th Cir. 2019). This is an important transfer pricing case clarifying what constitutes an “intangible” that must be valued and included in a buy-in payment to a cost-sharing arrangement between a parent company and its foreign subsidiary entity. The 9th Circuit panel affirmed the Tax Court, declining to apply Auer deference and holding that certain of Amazon’s abstract assets, like its goodwill, innovative culture, and valuable workforce, are not intangibles.

The committee also discussed Chief Counsel Notice CC-2019-006 “Policy Statement on Tax Regulatory Process” (9-17-2019).  A copy of the complete policy statement can be found here.   Each of the four points is important in its own way.  I find number three to be especially important.  We discussed the notice previously in a post here.

A few recent cases were mentioned as especially important to administrative practice:

Mayo Clinic v. United States, 124 AFTR2d 2019-5448 (D. Minn. 2019) provides the most recent interpretation of Mayo and what it means, in the context of whether Mayo Clinic was entitled to an exemption as an “educational organization” under Treas. Reg. § 1.170A-9(c).

Baldwin v. Commissioner, 921 F.3d 836 (9th Cir. 2019) is a mailbox rule case in which the taxpayer seeks to overrule National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005).

Bullock v. IRS, 2019 U.S. Dist. LEXIS 126921 (D. Mont. 2019) is a pre-enforcement challenge to Rev. Proc. 2018-38 which relieves 501(c) organizations of the obligation to disclose the names and addresses of their donors.

Court Practice and Procedure Committee

Robin Greenhouse, who now heads Chief Counsel’s LB&I office, gave the report for Chief Counsel’s office.  She read from her notes and provided no PowerPoint presentation or handout material, so this time I cannot FOIA the PowerPoint presentation to provide the data.

She discussed two financial disability decisions which seems like an interesting place to begin.  First she mentioned Carter, as representative for Roper, v. United States, 2019 U.S. Dist. LEXIS 134035 at( N.D. Ala. 2019) in which the court determined that an estate cannot use 6511(h) to assert financial disability because an estate is not an individual.  I wrote a post on this case earlier in the fall.   Next she mentioned the case of Stauffer v. Internal Revenue Service, which I recently wrote about here.  I failed to make notes on the other cases she discussed and I cannot remember why.

Judge Marvel talked about the new Tax Court announcement on limited scope representation and the Chief Counsel Notice, CC-2020-001 on that issue.  During the first month of the fall Tax Court calendar four persons entered a limited appearance, including our own Christine Speidel.  The limited appearance ends when the calendar ends, making it not entirely clear what to do with a decision document.  Some suggested getting the decision document signed by the petitioner was the way to go.

So far the Tax Court has 18 pending passport cases.  Judge Marvel indicated that we might see the first opinion in a passport case soon.

Effective on September 30, 2019 the Tax Court has begun accepting electronic filing of stipulated decisions.  The practical effect of this is that because the IRS always signs the decision document last, it will be the party to submit the document.  I doubt this change will have a profound impact on Tax Court practice but, in general, more electronic filing is better.

Development of the Tax Court’s new case management system is moving quickly.  The court expects it to go online by Spring of 2020.  When implemented, this system will allow parties to file petitions electronically.  Judge Marvel expects that practitioners will like the new system.  The new system may allow changes to the public’s access to documents; however, whether and how that might happen is unclear.

Gil Rothenberg, the head of the Department of Justice Tax Division’s Appellate Section gave an update on things happening at DOJ.  He said there have been 75 FBAR cases filed since 2018 with over $85 million at issue.  Several FBAR cases are now on appeal – Norman (No. 18-02408) (oral argument held on October 4th) and Kimble (No. 19-1590) (oral argument to be scheduled) both in the Federal Circuit; Horowitz (No. 19-1280) (reply brief filed on July 18th) in the 4th Circuit and Boyd (No. 19-55585) (opening brief not yet filed) in the 9th Circuit.

Over 40 bankers and financial advisors have been charged with criminal activity in recent years and the government has collected over $10 billion in the past decade.  I credit a lot of the government’s success in this area to John McDougal discussed here but the Tax Division certainly deserves credit for this success as well.

DOJ has obtained numerous injunctions for unpaid employment taxes in the past decade.  It has brought over 60 injunction cases against tax preparers and obtained over 40 injunctions.  These cases take a fair amount of time and resource on the part of both the IRS and DOJ.  They provide an important bulwark against taxpayers who run businesses and repeatedly fail to pay their employment taxes.  Usually the IRS revenue officers turn to an injunction when the businesses have no assets from which to administratively collect.  We have discussed these cases here.  I applaud DOJ’s efforts to shut down the pyramiding of taxes.  Congress should look to provide a more efficient remedy, however, for addressing taxpayers who engage in this behavior.

