District Court FBAR Penalty Opinion Raises Important Administrative and Constitutional Law Issues

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There are only a handful of court cases considering the procedures and substance relating to penalties imposed for failing to file a foreign bank account reporting form, the notorious FBAR. As most observers know, IRS has been active in offshore compliance, and the penalties for failing to file the FBAR can add up. Despite the attention to the issue, the procedures associated with the imposition of civil penalties are not well-established. This is in part due to the penalties’ provenance in the Bank Secrecy Act and Title 31, rather than the Internal Revenue Code and Title 26.

Last week, in response to a summary judgment motion, in Moore v US the district court for the western district of Washington reviewed the procedures and standards that apply to penalties for non-willful failure to file the FBAR. In the opinion, the district court held that the taxpayer violated the law by not filing FBARs and did not have reasonable cause for the nonfiling but that the record before it was inadequate for it to determine whether the amount of the penalties was appropriate. The opinion is interesting for many reasons, including its extensive discussion of the Administrative Procedure Act and the constitutional challenges Moore raised in opposition to the IRS’s assessing FBAR penalties. In addition, the opinion discusses the merits of Moore’s reasonable cause defense, a defense with considerable law in the context of civil tax penalties but not much law in the world of FBAR penalties.

What follows is a discussion of the facts and procedural background, as well as the court’s holding. I borrow heavily from our blogging colleague Jack Townsend at Federal Tax Crimes, who has written extensively on offshore compliance issues, who discusses the case and links the pleadings here. I also benefitted from email exchanges with Carlton Smith and Pat Smith, who in addition to sharing a surname also share the distinction of being two of PT’s finest guest posters. In a later post, I will consider the constitutional issues raised in the case.

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Legal and Factual Background

The opinion gives the essential facts:

There is no dispute that for nearly two decades, Mr. Moore maintained a foreign account subject to FBAR requirements. Its predecessor was an account Mr. Moore opened at a Bahamian bank in about 1989 when he moved to The Bahamas. He opened that account in the name of a Bahamian corporation that he created (and solely controlled) for the purpose of investing in a resort in The Bahamas. He soon transferred the balance to an “investment account” with a Bahamian branch of a Swiss bank, again holding the account in the name of his Bahamian corporation. Mr. Moore moved back to the United States in 1990, but the account remained in The Bahamas. In about 2003, when the Swiss bank ceased its Bahamian operations, the account migrated to Switzerland, where it has remained ever since. At all relevant times, the balance in the account exceeded $ 300,000, but was less than $ 550,000.

There is also no dispute that Mr. Moore filed no FBARs until at least 2009. It was around that time that he became aware of an effort by the IRS to encourage people who had not been reporting foreign accounts to come forward…Through his counsel, he approached the IRS. Ultimately, he amended six years of tax returns (from 2003 through 2008) to report income for each of those years from his foreign account. Mr. Moore and the Government appear to agree that those amendments increased the taxes he owed by about $ 18,000. Even assuming there is any dispute over Mr. Moore’s tax liabilities, that dispute is not before the court. In addition to amending his tax returns, Mr. Moore in 2010 filed late FBARs for 2003 through 2008, as well as his first timely filed FBAR, for 2009.

The legal backdrop is straightforward, at least initially. 31 USC 5321 provides that the IRS can impose a penalty on anyone who fails to file the annual FBAR form; for non-willful failures, section 5321(5)(B)(i) provides that the penalty cannot exceed $10,000 (recall that we recently ran an excellent two-part guest post here discussing in great detail the standard for willfulness for the more severe penalty associated with willful failures).

The opinion also discussed the IRS’s investigation that led to the assessment of the penalties for failing to file the FBAR for the years 2005-08. I include most of the detail from the opinion because the IRS’s actions are more important in the context of traditional APA abuse of discretion review, when the court’s focus is not so much on reaching the correct result but looking to see if the agency followed appropriate procedures, whether the agency adequately explained the decision at Appeals, and whether there was a clear error in judgment.

At some point, the IRS requested an interview with Mr. Moore. He agreed, and IRS Agent Shu Lin Tjoa interviewed him, with his counsel present, by telephone in October 2011….

Agent Tjoa prepared an FBAR Penalty Summary Memo recommending that the IRS impose a penalty of $ 10,000 for each of the four years from 2005 to 2008. Mr. Moore had no access to the Summary Memo until he received it in connection with this lawsuit. The Summary Memo is an eight-page, relatively detailed account of Agent Tjoa’s reasons for recommending a $ 40,000 penalty.

