Is There Still Hope for Taxpayers? Another Court Determines Previous IRS Guidance Limiting FBAR Penalty is Invalid
July 26, 2021
On July 13, 2021, the Second Circuit issued an opinion in United States v. Kahn, No. 19-3920 (2d Cir. 2021) affirming the trial court’s grant of summary judgment against the defendants for FBAR penalties, plus statutory additions and interest, in the amount of $4,264,728. The facts in Kahn were largely undisputed, but the government and defendants ultimately disagreed with the application of a 1987 Treasury Department regulation, 31 C.F.R. § 1010.820(g)(2), to the case.
31 U.S.C. §§ 5314 and 5321 require taxpayers to file a Report of Foreign Bank and Financial Accounts (“FBAR”) for each year in which the taxpayer has a beneficial interest in a foreign financial account greater than $10,000 in aggregate (balances in foreign accounts are aggregated together to determine the reporting requirement). Section 5321, containing the penalty provisions, was amended in 2004 to include a maximum permissible penalty of 50% of the aggregate value of all such accounts during the year or $100,000, whichever is greater, for a willful failure to file an FBAR. The previous iteration of the statute set the maximum penalty at the greater of $25,000 or an amount (not to exceed $100,000) equal to the balance in the account at the time of the violation. Prior to 2004, the Treasury Department had issued 31 C.F.R. § 1010.820(g)(2), which limited willful FBAR violations to only $100,000 per account, based upon the plain language of the statute at that time. Thus, the current iteration of 31 U.S.C. § 5321 is potentially at odds with the language of 31 C.F.R. § 1010.820(g)(2), as the Treasury Department never issued an update to the regulation based on the amended statute.
In Kahn, it was undisputed that the defendants willfully failed to file FBARs, but the parties disagreed over the application of 31 C.F.R. § 1010.820(g)(2). Defendants argued that the regulation still applied—limiting the penalties to only $100,000 per year. The government argued that the amendment to 31 U.S.C. § 5321 in 2004 superseded the ceiling imposed by the previous regulation, and was, thus, not binding on the government. The trial court held for the government, and the Second Circuit affirmed the trial court’s finding.
This case is interesting because there is a potential circuit split on this issue. The ruling in Kahn joined other circuits, such as the Seventh Circuit, in holding that the regulation no longer was binding—meaning the government could assess penalties above the previous $100,000 ceiling. The rationale provided by these courts focuses on the amendment made to the statute in 2004. Specifically, these courts reason that a regulation is invalid if it is “fundamentally at odds with manifest Congressional design.” And in the Second Circuit’s opinion, the design of the 2004 amendment was to enhance the maximum penalty that could be imposed for a willful FBAR violation—nullifying the previous regulation.
However, Judge Menashi dissented from the majority in Kahn. Judge Menashi quotes from Ft. Stewart Schs. V. Fed. Lab. Reels. Auth., 495 U.S. 641 (1990):
Judge Menashi’s dissent is in line with holdings in other specific trial courts located in other circuits, such as certain trial courts under the Fifth and Tenth Circuits. See United States v. Colliot, No. AU-16-CA-01281-SS, 2018 BL 175652, 2018 U.S. Dist. Lexis 83159, 2018 WL 2271381 (W.D. Tex. May 15, 2018) (“In sum, § 1010.820 is a valid regulation, promulgated via notice-and-comment rulemaking, which caps penalties for willful FBAR violations at $100,000. 31 C.F.R. § 1010.820.”); United States v. Wadhan, 325 F. Supp. 3d 1136 (D. Colo. 2018) (“The Court’s reasoning is congruous with the Western District of Texas’ determination on the same issue in United States v. Colliot, No. 16-CA-1281-SS, 2018 U.S. Dist. Lexis 83159, 2018 WL 2271381 (May 16, 2018). Although the IRS believes that it is empowered by 31 U.S.C. § 5321 to act, it is not. It is empowered by the Secretary who has discretion to determine what penalties are imposed. § 1010.820 remains in effect until amended or repealed.”). While Kahn does deal a blow to some taxpayers fighting willful FBAR penalties, the war has yet to be won by the government. But the government has yet to lose the war as well, as it has the opportunity to create a circuit split and push the issue into the Supreme Court. These cases in trial courts in the Fifth and Tenth Circuits have yet to be appealed, and it is unclear how those Appeals Courts may ultimately rule on the issue. Thus, any taxpayer fighting an FBAR penalty must be cognizant of where he/she lives and which circuit court would ultimately review any appeal, as it may be outcome determinative for his/her case.
If you have questions regarding the FBAR Penalty or any other tax-related issue, please contact me at (214)744-3700 or rdean@meadowscollier.com.
31 U.S.C. §§ 5314 and 5321 require taxpayers to file a Report of Foreign Bank and Financial Accounts (“FBAR”) for each year in which the taxpayer has a beneficial interest in a foreign financial account greater than $10,000 in aggregate (balances in foreign accounts are aggregated together to determine the reporting requirement). Section 5321, containing the penalty provisions, was amended in 2004 to include a maximum permissible penalty of 50% of the aggregate value of all such accounts during the year or $100,000, whichever is greater, for a willful failure to file an FBAR. The previous iteration of the statute set the maximum penalty at the greater of $25,000 or an amount (not to exceed $100,000) equal to the balance in the account at the time of the violation. Prior to 2004, the Treasury Department had issued 31 C.F.R. § 1010.820(g)(2), which limited willful FBAR violations to only $100,000 per account, based upon the plain language of the statute at that time. Thus, the current iteration of 31 U.S.C. § 5321 is potentially at odds with the language of 31 C.F.R. § 1010.820(g)(2), as the Treasury Department never issued an update to the regulation based on the amended statute.
