Taxpayers' Closing Agreement on FBAR Penalties Wasn't Entered Under Duress

(Parker Tax Publishing March 2021)

A district court held that a couple, who entered into a closing agreement with the IRS under which they paid back taxes and penalties due to their failure to file a foreign bank account report and who gave up their right to seek a future refund of that penalty, could not nullify the closing agreement by arguing they had entered into the agreement under duress. The court found that adequate procedural safeguards existed, given that the couple could have opted to go through the examination process and file suit for a refund, and the fact that the IRS informed the couple that they risked higher penalties if they did not sign the closing agreement did not mean that the agreement was entered under duress. Harrison v. IRS, 2021 PTC 68 (D.D.C. 2021).

Background

Generally, a taxpayer who owns holds a foreign bank account with assets exceeding $10,000 in the prior year must report the account to the IRS on a Foreign Bank Account Report (FBAR). Penalties for failing to file FBARs can be severe. Willful failure subjects the taxpayer to potential criminal prosecution resulting in up to five years in prison. On the civil side, maximum penalties for a willful violation are the greater of $100,000 or 50 percent of the balance of the unreported foreign bank account, while non-willful civil penalties are capped at $10,000 per violation, and may even drop to zero if the taxpayer can establish reasonable cause for the FBAR violation.

In 2009, the IRS introduced the Offshore Voluntary Disclosure Program (OVDP) to encourage taxpayers to disclose previously unreported foreign investment income. Under the OVDP, the IRS would limit the number of tax years considered in calculating a penalty and consolidate the penalties for non-compliance into a single payment known as the "miscellaneous offshore penalty" (MOP). This single payment was set at 27.5 percent of the highest aggregate balance of the account in question. As a further benefit to induce participation in the OVDP, the IRS would recommend against criminal prosecution and execute a settlement agreement (i.e., a closing agreement) with the participants. To participate in the OVDP, a taxpayer was required to, among other things, file eight years of tax returns and FBARs, and pay the tax and interest due on any undisclosed accounts, along with associated accuracy-related penalties, for the same time period.

The OVDP began in 2009 and was phased out in 2018. In mid-2014, the IRS created another program - - the "Streamlined Procedures" - - for individuals with unreported foreign accounts who were not currently participating in the OVDP and who certified that their failure to previously report their accounts was non-willful. Taxpayers who submitted the required certification only had to pay a flat 5 percent MOP. However, this lower rate came with the caveat that taxpayers taking advantage of the Streamlined Procedures would still be subject to a risk of examination under the IRS's usual audit programs, along with the prospect of higher penalties and potential criminal prosecution if, following the audit, the IRS disagreed with the non-willful self-certification. The IRS issued rules which enabled individuals who were enrolled in the OVDP to be treated under the Streamlined Procedures (Transition Rules). The Transition Rules, which were outlined in a FAQ on the IRS website, required taxpayers to submit a sworn statement certifying that their failure to file FBARs was non-willful. To grant transitional treatment, the IRS had to agree with the taxpayer's certification of non-willful conduct. Eligibility was determined by an IRS examiner along with the examiner's managers and a technical advisor, and such decisions were subject to review by a Central Review Committee whose determination was final. If the IRS rejected the request for transitional treatment, the taxpayer could still choose to have their case resolved through either (1) the OVDP, or (2) a typical examination process, during which the taxpayer could seek to establish non-willfulness.

In the early 2000s, Robert Harrison and Julianne Sprinkle, a married couple, placed approximately $850,000 in a Swiss bank account while living abroad. The couple failed to report the account or the associated income to the IRS for more than a decade. After returning to the United States in early 2014, they entered the OVDP and disclosed the account, which had reached a peak value of $1.2 million in 2007. But when the Streamlined Procedures were announced shortly thereafter, the couple sought to transition to the Streamlined Procedures' more favorable penalty structure under the Transition Rules. They submitted the required self-certification of non-willfulness and were informed by an IRS officer that they qualified for the lower penalties under the Transition Rules. However, in 2017, they found out that the Central Review Committee had denied their request for transitional treatment.

