Taxpayer Lawsuit Challenges IRS PFIC Tax Rules in Court

Taxpayer Lawsuit Challenges IRS PFIC Tax Rules in Court

Taxpayer Lawsuit Challenges IRS PFIC Tax Rules in Court

Taxpayer Lawsuit Challenges IRS PFIC Tax Rules in Court: A Taxpayer has the right to file a lawsuit against the IRS and U.S. Government, and is not required to be represented by counsel — although having an attorney can help. When a Taxpayer sues the government, it is important that they have their ducks in a row, and are ready and prepared to challenge the U.S. Government. When the tax issues involve an underlying statute and the challenge is whether the statute is fair and equitable — it is going to be a very steep uphill battle from the start.

In the case of Shnier, they filed a lawsuit involving PFIC — which is actually a great idea. The PFIC regime is lopsided and unfair to Taxpayers — especially when they owned the “PFIC” before becoming U.S. Persons.

Let’s take a look at Shnier v. United States and the anatomy of how a Taxpayer Lawsuit Challenges IRS PFIC Tax Rules.

Shnier v. United States, 18-1257 (Fed. Cl. 2020)

The first thing to note is that this case took place in the US Court of Federal Claims.

The Court of Federal Claims is a forum used to sue the US government only. In addition, there is no jury, which may have been a detriment to the  taxpayer.

A Taxpayer has the opportunity to sue in various district courts countrywide. Choosing the Court of Federal Claims in order to pursue a tax case, where equity and fairness were cornerstones of the complaint — but without a jury of their peers — already puts the Plaintiffs at a disadvantage.

What is a PFIC?

A PFIC Is a Passive Foreign Investment Company.

The concept behind the PFIC regime is that US taxpayers should not be allowed to keep their foreign passive earnings in passive foreign companies to avoid US tax. Whereas a long term capital gain (LTCG) may be taxed at 15 or 20% depending on the tax rate of the filer, the same capital gain that’s locked inside a PFIC and then released by way of a distribution can be taxed at the highest tax rate available — in addition to interest — which generally results in an overally tax liability/tax debt far beyond what it ordinarily would have been as general passive income.

So you can see why the Shnier’s we’re pissed off  — and rightfully so.

Gist of Plaintiff’s Argument

  • According to plaintiffs, the context demonstrates “the PFIC regime was created to discourage American investors to hold passive investments through foreign corporations that would allow them certain advantages,” so the statute includes a willfulness requirement, which plaintiffs fall outside of. Id.4 Plaintiffs argue the PFIC regime is “punitive” because it “was intended to dissuade US investors from investing offshore” but “it is an aberration of justice to apply the punitive PFIC regime” to them because their PFIC status was non-willful.

  • Plaintiffs further assert the government’s application of PFIC regime to people like them is so disruptive it “has caused thousands of Americans to renounce their citizenship.” OA Tr. at 10:10–12. According to plaintiffs, PFIC taxes should not apply to “situations like ourself [sic],” where immigrants happen to own passive offshore investments “not funded by one cent of American money”; rather, the taxes should apply only “to Americans who funded these companies with American-sourced money.”

Factual Background

As provided by the court in pertinent part:

  • In the 1960s, plaintiff David Shnier’s “father and four uncles . . . established family trusts to share ownership of their jointly owned [Canadian] floorcovering company.” Pls.’ Cross-Mot. for Summ. J. and Opp’n to Def.’s Mot. for Summ. J. (“Pls.’ Cross-MSJ”) at 11, ECF No. 26; see Compl. at 2, ECF No. 1.

  • After the Canada Revenue Agency issued regulatory changes making holding a corporation through trusts less advantageous, the five men created five holding companies—“one for each family”—through which they jointly owned the floorcovering company.

  • Mr. Shnier immigrated to the United States from Canada in the mid-1990s. 

  • In 2007, before the death of Mr. Shnier’s father, “the floorcovering company was sold.” 

  • Mr. Shnier’s father “made the decision on which investment management companies to use” when investing Enshnierco’s portion of the proceeds from the sale, thereby transitioning the holding company’s “main asset[s]” from the floorcovering corporation to passive investments, including real estate.

  • Despite receiving advice in 2007 from a Canadian accounting firm they “could be subject to U.S. tax reporting laws [such as 26 I.R.C. § 1297] with respect to those holding companies,” plaintiffs did not report the distributions on their federal tax returns.

  • In late 2013,  however, Mr. Shnier filed amended 2007, 2010, and 2011 tax returns while participating in the IRS’s Offshore Voluntary Disclosure Program (“OVDP”).

