The U.S. Tax Court recently held that the Internal Revenue Service (“IRS”) lacked statutory authority to assess Internal Revenue Code (“IRC”) Section 6038(b) penalties against an individual for failure to file Forms 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations.
The case has ramifications for any taxpayer that has been assessed by the IRS with penalties under Section 6038(b) and/or has paid penalties of this nature in the past for late filing or failure to file Forms 5471. Furthermore, similar situated penalties which are not assessable penalties nor subject to deficiency procedures may be subject to the same analysis and rationale found by the Tax Court.
In Alon Fahry v. Commissioner, the Taxpayer owned a foreign corporation incorporated in Belize during the 2003 through 2010 tax years, and a second foreign corporation incorporated in Belize during the 2005 and 2010 tax years. For the years at issue, the Taxpayer had a reporting obligation under Section 6038(a) to report on Forms 5471 his ownership interests in both entities incorporated in Belize.
In response to the Taxpayer’s failure to file Forms 5471, the IRS imposed an initial $10,000 penalty per year and per entity under Section 6038(b) and $50,000 per year in continuation penalties for the tax years 2003 through 2010.
The IRS issued Taxpayer a Notice of Determination with respect to his liabilities for unpaid Section 6038(b) penalties and sustaining its proposed collection action. Subsequently, the Taxpayer filed a petition with the U.S. Tax Court for a review of the agency’s determination.
The only issue before the Tax Court was whether the IRS had statutory authority to assess penalties under section 6038(b).
The Tax Court decided the issue in favor of the Taxpayer and held that the IRS lacked statutory authority to administratively assess the penalties.
The Tax Court explained in its April 3 opinion that “the mere fact that a penalty is not subject to deficiency procedures does not automatically give rise to the conclusion that it is an assessable penalty, such as where, as here, Congress has not given the Commissioner the authority to assess these particular penalties.” In its decision, the Tax Court also held that the IRS could not proceed with the collection of the penalties via its proposed levy against the Taxpayer.
Taxpayers and tax practitioners should look at the Fahry case if (i) they have discovered missed Forms 5471 and are planning to amend tax returns, (ii) have penalty abatement cases pending review by the Independent Office of Appeals, or (iii) have paid penalties of this nature in the past and may want to seek a refund.
Below are some considerations in the aftermath of the Tax Court’s ruling.
Action Items and Taxpayer Considerations
- No indication from the IRS on whether it will appeal this Tax Court decision to the D.C. Circuit.
- Taxpayers should review whether they have paid any penalties with respect to the Form 5471. If they have, consult with their tax advisor on whether they could seek a refund.
- Although the Tax Court in Fahry only addressed Form 5471 penalties, the logic of the ruling could also extend to assessment authority on penalties imposed for late filing or failure to file Forms 5472, 8865, 926, 8938 and 8858.
- If Taxpayers have outstanding penalty cases being considered administratively by the IRS, we strongly recommend amending abatement requests or refund claims so that they mention Fahry.
- Absent a legislative fix by Congress to make these penalties assessable penalties, subject to deficiency procedures or a successful appeal by the IRS to the U.S. Court of Appeals for the D.C. Circuit, it appears that the only avenue for the IRS to collect these penalties would require involvement of the Justice Department Tax Division.
Ultimately, we recommend Taxpayers consult with their tax advisors in order to assess whether (i) these penalties could apply to the Taxpayer in a particular tax year, (ii) the taxpayer should file protective claims for refund, or (iii) the taxpayer should amend tax returns to include missed foreign information returns.
The case is Fahry v Commissioner, 160 T.C. No 6. (April 3, 2023).