In Harrison v. IRS, 2021 U.S. Dist. LEXIS 45582 (D. D.C. 3/11/21),* here, the taxpayers entered the OVDP program prior to the IRS offering the Streamlined Domestic Procedures (“SDP” program in 2014. The SDP penalty requirements were less than the OVDP’s penalty requirements and required taxpayers to certify nonwillfulness and provide support for that certification. Incident to the SDP, the IRS permitted taxpayers then in OVDP to “transition” to SDP. The transition required (just as the SDP required) that taxpayers certify nonwillfulness and support the certification. The IRS (through its Central Review Committee, determined that the taxpayers had not established their nonwillfulness and therefore left them in OVDP where the options were (i) accept the OVDP penalty structure which was more than SDP but less than the law could impose outside OVDP or (ii) opt out of OVDP and take their chances on audit. Rather than take the risk of higher penalties on audit, the taxpayers chose to accept the OVDP penalty structure. Accepting OVDP required that the taxpayers enter a closing agreement which provided, in part, that the taxpayers would not file a claim for refund of any amounts paid pursuant to the closing agreement. They did and paid the resulting tax, penalties and interest, including the miscellaneous offshore penalty in lieu of an FBAR penalty in the amount of $519,943.44.
Two years after entering the closing agreement, the taxpayers brought what was in effect a refund suit but, apparently realizing that the closing agreement might be a bar, couched the suit under a mélange of legal theories: (i) APA claims that the transition rules were adopted without notice and comment and, in any event, were arbitrary and capricious under APA section 706(2)(A); (ii) Due Process claim based on the alleged purported absence of procedural protections; and (iii) duress claim that the Closing Agreement was invalid.
The Court rejected their claims. The Procedurally Taxing Blog has a good discussion of the APA aspect of the case. Leslie Book, APA Offers No Avenue For Relief For Challenge to Offshore Transition Rules Penalty Regime (Procedurally Taxing Blog 3/15/21), here. Basically, the Court held that a refund suit would be an adequate remedy thus precluding subject matter jurisdiction of the APA claims. I encourage readers to read that blog and will only address here some nuances on the APA claims.
In the blog, Professor Book states: “The needle can still be thread: if someone else has fully paid and is not subject to a closing agreement they could bring a refund suit in federal court and get a court to consider the merits of the APA challenge.” That is the part I want to thrash upon further.
Let’s posit that a taxpayer in the situation in the case did not accept the OVDP settlement but instead took their chances on audit and the general maximum 50% penalty was imposed. No closing agreement is required. So, in that case, I suppose Professor Book’s statement is that the taxpayers could then pursue their APA claims in the refund suit; alternatively, and more likely, the government would have pursued a collection suit and the taxpayer’s APA arguments could be pursued there (recall that the government must bring that suit within two years of the assessment of the FBAR penalty). (In considering a refund suit possibility, recall also that full pre-litigation payment may not be required (James R. Malone, Half a Loaf Might Suffice: FBARS, Flora and Federal Jurisdiction (Post & Schell Tax Controversy Posts 2/13/17), here.) and in the collection suit, no pre-litigation payment is required.) I suppose both of those potential options to present the APA claims might be deemed sufficiently adequate to preclude stand alone jurisdiction to present the APA claims.
What exactly are those APA claims?
Failure to adopt with notice and comment rulemaking
The first is that the transition rules should have been established by notice and comment regulation and are invalid under APA § 706(2)(D) (“without observance of procedure required by law”). Notice and comment regulations are required only for legislative rules – rules that establish new duties and rights. The transition rules did not establish new duties and rights but rather simply established a settlement process with respect to existing duties and rights (i.e., specifically the FBAR reporting and penalty regime). I don’t see how settling somewhere in the area between the best result and the worst result under existing law establishes new duties and rights requiring that the settlement process be promulgated by notice and comment. Just think of the chaos that could create if all IRS general settlement offers (such as the settlements offered for abusive tax shelters) required notice and comment rulemaking. And extending that even further, perhaps all settlements with the IRS and other government agencies might require notice and comment rulemaking. That makes no sense to me. (I know that saying that it makes no sense to me is not legal analysis, but that is as far as I can go right now without more time than I have right now; I would appreciate readers’ views on the subject, however.)
Arbitrary and capricious claims
I suppose the taxpayers could make better facial APA claims on arbitrary and capricious if they attacked in a proper suit (refund or collection) (i) the transition rules as arbitrary and capricious or (ii) the IRS’s denial of their particular transition request as arbitrary and capricious. Perhaps that is what Professor Book is alluding to in saying that the APA claim could be pursued in a proper refund suit without a closing agreement foreclosing the refund suit. Related to my analysis above, I am having some difficulty how the taxpayers would prevail in the posited example of attacking the transition rules themselves in a refund suit (or a collection suit for that matter). If the transition rules are struck down as arbitrary and capricious, then taxpayers then would be subject to the OVDP penalty regime or audit and, in the posited example, they voluntarily chose audit and took their chances. There is nothing arbitrary and capricious about that choice.
At least facially, a claim might be stated that the IRS acted arbitrarily and capriciously in denying them transition relief because their individual certifications of nonwillfulness. Of course, in the Harrison, the IRS had ample arguable grounds to deny, so on the facts the IRS cannot be said to have acted arbitrarily or capriciously. But, beyond that point, does that mean that every action of any government agency is subject to APA attack? I am not sure that is a good reading of the APA. I will need to think more about that.
I would appreciate readers thoughts on the subject. As I indicated, I have not fully plumbed the depths of this issue and would appreciate any help offered.
* Lexis-Nexis’ citation for the case is: Sprinkle v. IRS, No. 20-cv-828 (CRC), 2021 U.S. Dist. LEXIS 45582 (D.D.C. Mar. 11, 2021). The plaintiffs were listed as Robert Harrison and Julianne Sprinkle, so the normal citation would be Harrison v. IRS. Accordingly, I use that caption rather than the one in L-N.
This blog blog post is cross-posted on my Federal Tax Procedure Blog, here.