You Make the Call - Aug. 10, 2023

Question: Rafael is a U.S. citizen who owns more than 10% of a foreign corporation. As such, he is required to report information regarding his foreign ownership annually under. §6038(a). He failed to do so by not filing the required Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, for tax years 2019 – 2020 due to disruptions during COVID-19. His refusal to file appears to be a willful and intentional disregard of the filing requirement.

Without review, the IRS promptly and administratively assessed a penalty under §6038(b)(1) of $10,000 for each annual accounting period Rafael did not file Form 5471. He received IRS notices for tax years 2019 and 2020. He still did not file the required Forms 5471 for more than 90 days after the date of the notice of his failure to file. As a result, he was assessed continuation penalties under. §6038(b)(2) of $10,000 for each month or partial month that the failure continued after the 90-day period beginning with the date of the notice. The continuation penalty is capped at $50,000. His total penalty for the failure to file is capped at $60,000 per year, or $120,000 in total. What remedy does Rafael have in the wake of the recent case, Alon Farhy v. Commissioner, 160 T.C. No. 6 (April 3, 2023), that was decided by the U.S. Tax Court, challenging the IRS's right to automatically assess penalties (administratively) under the code section governing Form 5471 penalties (§6038)?

Answer: Rafael will not have to pay. The U.S. Tax Court's decision in Farhy found that, while the Tax Code provides the IRS with the ability to assess penalties, the specific penalty under §6038(b), unlike others in the code, does not authorize the assessment of the penalty it calls for. Therefore, the §6038(b) penalty is not an “assessable penalty”, and only a civil action may force collection as opposed to an administrative assessment. Essentially, because this code section falls outside of the sections in Subchapter B of Chapter 68 of Subtitle F, entitled “Assessable Penalties,” and because it has no language linking its penalty provision to any other authorization to assess and collect penalties, the IRS does not have authority to assess and collect this penalty.

This decision is expected to have a broad reach and will affect most Form 5471 filers, namely category 1, 4, and 5 filers. It will not affect category 2 and 3 filers, who are subject to penalties under §6679, which remains assessable.