  • Plaintiffs’ amended returns  included “the distributions from the Canadian holding company Metropolitan Equities Limited as income from a passive foreign investment corporation.”

  • More than one year later, on 16 July 2015, plaintiffs sent a letter to the IRS opting out of OVDP.

  • The IRS continued to offer plaintiffs the opportunity to participate in OVDP while at the same time warning it might audit plaintiffs “under standard examination procedures” should they continue not to comply.

  • On 28 April 2017, the IRS  assessed PFIC taxes against plaintiffs, leading to payments of additional taxes, interest, and I.R.C. § 6662 penalties totaling $49,949.12, $12,115.69, and $5,228.21 for 2007, 2010, and 2011, respectively.

  • Plaintiffs appealed the IRS’s decisions through itsprocedures, which “concluded in May 2018.” Compl. at 2 (“According to the IRS Appeals decision letter ‘1363’ dated May 15, 2018, we can contend the decisions in the United States Court of Federal Claims.”).

What is OVDP?

OVDP was the Offshore Voluntary Disclosure Program. It was in existence from 2009 (when it was referred to as OVDI) through 2018 when the program was closed.

Opting Out of OVDP

When a taxpayer opted out of OVDP, they were not opting out of the program itself but rather opting out of the penalty scheme and seeking to seek a reduced penalty.

Plaintiffs Rejected ADR

  • The court recommended potential ADR (Alternative Dispute Resolution) On 7 April 2020, the Court held a telephonic status conference to discuss whether plaintiffs would like the Court to refer their case to the Court’s Bar Association Pro Bono/Attorney Referral Pilot Program. See Status Conference Tr., ECF No. 36. The parties agreed “there’s no possibility of resolution through ADR . . . .”

The Court inquired as to whether plaintiffs would like to participate in the Court’s pro bono representation program, and plaintiffs replied they were open to representation, but not by a tax attorney.

Apparently, Plaintiffs were not fond of tax attorneys.

Dueling Motions for Motion for Summary Judgment on PFIC Willfulness Tax Issue

The government filed a motion for summary judgment, and the plaintiffs filed their own cross motion for summary judgment.

The court rejected plaintiffs’ (Taxpayers) motion and accepted defendants’ (Government) motion.

Here are some of the highlights from the court’s ruling and why the Court of Federal Claims Denies Taxpayer PFIC Claim:

  • The IRS continued to offer plaintiffs the opportunity to participate in OVDP while at the same time warning it might audit plaintiffs “under standard examination procedures” should they continue not to comply.

  • On 28 April 2017, the IRS  assessed PFIC taxes against plaintiffs, leading to payments of additional taxes, interest, and I.R.C. § 6662 penalties totaling $49,949.12, $12,115.69, and $5,228.21 for 2007, 2010, and 2011, respectively.

  • “Plaintiffs “want the Court to rule that the PFIC statutes does [sic] not support the Defendant’s broad application,” which would result in the government “desist[ing] from treating Enshnierco and everything it owns, as a PFIC” and taxing the distribution income as if it were from “a normal foreign corporation.” Pls.’ Reply at 6; Pls.’ Cross-MSJ at 17.

  • The Anti- Injunction Act “flatly prohibits” the grant of injunctive relief in IRS collection proceedings. Ledford v. United States, 297 F.3d 1378, 1381 (Fed. Cir. 2002) (“[N]o statutory authority exists that would grant the Court of Federal Claims the power to enjoin an IRS collection proceeding.”). This Court possesses limited jurisdiction under the Tucker Act, and it has no jurisdiction over claims for equitable relief like plaintiffs’ request for injunction here. See Brown v. United States, 105 F.3d at 624. Rule 12(b)(1) requires the Court to dismiss any request outside its jurisdiction.

  • Plaintiffs ask the Court to look to legislative history to determine the meaning of the statute, but because plaintiffs agree “the text answers the question, that is the end of the matter.”

  • The Court accordingly dismisses plaintiffs’ request for injunctive relief for lack of subject matter jurisdiction. Ledford, 297 F.3d at 1381; see Matthews v. United States, 72 Fed. Cl. 274, 278 (2006) (“If the court finds that it lacks jurisdiction over the subject matter, it must dismiss the claim.”).”

  • “Plaintiffs request the Court “reward [them] for half the[ir] legal and/or accounting fees ($57,536)” if the Court “determines that the Defendant has miss-applied to PFIC regime against the Plaintiffs [sic].” Pls.’ Cross-MSJ at 17. Plaintiffs do not identify a basis for such an award but “defer that decision to the Court and their familiarity with Court decisions on similar matters.” Id.

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