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Large Penalties: Form 5471 Information Return of U.S. Persons With Respect to Certain Foreign Corporations

Internal Revenue Code (I.R.C.) Section (§) 6038(a) and Treasury Regulation § 1.6038-2(a) require a U.S. citizen or resident alien to furnish information with respect to certain foreign business entities. This information includes any foreign partnership/corporation entity data, stock ownership data, financial statements, and intercompany transactions with related persons. The Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, is used to comply with the law and regulations. Penalties for not timely filing the Form 5471 are severe. I.R.C. § 6038(b)(1) provides for a monetary penalty of $10,000 for each Form 5471 that is filed after the due date of the associated income tax return, including any extensions.

Penalties on late-filed Forms 5471 are systemically assessed, resulting in significantly more penalty assessments. The IRS sends taxpayers a CP 215 notice when it systemically assesses a late-filed Form 5471 penalty. Taxpayers can request that the IRS remove the penalty by providing a reasonable cause for abatement.

Reasonable cause is based on all the facts and circumstances in each situation and allows the IRS to provide taxpayers relief from a penalty that would otherwise be assessed. Reasonable cause relief is generally granted when taxpayers exercised ordinary business care and prudence in determining their tax obligations but nevertheless failed to comply with those obligations. The IRS’ Ogden Accounts Management Campus primarily handles the reasonable cause abatement requests resulting from systemic penalties on late-filed Forms 5471 attached to a Form 1120.

The reasonable cause standard evaluates whether the taxpayer has “exercised ordinary business care and prudence in determining their tax obligations.” Some previously acceptable justifications for abatement are not supported when the decision tree is utilized (e.g., reliance upon a professional, first-time filing, taxpayer ignorance of the law, unobtainable records and unintentional failure to file an extension).

The IRS has a formal penalty abatement decision tree model that its personnel must follow (Internal Revenue Manual section 21.8.2.21.2) to determine whether a reasonable cause exists to abate the penalties. When the IRS receives a taxpayer’s reasonable cause request to have a systemically assessed late-filed Form 5471 penalty abated, an Accounts Management employee should evaluate the request using an IRS decision tree. The decision tree was designed to uniformly assist employees in determining whether a request to abate the late-filed Form 5471 penalty for reasonable cause should be granted, denied, or referred to a specialist or the Examination function. The decision tree provides a list of questions that require a “Yes” or “No” response under an “If” and “Then” conditional statement to determine whether the penalty should be abated or the reasonable cause request denied.

The Internal Revenue Manual 21.8.2.21.2(4) (Oct. 1, 2010) also requires employees to notate the section and specific question in the decision tree that led to his/her determination to abate the penalty or to deny the reasonable cause request.

The IRS is continuing to make the U.S. tax aspects of international compliance a key focus, with the imposition of penalties being a significant “stick” in their arsenal to increase overall taxpayer compliance with these reporting obligations. With the increased penalty assessments and the percentage of taxpayers granted abatements trending downward, taxpayers and their tax advisors will need to increase their awareness of the potential for international tax penalties and exercise more vigilance in this important reporting area.