Joint Discovery Motion Filed in FBAR Penalty Dispute

ALBERTO AROESTE, ESTELA AROESTE,
Plaintiffs,
v.
UNITED STATES OF AMERICA,
Defendant.

UNITED STATES OF AMERCA,
Counterclaim Plaintiff,
v.
ALBERTO AROESTE, ESTELA AROESTE,
Counterclaim Defendants.

Patrick W. Martin (Texas Bar No. 24086371)
Email: patrick.martin@chamberlainlaw.com
Jose Anuar Estefan Davila (Bar No. 330350)
Email: Anuar.estefan@chamberlainlaw.com
Jaime Vasquez (Texas Bar No. 24066235)
Email: jaime.vasquez@chamberlainlaw.com
Leo Unzeitig (Texas Bar No. 24098534)
Email: leo.unzeitig@chamberlainlaw.com
CHAMBERLAIN, HRDLICKA, WHITE, WILLIAMS & AUGHTRY, P.C.
112 E Pecan St., Suite 1450
San Antonio, Texas 78204
Telephone: (210) 253-8383
Facsimile: (210) 253-8384

Attorneys for Plaintiffs Alberto and Estela Aroeste

IN THE UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF CALIFORNIA

JOINT DISCOVERY MOTION

PLAINTIFFS' POSITION

This case, directly and indirectly, concerns substantial penalties for a Mexican national and resident for failing to file United States information returns. The Government argues that Alberto Aroeste, who is not a “United States person” and who has minimal ties to the United States, should nonetheless be subject to draconian penalties as if he was a United States person or as if he did have substantial ties to the United States. Fortunately, the law and the facts prevent such a harsh result.

The threshold issue in this case is whether Alberto Aroeste is subject to the FBAR filing requirement or whether he is exempt (1) under the United States — Mexico tax treaty and/or (2) by reason of having abandoned his lawful permanent resident status under immigration law. We start with the law to frame the analysis and then move on to why discovery of the administrative record is necessary to develop the facts.

Issue 1: How is Alberto Aroeste's status under the United States — Mexico tax treaty germane to the FBAR filing requirement?

Title 31 regulations provide that each “United States person” having an interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country shall report such relationship to “the Commissioner of Internal Revenue” on a Report of Foreign Bank and Financial Accounts, or “FBAR”. 31 C.F.R. § 1010.350(a).

Thus, the first question is who is a “United States person” for FBAR purposes? The Title 31 regulations provide that a United States person is (1) a citizen of the United States (which the parties agree Alberto Aroeste is not); (2) an entity organized in the United States (which the parties agree Alberto Aroeste is not), or (3) “an individual who is a resident alien under 26 U.S.C. 7701(b) and the regulations thereunder”. 31 C.F.R. § 1010.350(b).

This leads us to the second question: who is a “resident alien under 26 U.S.C. 7701(b)”? Section 7701(b)(1)(A) says that it is an individual who (1) meets the substantial presence test by spending a set number of days in the United States according to a look-back formula (which the parties agree Alberto Aroeste did not meet that test), (2) makes a “first year election” (which the parties agree Alberto Aroeste did not make), or (3) is a lawful permanent resident at any time during such calendar year.

This leads us to the third question: who is a “lawful permanent resident”? Section 7701(b)(6) says that an individual is a lawful permanent resident of the United States if such individual has the status of having been “lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws” Moreover, section 7701(b)(6) flush language provides that an “individual shall cease to be treated as a lawful permanent resident of the United States if such individual commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country.” (emphasis added).

Thus, to determine who must file FBARs, we look to the Title 31 regulations which cross-reference and adopt the definition of United States person found in Title 26. The Title 26 definition provides that individuals who have abandoned their immigration status or who are treated as residents of a foreign country under a tax treaty are not United States persons. Thus, answering the Court's query, status under the tax treaty is relevant to the FBAR filing requirement because Title 31 regulations (setting forth who must file an FBAR) direct us to a Title 26 definition of “United States person” that incorporates the tax treaty.

Issue 2: How is discovery of the entire administrative record in this matter relevant and proportional to determining Alberto Aroeste's status under the tax treaty and whether he was a United States person for purposes of filing an FBAR?

