On April 16, 2019, the Large Business and International (LB&I) Division of the Internal Revenue…
Tax Court Rules IRS Cannot Assess or Collect Form 5471 Penalties
Last week the US Tax Court issued its opinion in Farhy v. Commissioner, ruling that the Internal Revenue Service (IRS) could not assess or collect penalties under Internal Revenue Code (Code) Section 6038(b) for a late-filed Form 5471 against Alon Farhy.
This is a big win for taxpayers because the IRS automatically assesses these penalties on any late-filed Form 5471, Information Return of US Persons with Respect to Certain Foreign Corporations. This practice should presumably be immediately ceased. Moreover, any taxpayer who was assessed and paid a penalty on a late-filed Form 5471 may be able to obtain a refund on the penalty paid.
Farhy had failed to file Form 5471 with his US federal income tax return. Failure to timely file Form 5471 comes with a civil tax penalty of $10,000 for each year. (See IRC Section 6038(b)(1).) If the IRS sends the taxpayer notice of its failure to file Form 5471, the taxpayer has 90 days after the notice is mailed to comply with the filing requirement. Failure to comply within the 90-day period subjects the taxpayer to an additional penalty of $10,000 for each 30-day period, with a $50,000 maximum. (See IRC Section 6038(b)(2).)
Code Section 6201(a) permits the IRS to “assess” taxes and assessable penalties. Assessment is the act of formally recording a tax liability on the IRS’s records for a taxpayer. After assessment and failure to pay, the IRS can enforce the collection of tax, penalties and interest by asserting a lien on property or by levying (taking) property.
The tax law permits the IRS to assess taxes (including interest, additional amounts and additions to tax) and certain types of penalties (assessable penalties). In Farhy, the Tax Court held that the law does not specifically allow the IRS to assess the penalty provided in Code Section 6038(b). As such, although the IRS correctly determined that Farhy should be penalized for failing to file Form 5471 with his return, the IRS lacked the legal ability to assess and collect the penalty under traditional assessment and collection procedures that they use for other penalties (essentially treated similar to deemed taxes). Under current law, the IRS could only file a civil action in court to collect the Form 5471 penalty.
Farhy is a major taxpayer victory, which favoriable affects thousands of taxpayers. The case evinces a technical problem in the law for the IRS to assess and collect Form 5471 penalties.
It is also possible that other penalties for failure to file certain international information returns (e.g., Form 3520 for reporting gifts received from foreign persons pursuant to Section 6039F) are also likely not “assessable” penalties, which means assessment and collection of those penalties also could stop. We will see how the government reacts to this major loss.
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