For taxpayers who have received penalties for failure to file, or late filing of foreign information reporting requirements (e.g., Forms 5471, 5472, 8858 or 8865), recent decision out of the U.S. Tax Court bears great significance.
On April 3, 2023, the U.S. Tax Court issued a ruling in Farhy v. Commissioner, stating that the Internal Revenue Service (“IRS”) lacked statutory authority to assess Internal Revenue Code (“IRC”) Section 6038(b) penalties for failure to file Forms 5471.
However, on May 3, 2024, the D.C. Circuit reversed the Tax Court’s decision in Farhy. According to the Appeals Court, the IRS could assess and collect Section 6038(b) penalties based on the text, structure and function of the applicable code sections.
A few months later after the D.C. Circuit Farhy decision, the IRS sought to reestablish their authority to assess penalties under Section 6038(b) in a new case in Mukhi v. Commissioner. In a motion for reconsideration, the IRS asked the Tax Court to follow the D.C. Circuit’s Farhy opinion. But on its November 18, 2024 opinion, the Tax Court decided en banc (a 15-1 ruling), that the IRS lacked the authority to assess penalties against a taxpayer for failing to report foreign business ownership.
By declining to follow the D.C. Circuit’s Farhy ruling on the issue, the Tax Court instead affirmed its own decision in Farhy. The Tax Court noted that the parties in Mukhi had stipulated the case is appealable to the U.S. Court of Appeals for the Eighth Circuit and thus, the D.C. Circuit’s decision in Farhy was not binding to the taxpayer in Mukhi.
The Mukhi decision came less than sixth months after the D.C. Circuit reached the opposite conclusion about foreign business reporting, creating significant judicial friction.
As a result, taxpayers falling outside the D.C. Circuit’s jurisdiction should continue to raise Farhy as authority that the IRS does not have statutory authority to assess penalties related to certain foreign information reporting requirements.
While Mukhi comes as a win to taxpayers, the IRS will likely appeal the decision to the 8th Circuit. There’s a distinct possibility the result from that appeal may create a circuit split that could ultimately be reviewed by the U.S. Supreme Court.
Meanwhile, taxpayers facing issues of assessment or payment relating to penalties for late filing (or failure to file) of foreign information reporting requirements should consult their tax advisors about a path forward.
Oscar Carrillo is a Senior Associate within ZMF’s tax planning and controversy team. He specializes in providing tax efficient strategies to high-net worth individual clients while also representing and advocating for clients under IRS examinations and appeals. His experience includes inbound and outbound matters, corporate taxation, U.S.-International tax compliance, federal tax controversy, penalty abatement cases, and corporate governance.
