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In brief

In Mendu v. United States, the Court of Federal Claims held that penalties for failure to timely file a Report of Foreign Bank and Financial Accounts (FBAR), commonly known as “FBAR penalties,” were not subject to the Flora full payment rule, which requires a plaintiff to make payment of the full tax amount before they bring suit in the Court of Federal Claims or any US district court for the refund of any “internal-revenue tax.”

The plaintiff, Mendu, filed an action in the Court of Federal Claims challenging the assessment of a USD 752,920 FBAR penalty under 31 U.S.C. § 5321(a)(5) (willful FBAR penalty) after having made only a partial payment of USD 1,000 against the FBAR penalty, seeking to recover the USD 1,000 payment. The government filed a counter claim for the rest of the asserted FBAR penalty. Mendu then moved to dismiss the suit for lack of jurisdiction.

At issue was whether a FBAR penalty was an “internal-revenue tax” within the meaning of 28 U.S.C. § 1346(a). Section 1346(a)(1) grants district courts jurisdiction, concurrent with the Court of Federal Claims, of refund suits for any “internal-revenue tax.” The Supreme Court, in Flora v. United States, 357 U.S. 63 (1958) (“Flora I”) and, on rehearing, Flora v. United States, 362 U.S. 142 (1960) (Flora II, together with Flora I, “Flora”), interpreted section 1346(a) to require full payment of the challenged tax before jurisdiction is found—the so-called Flora full payment rule. Although 28 U.S.C. § 1491(a)(1) rather than section 1346(a)(1) typically provides the Court of Federal Claims with jurisdiction over refund suits, the Flora full payment rule also applies to refund suits before the Court of Federal Claims. Thus, in Mendu, if FBAR penalties were internal- revenue taxes within the meaning of section 1346(a), then the Flora full payment rule applied, and the court lacked jurisdiction, because the plaintiff had not paid the full FBAR penalty assessed against him. Conversely, if FBAR penalties were not internal-revenue taxes, then the Flora full payment rule did not apply, and the court had jurisdiction over the plaintiff’s claim.

Under the Bank Secrecy Act (BSA), US persons must annually report certain foreign financial accounts, such as bank accounts, brokerage accounts and mutual funds, to the Treasury Department and keep certain records of those accounts. To properly disclose, US persons whose foreign financial accounts exceed USD 10,000 in aggregate value at any time during the calendar year must file a FBAR with the IRS on or before 30 June of the year following the calendar year for which the financial account is maintained. The accounts are reported by filing FBAR on FinCEN Form 114. The Secretary of the Treasury may impose civil money penalties on any person who fails to file a required FBAR. The civil penalties for failure to file are graduated according to the gravity of the offense, which may be either willful or non-willful.  A failure to file is willful if the taxpayer was aware of the filing requirement but intentionally did not comply. Treasury may assess FBAR penalties any time before the end of the 6-year period beginning on the date of the transaction with respect to which the penalty is assessed. After timely assessment, Treasury may sue for collection, provided it does so within two years of either the date of assessment or the date on which the person was convicted of a criminal FBAR violation, whichever is later.

The court concluded that the structure of the BSA indicated that the FBAR penalty is not an “internal-revenue tax.” The court explained that, while section 1346(a) does not explicitly limit internal-revenue taxes to Title 26 taxes, Congress’s placement of FBAR penalties outside Title 26 distinguished FBAR penalties from internal-revenue taxes. Moreover, the court noted, because the FBAR penalties are not located within Title 26, the FBAR penalties are not subject to the various statutory cross-references in Title 26 that equate “penalties” with “taxes.” Both parties acknowledged that they were unable to find any example of a penalty outside Title 26 that is subject to the Flora full payment rule.

