Wednesday, January 26, 2022

11th Cir. Remands For IRS To Re-Determine FBAR Penalties After Affirming Original Calculation Was Arbitrary And Capricious (1/26/22)

In United States v. Schwarzbaum, ___ F.4th ___, 2022 U.S. App. LEXIS _____ (11th Cir. 1/25/22), CA11 here and GS here, the Court affirmed the district court’s holdings that (i) Schwarzbaum was liable for the FBAR civil willful penalty and (ii) that the IRS calculation of the willful penalty was arbitrary and capricious. Based on the latter holding, the Court remanded for the IRS to recalculate the penalty.

The first holding—liability for the willful penalty—is consistent with the consensus holdings expanding the element of willfulness for the civil penalty beyond the strict meaning it has for the criminal penalty. Specifically, the willful penalty can apply to reckless conduct. However, in making that holding, the Court footnoted some of its reasons for the reckless conclusion (Slip Op. 13 n8):

   n8 Schwarzbaum argues that the district court’s finding that he recklessly violated the FBAR reporting requirements, even though his CPAs had advised him in previous years that he need not report accounts lacking a U.S. connection, conflicts with United States v. Boyle, 469 U.S. 241 (1985), in which the Supreme Court said: “When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice.” Id. at 251 (emphasis omitted).
       Boyle concerned a different tax statute and did not provide the legal standard for willfulness in the FBAR context. Moreover, the Supreme Court’s statement in Boyle is readily distinguishable. While it may be generally reasonable for a taxpayer to rely on professional advice, it is no longer reasonable once the taxpayer has realized—as Schwarzbaum should have, once he read the FBAR instructions—that he has been receiving bad advice.

The second holding—arbitrary and capricious calculation with its consequence of remand to the IRS for recalculation—is, for me, the troublesome part of the opinion. The district court and the Court of Appeals applied the APA arbitrary and capricious test for review of agency actions. 5 U.S.C. § 706(2)(A). The statute states that the willful penalty per unreported account “shall not exceed” the greater of $100,000 or 50% of the amount in the account in the unreported account on the reporting date (June 30 for the years involved). The IRM has a formula that determines the maximum willful penalty that it will assess at 50% of the highest amount in the accounts in all willful years. The IRM then allocates that penalty in equal portions over the willful years. For example, assume that the person had $900,000 static amount in an account over 3 years and their respective reporting dates that was willfully not reported on timely FBARs. The IRS could theoretically assess $450,000 per year for an aggregate of $1,350,000. The IRM nevertheless provides a formula for a lesser penalty of 50% of the highest amount in all willful years ($450,000) and applying that amount over all three years in proportion to the high amounts in the accounts for each year provided that the amount allocated for each year cannot exceed the maximum the statute allows (50% of the amount on the reporting date for the year). This formula will always result in the penalty for a year never exceeding the amount the statute permits the IRS to assess. Indeed, the example illustrates this perfectly because the IRS could have assessed $1,350,000, but under the formula, the penalty is substantially less, $450,000. In effect, the IRS has (in mind) exercised its discretionary authority to impose a lesser penalty than it could have. I discuss this aspect in District Court Muddles an FBAR Willful Penalty Case (Federal Tax Crimes Blog 3/22/20; 3/24/20), here; see par. 4 of that blog. (I should note that, depending upon the numbers assumed in the account for high amounts and reporting date amounts, the IRM formula could be affected, but the formula would always limit the amount that could be assessed for each year to 50% of the unreported account amount(s) on the reporting date.)

Without getting to the nitty-gritty, the Court of Appeals held that, since the allocation formula was based on the high amounts during the reporting year rather than the amounts on the reporting dates, the allocation was arbitrary and capricious and could not be sustained. Moreover, since determination of the penalty in an amount less than the statutory maximum was a discretionary determination by the IRS, the district court could not substitute its judgment for the IRS’s “arbitrary and capricious” judgment for the allocation. Accordingly, so the Court held, the matter must be remanded to the IRS to redetermine the penalty amounts as permitted by the statute.

