FBAR Penalties Not Subject to Pay to Play Rule

In a recent case out of the United States Court of Federal Claims, the Court held that the plaintiff was not required to pay the full amount of the assessed Report of Foreign Bank and Financial Accounts (“FBAR”) penalty in order for the Court to have jurisdiction over a suit for refund.[1] The Court of Federal Claims has jurisdiction over any suit for a refund of tax that has been erroneously or illegally assessed, any penalty claimed to have been collected without authority, and any sum alleged to have been excessive or in any manner wrongfully under the internal revenue laws.[2] However, since the Court of Federal Claims only has jurisdiction over refund suits, the tax, penalty, or other sum must be paid, at least in part, in order for the Court to have jurisdiction. When the suit is for a refund of any “internal-revenue tax”, the entire amount of the tax must be paid before the Court has jurisdiction, a rule known as the Flora Rule.[3] However, the Flora Rule does not apply to penalties or other sums collected that nevertheless give the Court of Federal Claims jurisdiction but are not considered part of the internal revenue taxing regime.[4]  At issue in the Mendu case discussed in this article was the FBAR penalty assessed by the IRS against Mr. Mendu and whether the Flora Rule applied to the FBAR penalty. In other words, is the FBAR penalty an “internal-revenue tax” under 28 USC § 1346(a)(1) (which governs jurisdiction for the Court of Federal Claims) and thus subject to the Flora Rule?

Jurisdiction to Litigate Tax Assessments

Prior to discussing the facts, it might be helpful for a very quick, high level discussion of how to challenge a tax assessment from the IRS. The first option is the United States Tax Court, the only option where the taxpayer is not required to first pay the tax prior to challenging the assessment. The next two options are the so-called pay to play options, the United States District Court and the Court of Federal Claims. Both of these options apply the Flora Rule discussed above where the amount collected is a tax. A fourth option is the United States Bankruptcy Court though that is less common and subject to a completely different set of limitations.

FBAR Primer

It will also be helpful for a high-level discussion of the FBAR reporting and penalties. The FBAR is ultimately a creature of the Currency and Foreign Transactions Reporting Act of 1970, also known as the Bank Secrecy Act. The statutory authority for the FBAR is found in 31 USC § 5314 which directs the Treasury to require a resident or citizen of the United States to keep records and/or file reports when making transactions or maintaining a relationship with a foreign financial agency, and 31 USC § 5321(a)(5) and (a)(6) establish civil penalties for violations of the FBAR reporting and recordkeeping requirements. Through a series of delegations, the FBAR is enforced by the IRS. It is not part of the Internal Revenue Code, also known as Title 26, but rather is part of Title 31. The FBAR, known technically as the FinCen Form 114, is the result of FinCen regulations[5] which require an FBAR to be filed by any US person who has a financial interest in a financial account or signature or other authority over a financial account that is in a foreign country, and the aggregate amount(s) in the account(s) valued in dollars exceed $10,000 at any time during the calendar year.

Facts

Mr. Mendu held signatory authority for two business bank accounts held in Mauritus as well as one personal account maintained in India. In 2009, he did not file an FBAR for any of the three accounts. The IRS assessed a $752,920 penalty against Mr. Mendu. In response, Mr. Mendu made a partial payment of $1,000 and sued in the Court of Federal Claims alleging that the FBAR penalty was erroneous and that his $1,000 payment had been illegally exacted from him. In response, the government filed a counterclaim seeking full payment of the $752,920 penalty plus interest.

Plot-Twist – Mendu Files Motion to Dismiss Own Claim

Following the government’s counterclaim, Mr. Mendu filed a motion to dismiss his own suit alleging that the Court of Federal Claims did not have jurisdiction, presumably due to avoid the government’s counterclaim, though the purposes for this are not clear. Mr. Mendu relied on the Flora Rule in his motion to dismiss his claim, alleging that the full payment rule was applicable to his case and his suit must be dismissed since he had made only a partial payment. Mr. Mendu alleged that he had recently discovered some dictum in United States Court of Appeals for the Third Circuit case which stated in a footnote that the Third Circuit was “inclined to believe” the FBAR penalty is an “internal-revenue tax” under 28 USC § 1346(a)(1) and thus the Flora Rule was applicable.[6] The IRS opposed Mr. Mendu’s motion to dismiss the claim thus resulting in the Court’s ruling discussed in this article.

Analysis

As noted above, the issue for the Court to decide was whether the FBAR penalty is an “internal-revenue tax” under 28 USC § 1346(a)(1), the federal statute providing the matters for which the Court of Federal Claims has jurisdiction. Neither party contested that the Court had jurisdiction over FBAR penalties, but only whether the FBAR penalty was an “internal-revenue tax” and thus subject to the Flora Rule. If the FBAR penalty is an “internal-revenue tax”, then the Flora Rule applies. However,if it is a penalty or other sum collected by the United States, the Court of Federal Claims would still have jurisdiction and the Flora Rule would not be applicable.

The Court starts its analysis with a discussion of the Bank Secrecy Act and the FBAR history, concluding that it was part of Title 31 of the US Code which is titled “Money and Finance”. In contrast, Title 26 of the US Code is known as the Internal Revenue Code. The Court concluded that, since Congress chose to use Title 31 to enact FBAR penalties, and not Title 26, the FBAR penalties were not “internal-revenue taxes” and not subject to the various cross references relating to “internal-revenue taxes”, including that found in 28 US § 1346(a)(1) governing the Court’s jurisdiction. As such, the FBAR penalty was not an “internal-revenue tax” subject to the Flora Rule, and thus Mr. Mendu was not required to pay the full amount of the FBAR penalty to file his suit.

In its opinion, the Court briefly discussed the footnote in Bedrosian noting that it did not agree with it and did not find it to be conclusive or definitive since it was in dictum and the opinion itself did not directly address the issue. Further, both parties admitted they could not cite to any other example of a penalty found outside of the Internal Revenue Code that had been determined to be subject to the Flora Rule.

Conclusion

In short, the Court held the FBAR penalty was not an “internal-revenue tax” subject to the Flora Rule, and thus denied Mr. Mendu’s motion to dismiss his own suit. The primary basis for the decision seems to be that Congress chose to enact the FBAR regime and penalties under the Bank Secrecy Act under Title 31 of the US Code, Money and Finance, rather than Title 26, the Internal Revenue Code. As such, the FBAR penalties would not be an “internal-revenue tax” as that term is used in determining the Court of Federal Claims jurisdiction. Now that this issue has been determined, at least by the Court of Federal Claims, anybody who wants to challenge an FBAR penalty may now do so in the Court of Federal Claims without having to fully pay the penalty. The same analysis likely applies to challenging an FBAR penalty in United States District Court, but maybe not for in a District Court appealable to the Third Circuit due to the dicta discussed above in the Bedrosian  case. To my knowledge, the fight has yet to be had in that court.

[1] Mendu v. U.S., 127 AFTR 2d 2021-259 (Ct. Fed. Cl. 2021).

[2] 28 USC §1346(a)(1).

[3] Flora v. U.S., 5 AFTR 2d 1046 (1960).

[4] Id.; Note that certain “penalties” under Internal Revenue Code are considered to be “internal-revenue taxes” and thus are subject to the Flora Rule. One example is the trust fund recovery penalty under IRC §6672, but since that penalty is enforced quarter by quarter, the taxpayer may satisfy the Flora Rule by merely paying the full penalty for one quarter even if there are multiple quarters at issue.

[5] 75 Fed. Reg. 8844 (February 26, 2010).

[6] Bedrosian v. U.S., 912 F.3d 144 (3rd Cir. 2018).