A district court held that, even though 31 U.S.C. Section 5321(a)(5) had been amended in 2004 to increase the cap on the penalty for willfully failing to report a foreign account, the IRS could not assess a penalty in excess of the lower cap amount in the underlying regulation, 31 C.F.R. Section 1010.820, which has never been revised to reflect the amendment to Section 5321(a)(5).
In December 2016, the IRS filed to collect outstanding civil penalties assessed against Dominique Colliot for his willful failures to timely file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) (now FinCEN Form 114), for the years 2007 to 2010. The IRS assessed penalties under 31 U.S.C. Section 5321(a)(5) and 31 C.F.R. Section 1010.820(g)(2) of $548,773 for four separate FBAR violations for 2007, and of $196,082 for four FBAR violations for 2008. The IRS also assessed smaller penalties for 2009 and 2010.
In district court, Colliot moved for summary judgment, claiming that the IRS incorrectly applied the law by assessing penalties in excess of those allowed under 31 C.F.R. Section 1010.820(g)(2).
The legal framework
Currently, under Section 5321(a)(5), the maximum penalty for a willful FBAR violation is the greater of $100,000, or 50% of the balance in the unreported account at the time of the violation. However, prior to amendment in 2004, Section 5321(a)(5) allowed for a penalty of the greater of $25,000 or the balance of the unreported account up to $100,000. Based on the pre-2004 version of Section 5321(a)(5), Treasury promulgated, via notice-and-comment rulemaking, 31 C.F.R. Section 103.57(g), which states that "[f]or any willful violation committed after October 26, 1986 . . . the Secretary may assess upon any person, a civil penalty . . . not to exceed the greater of the amount (not to exceed $100,000) equal to the balance in the account at the time of the violation, or $25,000."
In 2002, Treasury delegated the authority to assess penalties under Section 5321(a)(5) to the Financial Crimes Enforcement Network (FinCEN) in Treasury Order 180-01. In addition to this delegation of enforcement authority, Treasury Order 180-01 provided that related regulations were unaffected by this transfer of power and should continue in effect "until superseded or revised." Roughly six months later, FinCEN redelegated the authority to assess penalties under Section 5321(a)(5) and its related regulation, Section 103.57, to the IRS.
Despite the 2004 change in the maximum penalty amount in Section 5321(a)(5), Section 103.57(g)(2) remained unchanged and therefore continued to indicate the maximum civil penalty for willful failure to file an FBAR was capped at $100,000. FinCEN later renumbered Section 103.57 as 31 C.F.R. Section 1010.820, but it did not revise the regulation to account for the increased maximum penalty authorized under Section 5321(a)(5). Nevertheless, the IRS, since the change to Section 5321(a)(5), has repeatedly levied penalties for willful FBAR violations in excess of the $100,000 cap in Section 1010.820(g)(2).
Under 5 U.S.C. Section 706(2)(A), a court must "hold unlawful and set aside agency action, findings, and conclusions found to be— . . . arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law."
The district court's decision
The district court held that the IRS could not assess Colliot penalties under Section 5321(a)(5) in excess of the cap in 31 C.F.R. Section 1010.820(g)(2). The court found that the regulation was a valid regulation issued under notice-and-comment rulemaking and had not been repealed at the time the IRS assessed the FBAR penalties against Colliot, so the IRS was bound by the limits on the penalties in the regulation.
Colliot argued that the IRS acted arbitrarily and capriciously by assessing penalties against him in excess of those allowed by Section 1010.820(g)(2). The IRS argued that the regulation was inconsistent with the 2004 amendments to Section 5321(a)(5)(C) and was therefore implicitly superseded or invalidated by those statutory revisions. Citing Larionoff, 431 U.S. 864 (1977), the court found that if the amendments to Section 5321(a)(5) vitiated the lower penalty threshold set out in Section 1010.820(g)(2), then the IRS could not have acted arbitrarily or capriciously by failing to cap the penalties it assessed at $100,000.
The district court determined, however, that Section 5321(a)(5)(C) had not implicitly superseded or invalidated Section 1010.820(g)(2). The court explained that while Section 5321(a)(5)(C) sets a ceiling for penalties assessable for willful FBAR violations, it also vests the secretary of the Treasury with discretion to determine the amount of the penalty to be assessed so long as that penalty does not exceed the ceiling set by Section 5321(a)(5)(C). Section 1010.820(g)(2), a valid regulation that has not been repealed, limits that discretion by capping penalties at $100,000. Thus, considered in conjunction with Section 5321, Section 1010.820 is consistent with Section 5321's delegation of discretion to determine the amount of penalties to be assessed. Because Section 1010.820 can be applied consistent with Section 5321(a)(5), the court concluded that Section 5321(a)(5) does not implicitly invalidate or supersede Section 1010.820.
The court stated that Section 1010.820, because it is a regulation promulgated via notice-and-comment rulemaking, could only be repealed through notice-and-comment rulemaking. Because it had not been repealed, it remained good law. Consequently, the IRS had acted arbitrarily and capriciously in not applying the cap on penalties in the regulation.
As the court observes in a footnote to the case, if the IRS and FinCEN had wished to preserve the discretion to charge the maximum willful FBAR penalty, all that was necessary for them to do was to update Section 1010.820 to reflect the increased penalty amounts in Section 5321(a)(5), which they could have easily done. Interestingly, despite not updating Section 1010.820 to reflect the new statutory penalty, FinCEN has been updating Section 1010.821 to reflect inflation-adjusted amounts based on the statutory penalty.
Colliot, No. AU-16-CA-01281-SS (W.D. Tex. 5/16/18)