In Flora, the IRS had sent the taxpayer a notice of deficiency for income tax. Instead of filing a petition in Tax Court, the taxpayer paid part of the deficiency, filed a refund claim, and brought suit for a tax refund in district court. After recounting the history of section 1346(a)(1), the Supreme Court concluded that the statute was not intended to alter the historical practice that a taxpayer must “pay first and litigate later.” Generally, a taxpayer may appeal a deficiency in Tax Court without paying any portion of the deficiency, but once the time for filing the appeal expires, they must first pay the tax before filing any refund claim in a US district court or the Court of Federal Claims. Flora II reiterated the holding in Flora I that a claimant must pay the full tax amount prior to filing a tax refund. The Court looked to the nature of “internal-revenue tax” and the refund scheme Congress had devised and noted that the full payment rule was established because permitting partial payment in tax refund suits could seriously impair the government’s ability to collect taxes. In addition, such a suit would effectively be a suit for a declaratory judgment and would therefore contravene Congress’s prohibition of declaratory judgments over disputes with respect to Federal taxes.

The Mendu court distinguished Flora from the situation at hand and reasoned that Flora’s concerns with permitting tax refund suits prior to full payment of the disputed tax were not present in illegal exaction suits involving FBAR penalties. In particular, there was no concern that the collection of FBAR penalties would be seriously impaired without the application of a full payment rule. The court observed that, unlike the internal-revenue laws included in section 1346(a)(1), FBAR penalties are enforced mainly through a civil action to recover a civil penalty, and there were no administrative collection procedures for FBAR penalties with which a partial payment illegal exaction claim would interfere.

The plaintiff had relied heavily on Bedrosian v. United States, 912 F.3d 144 (3rd Cir. 2018) to support his assertion that the court did not have jurisdiction over the plaintiff’s claims (after a change of heart after the Court of Federal Claims rendered an opinion in a different FBAR case that was unfavorable to the plaintiff), but the court held that Bedrosian was not persuasive. In Bedrosian, the Third Circuit noted in dicta that it was “inclined to believe” that the district court did not have jurisdiction to hear Bedrosian’s refund claim because Bedrosian had brought suit after having paid only one percent of the total assessed FBAR penalty, contrary to what the court expected the Flora full payment rule required. This did not determine the jurisdictional issue, however, because the Third Circuit found that the government’s counterclaim for the full penalty amount supplied the necessary jurisdiction. Given the procedural posture, the Third Circuit left “a definitive holding on this issue for another day.”

The Third Circuit did not provide grounds for its belief that the Flora full payment rule applied, only pointing to several authorities that countered the parties’ contention that the “internal-revenue laws” under section 1346(a) referred only to laws codified in Title 26 of the US Code. While the authorities noted that “internal-revenue laws” are not limited to Title 26, the Mendu court concluded that none supported the conclusion that FBAR penalties were subject to the Flora full payment rule. In Wyodak Res. Dev. Corp. v. United States, 637 F.3d 1127 (10th Cir. 2011), for example, then Judge Gorsuch explained in concurrence that “internal-revenue laws” are defined by their function and not their placement in the US Code. The concurrence looked to the meaning of the term “internal- revenue laws” when Congress wrote it into the predecessor of section 1346(a)(1) under the Revenue Act of 1921, and argued that a law was an internal-revenue law if it was enacted pursuant to Congress’s power to tax, for the purpose of raising revenue. In contrast, a law enacted pursuant to Congress’s power to regulate private behavior was not a revenue law. The coal reclamation fees under the Surface Mining Control and Reclamation Act of 1977 (SMCRA) at issue in Wyodak was not an internal-revenue law, the concurrence argued, because its purpose was to protect the environment, in particular, by imposing a fee on coal mining and commanding that the resulting funds be used to reduce and repair the damage caused by mining activities. The concurrence also noted the SMCRA’s references to Congress’s authority to regulate interstate commerce and the statute’s consistent use of the term “fee” as opposed to “tax.” Applying this functional approach, the Mendu court held that the BSA’s stated purpose “to require certain reports or records where they have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities” clearly extended beyond revenue raising and was regulatory in nature. The Mendu court also noted the BSA’s use of the term “civil money penalty” as opposed to “tax penalty.”

In short, under Mendu, taxpayers are permitted to bring illegal exaction suits for FBAR penalties in the Court of Federal Claims without first having paid the penalties.


Young-Eun Choi is a partner in Baker McKenzie's Tax Practice Group in San Francisco. She provides US and international tax planning advice for corporations.


Ida Varshavsky is an associate in Baker McKenzie's Tax and Global Wealth Management practice groups in Zurich.

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