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Plaintiff Tries to Dismiss His Own FBAR Lawsuit and Fails

Lawsuit

Why would you file a lawsuit against the IRS just to turn around and ask the District Court to dismiss it? A combination of impatience, new precedent, and personality changes left a Plaintiff looking for a way out of the Federal Court of Claims.




International Entrepreneur Rushes to File FBAR Lawsuit Against IRS

In 2007, Raghuveer K. Mendu and his business partner founded an investment company in Mauritius, an island nation in the Indian Ocean near Madagascar. As part of opening Venture East Mauritius Advisors (VMIA), Mendu and his partner opened two business bank accounts at the State Bank of Mauritius. Plaintiff also opened a personal account there, where he deposited income from his rental home in India.

By 2009, VMIA was prospering and the three bank accounts had well over the $10,000 minimum requiring Mendu to file a report of his foreign bank accounts (FBAR). He didn’t. Mendu says he did not know about the FBAR filing requirements until 2011, when he hastily prepared and filed the delinquent FBAR filings. He was so hasty, the forms contained many misstatements and had to be corrected in June 2012. This flurry of filings triggered an IRS audit. As a result, the IRS determined that Mendu had willfully failed to file a complete and accurate FBAR and assessed a civil penalty for $752,920. Mendu appealed to the IRS Appeals Office, but the willful FBAR penalty stands.

Ordinarily, when a taxpayer gets an unfavorable ruling from the IRS Appeals Office, the next step is to wait for the IRS to file a collections action in federal court. Mendu, apparently, was impatient. Rather than waiting to defend his case, Mendu paid $1,000 to the IRS and then proactively filed an FBAR lawsuit in June 2017, asking the Federal Court of Claims to rule the assessment was an illegal exaction and set aside the penalty.

The IRS could not have filed its collections action in the Federal Court of Claims. Those collections cases usually go through the Federal District Court in the district in which the taxpayer resides. However, once Mendu opened the door with his complaint, the IRS quickly filed a counter-complaint in October 2017 to collect the remaining $751,920 in penalties, along with interest and fees.

3-Year Pause Leads to Plaintiff’s Motion to Dismiss His Own Lawsuit

No case exists in a vacuum. Lawyers and judges watch developments in other tax cases across the country to see how those decisions will affect their own decisions. This is called precedent. When a case is decided by a court directly above the one where your case is filed, those decisions are “binding precedent” on the lower courts -- meaning the trial-level judges must apply the same reasoning as those higher courts to related issues in their own cases. If a decision comes from a different court, somewhere else in the country, the decision isn’t binding, but it may be persuasive -- the trial court may choose to apply the same reasoning or not.

By December 2018, it was clear that the decision by the Federal Circuit Court in Norman v United States over the cap on willful FBAR penalties would be binding precedent on the same issue in Mendu’s case. Mendu’s lawyer and the IRS agreed to stay the case and wait for the Federal Circuit Court to issue its opinion. Then two things happened: (1) Mendu’s case was assigned to a new judge, and (2) the Norman Court ruled in favor of the IRS. Suddenly, Mendu’s chances of escaping his $750,000 FBAR penalty weren’t looking so good.

Mendu’s lawyer filed a motion to dismiss his own lawsuit. Mendu argued that, in fact, now that he thought about it, the Federal Court of Claims never had jurisdiction over his case in the first place. After all, he’d only paid $1,000, and in internal revenue tax cases, everyone knows, plaintiffs must pay first and sue second, a provision called the “full-payment rule”. That meant, Mendu argued, the Court of Claims must dismiss his case without prejudice and the IRS’s collections counter-complaint along with it. Either that, or at least transfer the case to California, where the Norman decision wouldn’t be binding precedent.

The plaintiff’s lawyer based his argument off a footnote in another court’s opinion. The Third Circuit (which does not have appellate jurisdiction over Federal Court of Claims decisions) was “inclined to believe” that a taxpayer must “pay the full [FBAR] penalty before filing suit” while leaving the issue for a final decision another day. Mendu’s lawyers argued that the footnote was persuasive and meant that he should never have filed his lawsuit in the first place.

Court Says Civil FBAR Penalties Aren’t Taxes; Full-Payment Rule Doesn’t Apply

Federal Court of Claims Judge Eleni M. Roumel saw through the Plaintiff’s attempts to forum shop and cut off the IRS’s collections efforts. The Judge noted:

“Generally, a party cannot seek to dismiss an action merely to escape an adverse decision [or] to seek a more favorable forum."

(Internal quotations omitted). Instead, the dismissal would depend on whether the IRS’s willful FBAR assessment was a civil penalty or an internal revenue tax. The Judge examined the Bank Secrecy Act on three levels to determine whether willful FBAR penalties were a tax triggering the full-payment requirement:

  1. The announced purpose
  2. Its power to regulate interstate commerce
  3. Consistent use of the term “fee” or “penalty” instead of tax

The Judge found that FBAR was designed to assist the IRS in investigating international tax fraud and this went beyond “general revenue raising.” Congress too called the assessments in the Bank Secrecy Act a “civil penalty” rather than a tax. Finally, the IRS cannot enforce FBAR penalties with the same tools it collects unpaid tax assessments. It must sue a delinquent taxpayer and receive a civil judgment before collecting the penalties. All of this meant that the willful FBAR penalties were not an internal revenue tax, and Plaintiff’s partial payment was enough to give the Court of Claims jurisdiction over both the plaintiff’s initial FBAR lawsuit and the countersuit for collections that Mendu was now trying so hard to avoid.

As unusual as Mendu’s case is, it shows how a new appellate decision can change the trajectory of any lawsuit. When an unfavorable decision is made, taxpayers’ attorneys often need to adjust their legal arguments to account for the new precedent. This could mean encouraging taxpayers to settle, or making new and novel arguments to their trial courts. Early on, it may even make sense to dismiss a case or file in a different jurisdiction. However, these decisions should be made thoughtfully, in consideration of all the laws and court rules that apply to a taxpayer’s case, not simply a favorable footnote.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding FBAR lawsuit strategies, contact Joe Viola to schedule a free consultation.

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