April 12, 2023
Tax Court rules IRS cannot assess penalties under IRC Section 6038(b) for willfully failing to report foreign income
The Tax Court held (Farhy v. Commissioner, 160 T.C. 6 (April 3, 2023)) that the IRS is not authorized to assess penalties under IRC Section 6038(b) against a taxpayer that willfully failed to report foreign income on Form 5471, Information Return of U.S Persons With Respect to Certain Foreign Corporations. As a result, the IRS cannot collect the penalties it assessed through a levy notice. The IRS may, however, collect the penalties through a civil action.
Taxpayer owned two foreign corporations in Belize during tax years 2003--2010. The parties stipulated that he participated in an illegal scheme at that time to reduce the income tax he owed. In 2012, he was granted immunity from prosecution. During the years at issue, taxpayer willfully, and without reasonable cause, failed to file Forms 5471.
In 2018, the IRS assessed an initial penalty under IRC Section 6038(b)(1) of $10,000 for the delinquent Forms 5471 for each year at issue and continuation penalties under IRC Section 6038(b)(2) totaling $50,000 for each year at issue. In 2019, the IRS attempted to collect the penalties through a levy notice. This case arises from the taxpayer’s petition to review the IRS’s collection action under the Collection Due Process procedures in the Tax Court.
Arguments of the parties
The taxpayer and the IRS agreed on all of the relevant facts and submitted the case to the Court to decide the only issue in dispute: whether the IRS had statutory authority to assess penalties under IRC Section 6038(b).
The taxpayer argued that the IRS could not assess the penalty because no statutory provision in the Code or otherwise authorizes the IRS to assess IRC Section 6038(b) penalties. While IRC Section 6201 expressly allows the IRS to assess “assessable penalties,” the Code does not expressly specify that IRC Section 6038 is an assessable penalty; therefore, Congress did not authorize the IRS to assess it.
The IRS argued that (1) “assessable penalties” should be read broadly to include any penalties in the Code that are not subject to the Code’s deficiency procedures; (2) “taxes” in IRC Section 6201 is broad enough to encompass IRC Section 6038 penalties; and (3) legislative history supports the IRS’s position.
The Tax Court rejected the IRS’s arguments, concluding that “Congress has explicitly authorized assessment with respect to myriad penalty provisions in the Code, but not for [IRC S]ection 6038(b) penalties.” The court went on to say “we are loath to disturb this well-established statutory framework by inferring the power to administratively assess and collect the [IRC S]ection 6038(b) penalties when Congress did not see fit to grant that power to the Secretary of the Treasury expressly as it did for other penalties in the Code.”
The decision of the Tax Court, if unchanged on appeal, would broadly undermine the IRS’s current practices for assessing and collecting penalties under IRC Section 6038. The Tax Court suggests in its decision that the IRS pursue such penalties through civil action under 28 U.S.C. Section 2461(a). Without a court decision imposing the penalties, the IRS’s administrative determination, standing alone, would be insufficient to impose any payment obligation on taxpayers for the penalty under IRC Section 6038. Similar reasoning may apply to other penalties in the Code that are not specifically identified as assessable.
While the Tax Court’s decision remains subject to appeal and only addresses IRC Section 6038, taxpayers who have paid penalties under IRC section 6038 (or similar penalty provisions not specifically identified as assessable penalties) based only upon the IRS’s assertion of such penalties may consider whether a timely refund claim or other action is warranted in light of the Tax Court’s decision. Timely refund claims may be appropriately filed on a protective basis while awaiting the resolution of any appeal or other action required for the Tax Court’s decision to become final.
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor