Form 5471 Penalties Upheld in Latest Court Ruling

The D.C. Circuit handed the IRS a big win last week, holding that the IRS could assess international information return penalties for the failure to file Forms 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.”

The Court reversed the Tax Court in its May 3 decision in Farhy v. Commissioner. It held inferentially that the text, structure, and function of section 6038 indirectly support the IRS’s assessment authority for those penalties.   “It is hardly anomalous that section 6038(b) penalties are assessable even though the text of section 6038 does not explicitly label them as such. . . . Scattered across the tax code are more than one hundred penalties applicable to diverse forms of noncompliance and set forth in varied ways. Discerning the operation of each penalty is necessarily a context-dependent exercise,” Judge Cornelia Pillard wrote. “The absence of the penalty from Chapter 68 and the lack of either a cross-reference to Chapter 68 or explicit language directing that the penalty ‘shall be assessed’ is not determinative. Congress can make a penalty assessable by implication, and it did so here.”

In 2023, the lower Tax Court held in the taxpayer’s favor, finding that the IRS could not assess penalties under section 6038(b) for failure to file Forms 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” The Tax Court reasoned that Congress had not explicitly authorized assessment for the section 6038(b) penalties.

This new court decision reverses the ‘foot fault’ technicality found by the lower court in favor of the IRS’ ability to assess Form 5471 penalties.  The IRS should now (unfortunately for taxpayers) be emboldened to assess penalties.

The court stated that section 6038(c)(4)(B) explicitly made reasonable cause determinations [by the IRS to excuse the penalty] so that the IRS implicitly should be able to assess the penalty. 

Unfortunately, the IRS rarely considers reasonable cause statements submitted with late returns that include late Forms 5471. Instead, the IRS routinely assesses 6038 penalties automatically for many filers. As a result, the filers are left with years of penalty appeals and waste time and money litigating penalties.

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