On December 13, 2011, the IRS sent Mr. Moore a letter stating that it was “proposing a penalty” totaling $ 40,000. In contrast to the Summary Memo, the letter provided almost no information about the basis for that penalty. It identified the applicable portions of the Bank Secrecy Act and the years in question. It did not explain why the IRS had selected the maximum penalty. The letter demanded that Mr. Moore either accept the penalty or “request a conference with our Appeals Office” by no later than January 28, 2012. It also explained that if Mr. Moore did nothing by January 28, 2012, it would “assess the penalty and begin collection procedures.”

The IRS ignored the terms of its own letter and assessed a $ 10,000 penalty against Mr. Moore on January 23, 2012. That penalty covered only 2005. Agent Daisy Batman declares that the IRS imposed that penalty after Mr. Moore refused to agree to an extension of the applicable statute of limitations. No one explains why the IRS did not honor its agreement to delay assessment of the penalty pending the “appeal” deadline. The court assumes, because the parties do not assert otherwise, that the six-year limitations period for assessing an FBAR civil penalty for 2005 would have run on July 1, 2012, six years after the June 30, 2006 deadline for submitting an FBAR for 2005. 31 U.S.C. section 5321(b)(1) (“The Secretary of the Treasury may assess a civil penalty . . . at any time before the end of the 6-year period beginning on the date of the transaction with respect to which the penalty is assessed.”). In any event, the IRS does not argue that a statute of limitations would have expired between its assessment of a $ 10,000 penalty on January 23, 2012 and the January 28, 2012 response deadline it gave to Mr. Moore.

Mr. Moore requested an “appeal” of the proposed assessment. Although the IRS had already assessed the 2005 penalty, it is apparent that it permitted Mr. Moore to contest that assessment along with his request that it not impose penalties for 2006 through 2008. In both his January 2012 request for an appeal and his December 2012 letter in support of the appeal, Mr. Moore’s counsel provided detailed argument in support of his request that the IRS either assess no penalty or assess a reduced penalty. Among other things, counsel insisted that Mr. Moore satisfied the requirements of 31 U.S.C. section 5321(b)(5)(B)(ii)(I), which prohibits the imposition of a penalty for an FBAR violation “due to reasonable cause. . . .” The IRS’s response, in a December 18, 2012 letter, was terse:

Dear Taxpayer:

I have completed my review of your request to adjust the penalty(s) assessed against you. Based on the facts presented, including additional information you submitted, I find that no basis for abatement of the penalty(s) is warranted within the protective framework of reasonable cause. Your case is now closed in Appeals.

The remainder of the letter provided payment information and a statement that Mr. Moore could sue in federal court, along with an invitation to participate in a “Appeals customer satisfaction survey.” The letter said nothing about when the IRS would assess the penalties. It assessed $ 10,000 penalties for 2006, 2007, and 2008 on January 24, 2013.

[footnote and cites to record omitted]

Jack Townsend summarizes the court’s conclusion in light of the above:

In summary, on opt out from the OVDI/P [my note: I will not in this post discuss OVDI and opt out; readers wanting more on this can wade into Jack’s outstanding criminal tax blog, where he has discussed the issues extensively], the IRS imposed 4 years of maximum nonwillful penalties against the taxpayer (Moore).  The record before the court was inconclusive as to precisely why the IRS chose to impose 4 years of nonwillful penalties and why to max out the nonwillful penalties.  In the de novo proceeding in the district court, the court determined that the taxpayer was liable for the nonwillful penalties.  The caption for that part of the opinion tells the conclusion:  “On De Novo Review, the Court Concludes that Mr. Moore Violated the Law By Not Filing FBARs and is Subject to a Civil Penalty.”

The court then held that it could not determine on the record whether the IRS had followed the proper procedures under the APA.  The Court rejected the taxpayer’s arguments on due process and excessive fines.  There will be further submissions on the APA issue; it is unclear where that is going…. There might be a remand to the IRS for further consideration, but presumably the IRS would just clean up the administrative record and impose the same penalty now that the district court has held that he is liable for the penalty.  Alternatively, since the $10,000 per year penalty is an “up to” penalty, the Court may enter the fray on whether the IRS should have imposed the maximum penalty or some lesser penalty….

 

So, in a nutshell, what the Court decided in Moore was the following:

1)    Moore committed non-willful violations of the Bank Secrecy Act and was subject to some penalty;

2)    IRS failed to provide a record from which the court could determine under the judicial review provisions of the APA whether IRS acted arbitrarily or capriciously in determining the amount of the penalty; and

3)    The IRS’s assessment of the penalties did not run afoul of the constitution, namely the Fifth Amendment’s due process clause or the Eight Amendment’s Excessive Fines Clause.

Some of the Interesting Procedural Issues

The case spins off a number of interesting procedural issues. I will discuss a few of these issues in this post, but I suggest reading the 25-page opinion and the pleadings for those wanting more.