As I said in my previous blog on the district court’s original holding, I question the arbitrary and capricious holding, and thus, I also question the Court of Appeals' holding. As best I understand it, the Court of Appeals is saying that, so long as the IRS makes its allocations based on the amounts in the accounts on the reporting date, that’s OK. In the above example, I posited the same amount ($900,000) at all relevant times; if the IRS used the same formula except allocated based on reporting date amounts, the same penalty amounts would be generated. I just don’t understand how that allocation is arbitrary and capricious and some other allocation formula based on reporting dates, producing the same aggregate penalty, would not be arbitrary and capricious. Note in this regard that the FBAR penalty does not draw interest until assessed, so no real world different real result would be produced.

Finally, I think the Court of Appeals glides over without detailed analysis a major problem of whether the FBAR civil statute of limitations (6 years from the respective reporting dates plus any extensions that apply) will foreclose the IRS’s assertion of a new penalty to replace the penalty found to be arbitrary and capricious. I just quote the portion of the opinion dealing with that issue (Slip Op. 21-22):

            Finally, Schwarzbaum argues that remand to the IRS is unnecessary—and that we should instead direct a judgment in his favor—because the IRS would be time-barred on remand from recalculating his FBAR penalties. Ordinarily, “[i]f [an] agency has misapplied the law . . . the case must be remanded to the agency to make a new determination.” Fla. Dep’t of Lab., 893 F.2d at 1322 (citing Chenery I, 318 U.S. at 94). But “the rule in Chenery does not require courts to remand in futility.” Ridgewood Health Care Ctr., Inc. v. NLRB, 8 F.4th 1263, 1276 (11th Cir. 2021) (quotation omitted and alterations adopted). “Remand is futile when only one conclusion would be supportable.” Id. (quotation omitted and alteration adopted).

            Schwarzbaum has not established that remand for the IRS’s recalculation of his penalties would be futile. He cites the FBAR civil penalty statute’s six-year statute of limitations for assessing penalties. See 31 U.S.C. § 5321(b)(1) (providing that “[t]he Secretary of the Treasury may assess a civil [FBAR] penalty . . . at any time before the end of the 6-year period beginning on the date of the transaction with respect to which the penalty is assessed”). But he cites no authority standing for the proposition that, on remand from judicial review under the APA, an agency could be time-barred from re-evaluating its original actions. We are aware of none. There is no dispute that the IRS timely assessed Schwarzbaum’s original FBAR penalties. n13 The remand we now direct is not for the IRS to issue new penalties, but for it to recalculate the penalties it has already assessed.
   n13 By contrast, in Brafman v. United States, 384 F.2d 863 (5th Cir. 1967)—the principal case Schwarzbaum relies on in support of his time-bar argument— the former Fifth Circuit held that a tax collection action must be dismissed because, in its initial assessment of an estate tax, the IRS failed to assess the tax within the statutory time period. See id. at 864–68. Brafman did not address when, if ever, an agency would be time-barred on remand from re-evaluating agency action that was timely in the first instance.

If it is true that the IRS can now "recalculate" the penalties, so long as the 50% of the aggregate amounts in each year exceed the amount the IRS has already assessed, the IRS will be able to assess the same aggregate penalty amounts with, perhaps, the allocations to each willful year being different.  In other words, a tempest in a teapot.  

JAT Comments:

1.     (Added 1/27/22 1:30pm).  I offer a thought experiment. Take the example I posed above with $900,000 static amount over three years at all relevant times (including respective reporting dates). Say, as in Schwarzbaum, the Court finds that the person is not willful for one year, say year 1, in the three-year period. That would leave two years for which the IRS had assessed $150,000 per year, for an aggregate of $300,000. On remand to the IRS, could the IRS allocate the penalty quantified at 50% of the high year balances (i.e., $450,000) to years 2 and 3 in my example, so that for each of those years the penalty is $225,000 (and $450,000 aggregate just as the original assessment which is still less than each year's maximum penalty could be ($450,000))? Alternatively, could the IRS assess the entire penalty on year 3? Would increasing the earlier yearly penalty amounts be permitted under statute of limitations concepts? (This is a variation of the Court's point above on recalculations.)

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