Harrison v. Internal Revenue Serv.
| Decision Date | 11 March 2021 |
| Docket Number | Case No. 20-cv-828 (CRC) |
| Parties | ROBERT HARRISON and JULIANNE SPRINKLE, Plaintiffs, v. INTERNAL REVENUE SERVICE, CHARLES RETTIG, in his official capacity as Commissioner of Internal Revenue, UNITED STATES DEPARTMENT OF THE TREASURY, JANET L. YELLEN, in her official capacity as United States Secretary of the Treasury, UNITED STATES OF AMERICA, Defendants. |
| Court | U.S. District Court — District of Columbia |
U.S. taxpayers who hold foreign bank accounts must report them on their tax returns. Failure to do so can result in civil penalties and even criminal prosecution if the concealment was intentional. To encourage reporting, the Internal Revenue Service has previously allowed qualified taxpayers to reduce their legal and monetary exposure by voluntarily disclosing previously-unreported offshore accounts and entering a settlement agreement with the agency.
In 2018, plaintiffs Robert Harrison and Julianne Sprinkle took advantage of one of two IRS voluntary-disclosure programs for holders of offshore accounts. They fessed up to having maintained an unreported Swiss bank account for roughly a decade, paid back-taxes along with a lower (though still substantial) penalty, and executed a settlement agreement with the IRS in which they gave up the right to seek a refund of the penalty payment in the future.
Two years later, however, the couple apparently had a change of heart. They filed this lawsuit to nullify the settlement agreement and recoup the penalty, claiming that they settled under duress. They also challenge the process by which the IRS denied their request to participate in the alternative (and more lenient) voluntary disclosure program. The IRS has moved to dismiss the couple's amended complaint. Finding that Harrison and Sprinkle have not plausibly alleged duress and that their procedural objections can be pursued only through a tax refund suit, which they waived as part of the settlement, the Court will grant the motion.
Detecting tax code violations takes time and costs money. Like any agency operating under budget constraints, the IRS must cope with the reality that it cannot investigate every potential instance of potential tax evasion. In the normal course, the agency must rely on the risk of civil and criminal penalties—and a large measure of good faith—to maintain public compliance with the tax code. See United States v. Bisceglia, 420 U.S. 141, 145 (1975). In the mid-2000s, one area of tax evasion which bedeviled the IRS concerned unreported income and assets held abroad. The obligation to report these holdings arises in part from the Bank Secrecy Act of 1970, which requires the Secretary of the Treasury to issue rules requiring individuals to file annual reports identifying selected relationships with foreign financial institutions. See 31 U.S.C. §§ 5314(a), 5321(a)(5). The regulations implementing this dictate require certain U.S. taxpayers to file an annual "Foreign Bank Account Report" ("FBAR") for accounts with foreign institutions that exceeded $10,000 in the prior calendar year. See 31 C.F.R. §§ 1010.350,1010.306(c). Penalties for failing to file FBARs can be severe. See id. § 1010.810(g). Willful failure subjects the taxpayer to potential criminal prosecution resulting in up to five years in prison. See 31 U.S.C. § 5322. On the civil side, maximum penalties for a willful violation are the greater of $100,000 or 50% of the balance in the unreported foreign account, while non-willful penalties are capped at $10,000 per violation and may even drop to zero if the taxpayer can establish "reasonable cause" for any FBAR violation and accurately reported the amount in the account. See id. §§ 5321(a)(5)(B), 5321(a)(5)(C)(i).