One of the primary purposes of tax treaties is to ensure that “dual resident taxpayers” (i.e., individuals who are residents of both the United States and another country) are spared the burdens of complying with duplicate tax responsibilities and filing obligations in two separate countries. In furtherance of that objective, Article 4 of the U.S. — Mexico treaty contains “tie-breaker rules” that determine a dual resident taxpayer's residence for purposes of tax and information return filing requirements. At a high level, the test is intended to limit tax and reporting obligations for dual resident taxpayers to the country in which they have a closer connection. The tie-breaker test starts as follows (and cascades to subsequent tests if the first test offers no clear result):

Where . . . an individual is a resident of both Contracting States, then . . . he shall be deemed to be a resident of the State in which he has a permanent home available to him; if he has a permanent home available to him in both Contracting States, he shall be deemed to be a resident of the State which his personal and economic relations are closer (center of vital interest). . . .

Here, Alberto Aroeste has homes in both the United States and Mexico. We thus turn to the second criteria that says he shall be deemed a resident of the country in which his personal and economic relations are closer. This is a necessarily fact-intensive inquiry.

Turning to the administrative record and its relevance to the treaty and immigration issues, we highlight that the IRS conducted a single administrative audit in this case, spending many years and hundreds of hours with numerous technical advisors, managers, and reviewers. The single audit focused primarily on the issue of whether Alberto Aroeste was a United States person under immigration law and the treaty tie-breaker rules. Secondary components of the audit were whether the filing failures were willful and whether the Aroestes qualified for the reasonable cause defense

Our experience in cases like this suggests that the bulk of the contents in the administrative record are inextricably tied (and likely not segregable) because the finding that Alberto Aroeste was a United States person under immigration law and the treaty tie-breaker rules likely stems from the factual investigation and determinations made throughout the entire years-long audit. Virtually every inquiry made by the revenue agent, every document requested from third parties (particularly financial institutions), every document provided (with or without context) is relevant to the treaty residency questions. All records tie to the inherently factual determination regarding Mr. Aroeste's residency status and his “center of vital interests”, which necessarily looks at all economic and family connections, points of contact, physical residency, social contacts, primary financial relationships, credit card activity, telephone records, and movements during the years at issue and prior years.

We are in possession of an old copy of the administrative record that references otherwise unproduced documents showing Alberto Aroeste's relative presence in both countries. It is over 7,000 pages long and contains records such as a redacted U.S. Customs and Border Protection TECS report and a redacted spreadsheet compiling information from bank, immigration records, passport stamps, safe deposit box records, and other records that show Alberto Aroeste's contacts in Mexico and the United States. Apart from those overly redacted records, the old copy of the administrative file includes 77 pages worth of case activity records recording the revenue agent's time spent on this FBAR case (a whopping 354 hours). Her time entries reference numerous discoverable documents that have not been produced such as established policy papers¹ and exculpatory evidence². The case activity record also shows how all Title 26 and Title 31 issues tend to blend together in the file, particularly in this case where the issue of whether Alberto Aroeste was a “United States person” would definitively resolve both the Title 31 and Title 26 issues before the Courts and the IRS. To demonstrate this, we have attached 10 of the 77 pages from the case activity record that highlight the nature of the administrative file and the documents existing but not received.

Given the foregoing, we respectfully request that the Court order production of the administrative record in this case as we work towards resolving the immigration and treaty tie-breaker issues currently before the Court.

DEFENDANT'S POSITION

This case is about the Aroestes failing to disclose foreign financial accounts under the Bank Secrecy Act. These disclosures are commonly referred to as “FBARs.” The law requires “U.S. persons” to file FBARs, so whether Mr. Aroeste is one is essential to imposition of the FBAR penalties against him.

1. Alberto Aroeste's status under the United States — Mexico tax treaty is not germane to the issue of whether Mr. Aroeste was required to file the FBAR reports at issue.

The United States — Mexico income tax treaty governs income taxes, not FBAR penalties. Thus, the treaty is not relevant to whether Mr. Aroeste was a “U.S. person” required to file the FBAR reports at issue. The plain, unambiguous text of the treaty demonstrates its irrelevance. Under Article 2 of the treaty, the treaty only “applies to income taxes imposed by each of the Contracting States.” See Convention, Art. I, § 1 (emphasis added). The same Article specifies what qualifies as an income tax in each jurisdiction. The treaty says it only applies to U.S. income and excise taxes:

[T]he Federal income taxes imposed by the Internal Revenue Code (but excluding the accumulated earnings tax, the personal holding company tax, and social security taxes), and the excise taxes imposed on insurance premiums paid to foreign insurers and the excise taxes with respect to private foundations to the extent necessary to implement the provisions of paragraph 4 of Article 22 (Exempt Organizations). The Convention shall, however, apply to the excise taxes imposed on insurance premiums paid to foreign insurers only to the extent that the risks covered by such premiums are not reinsured with a person not entitled to exemption from such taxes under this or any other convention which applies to these taxes.

