U.S. Tax Court Rules IRS Lacks Statutory Authority to Assess Penalties for Failure to File Form 5471

The U.S. Tax Court held on April 3, 2023, in Farhy v. Commissioner, 160 T.C. No. 6 (April 3, 2023), that the Internal Revenue Code does not provide authority for the Internal Revenue Service to assess penalties imposed under IRC Sec. 6038(b)(1) or (2) for failure to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. against taxpayers. Consequently, the court further held that the IRS may not administratively collect such penalties via levy.

Facts

The taxpayer, Alon Farhy, owned 100% of a Belize corporation from 2003 through 2010, as well as 100% of a second Belize corporation from 2005 through 2010. Farhy admitted to participating in an illegal scheme to reduce his income tax; he was granted immunity from prosecution. During the period of ownership of the Belize corporations, however, he was required to file Forms 5471 for both corporations but did not.

The IRS mailed notice to the taxpayer in February 2016 of his failure to file the Forms 5471, but he never filed them. In November 2018, the IRS assessed $10,000 per failure to file, per year, as well as a continuation penalty of $50,000 for each year. The IRS also determined that Farhy’s failures to file were willful. The penalties received appropriate supervisory approval within the IRS.

Court’s Opinion

The U.S. Tax Court held that Congress authorized assessment for a variety of penalties, notably for the penalties found in subchapter B of chapter 68 of subtitle F, that is, IRC Sections 6671–6725), but not for the penalties under Sections 6038(b)(1) and (2), which apply to Form 5471. Because these penalties were not assessable, the court held that the IRS was barred from proceeding with collection. 28 U.S.C. Sec. 2461(a), which allows recovery of any penalty by civil court action, is the only way the government could pursue collection of the penalties in question.

Insights

Taxpayers may be considering whether to file refund claims for penalties assessed and paid under Section 6038(b) in the wake of this decision; however, it is unclear whether the Farhy case creates a right to a refund for penalties previously assessed and/or paid.

The Farhy case holds that the IRS may not assess penalties under Section 6038(b) (failure to file Form 5471). It is possible that the same analysis would apply to other international information return penalties, such as the penalties under Section 6038A(d) for failure to file Form 5472. However, taxpayers should be aware that the case does not relieve the obligation to file Form 5471 or any other required form. Moreover, the failure to file certain international information returns, such as Forms 5471 and 5472, may impact the limitations period on a taxpayer’s return; this case does not change that rule.