Occasionally, a tax news alert hits your inbox that causes you to pause, read it again, and say, “That cannot be right.”  The U.S. Tax Court decision in the Farhy v. Commissioner case is the latest example.

The U.S. Tax Court ruled that the Internal Revenue Service (IRS) lacked statutory authority to assess penalties imposed under Section 6038(b)(1) or (2) of the Internal Revenue Code for failure to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. The Tax Court also held that the IRS could not proceed with the collection of penalties for failure to file Form 5471.

Pause for a moment and let that sink in.  The U.S. Tax Court ruled that the IRS cannot assess or collect penalties that are codified under a specific section of the Internal Revenue Code.  The penalties assessed under Section 6038 are draconian ($10,000 to $25,000 per missed filing) and meant to enforce strict compliance related to foreign information reporting requirements.

Mr. Farhy was required to report information about his ownership interests in several foreign investments and willfully failed to do so.  Mr. Farhy did not dispute these facts; rather, he challenged whether the IRS could assess and collect penalties under Section 6038; and the Tax Court agreed with him.

The ruling does not relieve taxpayers of the requirement to file certain international information returns such as Form 5471 or any other form.  Failure to file certain international information returns may impact the statute of limitations for the taxpayer’s entire return.

What does this mean and where do we go from here?  Expect the IRS to respond regarding its position on the current process and any pending or future abatement requests.  It is unclear whether this ruling creates a right to refund for previously assessed or paid penalties.  Taxpayers who have previously been assessed penalties for failure to file Form 5471 or that may have delinquent Form 5471 reporting requirements are encouraged to contact a GBQ tax advisor.


Article written by:
Bart Hickey, CPA
   Tax Senior Manager
Tyler Gabalski, CPA
   Tax Manager

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