Just When You Thought It Was Safe to Go Back in the Water, FBAR Style by ROBERT S. HORWITZ
I thought after my last series of blogs on recent FBAR cases that it would be safe to venture into the waters of Title 26 cases. But just when I was starting to work on some blogs on interesting tax cases, a school of Title 31 willful FBAR penalty cases broke the surface, jaws open, circling in the… . You get the picture. This blog will consider two recent Court of Federal Claims FBAR cases, Mendu v. United States, Case No. 17-cv-738T (April 7, 2021), and Landa v. United States, Case No. 18-365 (April 19, 2021). The next blog will discuss the Eleventh Circuit’s decision in United States v. Rum.
Mendu addresses the question of whether the Title 31 FBAR penalty is an “internal revenue” penalty. The Third Circuit, in a footnote in Bedrosian v. United States, stated that FBAR penalties, although found in Title 31of the United States Code, and not Title 26, are “internal revenue” penalties, requiring full payment under Flora v. United States, 362 U.S. 145 (1960), before a person can sue for refund. Mendu had paid $1,000 towards a $752,000 FBAR penalty and the Government counter claimed for the balance.
Mendu was the co-founder of an Indian venture capital company. He had signature authority over the company’s overseas accounts. He also had a personal account where he deposited rental income from a home he owned in India. He did not file a 2009 FBAR by the due date. After learning about the requirement to file FBARs, he filed a 2009 FBAR in 2011 and an amended 2009 FBAR in 2012. The IRS audited Mendu, determined his failure to file was willful and assessed the penalty that was in issue.
While the case was pending, the Federal Circuit issued its opinions in Norman and Kimble, affirming decisions in favor of the Government in FBAR willful penalty cases and holding that the Treasury Regulation imposing a $100,000 cap on the FBAR penalty was rendered void by the 2004 amendment to 31 U.S.C. 5321 and that signing a return falsely answering “no” to the question whether the taxpayer has a financial interest in or signature authority over a foreign account has acted with reckless disregard and, thus, willfully. This double whammy apparently gave Mendu second thoughts about the sagacity of seeking a refund in the Court of Federal Claims. He therefore filed a motion to dismiss the case for lack of subject matter jurisdiction, arguing that the FBAR penalty was an “internal revenue” penalty and, therefore the Flora full-payment rule applied. The Government argued that the Flora rule does not apply to the FBAR penalty since it is in Title 31, not Title 26, the Internal Revenue Code, that the FBAR penalty was not subject to IRS collection procedures, and apply Flora to FBAR penalties would not further any policy. It also argued that if the court determined it was without jurisdiction it should transfer the case to the Central District of California.
The Court held that FBAR penalties are not internal revenue penalties. The Court began by noting that it had jurisdiction over claims of illegal exaction of money by the United States, including for the refund of any illegally exacted penalty. Unless the FBAR penalty was an “internal revenue penalty” within the meaning of 28 U.S.C. sec. 1346(a)(1) (which gives district courts jurisdiction over tax refund suits), the full-payment rule did not apply and it had jurisdiction over Mendu’s case.
The Internal Revenue Code was created “to consolidate and codify the internal revenue laws of the United States.” The Court reasoned that since the FBAR penalty was in Title 31 and not in Title 26, the references in Title 26 equating penalties to tax do not apply. Further, there were no statutory references equating the FBAR penalty to a tax or a penalty under the Internal Revenue Code. To reach its decision in Flora, the Supreme Court looked to the nature of internal revenue taxes and the refund scheme Congress devised and noted that permitting refund suits without full payment could seriously impair the collection of tax and would effectively be a declaratory judgment that would contravene the prohibition on declaratory judgments in tax cases. These concerns don’t apply to the FBAR penalty, since enforced collection is usually through a suit to recover a civil penalty and there is no administrative collection procedure a civil suit would interfere with.
The Court noted that Bedrosian was a Third Circuit case that was not binding on it and the Bedrosian court noted it was leaving a definitive holding to another day. The Court also noted that the Bank Secrecy Act has a regulatory purpose and Congress termed the FBAR penalty a “civil money penalty,” noting that in Simonelli, 614 F.Supp. 2d 241 (D. Conn. 2008), the court held that the FBAR penalty was not a tax penalty and thus was not discharged in bankruptcy. While the FBAR penalty had some similarities with Internal Revenue Code sec. 6038 return reporting penalties, the Tax Court in Flume v. Commissioner, 113 T.C.M. 1097, held that the IRC 6038 penalty that can be collected by administrative levy. [Those familiar with the issue know that the current Taxpayer Advocate, Erin Collins, and I both are of the opinion that IRC 6038 penalties are not “tax” and may not be assessed or collected as a tax.]