In Kahn, it was undisputed that the defendants willfully failed to file FBARs, but the parties disagreed over the application of 31 C.F.R. § 1010.820(g)(2). Defendants argued that the regulation still applied—limiting the penalties to only $100,000 per year. The government argued that the amendment to 31 U.S.C. § 5321 in 2004 superseded the ceiling imposed by the previous regulation, and was, thus, not binding on the government. The trial court held for the government, and the Second Circuit affirmed the trial court’s finding.
This case is interesting because there is a potential circuit split on this issue. The ruling in Kahn joined other circuits, such as the Seventh Circuit, in holding that the regulation no longer was binding—meaning the government could assess penalties above the previous $100,000 ceiling. The rationale provided by these courts focuses on the amendment made to the statute in 2004. Specifically, these courts reason that a regulation is invalid if it is “fundamentally at odds with manifest Congressional design.” And in the Second Circuit’s opinion, the design of the 2004 amendment was to enhance the maximum penalty that could be imposed for a willful FBAR violation—nullifying the previous regulation.
However, Judge Menashi dissented from the majority in Kahn. Judge Menashi quotes from Ft. Stewart Schs. V. Fed. Lab. Reels. Auth., 495 U.S. 641 (1990):
It is a familiar rule of administrative law that an agency must abide by its own regulations. Ft. Stewart Schs. v. Fed. Lab. Rels. Auth., 495 U.S. 641, 654 (1990). We call this rule “the Accardi principle” after the case most associated with it, United States ex rel. Accardi v. Shaughnessy, 347 U.S. 260 (1954). In this case, the Accardi principle requires that we reverse the judgment of the district court.
Judge Menashi notes that the Treasury Department neglected to update its previous regulation, and its failure to do so was fatal to the government’s position. 31 C.F.R. § 1010.820(g)(2) unquestionably limits the FBAR penalties to $100,000. But the question is if that regulation is still binding on the government amid the amendment to the statute in 2004. Judge Menashi determined that the regulation was still binding because, in reality, it did not actually conflict with the statute, as amended. Specifically,
The amended statute provides that “[t] he Secretary of the Treasury may impose a civil money penalty on any person who” fails to file an FBAR. 31 U.S.C. § 5321(a)(5)(A) . . . While the court is correct that the statute allows the Secretary to impose a penalty in excess of the $100,000 regulatory cap, it errs in interpreting the statute to require that the Secretary subject violators to an increased penalty—or even a “potentially” increased penalty . . . The statute does not require the Secretary to do anything.
. . .
[T]he regulation currently codified at 31 C.F.R. § 1010.820(g)(2), which limits the FBAR penalty to a maximum of $100,000, represents a due exercise of the Secretary’s authority that limits her discretion beyond the statutory constraints. “[H]aving” so exercised that authority, the Secretary may “not, so long as the [r]egulations remained unchanged, proceed without regard to them,” Service, 354 U.S. at 388, “even though without such regulations [s] he could” impose a fine that exceeds $100,000, Vitarelli, 359 U.S. at 540.
(Emphasis in original). In short, Judge Menashi determined that the regulation was still binding because it was not explicitly overruled by the 2004 amendment to the statute, as that amendment did not mandate the increased penalty, but merely allowed for the increased penalty to be imposed at the discretion of the Treasury Department. And previous guidance issued by the Treasury Department limits the cap on the penalty.. . .
[T]he regulation currently codified at 31 C.F.R. § 1010.820(g)(2), which limits the FBAR penalty to a maximum of $100,000, represents a due exercise of the Secretary’s authority that limits her discretion beyond the statutory constraints. “[H]aving” so exercised that authority, the Secretary may “not, so long as the [r]egulations remained unchanged, proceed without regard to them,” Service, 354 U.S. at 388, “even though without such regulations [s] he could” impose a fine that exceeds $100,000, Vitarelli, 359 U.S. at 540.
Judge Menashi’s dissent is in line with holdings in other specific trial courts located in other circuits, such as certain trial courts under the Fifth and Tenth Circuits. See United States v. Colliot, No. AU-16-CA-01281-SS, 2018 BL 175652, 2018 U.S. Dist. Lexis 83159, 2018 WL 2271381 (W.D. Tex. May 15, 2018) (“In sum, § 1010.820 is a valid regulation, promulgated via notice-and-comment rulemaking, which caps penalties for willful FBAR violations at $100,000. 31 C.F.R. § 1010.820.”); United States v. Wadhan, 325 F. Supp. 3d 1136 (D. Colo. 2018) (“The Court’s reasoning is congruous with the Western District of Texas’ determination on the same issue in United States v. Colliot, No. 16-CA-1281-SS, 2018 U.S. Dist. Lexis 83159, 2018 WL 2271381 (May 16, 2018). Although the IRS believes that it is empowered by 31 U.S.C. § 5321 to act, it is not. It is empowered by the Secretary who has discretion to determine what penalties are imposed. § 1010.820 remains in effect until amended or repealed.”). While Kahn does deal a blow to some taxpayers fighting willful FBAR penalties, the war has yet to be won by the government. But the government has yet to lose the war as well, as it has the opportunity to create a circuit split and push the issue into the Supreme Court. These cases in trial courts in the Fifth and Tenth Circuits have yet to be appealed, and it is unclear how those Appeals Courts may ultimately rule on the issue. Thus, any taxpayer fighting an FBAR penalty must be cognizant of where he/she lives and which circuit court would ultimately review any appeal, as it may be outcome determinative for his/her case.
If you have questions regarding the FBAR Penalty or any other tax-related issue, please contact me at (214)744-3700 or rdean@meadowscollier.com.