In August 2017, the IRS informed Harrison and Sprinkle that they would need to choose whether to remain in the OVDP and execute a closing agreement, or proceed to an examination under the IRS's traditional procedures. Harrison and Sprinkle ultimately decided against going through the typical examination process because they believed that they would face such extreme penalties that they would lose all their financial assets. They instead executed a closing agreement in April 2018 and paid $510,943, representing the 27.5 percent MOP plus the back taxes, interest, and other penalties owed. Under the closing agreement, the couple agreed not to file a refund claim for the underlying tax, penalties, and interest for any amount that related to the underreported income for any years subject to the closing agreement, on any grounds.

Approximately two years after executing the closing agreement, Harrison and Sprinkle sued the IRS in a district court seeking to nullify the closing agreement and recoup the penalty. They asserted that: (1) the Transition Rules were issued without a notice and comment period in violation of the Administrative Procedure Act (APA); (2) the application of the Transition Rules was arbitrary and capricious and an abuse of discretion under the APA; (3) the absence of procedural protections in the Transition Rules was a due process violation; and (4) the closing agreement was invalid because the couple executed it under duress. The IRS moved to dismiss the complaint in its entirety.

Analysis

The district court granted the IRS's motion and dismissed all of the couple's claims. Regarding the couple's claims under the APA, the court noted that the APA supports a cause of action only when there is no other adequate remedy; if an adequate alternative remedy exists, then the APA claims fall outside of the government's waiver of sovereign immunity. The court found that Harrison and Sprinkle had an adequate alternative remedy in the form of a refund suit under Code Sec. 7422(a), since their lawsuit principally sought a refund of the money they paid through their participation in the OVDP. The court further found that in Maze v. IRS, 2017 PTC 328 (D.C. Cir. 2017), the D.C. Circuit specifically held that a refund suit provided an adequate alternative remedy for taxpayers challenging the IRS's denial of their request to transition from the OVDP to the Streamlined Procedures. The court added that it did not matter that the couple was also seeking to set aside the Transition Rules as unlawful, since that issue could have also been raised in a refund suit.

The court rejected the couple's due process claim because it found that, contrary to the couple's argument, adequate procedural safeguards were provided. The court noted that after the IRS rejected the certification of non-willfulness in their request to transition to the Streamlined Procedures, the couple could either accept the penalty structure imposed by the OVDP and execute a closing agreement waiving their right to further contest the penalties or proceed through the typical audit procedure. The court said that, while these procedures risked higher civil and criminal penalties than the OVDP, they also held out the possibility of lower penalties than even those offered under the Streamlined Procedures. The court found that the IRS's rejection of the couple's certification in no way closed off these procedures or the prospect of eventual judicial review of the agency's determination should the couple have opted against executing a closing agreement. The court said that Harrison and Sprinkle chose to settle their issues with the IRS rather than go through the process of an examination and judicial review, which simply did not amount to a due process violation.

The court further found no grounds on which to invalidate the closing agreement due to duress. Harrison and Sprinkle contended that they had no choice but to enter the agreement because the alternative would be to face an audit with the prospect of devasting penalties. But the court found that the fact that the IRS informed the couple that they risked substantial penalties if they did not sign the closing agreement was plainly insufficient for a claim of duress. The court also noted that the applicable penalties are a consequence of the statutory scheme enacted by Congress, not threats by the IRS. According to the court, the IRS's rejection of the couple's certification of non-willfulness did not transform its conduct into duress, since the rejection did not mean that the IRS had predetermined the couple's ability to demonstrate their non-willfulness. The court said that the IRS was entitled to inform the couple of their options to either resolve the matter with a closing agreement or proceed to examination and retain the possibility of a subsequent refund suit.

For a discussion of information reporting rules for foreign bank accounts, see Parker Tax ¶203,170.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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