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IRS Can Enforce Form 5471 Penalties: Farhy Overturned

As expected, when the Tax Court decided the IRS could not enforce penalties such as Form 5471, this was not the end of the discussion. The D.C. Circuit Court’s has overturned the Tax Court’s decision in Farhy v. Commissioner. This significantly impacts taxpayers, especially those required to file international information returns like Form 5471. This decision, affecting taxpayers with foreign investments or interests in foreign corporations, reinforces the IRS’s authority to impose penalties for failing to comply with the filing requirements under section 6038 of the Internal Revenue Code.

Alon Farhy, the taxpayer in this case, owned interests in foreign corporations and had to report these interests by filing Form 5471 under I.R.C. § 6038(a). However, Farhy did not file these forms for several years. Consequently, the IRS imposed penalties under I.R.C. § 6038(b), starting with initial penalties of $10,000 per year and escalating to additional continuing violation penalties of up to $50,000 per year. Farhy contended that the IRS did not have the statutory authority to assess these penalties and argued that the agency should instead collect them through a civil action as mandated by 28 U.S.C. § 2461(a). The Tax Court initially ruled in favor of Farhy, agreeing that the IRS did not have the authority to assess the penalties administratively and that they must be collected through judicial action.

Section 6038(b) imposes penalties for failure to file certain information regarding foreign corporations but does not explicitly state that these penalties are “assessable penalties.” This omission is critical because for the IRS to assess and collect penalties administratively (i.e., without going to court), the penalties must be explicitly defined as “assessable penalties” within the statute. Because the statute lacked that explicit language, Farhy argued that the IRS should have been required to recover the penalties in a civil action, if at all. The Tax Court initially agreed, comparing the language of 6038(b) which lacks the specific language authorizing administrative assessment found in other statutes.

The D.C. Circuit Court found the broader context and structure of the Internal Revenue Code to imply that Congress intended for the penalties to be administratively assessable, despite the absence of explicit language. The appellate court noted that since 1982, the IRS had been assessing these penalties, and Congress had amended the section multiple times without incorporating explicit language. This suggested that Congress was aware of and had acquiesced to the IRS’s interpretation.

The reversal grants the IRS the authority to impose penalties for failing to meet the filing requirements of Form 5471 and similar forms without having to engage in civil litigation. This decision affects taxpayers with foreign interests who must file international informational returns. Taxpayers who were hoping this case might offer a reprieve from penalties must now explore other relief options, such as demonstrating reasonable cause or qualifying for other statutory exceptions to penalty assessments. Additionally, this decision reminds taxpayers to fulfill their filing responsibilities, especially concerning international tax issues.

Disclaimer: Hone Maxwell LLP articles and blogs are not intended as legal advice. Additional facts, facts specific to your situation or future developments may affect subjects contained herein. Seek the advice of an attorney before acting or relying upon any information herein.

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