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By: Rebecca K. Wohltman

Just a few months after the U.S. Supreme Court’s ruling in Bittner v. United States, the Tax Court dealt another blow to the IRS’ use of penalties to enforce the Tax Code.

In early April 2023, the Tax Court entered its decision in Farhy v. Commissioner, 160 T.C. No. 6, regarding the IRS’ ability to assess penalties for failing to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. (A taxpayer is required to file Form 5471 to report certain interests in foreign corporations. Those filing requirements are beyond the scope of this blog.)

Section 6038(b) of the Internal Revenue Code authorizes a penalty of up to $10,000 for failing to file Form 5471. If the IRS sends notice to a taxpayer advising the taxpayer of its obligation to file Form 5471 and the taxpayer fails to do so for 90 days, the statute authorizes an additional $10,000 penalty for each 30-day period thereafter that the taxpayer fails to file Form 5471, up to a total of $50,000.

In Farhy, the IRS assessed this penalty against Mr. Farhy for 8 years (2003-2010), then proposed to utilize its levy power to collect this penalty. There was no question that Mr. Farhy had an obligation to file Form 5471. There was also no dispute that his failure to file Form 5471 for several years was willful and not due to reasonable cause.

The question before the Tax Court was whether the IRS has statutory authority to assess and collect the penalties for failing to file Form 5471.

Mr. Farhy argued, and the Tax Court agreed, that Section 6038(b) does not authorize the IRS to assess the penalty that the statute establishes. Mr. Farhy conceded that the IRS could collect this penalty through a civil action. The Tax Court agreed that the proper method for the IRS to assess the penalty for failure to file Form 5471 is through a civil action, not through its normal methods.

Thus, even though Section 6038(b) authorizes a penalty for failing to file Form 5471, the Tax Court held that the statute does not authorize the IRS to assess and collect this penalty, at least not through its traditional administrative processes.

As of the writing of this blog, no appeal has been filed in the case, though there is still time for the IRS to file an appeal.

Despite this ruling from the Tax Court, if you own an interest in a foreign company of any kind, you should evaluate whether you are required to file Form 5471. If you are unsure if you are required to file Form 5471, contact Rebecca K. Wohltman.

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