IRS Lacks Authority to Assess 5471 Penalties

In April 2023 in the case of Farhy, the United States Tax Court held the following:

• • Held: R lacks statutory authority to assess penalties under I.R.C. § 6038(b)(1) or (2) against P.

  • Held, further, R may not proceed with collection of these penalties from P via the proposed levy.

In Farhy, the Tax Court found that the Internal Revenue Service does not have the right to assess penalties against Taxpayers for failing to file Form 5471 – and/or the continuing failure to file Form 5471 — although the IRS may still file a lawsuit against Taxpayers. It is important to note that the Court did not consider willfulness vs. non-willfulness (Petitioner was willful) and Reasonable Cause would not apply (because Petitioner was willful). Rather, the Tax Court based its conclusion on the simple fact that the statute does not permit the IRS to ‘assess penalties.’ Therefore, the only way the IRS may go after the Taxpayer is by filing a lawsuit. We previously published a separate article identifying the key provisions from that ruling but for now, let’s look at how the Tax Court came to this conclusion.

The IRS Lacks Authority to Assess 5471 Penalties, a Roadmap

Section 6038 (b)(1) or (2) Penalties

The Internal Revenue Code Section 6038 requires Taxpayers to report their ownership of foreign assets on certain international information reporting forms. Taxpayers who have an ownership interest in foreign corporations may have to report their ownership on Form 5471– if they meet the threshold requirements for reporting their foreign entity to the IRS. If a Taxpayer does not timely file Form 5471 (or fails to file it at all), the code section provides that they can be penalized upwards of $10,000 per year, as well as a $50,000 ‘continuing failure-to-file penalty.’

Assessable Penalties in General

Assessable penalties in general are very dangerous and unfair to Taxpayers. That is because assessable penalties are usually assessed by the Internal Revenue Service without providing the Taxpayer with any pre-assessment notice and/or opportunity to dispute the penalty before it is issued — as is the case with typical deficiency procedures matters. Thus, the Taxpayer’s first notice about an assessed penalty is when they have actually been penalized – leaving the Taxpayer without an opportunity for a pre-assessment hearing, exam, or other negotiation with the IRS.

*This is a common practice for the IRS when issuing Form 5471 penalties, in which the Taxpayer’s first notice of the penalty is when they receive a CP-15 Notice.

Statutory Authority to Penalize

The crux of the ruling is that IRC 6038 lacks the necessary statutory provision that would authorize the IRS to assess penalties. In other words, the code section does not contain a provision allowing for the assessment of penalties.

Court Ruling, Page 5:

• • • “There is no statutory provision, in the Code or otherwise, specifically authorizing assessment of these penalties.”

For example, if the assessable language was contained in the statute, it would read similar to other sections, such as 6665:

• • • “(1) the additions to the tax, additional amounts, and penalties provided by this chapter shall be paid upon notice and demand and shall be assessed, collected, and paid in the same manner as taxes.”
      

What Comes Next for Form 5471 Penalties?

This ruling puts Form 5471 penalty procedures in a state of flux. The IRS can appeal the notice, but that type of strategy may backfire, especially in light of the fact that several other international code sections are equally lacking in statutory authority. The IRS may also issue a nonacquiescence to the Tax Court’s ruling.

As provided by the IRM:

• • • “Nonacquiescence signifies that, although the decision was not appealed or was not reviewed by the Supreme Court, the Service does not agree with the holding of the court and will not follow it nationwide in disposing of other cases. With respect to opinions of an appellate court, the Service generally will follow the holding in cases appealable to that circuit due to the binding nature of the opinion on lower courts even when the office concludes that the opinion is erroneous.

    • The AOD may include a statement that the holding will not be followed in future cases in the circuit if the case can be distinguished on the facts. Any decision to not follow circuit court precedence in that circuit is a strategic decision, which can only made after consultation with the Department of Justice Tax Division.”

What About Other Types of International Reporting Penalties?

Another potential issue for the IRS is regarding other international reporting forms, such as Form 3520, etc. Will the courts consider the IRS lacking in statutory authority in assessing these penalties as well?  In the meantime, Taxpayers who are out of compliance or who may have been previously penalized for noncompliance with Form 5471 and other international reporting forms, may want to consider their options.

Getting into International Tax Compliance

Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.