He said that while tax shelter litigation was generally down, the Midco cases continued.  He mentioned Marshall v. Commissioner in the 9th Circuit (petition for rehearing en banc was denied on October 2nd) and Hawk v. Commissioner in the 6th Circuit (petition for certiorari was denied by the Supreme Court on October 7th).  We have discussed Midco cases in several posts written by Marilyn Ames.  These cases arise as transferee liability cases.  See our discussion of some past decisions here and here.  My hope is that the government will continue to prevail on these cases as the scheme generally serves as a way to avoid paying taxes in situations with large gains.  I wonder how many of these cases the IRS misses.

In Fiscal 2019 there were 200 appeals.  The government won 94% of the cases appealed by taxpayers and 56% of the cases appealed by the government.  I was naturally disappointed that he only talked about cases in which the government prevailed and did not discuss some of the larger losses such as the one in Myers v. Commissioner discussed here.

He briefly discussed the Supreme Court’s decision in Taggart v. Lorenzen, a bankruptcy case, in which the court held that the proper standard for holding the government in contempt for violating the discharge injunction required mens rea.  This followed the position of the amicus brief submitted by the Solicitor General. The Court declined to adopt the petitioner’s position, which would permit a finding of civil contempt against creditors who are aware of a discharge and intentionally take actions that violate the discharge order. The Court found this proposal to be administratively problematic for bankruptcy courts, distinguishing between the purpose and statutory language of bankruptcy discharge orders (which require mens rea) and automatic stays (which do not).

He ended by announcing that he will retire on November 1, 2019.

Virtual Currency, FBAR, and the Ripple Effect

We welcome back guest blogger James Creech. In this post James explains some of the current uncertainties surrounding virtual currency, particularly in how future IRS guidance might interact with legal positions taken by other federal agencies. Christine

Recently FinCen informed the AICPA Virtual Currency Task Force that Bitcoin and other Virtual Currencies do not trigger FBAR reporting even when held in an offshore wallet.

This guidance comes as a bit of a surprise for some tax practitioners. Conventional wisdom had been that there was a difference between Virtual Currencies being held in cold storage on a thumb drive in a foreign county, and those being held by a foreign third party who also retained the private keys to the Virtual Currency as a part of their service. It was believed that if the private keys were stored by the wallet service, and the wallet service could convert the Virtual Currency to fiat currency, then the account could be considered similar to an online poker account and reportable under U.S. v Hom, No. 14-16214, 9th Cir., (7/26/16).

While this will be welcome news for many taxpayers who hold foreign wallets, this guidance by FinCen has the potential to be more impactful on the tax consequences of Virtual Currencies than would initially be apparent. The IRS has long relied on other agencies to define key terms, and to more fully develop the legal nature of Virtual Currencies. This FinCen guidance may be the beginning of a deepening rift between agencies.

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It is expected that the IRS will be releasing new Virtual Currency guidance shortly that will address some of the technological developments in the industry. One of the areas that could be addressed by this guidance is whether Virtual Currency held in foreign wallets is reportable on Form 8938. If the IRS decides that the Hom rational is correct and that foreign wallets are reportable this will create another significant distinction between the FBAR and Form 8938. For taxpayers this creates a higher likelihood of unfilled Form 8938’s due to taxpayer error and greater confusion between FBAR and Form 8938 requirements. I expect that this increased error rate will be higher than normal due to the fact that the Virtual Currency community relies heavily on industry blogs that many times are more interested in promoting virtual currency purchases rather than informing readers about compliance requirements.

For tax practitioners this split also raises questions of how much weight to put on the guidance of other administrative agencies. Because the IRS has issued so little guidance on Virtual Currency there are very few absolutes. We know that Virtual Currency is property because Notice 2014-21 clearly says so. What we don’t know is how far that definition goes, or if it can be treated like other specialized types of property. In the non-IRS context, the SEC has defined certain types of Virtual Currency as securities, and the CFTC has said that it is a commodity. It logically follows that if the IRS says a certain Virtual Currency is property, and the SEC says this Virtual Currency is a security, that a dealer in that particular Virtual Currency should be able to use a mark to market election under IRC 475. Given that Virtual Currencies as a whole suffered a bear market in 2018, a mark to market treatment might provide a desirable tax loss for many in the industry.

If there is a split in the FBAR and Form 8938 definitions, then assumptions that the IRS will allow taxpayers to import definitions from other agencies in order to tackle unaddressed issues lose some of their logic. It is impossible to overstate how important prior FinCen definitions are for IRS Virtual Currency guidance. The root definition of what is a Virtual Currency for IRS purposes is based in a 2013 FinCen definition of “convertible virtual currencies”. If the IRS does not see eye to eye with FinCen then there is a diminished likelihood that the IRS would adopt a CFTC definition and allow Virtual Currencies the same type of preferential tax treatments that they would allow for an established commodity. Of course the opposite reaction might also be true. If the IRS is the first agency to state that foreign wallets are reportable, we might see FinCen respond by adjusting their guidance to require FBAR disclosure as well. Either way, the pending IRS guidance will tell us a lot about how the IRS is thinking about Virtual Currencies and how it intends to incorporate guidance from other administrative agencies.

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.