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What opportunity should you have to dispute an IRS penalty before it is assessed? Should you be able to take the government to court? What about an administrative hearing by the IRS Appeals Office? In a recent motion to dismiss a taxpayer’s complaint, the IRS says that all due process requires is a written response, not a hearing, and took a “better late than never” approach to administrative appeals.
In 2008, the IRS issued a “John Doe” summons to the Union Bank of Switzerland (UBS) in Zurich. They were trying to find unreported foreign assets and track down U.S. taxpayers using the Swiss bank to avoid paying taxes. UBS turned over thousands of records, among them, the account of Esther Zuhovitzky. Esther was a citizen of Austria and Israel, who had never never lived in the U.S., but her husband Jonathan was a U.S. citizen living in New York City between 1999 and 2010. You can read more about the Zuhovitzkys’ history here.
In investigating the UBS records, the IRS found that Esther had given Jonathan and her adult children powers of attorney, authorizing them to make decisions about the UBS account on her behalf. The power of attorney document said Jonathan could “deposit, buy and sell, pledge and convert security/book entry securities in [Esther’s] name, to lodge or withdraw funds in any manner whatsoever, … and generally do everything he/she/they may deem expedient or necessary.”
In 2011, based on this “signatory authority” the IRS began an audit into Jonathan and Esther’s financial situation. In 2012, failure to file Reports of Foreign Financial Assets (FBARs) got added to the possible list of offenses. At some point, the case was even considered for criminal charges for tax fraud, but on December 31, 2013, the Criminal Investigations Division decided not to pursue its criminal investigation.
That didn’t leave much time for the IRS to fully investigate and impose civil penalties for FBAR violations. The statute of limitations was set to run out on June 27, 2016. While the Zuhovitzkys’ attorneys agreed to an extension in January 2014, the IRS never received a signed FBAR extension form.
Less than three months later, on April 9, 2014, the IRS sent Jonathan a letter saying it intended to impose willful FBAR penalties. This letter said that if Jonathan disagreed with the determination, he needed to file a written protest by April 22, 2014, which was later extended to June 24, 2014. He did so on June 20, 2014. Three days after Jonathan issued his written protest of the assessment, the IRS assessed a willful FBAR penalty of $5,123,100 on June 27, 2014, and sent a letter demanding payment of the full amount.
Then, after the assessment had already been issued, the matter was assigned to the Office of Appeals, which acknowledged receipt of Jonathan’s protest on August 21, 2014. That letter invited Jonathan to submit additional information or evidence. A telephone conference between the appeals officer and Jonathan’s attorney happened almost a year later, on June 18, 2015. However, the officer refused to consider the additional evidence Jonathan’s attorney said existed because it was in Hebrew and wouldn’t be translated before the statute of limitations expired. Instead, the case was closed, and in 2017, the IRS began garnishing Jonathan’s social security payments.
Jonathan Zuhovitzky filed a complaint in the United States District Court in the Southern District of New York, asking the judge to stop the garnishment and overturn the assessment. His complaint raised four issues:
Then, late in 2020, the IRS filed a motion to dismiss Zuhovitzky’s complaint, addressing each of the four issues. The government’s brief said:
Interestingly, the IRS claims that by refusing to sign an extension of the statute of limitations extending the government’s time for making a penalty assessment already much delayed through no fault of his own, Zuhovitzky somehow chose not to exercise the administrative rights he was accorded almost no time to pursue. While it is clearly unfair to the taxpayer -- which the statute of limitations on assessment is designed to protect -- their right to due process prior to the imposition of severe monetary penalties is routinely made subordinate to the government’s unfettered ability to impose those same penalties. In the same way, a taxpayer who wants to contest an IRS audit by filing an administrative appeal must frequently waive the assessment statute of limitations as a condition for appealing at all.
The IRS’s response to Zuhovitzky’s due process concerns was particularly interesting. Due process is legal shorthand for a person’s constitutional right to be informed when a government action affects their rights, and an opportunity to be heard before that right is affected. Civil due process is less formal than the criminal arraignment or indictment process, but it is still a constitutional right.
Zuhovitzky said that by assessing the FBAR penalty before he had an opportunity to be heard by the Appeals Office, the IRS violated his due process rights. But the IRS said that he did have an opportunity to be heard -- when he lodged his written protest. According to the IRS, it didn’t matter that the case wasn’t assigned to the Appeals Office until after the assessment was issued. All that mattered was that it happened before the IRS actually started collecting on the debt two years later.
The argument is in keeping with the IRS’s pay first, sue second mentality. But if the court agrees it will shift tax assessment hearings further down the procedural line, forcing taxpayers to bear the burden of improper tax assessments that affect their credit rating, their bank accounts, and social security payments before they receive the opportunity to face the IRS and explain why the assessment is wrong.
Zuhovitzky’s attorney has an opportunity to respond to these arguments before the District Court makes its decision. Whether the IRS will be allowed to minimize taxpayers’ due process rights to a piece of paper has yet to be determined. However, this will remain a case to watch. The outcome could affect the way the IRS does its business in the future.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding FBAR penalties and due process, contact Joe Viola to schedule a consultation.