Federal Court Concludes that FBAR Penalties are not Subject to the Flora Rule
It has been more than 60 years since the Supreme Court held that, under 28 U.S.C. § 1346(a)(1), taxpayers seeking to file federal tax claims against the government in federal court must pay the full amount of tax prior to filing suit. See Flora v. U.S., 362 U.S. 145, 177 (1960). As a result, many taxpayers with large tax assessments often find it more difficult to obtain judicial review of IRS actions, particularly where important procedural rights are lost due to inaction.
But, by its own terms, 28 U.S.C. § 1346(a)(1) only applies to “internal-revenue taxes” and claims related to “internal-revenue laws.” Clearly, federal income taxes and penalties within Title 26 of the United States Code (i.e., the “I.R.C.”) may fall within these definitions. However, do other statutory provisions outside the I.R.C. also fall within the purview of 28 U.S.C. § 1346(a)(1) and the Flora rule?
Federal courts have struggled with this issue. For example, in 2018, the Third Circuit Court of Appeals hinted that FBAR penalties (located in Title 31) may fall within the reach of 28 U.S.C. § 1346(a)(1). See Bedrosian v. U.S., 912 F.3d 144, 149 (3d Cir. 2018). If this position were accepted by all federal courts, taxpayers subject to “willful” FBAR penalties—often up to 50% of the highest account balance of the foreign account—would find it much more difficult to seek judicial review of the FBAR penalty assessment.
Fortunately, the United States Court of Federal Claims recently issued a decision flatly rejection the Third Circuit’s Bedrosian decision. Specifically, on April 7, 2021, the court issued its decision in Mendu, which held that FBAR penalties are not subject to the Flora rule because FBAR penalties are not internal-revenue laws or internal-revenue taxes within the scope of 28 U.S.C. § 1346(a)(1). See Mendu v. U.S., No. 17-cv-738-T (Fed. Cl. Apr. 7, 2021). This Insight provides a quick overview of the Mendu decision.
Procedural Facts of Mendu.
Procedurally, the Mendu decision was an interesting one. On June 2, 2017, Mr. Mendu filed an action in the Court of Federal Claims challenging the assessment of approximately $750,000 of “willful” FBAR penalties. To ensure that the Court of Federal Claims had jurisdiction over his illegal exaction claim, Mr. Mendu paid a paltry portion of the FBAR penalties assessed against him—or $1,000—and then filed suit seeking a recovery of that amount.
Shortly thereafter, the government filed an answer and counterclaim seeking judgment of the entire $750,000 of FBAR penalties and interest. After the government filed its answer and counterclaim, Mr. Mendu sought to dismiss his own complaint on the basis that the court lacked jurisdiction over his illegal exaction claim under Flora, thereby further nullifying jurisdiction regarding the government’s counterclaim.
The Court of Federal Claims’ Jurisdiction over Illegal Exaction Claims.
To better understand Mendu, it is necessary to discuss the Court of Federal Claims’ jurisdiction over illegal exaction claims. Under the Tucker Act, the court has jurisdiction over illegal exaction claims “when the plaintiff has paid money over to the Government, directly or in effect, and seeks return of all or part of that sum that was improperly paid, exacted, or taken from the claimant in contravention of the Constitution, a statute, or a regulation.” Aerolineas Argentinas v. U.S., 77 F.3d 1564, 1572 (Fed. Cir. 1996) (internal quotes omitted). Although the Tucker Act provides the Court of Federal Claims with jurisdiction over illegal exaction claims, the Court of Federal Claims has also recognized that such claims related to federal taxes must also meet the Flora rule. This ensures that taxpayers cannot work around the Flora rule, which would otherwise govern in federal district court proceedings.
Whether FBAR Penalties are Subject to 28 U.S.C. § 1346(a)(1)?
Because Mr. Mendu had paid a portion of the FBAR penalties and filed suit under an illegal exaction claim against the government, but later sought to dismiss his own complaint as violative of the Flora rule—the Court of Federal Claims was presented squarely with the issue of whether FBAR penalties were “internal-revenue taxes” or “internal-revenue laws” under 28 U.S.C. § 1346(a)(1). And to make this determination, the court turned to the purpose and structure of FBAR penalties. Moreover, because Mr. Mendu relied on the Bedrosian decision, the court also carefully analyzed whether its reasoning was persuasive.
Structure and Purpose of FBAR Penalties.
Regarding the structure and purpose of FBAR penalties, the court first recognized that FBAR penalties are housed in Title 31 of the United States Code. The court concluded this placement by Congress was significant and “not a mere technicality.” Indeed, the court further recognized that the Internal Revenue Code had been initially created by Congress in an effort “to consolidate and codify the internal revenue laws of the United States.” Internal Revenue Code of 1939, ch. 2, 53 Stat. 1 (emphasis mine). Moreover, the court noted that FBAR penalties, unlike civil penalties under the I.R.C., contain no statutory cross-references that equate “penalties” with “taxes”. See, e.g., 26 U.S.C. § 6201(a).
In addition, the court found that the Supreme Court’s decisions in Flora I and Flora II were distinguishable from the case at hand. With respect to Flora I, the court noted that the Supreme Court had disapproved of a taxpayer’s efforts to miss the Tax Court filing deadline but then subsequently file a refund claim based on only a partial payment of the federal income tax. In this regard, the Supreme Court indicated that 28 U.S.C. § 1346(a)(1) was not intended to alter the historical practice that a taxpayer must “pay first and litigate later.” Flora I, 357 U.S. at 63-64.
And the Court of Federal Claims recognized that in Flora II, the Supreme Court again held that a taxpayer must pay the full tax amount prior to filing a refund suit under 28 U.S.C. § 1346(a)(1). See Flora II, 362 U.S. at 155. In so holding, the Supreme Court noted that the full payment rule was established because permitting partial payment in tax-refund suits could “seriously impair the government’s ability to collect taxes.” Flora II, 362 U.S. at 164, 176 n.41 & n.43. Moreover, the Supreme Court recognized that such a suit would be analogous to a suit for declaratory judgment and would thus contravene Congress’ prohibition on declaratory judgments over disputes related to federal taxes. Flora II, 362 U.S. at 164.
After reviewing Flora I and Flora II, the Court of Federal Claims concluded that “there is no concern that the collection of FBAR penalties will be seriously impaired without the application of a full payment rule.” This was so according to the court because “[u]nlike the internal-revenue laws included in section 1346, FBAR penalties are enforced primarily through ‘a civil action to recover a civil penalty.’” Compare 26 U.S.C. §§ 6301-6344 (providing that the IRS can collect internal-revenue penalties through a lien or levy) with 31 U.S.C. § 5321(b)(2) (providing that FBAR penalties may only be collected through “a civil action to recover a civil penalty”). Thus, there were “no administrative collection procedures for FBAR penalties with which a partial payment illegal exaction claim would interfere.”
The Bedrosian Decision.
The Court of Federal Claims found the footnote in Bedrosian equally unpersuasive. In that footnote, the Third Circuit had indicated that it was “inclined to believe” that an account holder must “pay the full . . . [FBAR] penalty before filing suit,” but left “a definitive holding on this issue for another day.” As summarized by the Court of Federal Claims, the Bedrosian footnote relied on the following rationale:
First, the footnote cites to a concurrence in Wyodak Res. Dev. Corp. v. U.S., 637 F.3d 1127 (10th Cir. 2011) for the proposition that ‘internal-revenue laws’ are defined by their function and not their placement in the U.S. Code. Second, the footnote analogizes FBAR reporting penalties to reporting penalties levied pursuant to I.R.C. § 6038(b), which are subject to the Flora full payment rule. Third, Bedrosian relies on another footnote in a United States Tax Court decision for the proposition that not all internal-revenue laws exist in Title 26. (citing Whistleblower 21276-13W v. Comm’r, 147 T.C. 121, 130 n.13 (2016)). Piecing these propositions together, the Bedrosian court was ‘inclined to believe’ that FBAR penalties may be subject to the Flora full payment rule.
After reviewing the rationale for the footnote, the Court of Federal Claims carefully analyzed the decisions cited and concluded that they were inapposite. With respect to the Wyodak decision, the court concluded that the “concurrence in Wyodak actually supports the conclusion that an FBAR penalty is not a tax.” In the concurrence, then-Judge Gorsuch argued that the proper inquiry for an “internal-revenue tax” under 28 U.S.C. § 1346(a)(1) was to analyze whether the statute in question should be “properly understood as levying a tax or imposing a regulatory fee.” In this regard, Judge Gorsuch further explained:
If a law’s purpose was to regulate private behavior, the costs imposed by it were treated as fees—and so required justification under the legislature’s regulatory authority . . . Meanwhile, a charge imposed for the purpose of raising general revenue was a tax, and so needed to be consistent with the sovereign’s authorized taxing powers.
Applying a similar approach, the Court of Federal Claims reasoned that Title 31—like the statute at issue in Wyodak—had a stated purpose that is regulatory in nature. See 31 U.S.C. § 5311 (stating that the Bank Secrecy Act’s purpose is “to require certain reports or records where they have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities, including analysis, to protect against international terrorism.”). On this basis, the court held that “[t]hese functions clearly extend beyond ‘general revenue raising’ and are more akin to a ‘regulatory fee.’”
The Court of Federal Claims also disagreed that the civil penalties under 26 U.S.C. § 6038 were similar to FBAR penalties. Indeed, the court reasoned that “[a]ny similarities between the FBAR and section 6038 are superficial.” Thus, the court recognized that although the reporting requirements under both provisions may be similar, the penalties assessed for a violation of either is “very different.” More specifically, “unlike the FBAR penalty, section 6038 penalties are treated as a tax and are subject to pre-suit collection procedures, including lien and levy collection procedures, which are traditionally used to collect taxes under Title 26.”
And with respect to the last case relied upon in Bedrosian—Whistleblower 21276-13W v. Comm’r, 147 T.C. 121, 130 (2016)—the Court of Federal Claims held that it did not support the characterization of the FBAR penalty as an internal-revenue law. Rather, that decision merely addressed the meaning of “collected proceeds” under a prior version of 26 U.S.C. § 7623(b)(1). Moreover, the Court of Federal Claims located three other Tax Court decisions that supported its view that FBAR penalties should not be characterized as “internal-revenue laws.”
The Court of Federal Claims concluded that FBAR penalties were not subject to the Flora rule because they were not “internal-revenue laws” or “internal-revenue taxes” under 28 U.S.C. § 1346(a)(1). In so concluding, the court held that although “[i]t may be accurate that every internal-revenue law is not necessarily contained in Title 26 . . . 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.”
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