In Larson v. United States, 2016 U.S. Dist. LEXIS 179314 (SD NY 2016), here, the Court rejected an attempt by a promoter assessed a very, very large § 6707 penalty to avoid the Flora full payment rule for refund litigation. The principal holding is that the § 6707 penalty is not a divisible penalty that could benefit under divisible tax exception to Flora's full payment rule. This aspect of the case is consistent with prior holdings such as Diversified Group Inc. v. United States, 841 F.3d 975, 981 (Fed. Cir. 2016), here.
The full bore application of the Flora full payment exception is troubling on these facts with very, very large § 6707 penalties. The IRS assessed a $24,745,026 penalty for the FLIP/OPIS shelter and a $135,487,056 penalty for the BLIPS shelter. The total was thus $160,232,026. The IRS did reduce the penalty by amounts paid by other co-promoters. The aggregate amount of that reduction was $96,820,667, leaving Larson liable for $63,411,359. (Co-promoters also might be liable for the unpaid balance.)
Larson made a partial payment of $1,432,735, hence his refund suit alleging a divisible tax as a basis for not paying all. The Court's basic analysis as to why the § 6707 penalty is not divisible is fairly straight-forward. I think the following discussion relating to the claims of hardship because of the amount of the penalty is interesting.
Indeed, at oral argument, Larson did not dispute that the failure to register a tax shelter was "only one act," or "one act per shelter," Tr. at 17:22-23; rather, Larson seeks to limit the applicability of the full-payment rule to his particular circumstances. In a due process challenge to the application of the full-payment rule, Larson argues that the full-payment rule violates "the Fifth Amendment where there is no alternative forum having jurisdiction over pre-payment challenges to such penalties and where an individual does not have the financial means to pay the penalties in full." Opp. Br. at 7. Foreclosed from review in Tax Court, Larson argues that because he cannot pay the penalty, and he cannot seek review for his claim without paying the penalty, the imposition of the full-payment rule violates his Fifth Amendment right to due process. n9
n9 Larson did not assert a Due Process claim in his Complaint, but he makes arguments based on the Due Process Clause in opposing the Government's motion to dismiss.
Larson argues that the Supreme Court in Flora I and Flora II never intended for the full-payment rule to apply in circumstances in which Tax Court review is unavailable and the challenged penalty amount is unaffordable to the taxpayer. Larson's reading of Flora I and Flora II strains to find due process arguments where none exists. In reviewing the legislative history of 26 U.S. § 1346(a)(1) and the legislative history that led to the creation of Tax Court, the Supreme Court noted that Congress created the Tax Court as a prepayment forum to ameliorate "the hardship of prelitigation payment." Flora I, 357 U.S. at 74, 75; Flora II, 362 U.S. at 158. But it is clear that Congress created the Tax Court out of legislative grace, not because it was a constitutionally-required response to the full payment rule. See Flora I, 357 U.S. at 75; Flora II, 362 U.S. at 158. Flora I and Flora II held that, in district court, a taxpayer must "pay first and litigate later," and Larson points to no authority that supports his argument that the unavailability of the Tax Court vitiates the full-payment rule in district court. Carving a "when Tax Court is unavailable" exception into the full-payment rule would subvert the full-payment rule's purpose in "promot[ing] the smooth functioning of [the tax litigation] system." See Flora II, 362 U.S. at 647. Although this Court is sympathetic to Larson's circumstances, this Court declines to recognize such an exception to well-settled jurisdictional limits.