The Court concluded that the fact the FBAR penalty is in Title 31 and not subject to traditional tax collection procedures “demonstrates that Congress did not intend to subject the FBAR penalty to the Flora full payment rule.”
Which brings us to an FBAR case where the court seemed sympathetic with the plaintiff, but upheld the willful penalty, Landa. In 1939, with the clouds of war gathering, Landa’s grandfather opened a bank account in Switzerland. Landa was born in the Ukraine. In 1975 he emigrated with his parents and brother to the United States, eventually becoming a naturalized U.S. citizen. They opened a jewelry business. His father told him about the Swiss bank account in 1980 and in 1985 gave Landa, his mother and his brother power of attorney on the account. Landa and his father annually traveled to Switzerland for a jewelry convention. While there, they would visit the bank where the account was . By the beginning of this century they had accounts at UBS and Credit Suisse. In 2001, Landa and his brother took over management of the accounts from their father.
In 2008, UBS announced it would no longer provide private banking services to U.S. citizens. A banker at. Credit Suisse advised Landa move the money to a bank with no U.S. operations, BSI. He opened a numbered account at BSI and moved the money in UBS and Credit Suisse to BSI. On the application he listed himself as the sole account holder and had a mail hold placed on the account.
When it came time to prepare his 2009 return, Landa did not tell his CPA about the Swiss account and his return did not report the income from that account. The “no” box was checked in response to the Schedule B question whether he had a financial interest in or signatory authority over any offshore accounts. Landa signed the return, which was filed with the IRS.
Notice 2010-11 gave persons with signatory authority over, but no financial interest in, a foreign account until June 30, 2011, to file the 2009 FBAR. Landa filed the 2009 FBAR in February 2011. He listed himself as power of attorney for the UBS and Credit Suisse accounts and as trustee for the BSI account. The FBAR reported the balance in the BSI account at $6,395,493. The IRS determined that Landa willfully failed to file the 2009 FBAR by the due date and assessed a $3,173,464 penalty. Landa paid it in full and filed suit to recover the funds as an illegal exaction. He alleged that he did not have a financial interest in the account and thus his filing was timely under Notice 2010-11.
The Government moved for summary judgment on the ground that Landa had a financial interest in the account and the Notice did not apply. At the time the 2009 FBAR was filed regulations defining “financial interest” had not yet been issued. The 2009 FBAR instructions defined it as an account in which the person is record owner or has legal title, whether the funds are held for his benefit or the benefit of others. Landa argued that Swiss law should apply in determining whether he had a financial interest and since he was holding the funds in trust for his family under Swiss law he would not have a financial interest. The Court rejected this argument. Under sec. 5321 the Secretary of Treasury is authorized to impose penalties on U.S. persons who fail to report a financial interest in a foreign account. The Secretary had delegated authority to the IRS and its definition of financial interest controlled. Since Landa was the owner of record of the BSI account he had a financial interest in the BSI account even if he held the funds for the benefit of his family. Since he had a financial interest in the account, the Notice did not apply and Landa’s 2009 FBAR was late.
Although Landa did not challenge the penalty on the ground that he was not willful, the Court addressed the question of willfulness. Noting that many of the factors present in the Norman and Kimble cases were in Landa’s case, the Court held he acted willfully under the reckless disregard standard. The Court did not discuss whether Landa’s belief that he did not have a financial interest and thus could file under the Notice negated willfulness.
Two other issues were considered by the Court: whether the $3.2. million FBAR penalty violated the Eight Amendment prohibition on excessive fines and whether imposition of the penalty was an abuse of discretion. Noting that the Eighth Amendment prohibits fines and penalties that are punishment for an offense and not civil penalties that are remedial in nature, the Court analogized the FBAR penalty to civil tax penalties, which do not implicate the Eight Amendment, the Court held that the Eighth Amendment doesn’t apply to the civil FBAR penalty. The Court also held that the imposition of the maximum 50% penalty was not an abuse of discretion. In its conclusion, the Court threw out a sop to Landa:
The Court appreciates the plaintiff’s unusual family history. These funds were hidden from the Nazis and subsequently hidden from the Communist authorities in the Soviet Union, where the Landa family resided until fleeing to the West. That history may help explain the plaintiff’s behavior, but it cannot relieve the plaintiff of a broadly applicable filing requirement. The law is unambiguous in its application to cases like the plaintiff’s.
Unlike cases involving the non-willful FBAR penalty, things look continually bleak for U.S. persons against whom the IRS assesses a willful penalty.
Robert S. Horwitz is a Principal at Hochman Salkin Toscher & Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division. He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions.