Private Clients - 09 Aug 2018
Since 2004, the IRS has had the statutory authority in cases where a U.S. person willfully fails to disclose balances held in foreign bank or financial accounts (under the “FBAR” rules) to assess a penalty of up to 50% of the balance in the undisclosed account. Or so we assumed.
Prior to 2004, the statute permitted the IRS to assess penalties for willful failures to file FBAR forms of up to $100,000 per account. Regulations interpreting this provision simply repeated that the IRS had the authority to impose penalties of up to $100,000. The regulations were not withdrawn after the 2004 amendment to the statute, and in a flurry of recently-decided cases courts have divided over whether those regulations continue to be binding, thereby preventing the IRS from imposing higher penalties than $100,000 per account.
It is a well-established rule of construction that where a statute, having been interpreted in regulations, is amended, the regulations are considered overridden to the extent of any inconsistency with the amended statute. Because of this principle the IRS has felt empowered to assess the higher post-2004 FBAR penalties despite the fact that the pre-2004 regulations, which have not been withdrawn, only authorize a lower level of penalties.
The procedure for challenging an FBAR penalty differs from that for challenging a penalty imposed under the Internal Revenue Code, because the FBAR rules are in a different Title of the United States Code. While disputes under the Internal Revenue Code can normally be brought by taxpayers in the U.S. Tax Court in advance of the IRS being able to enforce liability, penalties imposed under the FBAR rules cannot be challenged by the account holder until they are paid, at which point the party who has been penalized can sue the government for a refund. Jurisdiction over such cases is shared by the U.S. Court of Claims in Washington D.C., which considers exclusively monetary claims against the government, and Federal District Courts in each of the 50 States (as well as the District of Columbia), which have jurisdiction over a much broader category of disputes involving residents of those states.
In two separate Federal District Court cases decided in May and July of this year, courts in Texas and Colorado both held that because of the nature of the FBAR legislation, the 2004 amendments were not inconsistent with the pre-2004 regulations. This was because the 2004 statutory amendments allowed but did not oblige the IRS to impose penalties of up to 50% of the balance of the relevant account. Given this, the $100,000 per account limit set out in the regulations was not per se inconsistent with the new, higher discretionary limits. Had the IRS wished to enforce limits beyond those provided in the regulations, it would have been necessary to issue new regulations, or at least to withdraw the existing ones.
However, before the champagne could even go flat, the U.S. Court of Claims reached the opposite conclusion in another July 2018 decision. It considered that the 2004 regulations were inconsistent with the amended statute because they provided for a lower maximum penalty than that allowed under the statute.
None of these decisions have precedential effect save in the courts that decided them. Should the IRS appeal the District Court judgments in the appropriate Circuit Courts of Appeals (the Fifth and Tenth Circuits), each Circuit Court’s decision will be binding on Federal courts in the States which comprise that Circuit. The individual who lost in the Court of Claims could also appeal (to the Federal Circuit Court of Appeal), but the outcome of any such appeal will only be binding on the Court of Claims. In the event the appellate courts are not unanimous in their view of the issue, the matter could eventually reach the Supreme Court.
The current uncertainty over whether the IRS can impose the massive post-2004 FBAR penalties will likely change the dynamic in negotiations between taxpayers and the government in cases where there has been a willful failure to comply with applicable foreign income and asset reporting and taxation rules. Particularly with the encouragement of the result in the Court of Claims, it seems likely the IRS will challenge the District Court judgments. On the other hand, other taxpayers that are seeking refunds of FBAR penalties in Federal District Courts also aren’t likely to give up.
At least to eliminate uncertainty going forward, it would seem prudent for the IRS to do something about the existing regulations. Any withdrawal/amendment of those regulations presumably could not be effective earlier than the current year (i.e. for FBAR’s due to be filed in 2019).
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