IRC 6038 Requirements, Penalties, Procedures & Defenses

IRC 6038 Requirements, Penalties, Procedures & Defenses

IRC 6038 Requirements, Penalties, Procedures & Defenses

Defenses Against IRC 6038 Penalties: Internal Revenue Code 6038, 6038A, 6038C, and 6038D refer to Information reporting with respect to certain foreign Corporations, Partnerships, Foreign Assets, etc. (such as IRS Forms 8865, 8938 and 5471). When it comes to international information reporting, the Internal Revenue Service takes serious issue with US Taxpayers who failed to properly comply with these tax and reporting requirements. Our international tax lawyers specialize in representing Taxpayers who have to either file a late international reporting form — or have already been issued penalties and are seeking to abate or remove them. Even though some of the fear-mongering online tax attorney websites operated by self-proclaimed tax experts make it appear that there is no hope — and that all penalties must be litigated in court — that is absolutely incorrect. The Internal Revenue Service provides various mechanisms to allow taxpayers to dispute the penalty prior to going to court — such as through a protest letter; appeal and/or Collection Due Process Hearing (Form 12153). Let’s review the basics of some of the defenses against Internal Revenue Code section 6038 penalties:

What is IRC 6038?

Internal Revenue Code Section 6038 is primarily used to disclose foreign assets, corporations and partnerships. The key portions of the IRC 6038 et seq. are as follows:

IRC 6038 – Information reporting with respect to certain foreign corporations and partnerships

    • (a) Requirement

      • (1) In general

        • Every United States person shall furnish, with respect to any foreign business entity which such person controls, such information as the Secretary may prescribe relating to—

          • (A) the name, the principal place of business, and the nature of business of such entity, and the country under whose laws such entity is incorporated (or organized in the case of a partnership);

          • (B) in the case of a foreign corporation, its post-1986 undistributed earnings (as defined in section 902(c)); 

          • (C) a balance sheet for such entity listing assets, liabilities, and capital; (D)transactions between such entity and—

IRC 6038A – Information with respect to certain foreign-owned corporations

  • (a) Requirement

    • If, at any time during a taxable year, a corporation (hereinafter in this section referred to as the “reporting corporation”)—

      • (1) is a domestic corporation, and

      • (2) is 25-percent foreign-owned, such corporation shall furnish, at such time and in such manner as the Secretary shall by regulations prescribe, the information described in subsection

  • (b) and such corporation shall maintain (in the location, in the manner, and to the extent prescribed in regulations) such records as may be appropriate to determine the correct treatment of transactions with related parties as the Secretary shall by regulations prescribe (or shall cause another person to so maintain such records).

IRC 6038C – Information with respect to foreign corporations engaged in U.S. business

  • (a) Requirement If a foreign corporation (hereinafter in this section referred to as the “reporting corporation”) is engaged in a trade or business within the United States at any time during a taxable year—

    • (1) such corporation shall furnish (at such time and in such manner as the Secretary shall by regulations prescribe) the information described in subsection (b), and

    • (2) such corporation shall maintain (at the location, in the manner, and to the extent prescribed in regulations) such records as may be appropriate to determine the liability of such corporation for tax under this title as the Secretary shall by regulations prescribe (or shall cause another person to so maintain such records).

IRC 6038D – Information with respect to foreign financial assets

    • (a) In general

      • Any individual who, during any taxable year, holds any interest in a specified foreign financial asset shall attach to such person’s return of tax imposed by subtitle A for such taxable year the information described in subsection (c) with respect to each such asset if the aggregate value of all such assets exceeds $50,000 (or such higher dollar amount as the Secretary may prescribe).

    • (b) Specified foreign financial assets

      • For purposes of this section, the term “specified foreign financial asset” means— (1)any financial account (as defined in section 1471(d)(2)) maintained by a foreign financial institution (as defined in section 1471(d)(4)), and (2)any of the following assets which are not held in an account maintained by a financial institution (as defined in section 1471(d)(5))—

        • (A) any stock or security issued by a person other than a United States person,

        • (B) any financial instrument or contract held for investment that has an issuer or counterparty which is other than a United States person, and

        • (C) any interest in a foreign entity (as defined in section 1473).

IRC 6038 Penalties

IRC 6038 penalties can vary extensively, depending on the type of reporting form required and the number of years of noncompliance. Penalties range from $10,000 penalty per year – to a multiple year penalty upwards of $50,000 per year.  In order to avoid, abate and remove the penalties, there are various amnesty procedures available —

IRC 6038 Penalty Amnesty

The Offshore Amnesty Programs are programs developed by the Internal Revenue Service to assist Taxpayers who are already out of compliance for non-reporting.

Some of the more common programs, include:

Protesting an IRC 6038 Penalty

Before it is time to litigate an IRC 6038 penalty, the IRS CP15 Notice provides an opportunity to dispute the penalty based on reasonable cause and the CP15 Notice gives Taxpayer 30-days to respond. If Taxpayer can prove reasonable cause, the CP15 Notice for IRC 6038 violations may be abated or removed. Here is an example of the Reasonable Cause exception language from the statute:

6038D Reasonable Cause

      • No penalty shall be imposed by this section on any failure which is shown to be due to reasonable cause and not due to willful neglect. 

The CP15 Notice is from the IRS and the initial protest (pre-appeal) goes back to the IRS for the first round of Reasonable Cause penalty abatement review.