Standard of Review

Generally, in most Title 26 cases standard of review as relates to liability is straightforward; it is de novo. The FBAR penalty regime resides outside Title 26. What standard applied to the IRS’s determination on the FBAR penalty? The court accepted the government’s position that it “should determine de novo whether Mr. Moore is subject to an FBAR penalty, but should review the IRS’s determination of the amount of that penalty only for abuse of discretion.”

In Moore, while the court accepted the government’s proposal to bifurcate review it notes that the issue has not been decided by “binding caselaw” (though does cite some cases suggestive of the approach—see opinion, note 3). The district court does so because the government proposed that more favorable standard [see its motion and reply, linked above in the Criminal Tax Blog post], not because the court holds that is the right standard.

Moore thus opens the door to DOJ in the future to test the waters on perhaps getting a more deferential abuse of discretion standard of review on the question of liability. It is not clear to me as a legal matter why there should be a bifurcated standard of review under the APA following the same final agency action though as a policy matter I think taxpayers should have de novo review in court on that issue (I invite readers still with me who may have views on this to submit comments).

Reasonable Cause

Another interesting part of the case was its analysis on the merits where it determined that Moore did not have a reasonable cause defense to the FBAR penalty. It did so first by discussing what reasonable cause is in the FBAR context, an issue that like the standard of review issue above has no binding law to guide the court.

The court analogized to reasonable cause in Title 26 and imported that definition into this case:

There is no reason to think that Congress intended the meaning of “reasonable cause” in the Bank Secrecy Act to differ from the meaning ascribed to it in tax statutes. As with the tax statutes, Congress entrusted enforcement of the Bank Secrecy Act to the Treasury Department. If it intended Treasury to interpret “reasonable cause” differently in the newer statute, it left no clues to which any party has pointed. The court thus takes guidance from tax statutes and authority interpreting them, and concludes that a person has “reasonable cause” for an FBAR violation when he committed that violation despite an exercise of ordinary business care and prudence.

As such, it found that Moore did not exercise ordinary business care and prudence, looking to facts such as his Bahamian counsel’s absence of advising on US tax and reporting implications of his business structure and that even though he may have subjectively believed he had no reporting obligations he did so “even in the face of plain notice that he was mistaken.” To that end, the opinion considered his 2003 return which he self-prepared and his lack of responding on that return’s Schedule B, which included a question and reference to the FBAR filing requirements. The opinion also looked to later returns where he in response to a preparer’s questionnaire checked the box no in response to a question whether he had an interest in a foreign financial account.

Discounting his argument that his “age and ignorance” (he was in his seventies when the FBAR’s in question were not filed) contributed to his having reasonable cause for the failure, the opinion essentially finds that as a matter of law “evidence that a taxpayer ignored relevant questions on Schedule B and in tax organizers is evidence of willful conduct.” Given that the IRS only proposed penalties relating to non-willful failures to file, the opinion has little trouble concluding that as a matter of law he was liable.

The Absence of Statutory or Regulatory Procedures for FBAR Penalty Assessment: Informal Adjudications

Back in 2004, I wrote an article in the Houston Law Review discussing the constitutional and administrative law pedigree of CDP. In the article, I emphasized that tax assessment and collection generally had been able to insulate itself from the two main bulwarks that protect regulated parties form potentially inadequate or erroneous agency procedures, procedural due process and the Administrative Procedure Act (and administrative law generally). Over time, I argued, Congress and the courts had been chipping away at that isolation, and in some ways CDP reflected Congress’ concern that the IRS actions subjected individual interests to too great a risk of erroneous actions, notwithstanding the pre and post-assessment statutory and regulatory regime.

In Moore, the opinion notes that “[i]n contrast to well-worn procedures for assessing tax deficiencies, a person searching the Code of Federal Regulations or United States Code for information on the procedure fir FBAR penalty assessment will come up nearly empty-handed.” Here, the opinion notes that when the statutes and regs are silent, regulated parties look to the Due Process Clause and APA Section 555 (relating to the minimal requirements associated with agency informal adjudications).

As I discuss in the Houston Law Review article, the APA gives very little guidance in terms of procedural protections regulated parties enjoy in informal adjudications; generally speaking agencies have great discretion in fashioning procedures. Nonetheless, under the APA (5 USC 555(e)) the agency does have to give notice of any denial as well as explain in a “brief statement” the grounds for any denial.

In addition, under the APA, generally courts look to determine if an agency has acted arbitrarily or capriciously or in abuse of its discretion; this as the opinion notes generates a thorough, probing and in-depth review but is not an exercise that allows the court to substitute its judgment for that of the agency: the court looks to see whether the agency considered all the relevant factors and whether there has been a clear error.

