5th Cir. Affirms Passport Revocation as Valid Exercise of Power

5th Cir. Affirms Passport Revocation as Valid

In the recent case of Franklin, the Fifth Circuit Court of Appeals affirmed that taxpayers can have their passports revoked because of a seriously delinquent tax debt stemming from a foreign trust penalty. In this case, the Taxpayer made several arguments in support of his position that the IRS overstepped its boundaries by issuing the penalties. The District Court refused to consider multiple arguments because it claimed to lack subject matter jurisdiction (including a Flora Rule argument). Let’s walk through the basics of the case ruling to get an understanding of what it means for the taxpayer.

Factual Summary

• • • The Internal Revenue Service (IRS) found that James Franklin had failed to file accurate tax returns and had not reported a foreign trust of which he was the beneficial owner, and so it assessed penalties against him. Those penalties, assessed under 26 U.S.C. § 6677 on July 18, 2016, totaled $421,766.

    • In 2018, the IRS began its collection efforts against Franklin, filing a federal tax lien and later levying on Franklin’s Social Security benefits. The IRS also certified to the Department of State that Franklin had a “seriously delinquent tax debt” per 26 U.S.C. § 7345 (enacted under the Fixing America’s Surface Transportation (“FAST”) Act), which led the State Department to revoke Franklin’s passport.

Procedural Summary

• • • Franklin did not file an administrative appeal of the IRS’s response to his FOIA request; instead, he took the response at face value and assumed that the IRS had not complied with the procedural requirements (namely, that the penalties be approved in writing by a supervisor of the determining agent under 26 U.S.C. § 6751(b)). Franklin therefore filed an offer-in-compromise for a nominal sum, asserting a doubt of liability based on the purported procedural deficiencies.

    • The IRS returned the offer without processing it, sending two separate letters that said respectively that (1) the IRS lacked jurisdiction to process the offer because “[i]t is regarding a foreign return and/or related issues,” and (2) “[o]ther investigations are pending that may affect the liability sought to be compromised or the grounds upon which it was submitted,”. Franklin then sent a second offer-in-compromise based on the same grounds and offering the same nominal settlement.

District Court Lacked Jurisdiction

• • • The district court dismissed all of Franklin’s claims. It first found that it lacked jurisdiction over each of the various § 6751(b) claims, finding that each was a prohibited collateral attack on the existence or validity of Franklin’s tax liability for which the United States had not waived sovereign immunity. While the district court found that it did have jurisdiction over Franklin’s Fifth Amendment challenge to the FAST Act’s passport trevocation scheme, it also dismissed that claim after finding that the law was constitutional under rational-basis review.

    • Lastly, the district court found that while Franklin was eligible for attorneys’ fees under FOIA (because his lawsuit prompted the IRS to release documents it alleged showed compliance with § 6751(b)’s procedural requirements), he was not entitled to an award of fees. Franklin timely appeals.

What is the Flora Rule?

The Flora rule is a rule that goes back over 50-years. In order to pursue federal court litigation on an IRS matter, a taxpayer must first pay any outstanding debt — and then file a lawsuit (after following through with the necessary IRS administrative hurdles, such as making a claim for refund on the amount paid). While there has been some deviation of this requirement involving foreign bank and financial account matters (aka FBAR Litigation) – it is very limited in scope because the FBAR is technically not a tax form and thus, the Tax Court is not available to taxpayers to litigate FBAR.

Appellate Courts General Holding

• • • The district court was correct to find that each of these claims was a prohibited attempt to collaterally attack the actual penalties assessed. Under the Anti-Injunction Act, Congress has provided that, absent limited exceptions, “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.” 26 U.S.C. § 7421(a).

    • Thus, when challenging the validity of a tax liability, the general rule is that a taxpayer must “pay first and litigate later.” Flora v. United States, 362 U.S. 145, 164 (1960). “[O]nce a tax has been assessed, [a] taxpayer . . . has no power to prevent the IRS from collecting it;” instead, the taxpayer must “pay the tax in full, and then sue for a refund.” Jones v. United States, 889 F.2d 1448, 1449–50 (5th Cir. 1989).

    • Courts have zealously guarded this rule, recognizing the importance of the government’s ability “to assess and collect taxes alleged to be due without judicial intervention” so that “the United States is [assured] of prompt collection of its lawful revenue.” Enochs v. Williams Packing & Navigation Co., 370 U.S. 1, 7 (1962).

Constitutionality of the FAST Act’s Passport Revocation Scheme

• • • We turn to Franklin’s challenge to the constitutionality of the FAST Act’s passport-revocation scheme. The district court dismissed that claim under Rule 12(b)(6). “We review a district court’s ruling on a motion to dismiss de novo, ‘accepting all well-pleaded facts as true and viewing those facts in the light most favorable to the plaintiffs.’” Anderson v. Valdez, 845 F.3d 580, 589 (5th Cir. 2016) (quoting Dorsey v. Portfolio Equities, Inc., 540 F.3d 333, 338 (5th Cir. 2008)).

    • The FAST Act’s passport-revocation scheme also does not sweep beyond what is necessary to achieve Congress’s goal of trying to recoup the $5.8 billion or more in delinquent taxes owed to the government. The government is not authorized to seize the passport of any person who owes any taxes. Instead, the scheme is focused on those with serious tax debts and provides several procedural safeguards through both the tax process and, ultimately, through a cause of action should the certification itself be erroneous.

    • Under even intermediate scrutiny, the passport-revocation scheme is constitutional. See Eunique, 302 F.3d at 978 (McKeown, J., concurring) (upholding a similar passport-revocation scheme for those in serious arrears on child-support payments under intermediate scrutiny). The district court was correct to dismiss Franklin’s challenge.

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