Key Details:
The United States Court of Appeals for the District of Columbia Circuit recently reversed a significant decision by the U.S. Tax Court in the case of Farhy v. Commissioner of Internal Revenue. This reversal has far-reaching implications for taxpayers, particularly regarding the IRS's authority to assess and collect penalties under Section 6038(a) of the Internal Revenue Code (IRC). For further information and expertise or to discuss your unique tax plan, contact Ryan & Wetmore today.
Background on Section 6038(a) and the Case
Section 6038(a) of the IRC mandates that U.S. persons file information returns, such as Form 5471, to disclose their control over foreign businesses. In this case, Alon Farhy, the appellee, did not report his ownership of Belizean corporations, leading to $500,000 in penalties under Section 6038(b). Farhy challenged the IRS's authority to assess and collect these penalties administratively, asserting that Congress had not explicitly granted such authority and that the IRS would need to pursue civil action in federal court.
In April 2023, the U.S. Tax Court agreed with Farhy that the IRS lacked the statutory authority to assess and administratively collect penalties under Section 6038(b). However, the IRS appealed this decision to the D.C. Circuit, overturning the Tax Court's ruling.
D.C. Circuit Court Decision
The D.C. Circuit's ruling focused on whether the IRS could assess a penalty for failing to file a required form or if the Department of Justice must sue and obtain a judgment from a federal district court to enforce the penalty. The court reviewed the legislative history of Section 6038, which was amended in 1982 to include a fixed-dollar penalty for non-compliance.
Legislative History and Analysis
The court found that Congress intended these penalties to be assessable, stating that the text, structure, and function of Section 6038 support this interpretation. The court noted that requiring the IRS to sue for each penalty would undermine the efficiency intended by the 1982 amendments.
The court dismissed Farhy's argument that the penalties are not assessable because Section 6038 does not explicitly label them as such. The court concluded that Congress could make a penalty assessable by implication, and it did so in this case. It highlighted that not explicitly stating the assessable nature of the penalty does not negate the IRS's authority, especially when the legislative intent and practical enforcement considerations support such authority.
Practical Considerations
The court also considered the practical implications of not allowing the IRS to assess these penalties directly. If the IRS had to pursue civil action for each penalty, it would create a cumbersome process, resulting in fewer penalties being enforced and collected. This would contradict Congress's intent to ensure compliance through streamlined enforcement mechanisms.
Implications for U.S. Taxpayers
The D.C. Circuit's decision has restored the IRS's authority to assess and collect penalties under Section 6038(b) without pursuing civil action in federal court. This ruling underscores the importance of taxpayers complying with international information return requirements to avoid significant penalties.
The implications extend beyond Section 6038 penalties. The ruling reinforces the IRS's broader authority to assess penalties for non-compliance with various international reporting requirements, including Forms 5472, 8938, and 926.
Conclusion and Action Items
The reversal of the Tax Court's decision in Farhy v. Commissioner has significant implications for taxpayers with foreign business interests. The IRS's authority to assess penalties under Section 6038(b) has been affirmed, and taxpayers must ensure they fully comply with reporting requirements to avoid substantial penalties.
-
Ensure all foreign business interests and holdings are adequately reported on the appropriate IRS forms (e.g., Form 5471, Form 5472, Form 8938, and Form 926).
-
Keep up to date with IRS regulations and court rulings that may affect international reporting requirements.
-
Work with tax professionals to ensure compliance with all filing requirements and to navigate any complexities in international tax
-
Submit all required information returns on time to avoid the possibility of incurring
-
If unable to comply with reporting requirements, document any reasonable cause and be prepared to present it to the IRS if penalties are
-
Stay aware of potential changes in legislation that may impact reporting requirements and penalty assessments.
By following these action items, taxpayers can better manage their compliance obligations and mitigate the risk of penalties under Section 6038. This proactive approach is crucial given the recent court decision, ensuring taxpayers remain compliant and avoid the significant penalties associated with non-compliance. For further information and expertise, contact Ryan & Wetmore today.
Today’s Thought Leaders
About Peter Ryan
Partner, Co-founder, & CPA
Peter T. Ryan co-founded Ryan & Wetmore in 1988 with business partner Michael J. Wetmore. Peter provides clients with the best strategies for success. His expertise extends across various industries. Peter obtained a Master of Business Administration in Finance from the University of Baltimore and a Bachelor of Arts in Accounting from the Catholic University of America.
About Rosie Cheng
Finance Consultant
Rosie Cheng is a Finance Consultant at Ryan & Wetmore. She focuses on government contracting services and produces many of the firm’s government contracting newsletters. Rosie graduated from Georgetown University with a Master of Science in Management and from William and Mary with a Bachelor of Business Administration.