Are Assessed Form 5471 (Sec 6038) Penalties Unenforceable?

Are Assessed Form 5471 Penalties Unenforceable

A recent 2023 Tax Court case may put the brakes on the IRS‘ ability to pursue penalties in accordance with sections 26 U.S.C. 6038(a) and (b) – which generally refers to Form 5471 reporting. It is not that the IRS will lose all ability to pursue penalties for failure to file under this code section, but the IRS will not be able to enforce penalties through the automatically assessed penalty procedure that they have become accustomed to. We have written several articles on the issue of assessable penalties and how it is incredibly unfair for taxpayers as they do not get an opportunity to dispute the penalty before it is assessed as is common in most typical deficiency procedures. The Tax Court is basically taking a position that to pursue penalties for Form 5471, the IRS would have to pursue litigation. Let’s take a walk through the code section and the ruling from the US tax court:

26 U.S. Code § 6038(a) – Information reporting 

In pertinent part:

(a) Requirement

• • (1) In general

    • Every United States person shall furnish, with respect to any foreign business entity which such person controls, such information as the Secretary may prescribe relating to—

      • (A) the name, the principal place of business, and the nature of business of such entity, and the country under whose laws such entity is incorporated (or organized in the case of a partnership);

      • (B) in the case of a foreign corporation, its post-1986 undistributed earnings (as defined in section 902(c)); [1]

      • (C) a balance sheet for such entity listing assets, liabilities, and capital;

      • (D) transactions between such entity and—

        • (I) such person,
        • (ii) any corporation or partnership which such person controls, and
        • (iii) any United States person owning, at the time the transaction takes place—
          • (I) in the case of a foreign corporation, 10 percent or more of the value of any class of stock outstanding of such corporation, and
          • (II) in the case of a foreign partnership, at least a 10-percent interest in such partnership; and

      • (E)

        • (I) in the case of a foreign corporation, a description of the various classes of stock outstanding, and a list showing the name and address of, and number of shares held by, each United States person who is a shareholder of record owning at any time during the annual accounting period 5 percent or more in value of any class of stock outstanding of such foreign corporation, and

        • (ii) information comparable to the information described in clause (i) in the case of a foreign partnership. The Secretary may also require the furnishing of any other information which is similar or related in nature to that specified in the preceding sentence or which the Secretary determines to be appropriate to carry out the provisions of this title.

26 USC 6308(b) Dollar penalty for failure to furnish information

• • • In general

      • If any person fails to furnish, within the time prescribed under paragraph (2) of subsection (a), any information with respect to any foreign business entity required under paragraph (1) of subsection (a), such person shall pay a penalty of $10,000 for each annual accounting period with respect to which such failure exists.

• • • Increase in penalty where failure continues after notification

      • If any failure described in paragraph (1) continues for more than 90 days after the day on which the Secretary mails notice of such failure to the United States person, such person shall pay a penalty (in addition to the amount required under paragraph (1)) of $10,000 for each 30-day period (or fraction thereof) during which such failure continues with respect to any annual accounting period after the expiration of such 90-day period. The increase in any penalty under this paragraph shall not exceed $50,000.

Farhy vs Commissioner of Internal Revenue

 Key excerpts from the ruling:

Summary

• • • P failed to file Forms 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, for his 2003–10 taxable years as required by I.R.C. § 6038(a). P’s failure to file the information returns was willful and not due to reasonable cause. R assessed an initial penalty under I.R.C. § 6038(b)(1) and continuation penalties under I.R.C. § 6038(b)(2) against P for each of his 2003–10 taxable years. R proposed a levy to collect the unpaid penalties, and P timely requested an I.R.C. § 6330 hearing. After the hearing, R issued a notice of determination sustaining the proposed levy. P timely petitioned this Court. Held: R lacks statutory authority to assess penalties under I.R.C. § 6038(b)(1) or (2) against P. Held, further, R may not proceed with collection of these penalties from P via the proposed levy.

Procedural History

• • • On February 9, 2016, the Internal Revenue Service (IRS) mailed petitioner notice of his failure to file the required Forms 5471 for the years at issue, but petitioner never filed them. For each year at issue, petitioner’s failure to file the Form 5471 was willful and not due to reasonable cause.