See Convention, Art. I, § 2 (emphasis added). In short, nothing in the treaty itself suggests that a non-tax penalty assessed under a different Title of the U.S. Code should be subject to the benefits of the treaty. In fact, the treaty does not even apply to all taxes in Title 26 (“I.R.C.”). See id.

Further, nothing in Title 31 suggests that income tax treaties should apply in that context. Instead, 31 U.S.C. § 5314 allows the Secretary of the Treasury to create a “reasonable classification of persons subject to” the reporting requirements, including FBAR filings. 31 U.S.C. § 5314(b)(1). The regulation's definition of “U.S. person” includes “an individual who is a resident alien under 26 U.S.C. § 7701(b) and the regulations thereunder.” 31 C.F.R. § 1010.350(b)(2). In turn, I.R.C. § 7701(b)(1)(A)(i) defines “resident alien” to include anyone who is a lawfully admitted permanent resident any time during the calendar year whose status has not been revoked — and who has not chosen to commence proceedings to be treated as only a resident of the foreign country — with no caveat regarding where they lived or how long they were in the United States. See United States v. Little, 2017 U.S. Dist. LEXIS 67580, at *5 (S.D.N.Y. May 3, 2017). That the FBAR regulation references a definition in the Internal Revenue Code does not incorporate the entire I.R.C. nor the provisions of treaties imposed under the I.R.C.

Mr. Aroeste wants the income tax treaty to apply here for two inappropriate reasons. First, if the treaty did apply, the Court would have to consider where Mr. Aroeste's “center of vital interests” is when determining whether the FBAR assessments were correct. See ECF No. 1 ¶ 30. But looking at the plain language of the statutes and regulations regarding FBARs, when someone is a lawful permanent resident, the statutes and regulations provide no exception to the FBAR reporting requirement. Thus, under the law, it does not matter where Mr. Aroeste lives, works, or travels. It only matters that Mr. Aroeste has lawful permanent residence and has not rescinded that residency. In fact, he has used that residency status to enter the United States at least twenty-six times since January 1, 2012.

Second, the United States asserts that the residency status, while not germane to this matter, is germane to other liabilities Plaintiffs (including Mrs. Aroeste, whose penalties are not currently ripe for discovery) are challenging or intend to challenge. See ECF No, 32, at 3 (“Plaintiffs have requested a copy of the administrative file supporting the IRS' determination and the records supporting the imposition of the Title 31 FBAR and Title 26 information penalties.”) (emphasis added); see also Aroeste v. Commissioner, Case No. 013024-20 (U.S.T.C. filed Nov. 9, 2020). Discovery in Plaintiffs' Tax Court case, in which they challenge income tax liabilities (ECF No. 32, at 3), has not yet begun. Plaintiffs' information penalties were dismissed from that case on jurisdictional grounds. See id. Plaintiffs have not yet sued to challenge those information penalties. What Plaintiffs seek here include documents that they may be able to obtain in litigation about those information penalties. They simply do not want to wait for the appropriate time to seek those documents. Further, they seek to push the tax treaty residency issue so that this Court may adjudicate it — despite its irrelevance here — on the chance that the Court's ruling could somehow provide leverage in those other actions. But the Court does not have jurisdiction over those other liabilities and need not address tax treaty residency to benefit Plaintiffs' other litigation strategies.

2. Assuming Mr. Aroeste's status under the tax treaty is relevant, discovery of the entire administrative record in this matter is neither relevant nor proportional (within the meaning of Rule 26) to determining Mr. Aroeste's status under the tax treaty and determining whether he was a “United States person” for purposes of filing an FBAR.

a. Relevance and proportionality to status under the tax treaty

Assuming Mr. Aroeste's residency under the tax treaty is germane to this matter, discovery of the entire administrative record is neither relevant nor proportional to his status under the tax treaty. The entire administrative record contains documents and information not only about the FBAR penalties here, but also other assessments and penalties not currently under the jurisdiction of this Court, namely, income tax liabilities. See ECF No. 32, at 3 (Plaintiffs' description of the examination and audit creating the file, noting that the FBAR penalties are only “a small portion of that [total] liability”).

