Automatic Form 5471 and 5472 Penalties in Spotlight by 2020 National Taxpayer Advocate Report

IRS National Taxpayer Advocate yesterday released her 2020 annual report to Congress yesterday. Federal law requires the Annual Report to Congress to identify the “most serious problems” encountered by taxpayers and to make administrative and legislative recommendations to mitigate those problems.  Among the “most serious problems” addressed is the IRS’s treatment of Form 5471/5472 §§ 6038 and 6038A foreign information reporting penalties as systemically (automatically by IRS computers) assessable, which is deemed legally unsupportable, administratively problematic, and imposes costs, delays, and stress for many of our clients.

IRC § 6038 requires U.S. persons to furnish certain information regarding foreign business entities they control on Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, which is attached to taxpayers’ annual income tax returns. The failure to timely provide this information results in a $10,000 penalty, even if this information does not affect taxpayers’ ultimate tax liabilities. The IRS notifies taxpayers that the penalty has been assessed. If the taxpayer does not provide the required information within 90 days, the statute imposes an additional penalty “continuation penalty” for each 30-day period that the failure continues. This increase is capped at $50,000. Similarly, IRC § 6038A requires 25 percent foreign-owned domestic corporations to file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. The penalty under IRC § 6038A begins at $25,000, and the continuation penalty, which commences 90 days after notication of assessment, is $25,000 for each 30-day period, without an upper limit.

Originally, these penalties were imposed manually on taxpayers whose missing filings were discovered during an audit. However, in recent years, the IRS began the systemic automatic assessment of the penalty under IRC §6038(b)(1) for late-filed Forms 5471 and 5472.

As evidenced by high abatement rates (up to 71% of penalty amounts), much of this late filing is ultimately determined by the IRS to result from benign circumstances, including ignorance of the filing requirements, unavailability of the requisite information, and IRS error. The report recommends manual penalty assessment and automatic abatement of penalties.

We applaud the IRS for noticing these unfair penalties. Unfortunately, the IRS is not mandated to accept the recommendations. However, in the past, such recommendations were taken “into consideration” for future changes.

In the meantime, our office will continue to fight the unfair penalties for our clients. Our has successfully assisted over one hundred taxpayers with appeals and relief of Form 5471 and 5472 penalties.

The summary of the reported problem is pasted below:

Most Serious Problem #8:

INTERNATIONAL: The IRS’s Assessment of International Penalties Under IRC §§ 6038 and 6038A Is Not Supported by Statute, and Systemic Assessments Burden Both Taxpayers and the IRS

PROBLEM
The IRS’s treatment of IRC §§ 6038 and 6038A foreign information reporting penalties as systemically assessable is legally unsupportable, administratively problematic, and imposes costs, delays, and stress for
taxpayers. Because the penalties are immediately assessed, taxpayers’ only recourse is to rely on IRS discretion and request a reasonable cause abatement of the penalties or pay them and seek a refund in federal court.
This approach is particularly unsuited to these penalties, as demonstrated by abatement rates in excess of 55 percent when measured by number of penalties and 71 percent when measured by dollar value. Thus, both
taxpayers and the IRS are expending significant time, energy, and money addressing penalties that ideally should not be assessed in the first instance.


ANALYSIS
IRC §§ 6038 and 6038A impose harsh penalties for failure to file required international information returns. Thus, the IRS’s treatment of the penalties as summarily assessable is burdensome for taxpayers. The IRS
adopts the circular argument that because it lacks statutory authority to assert the penalties using deficiency procedures, this, by definition, must confer authority to undertake summary assessments. The National
Taxpayer Advocate and several commentators, however, find nothing in the IRC or the case law to support this reading. Given the existing hazards of litigation, the IRS should refer assessment and collection of these penalties to the Department of Justice, while seeking legislation providing authority to use the deficiency procedures. Administratively, the IRS could send soft notices to taxpayers upon discovery of late-filed international information returns to enhance compliance and minimizing the number of penalties being asserted. Further, the IRS should establish a first-time abatement for all Chapter 61 penalties, including the IRC §§ 6038 and 6038A penalties, to educate taxpayers and streamline tax administration.


RECOMMENDATIONS
The National Taxpayer Advocate recommends that the IRS stop erroneously assessing §§ 6038 and 6038A penalties, and refer assessment and collection efforts to the Department of Justice when appropriate; send soft notices to taxpayers upon discovery of late-filed international information returns as a means of enhancing compliance and minimizing the number of penalties being asserted; and extend eligibility for the first-time abatement to all Chapter 61 penalties, including the IRC §§ 6038 and 6038A penalties, regardless of whether the underlying return was filed late.
The National Taxpayer Advocate recommends that Congress expand deficiency procedures to cover Chapter 61, including the IRC §§ 6038 and 6038A penalties.

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