It was here that the court found fault with the IRS. Recall that above the IRS sent Moore only a three-sentence explanation that does “nothing to illuminate what the IRS considered or why it arrived at its decision…it says nothing at all about why it choose[sic] a $40,000 maximum penalty as opposed to a smaller amount.” In addition, the IRS promised to allow Moore to appeal the proposed assessment but in fact assessed 2005 (the earliest year) before allowing Moore to file his appeal.

The opinion was critical of the IRS’s failing to offer evidence from the administrative record explaining how it decided to impose the penalty or why the IRS backtracked on its promise to withhold assessment on one of the years until after an appeal. The opinion notes that there was nothing in the record discussing why the IRS imposed the penalty in the first place; there was a summary memo the agent prepared (though not shared with Moore) that the IRS produced in the case that explained why the agent proposed the maximum penalty. The IRS claimed deliberative process privilege for the Appeals Memo; the court had earlier in the case agreed with that claim but in the opinion notes that at the time it agreed on the privilege issue it did not know that the Appeals Memo was the only contemporaneous source that would explain why the IRS imposed penalties.

In addition, the court criticized the IRS pre-appeal 2005 assessment as “baffling” and “nonsensical” in light of its promise to Moore to allow him to appeal. Noting that the error may have been harmless, the IRS conduct on this likely contributed to the court’s view that IRS did not treat Moore fairly in the process.

At the end of the day, the administrative shortcomings did not warrant abating the assessment. As the opinion explains at around page 19, the typical remedy is that the agency is given a chance through affidavits or testimony the opportunity to show how it reached its decision below. The standard is relatively forgiving in that courts have discretion to accept contemporaneous evidence that it failed to disclose previously; in addition if the agency does not explain itself with ideal clarity the courts will give agencies some slack if the “path may be reasonably discerned.” Nonetheless, after the fact-rationalizations are generally not sufficient. In Moore, the district court directed that the government was to “provide evidence articulating its reasons for assessing a maximum penalty against Moore” and explain why it failed to honor its promise of assessing the 2005 penalty without providing the appeal it promised. Absent evidence on why it imposed the maximum penalty, the opinion warns then it would have no recourse but to conclude that the IRS acted arbitrarily and capriciously.

Conclusion

With the IRS active in offshore compliance, and the lack of established procedures when it comes to proposing penalties for failing to file the FBAR, the courts will lean heavily on general administrative law concepts, as well as constitutional concepts. It is likely that the IRS will be able to serve up evidence that will satisfy the court’s desire to show why it acted as it did in proposing the penalty. Whatever the outcome, IRS would be well-advised when it comes to penalties such as this that allow for a penalty “up to” an amount to not only have that explanation in its files, but it should share its explanation with taxpayers as early as possible. Taxpayers should not be forced to sue in federal court to get an explanation as to the agency’s rationale or the evidence it considered in making its decision.

As to the constitutional issues in the case, due process tends to generate eye glazing in many tax cases because protestors tend to raise those issues and because in straight up tax cases the Supreme Court has often carved tax away from mainstream procedural due process protections. The familiar balancing test from Mathews v Eldridge that courts often use in procedural due process cases is one that will likely find its way more explicitly in FBAR cases. I will come back to the constitutional issues in a later post.

Leslie Book About Leslie Book

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

Comments

  1. Les, thanks for the post. To me, the most troublesome aspects of cases like this are the “willfulness” and “reasonable cause” issues and the way they’re addressed by the courts. Here, Mr. Moore prepared his own returns for several years and apparently admitted that he had read the question about foreign accounts on Schedule B. Since he knew he had a foreign account and failed to check the instructions, the court apparently concluded that this was enough to establish absence of reasonable cause, even on the government’s motion for summary judgment. This may distinguish this from the cases where courts said or implied that an incorrect answer to the question or failure to answer was enough to establish “willfulness.” The Government has argued and at least one or two courts apparently have said or implied that, in such situations, signing the 1040 under penalties of perjury was evidence of willful failure to file a timely FBAR. My reaction is that the taxpayer in such cases might have been careless or “guilty” of willful blindness – or might even have committed perjury – but a detailed factual analysis would be needed to determine the proper factual conclusion to be drawn from the taxpayer’s action [or inaction] in each case. This shouldn’t be the basis for concluding that, as a matter of law, the taxpayer acted willfully. What am I missing here?
    Ron

  2. Thanks Ron. Seems that the court has an easier task when it is not considering the willful failure to file, and it makes all inferences in favor of the taxpayer on SJ.
    Yet, I think part 2 of Peter Hardy and Carolyn Kendall’s post from a few weeks ago addresses some of the concerns you have with the way courts have eroded the willful standard, albeit in full blown trials rather than on a summary judgment motion
    http://procedurallytaxing.com/between-the-national-taxpayer-advocate-and-the-courts-steering-a-middle-course-to-define-willfulness-in-civil-offshore-account-enforcement-cases-part-2/

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