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Are FBAR Penalties Taxes for Purposes of the Flora Rule?


In Mendu v. United States, No. 1:17-cv-00738 (Ct. Fd. Claims April 7, 2021) the Court of Federal Claims held that FBAR penalties are not taxes for purposes of applying the Flora rule.  In arguing for the imposition of the Flora rule the taxpayer, in a twist of sides, sought to have the court require that the individual against whom the penalties were imposed to fully pay the penalties before being allowed to challenge the penalties in court.  The FBAR penalties are not imposed under title 26 of the United States Code which most of us shorthand into the Internal Revenue Code but rather are imposed under Title 31 as part of the Bank Secrecy Act.

The possibility that the Flora rule could apply to non-tax issues first arose sua sponte in a Third Circuit case in 2018 which I wrote about here (see also my article on Flora from last year).  That post also contains a link to an excellent post by Jack Towsend.

I think the attorneys for Mendu may have read the prior blog post but if not they definitely read the Bedrosian opinion discussed in the blog post.  In Mendu, in a flip of the normal situation, the taxpayer argues that Flora applies and their case should be dismissed while DOJ argues on behalf of the IRS that Flora does not apply since this case does not involve a liability under the IRC.

The court picks up on why the plaintiff in this case would want the case dismissed and would make the Flora argument raised sua sponte in the Bedrosian case:

On November 8, 2019, the Federal Circuit issued its decision in Norman v. United States, 942 F.3d 1111 (Fed. Cir. 2019); as a result, the stay expired. In Norman, the Federal Circuit held that a now out-of-date Treasury Regulation did not cap FBAR penalties for willful violations at $100,000. The Federal Circuit’s ruling in Norman, which binds this Court, may have given Mr. Mendu pause about continuing litigation in this circuit because on January 20, 2020 — facing a counterclaim against him for potentially 700 times greater than the amount sought in his complaint — Mr. Mendu sought to dismiss his own complaint for lack of subject-matter jurisdiction, along with Defendant’s counterclaim. See generally Pl. Rule 7(b)(1) Mot. In his Rule 7(b)(1) Motion, filed in 2020, Plaintiff based his sudden change in course on a footnote in in a case decided two years earlier, Bedrosian v. United States, 912 F.3d 144, 149 n.1 (3d Cir. 2018). In that footnote, which appears to be dictum, the United States Court of Appeals for the Third Circuit (Third Circuit) commented, without substantive analysis, that it was “inclined to believe” that FBAR penalties are internal-revenue laws within the scope of 28 U.S.C. § 1346(a)(1), and are therefore subject to the full payment rule as articulated in Flora v. United States, 362 U.S. 145, 164 (1960). Pl. Rule 7(b)(1) Mot. at 4-5, 7-11. Accordingly, Plaintiff now believes that the Flora full payment rule requires this Court to dismiss Plaintiff’s claim for illegal exaction of his $1,000 partial payment because Plaintiff has not fully paid the FBAR penalty at issue. Pl. Rule 7(b)(1) Mot. at 3-4. Mr. Mendu notes that, because this Court does not have independent jurisdiction over the Defendant’s counterclaim for $752,920, this Court must dismiss the Defendant’s counterclaim as well. Pl. Rule 7(b)(1) Mot. at 2, 11-14; Pl. Resp. to Cross-Mot. at 12-15.

Because of the potential huge exposure in the Court of Federal Claims and the much smaller exposure that might exist in the Central District of California, one can hardly blame petitioner for trying to remove their case from this jurisdiction where the law has turned unfavorable and try to get to another location where the law might be much better.  Unfortunately for petitioner but fortunately for almost everyone else, petitioner’s Flora argument does not gain any traction.

The court sets the scene for its discussion of the application of Flora by stating:

The parties agree that the Flora full payment rule only applies if it is an “internal-revenue tax” as that term is used in section 1346(a)(1). See Pl. Rule 7(b)(1) Mot. at 7; Def. Resp. at 4. As noted, if FBAR penalties are considered internal-revenue taxes, then the Flora full payment rule applies, and this Court lacks jurisdiction over Plaintiff’s tax refund claim because the Plaintiff has not paid the assessed $752,920 FBAR penalties in full. Conversely, if FBAR penalties are not internal-revenue taxes then Flora full payment rule does not apply, and this Court has jurisdiction over Plaintiff’s $1,000 illegal exaction claim. See Ibrahim v. United States, 112 Fed. Cl. 333, 336 (2013) (finding that while tax refund claims are subject to the Flora full payment rule, the full payment rule does not apply to other illegal exaction claims).

The court then finds that the FBAR penalty is not a tax.  The fact that title 31 and not title 26 imposes the FBAR penalty is something the court describes as more than a mere technicality.  The court finds not only that the FBAR penalty derives from a separate statutory scheme, but that the reasoning behind the Flora decision does not apply in this context, since full payment of the penalty does not matter for this penalty the same way it matters for taxes and other penalties.  The court finds the footnote in the Third Circuit’s opinion suggesting, but not holding, that perhaps Flora should apply to the FBAR penalty does not provide a persuasive basis for bringing Flora into an entirely different statutory scheme.  After analyzing several different reasons why the footnote falls short of persuading, it concludes this section of the opinion by stating:

It may be accurate that every internal-revenue law is not necessarily contained in Title 26. However, 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.

The case then turns on the rules of the Court of Federal Claims.  The court rules do not track the Tax Court rules that do not allow a petitioner out of a deficiency case once properly filed (see discussion here); however, the rules do provide that once the defendant files an answer asserting a counterclaim the petitioner cannot seek dismissal of the counterclaim would not stand on its own in the court.  Here, the huge counterclaim made by the government would not survive if the complaint were withdrawn.  So, Mr. Mendu remains stuck in the Court of Federal Claims instead of being allowed to beat a retreat to the possible friendlier confines of the Central District of California.  Perhaps, he will continue to make the Flora argument.  I hope the court will continue to knock it down.

I do note that occasional guest blogger, Lavar Taylor, just won a big FBAR case in the 9th Circuit.  So, maybe Mr. Mendu has a good reason for wanting a change of scenery to Southern California. In Boyd v. United States,___ (9th Cir. 2021) the court held that 

Examining the statutory and regulatory scheme for reporting a relationship with a foreign financial agency under § 5314, the panel held that § 5321(a)(5)(A) authorizes the IRS to impose only one non-willful penalty when an untimely, but accurate, FBAR is filed, no matter the number of accounts.  

Perhaps we will give a further discussion of Lavar’s case in a future post.



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