Rule 26 limits discovery to what is relevant to this action. See Fed. R. Civ. P. 26(b)(1). What is relevant to this action broadly is what in that record pertains to the FBAR penalties assessed against Mr. Aroeste. But with discovery limited by Court order, what is relevant at this time is what in that record pertains to the twin issues ripe for discovery. See ECF No. 25, at 1; Fed. R. Civ. P. 26(b)(1) (prescribing scope “unless otherwise limited by court order”). Yet underlying that scope is the basic premise that those issues relate back to FBAR penalties. Fed. R. Civ. P. 26(b)(1); see ECF No. 1.

The tax treaty issue can be resolved without discovery of the entire administrative record, and thus its discovery is neither relevant nor proportional. By Plaintiffs' own admission, the entire administrative file does not pertain to the FBAR penalties at issue. ECF No. 32, at 3. Thus, the records in the file not relating to the FBAR penalties and specifically relating to the twin issues permitted for discovery, are not relevant to this action or its current scope of discovery. Fed. R. Civ. P. 26(b)(1).

Further, for the same reason, discovery of those portions of the file not germane to the twin issues as they relate to FBAR penalties would not be proportional to the needs of this case. The records are unimportant to resolving the issues; their discovery outweighs any likely benefit as they would have no impact on the FBAR penalties' validity or the two issues ripe for discovery. Plaintiffs seek an administrative file that spans far beyond that “small portion” they concede relates to their FBAR debts. Even assuming the tax treaty is relevant to resolving Mr. Aroeste's claims, their request is not only irrelevant, but also not proportional to the needs of this case.

b. Relevance and proportionality to whether he was a “United States person” required to file FBARs.

What is relevant to whether Mr. Aroeste was a “U.S. person” required to file FBARs is rather simple: his immigration status. If Mr. Aroeste is a lawful permanent resident, the inquiry ceases. 31 U.S.C. § 5314(b)(1); 31 C.F.R. § 1010.350(b)(2); 26 U.S.C. § 7701(b)(1)(A)(I). Mr. Aroeste has produced an Alien Registration Card and two passports. These two passports contain entry stamps showing that Mr. Aroeste has used that Alien Registration Card or his underlying lawful permanent resident status forty-six times since December 2007, including at least twenty-six times since January 1, 2012.³ And in response to the United States' request for evidence of status other than lawful permanent residence since the years at issue (which presumably would include evidence he notified the Treasury Secretary he formally commenced proceedings to be treated as only a resident of the foreign country under the treaty), Mr. Aroeste admitted he has no such documents. The United States has also produced ample records, some of which show that Mr. Aroeste admitted to being a “resident alien” under 26 U.S.C. § 7701(b) during the years at issue. See Exhibit B (“The taxpayer is also a 'resident alien' as defined by 7701(B)(1)(A)(I); i.e., a green card holder[.]”); Exhibit C, at 1 (same). Thus, the inquiry need not continue — both parties agree that Mr. Aroeste was a “resident alien” of the United States during the years at issue.

Thus, requiring the United States to disclose an entire administrative file that not only contains information about the FBAR assessments against Mr. Aroeste, but also other assessments unrelated to FBARs, is not only irrelevant but disproportionate. Fed. R. Civ. P. 26(b)(1). The key inquiry of whether Mr. Aroeste is a U.S. person under the statutes and regulations can already be answered, and can be done so without any further needless, irrelevant, burdensome, and potentially privileged productions by the United States.

Plaintiffs' reasons for requesting these records are improper — this Court need not grant a request that not only violates its own order limiting discovery, but that also seeks free discovery for assessments irrelevant and disproportionate to this case.

Respectfully submitted,

CHAMBERLAIN, HRDLICKA, WHITE, WILLIAMS & AUGHTRY, P.C.

By: Patrick W. Martin
State Bar No. TX24086371
patrick.martin@chamberlainlaw.com

Jaime Vasquez
State Bar No. TX24066235
jaime.vasquez@chamberlainlaw.com

Jose Anuar Estefan Davila
State Bar No. 330350
Anuar.estefan@chamberlainlaw.com

Leo Unzeitig
State Bar No. TX24098534
leo.unzeitig@chamberlainlaw.com
112 East Pecan St., Suite 1450
San Antonio, Texas 78205
Telephone: (210) 507-6508
Facsimile: (210) 253-8384

ATTORNEYS FOR PLAINTIFFS
ALBERTO AND ESTELA AROESTE