In 2009, the IRS promulgated a set of rules to encourage individuals to disclose previously unreported foreign investment income on their tax returns. See Dewees v. United States, 272 F. Supp. 3d 96, 98-99 (D.D.C. 2017) (Cooper, J.), aff'd, 767 F. App'x 4 (D.C. Cir. 2019). This program—the "Offshore Voluntary Disclosure Program" or "OVDP"—promised lower penalties for taxpayers who came clean. See id.; First Am. Compl. ("FAC") at ¶6. Specifically, the IRS would limit the number of tax years considered in calculating any non-compliance penalty and consolidate the penalties for non-compliance into a single payment known as a "miscellaneous offshore penalty" ("MOP"). See Maze v. Internal Revenue Serv., 206 F. Supp. 3d 1, 6 (D.D.C. 2016), aff'd, 862 F.3d 1087 (D.C. Cir. 2017); FAC at ¶38. This single payment represented a percentage of the highest aggregate balance of the account in question and, at all times relevant here, was set at 27.5 percent. FAC at ¶¶6, 38. As a further benefit to induce participation in the OVDP, the IRS would recommend against criminal prosecution and execute a settlement agreement—referred to as a "closing agreement" or "Form 906"—with the participants. Id. at ¶¶7, 32. In these closing agreements, the IRS would state that the payment of back taxes and penalties under the OVDP resolved the participants' tax liability. Id. at ¶¶32-33. To participate in the OVDP, a taxpayer was required to, among otherthings, 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. Id. at ¶6.
The OVDP began in 2009 and was phased out in 2018. See I.R.S. News Release IR-2018-52 (March 13, 2018). In mid-2014, the IRS inaugurated another program—the "Streamlined Domestic 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."1 FAC at ¶9. Taxpayers who submitted the required certification only had to pay a flat 5% MOP. Id. However, this lower rate came with the caveat that taxpayers taking advantage of the Streamlined Procedures would still be subject to a risk of audit 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. See Dewees, 272 F. Supp. 3d at 99; FAC at ¶¶8-9.
Anticipating demands by current OVDP participants who had not yet executed a closing agreement to switch to the Streamlined Procedures' lower-penalty regime, the IRS issued a set of "Transition Rules" which enabled individuals who were enrolled in the OVDP to be treated under the Streamlined Procedures. FAC at ¶¶42-43. The Transition Rules, which were outlined in a "FAQ" on the IRS's website, required taxpayers seeking transitional treatment to submit a sworn statement certifying that their failure to file FBAR reports was "non-willful[]." Id. at ¶45. To grant transitional treatment, the IRS had to "agree that the available information is consistentwith the taxpayer's certification of non-willful conduct." IRS, Transition Rules: Frequently Asked Questions (FAQs), FAQ #7, https://www.irs.gov/individuals/international-taxpayers/transition-rules-frequently-asked-questions-faqs (last updated March 4, 2020). Eligibility determinations were made in the first instance by an IRS examiner, along with the examiner's manager and a technical advisor. Id. at FAQ #8. These decisions were subject to review by a "Central Review Committee" whose determination was final. Id. In the event the IRS rejected the request for transitional treatment, the taxpayer could still choose to have their case resolved through either the OVDP or a typical examination process, during which the taxpayer could seek to establish non-willfulness. Id.; see also Maze, 206 F. Supp. 3d at 20.
Enter the plaintiffs: Robert Harrison and Julianne Sprinkle, a married couple. FAC at ¶58. In the early 2000s, while living abroad, the couple placed approximately $850,000 in a Swiss bank account but failed to report the account or the associated income for more approximately a decade. Id. at ¶¶62-64; Mot. to Dismiss Ex. A at 5.2 After returning the U.S. in early 2014, they entered into the OVDP program and disclosed the account, which had reached apeak value of approximately $1.2 million in 2007. Id. at ¶¶62-64; see Mot. to Dismiss Ex. A at 7. 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. FAC at ¶65. 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. Id. at ¶¶64-65. However, in 2017, the officer informed the couple that the Central Review Committee had denied their request for transitional treatment. Id. at ¶¶66-67; .
In August 2017, following the denial by the Central Review Committee, 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 (i.e., an audit) under the IRS's traditional procedures. Id. at ¶68; Mot. to Dismiss Ex. C at 1-2. The IRS conveyed the same message in a February 2018 follow-up letter. FAC at ¶69; Mot. to Dismiss Ex. D at 1. An IRS Territory Manager reiterated the point in April 2018 after the couple requested further review of their case. FAC at ¶70; Mot. to Dismiss Ex. E. at 1-3. 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." FAC at ¶71. They instead executed the Closing Agreement in April 2018 and paid $510,943.44—representing the 27.5% MOP plus the back taxes, interest, and other penalties owed—pursuant to the terms of the OVDP program. Id. at ¶¶73-74....
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