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The Administrative Procedure Act - Challenging FBAR Penalties

Over the past 10 years, thousands of U.S. taxpayers with a wide variety of circumstances have been forced to pay extraordinarily high penalties for failure to disclose foreign bank accounts. For years, tax experts said that the penalties imposed by the IRS for non-willful failure to file an FBAR is an issue ripe for a challenge. The first such challenge came in April of 2015 from our firm.

Treading new ground in tax and administrative law

Our case involved a taxpayer who did not report an overseas account for a number of years, then began to remedy his error by  (1) hiring a tax lawyer, (2) participating in the 2009 Offshore Voluntary Disclosure Initiative which included amending tax returns to report his overseas income and filing late FBARs.   As part of the OVDI, the IRS assessed a miscellaneous penalty of $100,218.    Based on our extensive experience with the Offshore Initiative, we advised our client regarding withdrawal from the program; which he then chooses to do.   The IRS then assessed our client $40,000 ($10,000 per year) in FBAR penalties.   However, our client was never given any explanation as to why the penalty was assessed or how the penalties were calculated.

We proceeded with administrative attempts to contest the penalties and to ascertain at a minimum an explanation as to why the penalties were assessed.  Eventually our client's administratively remedies were exhausted without a satisfactory explanation as to the penalties being imposed by the Internal Revenue Service.   The Internal Revenue Service then threatened to collect the Title 31 civil penalties by offsetting his social security benefits.

We believed that the government's conduct violated the US Constitution: the Fifth Amendment's right to Substantive and Procedural Due Process, the Eight Amendment prohibition against excessive fines, and the Delegation Clause.   We further believed that our client was entitled to judicial review of the IRS action under the Administrative Procedures Act.

The Constitutional Arguments

The court held that our client receiving notice and opportunity to contest the penalties was sufficient to provide Due Process.   As to the Eighth Amendment Excessive Fines argument the court held that since the fine involved here was only 10% of our client’s account balance it was therefore not “grossly disproportionate to the gravity of the taxpayer’s offense," however, it further held that such a fine on a smaller balance may well be!   This is a significant development on behalf of taxpayers facing these types of fines and opens the door a little wider for taxpayers to assert an excessive fine violation in these types of matters.

The APA Arguments

Our arguments that the IRS failed to meet the requirements under the Administrative Procedure Act (APA), however, received significant attention by the court. Firstly, it held that as an agency subject to APA requirements, the IRS’ actions are subject to judicial review to determine whether they were “arbitrary or capricious, constituted an abuse of discretion, or were otherwise not made in accordance with law” under 5 U.S. Code § 70. The court also stated that the IRS appeals letter did not satisfy the requirement to inform the taxpayer of its reasons for imposing the maximum penalty. Although the FBAR Summary Memorandum was more detailed in its analysis (this evidence was only discovered by Court Ordered discovery), the court held that it also did not qualify since (1) it was not sent to our client and (2) it still failed to adequately explain the reason for the penalties imposed.

The IRS was ordered to supplement its records with information explaining its decision to impose the maximum penalty. The court threatened that if it failed to do so, it would rule that the IRS had imposed penalties that were “arbitrary and capricious” in violation of the APA.

What everyone learned from this case

The result of this case was clarification of the IRS’ responsibility to comply with APA requirements, and it has received significant attention for that reason. Our case has also created a significant change in the way the IRS determines, calculates, and assesses FBAR penalties. U.S. taxpayers now know that:

  1. The IRS is subject to APA requirements
  2. The APA applies to FBAR penalties imposed by the IRS
  3. Taxpayers are entitled to timely notice of the IRS’ reasons for FBAR penalty assessments
  4. The penalty amount must be reasonable and proportionate
  5. Penalties must be reasonably justified to the taxpayer before they can be enforced

Because of firm’s efforts, the IRS was forced to change the Internal Revenue Manual and issue new guidance on FBAR penalties, significantly changing the way the IRS looks at foreign bank account cases and the imposition of penalties.  See SBSE-4-0515-0025 and applies to all open cases where the FBAR is considered.

Quality, aggressive penalty litigation

The tax attorneys at Moskowitz, LLP are ready and prepared to continue to make new ground in contesting unjust FBAR and other tax penalties. We stand ready to litigate the imposition of unfair FBAR penalty case.   Stay tuned.

Background of Administrative Procedure Act

The Administrative Procedure Act (APA) governs the practice and procedural formalities of administrative agencies of the federal government, including the U.S. Department of the Treasury.  The APA basically delineates the manner in which U.S. administrative agencies may establish regulations and the process of judicial review of agency decisions.

History of the APA

The APA was essentially a compromise between supporters and opponents of the New Deal programs that were initiated mainly during President Franklin D. Roosevelt’s first term in office (1933-1937). For a decade after the passage of the controversial Second New Deal, which included the establishment of the Social Security Act, the U.S. Housing Authority and the Fair Labor Standards Act, Republicans and Southern Democrats attempted to terminate New Deal programs (particularly the Securities and Exchange Commission and the National Labor Relations Board) through administrative and judicial restrictions on various governmental agencies. In turn, President Roosevelt vetoed bills that sought to strictly control those agencies.

In the early 1940s, a lengthy and detailed negotiation process was initiated that eventually led to enactment of the APA. Carl McFarland, Chairman of the American Bar Association’s Special Committee on Administrative Law, was respected by both supporters and opponents of the New Deal and was able to facilitate a compromise between the two sides. The APA effectively ended the battle between those who sought more bureaucratic power and supporters of individual rights. Although neither side was particularly enthusiastic about the APA, it gave broad freedom to governmental agencies yet imposed procedural requirements and standards for public participation in and judicial review of agency actions. In short, both sides gained a great deal and agreed that it was better than nothing.

Purposes of the APA

The APA has four main purposes:

  1. Establish uniform standards for rulemaking and adjudication
  2. Ensure that administrative agencies keep the public informed of rules and procedures
  3. Provide opportunities for the public to participate in the rulemaking process
  4. Define the scope of judicial review
The APA sets forth guidelines for administrative agencies on how to develop and issue rule and regulations. It includes guidelines the publishing of notices, policy statements, licenses, and permits, and provides an opportunity for the public to comment on proposed rules before they become effective.