Appealing a 6038 Penalty

If the IRC 6038 protest letter is rejected, Taxpayer can submit a supplemental response to their initial protest letter that was sent to the IRS — if they have “additional information” to present to the IRS Office of Appeals. Sometimes, before going to Appeals, the IRS will request additional information and the letter will first go back to the IRS and not the Office of Appeals — which can impact the overall strategy Taxpayer seeks to pursue. If not, the IRS Office of Appeals will consider the request, and may schedule a conference with Appeals — or not — depending on the specifics of the presentation and officer assigned to the matter.

Collection Due Process Hearing

After receiving a Notice of Federal Tax Lien or Intent to Levy, the Taxpayer may have the opportunity to pursue a Collection Due Process Hearing. The benefits of a Collection Due Process hearing is that it permits the Taxpayer to essentially get two bites of the apple — and it opens the door to go to Tax Court on multiple different arguments. But, the Taxpayer usually has to wait until they receive a Notice of Federal Tax Lien or Intent to Levy before they can pursue a CDP — which can be very unsettling for Taxpayers.

Tax Court

Most of the time, Tax Court cases involving IRC 6038 penalties involves a significant amount of time and resources on behalf of the Taxpayer. Taxpayers should keep in mind that the Attorney’s Fees for an experienced Litigation Attorney are usually very high — and billed hourly — which may not be feasible for many Taxpayers. Moreover, since 6038 penalties are not considered tax liabilities, but rather reporting penalties — in general courts have not been as inclined to provide the Taxpayers with much deference.

Federal Court

Another option for the Taxpayer is to pay the penalty upfront and then seek a refund from the IRS. If the refund request is denied — then the Taxpayer can sue in District Court. The idea behind having to pay upfront is the Flora Rule — which requires a Taxpayer to pay the debt at the IRS before moving forward in pursuing a federal claim. It is important to note that IRC 6038D penalties are not the result of tax liability — but rather the result of a reporting penalty. Therefore, the Taxpayer may want to take the position that similar to a recent ruling in an FBAR case, prepayment is not required up-front.

Reasonable Cause Defense to IRC 6038 Penalties

International information reporting penalties come in all shapes and sizes. One of the most common penalties is the penalty for not reporting a unreported foreign assets. Here is a common example: Frank is a lawful permanent resident in the United States who has foreign assets abroad. He learns about the reporting after filed files a Delinquent form 8938 and receives a penalty notice. The penalty notice arrives on a form CP15 Notice and Frank has 30 days to protest the penalty and show the noncompliance was due to reasonable cause.

Internal Revenue Manual Reasonable Cause Explained

Since reasonable cause is not definitively “defined” in the code, but is rather based on a totality of the circumstance — it is important to get a baseline understanding of what the IRS looks for when evaluating Taxpayer reasonable cause. One good place to start is the Internal Revenue Manual. While the Internal Revenue Manual is not binding, it does provide good insight into what reasonable cause is:

IRM Reasonable Cause

      • Reasonable cause is based on all the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise apply. Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining his or her tax obligations but was nevertheless unable to comply with those obligations.

      • In the interest of equitable treatment of the taxpayer and effective tax administration, the non-assertion or abatement of certain civil penalties based on reasonable cause or other relief provisions provided in this IRM must be made in a consistent manner and should conform with the considerations specified in the IRC, Treasury Regulations (Treas. Regs.), policy statements, and IRM Part 20.1, Penalty Handbook.

      • Reasonable cause relief is not available for all penalties; however, other exceptions may apply.

      • For those penalties where reasonable cause can be considered, any reason which establishes that the taxpayer exercised ordinary business care and prudence, but nevertheless was unable to comply with a prescribed duty within the prescribed time, will be considered.

      • If a reasonable cause provision applies only to a specific IRC section, that reasonable cause provision will be discussed in the IRM 20.1, Penalty Handbook, section relating to that specific IRC section. See IRM, Authority, and Exhibit 20.1.1-1, Penalty Relief Application Chart.

      • When considering the information provided in the following subsections, remember that an acceptable explanation is not limited to those given in IRM 20.1. Penalty relief may be warranted based on an “other acceptable explanation,” provided the taxpayer exercised ordinary business care and prudence but was nevertheless unable to comply within the prescribed time. See IRM, Ordinary Business Care and Prudence.

      • The wording used to describe reasonable cause provisions varies. Some IRC penalty sections also require evidence that the taxpayer acted in good faith or that the taxpayer’s failure to comply with the law was not due to willful neglect. See specific IRM 20.1, Penalty Handbook, sections for the rules that apply to a specific IRC penalty section. See IRM, Authority.

      • Taxpayers have reasonable cause when their conduct justifies the non-assertion or abatement of a penalty. Each case must be judged individually based on the facts and circumstances at hand. Consider the following in conjunction with specific criteria identified in the remainder of this subsection:

        • What happened and when did it happen?
        • During the period of time the taxpayer was non-compliant, what facts and circumstances prevented the taxpayer from filing a return, paying a tax, and/or otherwise complying with the law?
        • How did the facts and circumstances result in the taxpayer not complying?
        • How did the taxpayer handle the remainder of his or her affairs during this time?
        • Once the facts and circumstances changed, what attempt did the taxpayer make to comply?
      • Reasonable cause does not exist if, after the facts and circumstances that explain the taxpayer’s noncompliant behavior cease to exist, the taxpayer fails to comply with the tax obligation within a reasonable period of time.

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