IRS FBAR penalty conduct was capricious, so late payment interest and penalty voided

Moore, (DC VA 7/24/2015) 116 AFTR 2d ¶ 2015-5094

A district court has held that IRS's conduct in assessing penalties for a taxpayer's failure to file FBARs (Report of Foreign Bank and Financial Account) with respect to his foreign account was arbitrary and capricious, in violation of the Administrative Procedures Act (APA). As a result, the court disallowed IRS's assessment of interest and late payment penalties with respect to the original FBAR penalties.

Background. The Bank Secrecy Act (BSA) gave the Treasury Department authority to collect information from U.S. persons who have financial interests in or signature authority over financial accounts maintained with financial institutions located outside of the U.S. A provision of the BSA requires that a Form 114, Report of Foreign Bank and Financial Accounts (FBAR) be filed if the aggregate maximum values of the foreign financial accounts exceed $10,000 at any time during the calendar year. Enforcement authority regarding the FBAR has been delegated to IRS.

For non-willful BSA violations, the civil penalty that IRS can impose on a person who fails to file FBARs cannot exceed $10,000 per failure. (31 CFR 5321(5)(b)(i)) However, no penalty is imposed if several requirements are met, including that the violation was due to reasonable cause.

APA §555 provides minimal procedural guarantees for "information adjudication," including that an agency give "[p]rompt notice" when denying any request made in connection with any agency proceeding, and that the notice include a "brief statement of the grounds for denial."

Facts. For nearly two decades, James Moore maintained a foreign account subject to FBAR requirements. Mr. Moore filed no FBARs until at least 2009. In 2010, Mr. Moore filed late FBARs for 2003 through 2008, as well as a timely-filed FBAR for 2009.

In October of 2011, an IRS agent interviewed Mr. Moore and then prepared an FBAR Penalty Summary Memo (memo) recommending that IRS impose a $10,000 penalty for each year from 2005 to 2008. The memo, which provided the agent's reasoning in detail for recommending the penalty, wasn't disclosed to Mr. Moore at that point.

In December of 2011, IRS sent Mr. Moore a letter proposing a $40,000 penalty that provided virtually no information about the basis for the penalty, demanded that he accept the penalty or request a conference with Appeals by Jan. 28, 2012. However, on Jan. 23, 2012, IRS assessed a $10,000 penalty against Mr. Moore for 2005 only. Mr. Moore requested an appeal, and his counsel provided detailed arguments in a letter as to why Mr. Moore acted with reasonable cause. IRS responded in a brief letter upholding the penalties and assessed the $10,000 penalties.

Mr. Moore filed suit late in 2013. He argued that IRS violated the Fifth Amendment's Due Process Clause, the Eighth Amendment's Excessive Fines Clause, and the APA. He also sought to have IRS compelled to disclose the memo.

Earlier district court holding. In April, 2015 (see Moore v. U.S., (DC WA 2015) 115 AFTR 2d ¶2015-591; Weekly Alert ¶ 9 04/23/2015 ), the district court held that Mr. Moore committed non-willful violations of the BSA and was thus subject to civil penalties. It also rejected his reasonable cause, Fifth Amendment and Eighth amendment arguments for relief from that penalty.

As to Moore's APA argument, the court said the appropriate standard of review was whether IRS's actions were "arbitrary, capricious, an abuse of discretion, or otherwise not accordance with the law" under the APA. The court observed that, unlike tax deficiencies, there are "no codified procedures" for IRS to use in assessing FBAR penalties. Thus, IRS can essentially fashion its own procedures for doing so, subject to constitutional limitations and the APA.

But the court then examined the letter sent to Mr. Moore and found that it could not, on the record before it, determine whether IRS acted arbitrarily, capriciously, or abused its discretion in assessing the penalties. The court then issued an order that gave IRS time to introduce additional material in support of its determination to show that its decision wasn't arbitrary.

IRS's conduct was arbitrary and capricious. After reviewing the parties' supplemental briefs in response to its order, the court reached the following conclusions:

1. IRS demonstrated that its decision to assess Mr. Moore FBAR penalties of $10,000 for each year from 2005 through 2008 was not arbitrary, not capricious, and not an abuse of its discretion. The memo indicated that IRS was following Internal Revenue Manual (IRM) guidelines for such types of assessments. The court found that those guidelines were not arbitrary or capricious and that it was not an abuse of discretion for IRS to follow those guidelines in this case.

2. IRS's conduct in assessing those FBAR penalties, by contrast, was in several respects arbitrary and capricious.

IRS disclosed no adequate basis for its decision to assess the penalties until this litigation forced its hand. Even after this litigation began, IRS refused to disclose the evidence on which it relied to demonstrate the basis for its decision to impose those penalties. IRS did not simply fail to disclose the memo, it opposed Mr. Moore's motion to compel its disclosure. IRS offered no explanation for its apparent policy not to explain the assessment of FBAR penalties to citizens, and in particular for its apparent policy not to put that explanation in writing. No citizen should have to sue his own government to find out why he is being fined, or to find out why he is being fined $40,000 as opposed to a smaller amount. And once a citizen has sued, he should not have to fight over the most basic disclosures.

With respect to the 2005 penalty, IRS broke its own promise not to impose a penalty until Mr. Moore had an opportunity to respond to its "proposed" assessment. IRS explained that its Jan. 23, 2012 assessment was dictated by its internal policy to assess FBAR penalties at least 180 days before the expiration of the statute of limitations for doing so. The court said that such a policy is well within its discretion. What was not within its discretion was IRS's decision to offer Mr. Moore the opportunity to contest the 2005 FBAR penalty before its assessment, and then to impose the penalty before the deadline IRS imposed. IRS offered no explanation for why it allowed rote application of its internal policies to trump the individual assurances it made to Mr. Moore.

3. In light of the arbitrary and capricious conduct described above, any interest, late fee, or other supplemental assessment that IRS or another agency of the U.S. attempted to tack on to Mr. Moore's FBAR penalties was void. The government had to treat the FBAR penalties as if they were first assessed on the date of the court's order.

The court noted that there were two apparent harms arising from IRS's arbitrary and capricious conduct in imposing that penalty. First, Mr. Moore was given the unappealing choice to either accept IRS's unexplained imposition of a $40,000 penalty or to file suit. The court assumed that Mr. Moore's choice to sue cost him a substantial sum. Second, IRS assessed interest and other penalties on top of the FBAR penalties. The court said that it expressed no opinion on whether the first harm could be remedied. The court remedied the second harm.

References: For foreign financial accounts reporting requirements, see FTC 2d/FIN ¶ S-3650 ; United States Tax Reporter ¶ 60,114.06 ; TaxDesk ¶ 815,516 ; TG ¶ 60611 .

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