    • On November 5, 2018, the IRS assessed an initial penalty under section 6038(b)(1) of $10,000 for each year at issue, and on November 12, 2018, the IRS assessed continuation penalties under section 6038(b)(2) totaling $50,000 for each year at issue. These assessments are reflected on copies of Form 4340, Certificate of Assessments, Payments, and Other Specified Matters, that the parties have submitted as stipulated exhibits. The IRS complied with the written supervisory approval requirements in section 6751(b) for the section 6038 penalties for the years at issue.

    • On January 30, 2019, the IRS issued to petitioner Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing (levy notice). The IRS, through the levy notice, sought to collect section 6038 penalties that the IRS had assessed because petitioner was required, but failed, to file Forms 5471 for the years at issue.

    • Petitioner timely requested a hearing pursuant to section 6330. On February 19, 2019, petitioner’s counsel mailed the IRS a letter enclosing Form 12153, Request for a Collection Due Process or Equivalent Hearing. Among other issues, petitioner disputed whether the IRS has legal authority to assess section 6038 penalties.

    • On June 4, 2021, respondent issued petitioner a Notice of Determination Concerning Collection Actions under IRC Sections 6320 or 6330 of the Internal Revenue Code (Notice of Determination), regarding petitioner’s liabilities for unpaid civil penalties imposed pursuant to section 6038. The Notice of Determination sustained respondent’s proposed collection action. Petitioner timely filed a Petition with this Court for a review of the determination on June 9, 2021. The parties have stipulated that, except for the assessment authority issue in dispute,4 the settlement officer conducting the section 6330 hearing obtained verification from the IRS that the requirements of any applicable law or administrative procedure have been met as required by section 6330(c)(1). The parties have also stipulated that the settlement officer considered any issues raised at the hearing and whether any proposed collection action balanced the need for the efficient collection of taxes with petitioner’s legitimate concern that any collection action be no more intrusive than necessary. Finally, the parties stipulate that, except for the assessment authority issue in dispute, any error by the settlement officer was a harmless error and the settlement officer did not abuse his discretion in sustaining the levy proposed in the levy notice.

Assessment Authority for Section 6038(b) Penalties

• • • Section 6038(b)(1) imposes a penalty of $10,000, with respect to each annual accounting period for which a failure exists, if any person fails timely to furnish certain required information with respect to any foreign business entity. Section 6038(b)(2) imposes a continuation penalty of $10,000 for each 30-day period (or fraction thereof) during which such failure continues with respect to any annual accounting period after an initial 90-day notice period, subject to a maximum of $50,000.6 There is no statutory provision, in the Code or otherwise, specifically authorizing assessment of these penalties.

No Specific Provision for Assessment

• • • Petitioner contends that section 6038(b), unlike a bevy of other penalty sections in the Code (discussed below), contains no provision authorizing assessment of the penalty it provides for. Therefore, petitioner argues, a section 6038(b) penalty is not an assessable penalty, although it may be collected through a civil action.

Court Ruling

• • • We conclude that petitioner’s reading of the Code is the correct one. Congress has explicitly authorized assessment with respect to myriad penalty provisions in the Code, but not for section 6038(b) penalties. Section 6671(a) provides that the numerous penalties found in subchapter B of chapter 68 of subtitle F (i.e., in sections 6671–6725) “shall be assessed and collected in the same manner as taxes,” subjecting those penalties to the Secretary’s assessment authority under section 6201. Section 6665(a)(1) contains a similar statement that the additions to tax, additional amounts, and penalties provided in chapter 68 of subtitle F (i.e., in sections 6651–6751) “shall be assessed, collected, and paid in the same manner as taxes.”

    • Code sections outside of chapter 68 of subtitle F whose violations the Code specifically penalizes commonly (1) contain their own express provision specifying the treatment of penalties or other amounts as a tax or an assessable penalty for purposes of assessment and collection, see, e.g., §§ 527(j)(1), 856(g)(5)(C), 857(f)(2)(A), 4980H(d)(1), 5000A(g)(1), 5114(c)(3), 5684(b), 5761(e), 9707(f); (2) contain a cross-reference to a provision within chapter 68 of subtitle F providing a penalty for their violation, see, e.g., §§ 1275(c)(4), 6033(o), 6043(d), 6046(f), 6046A(e), 6420(i)(2), 6421(j)(1), 6427(p)(1), 7501(b); or (3) are expressly covered by a penalty provision within chapter 68 of subtitle F, see, e.g., §§ 6652(c), 6674, 6675, 6677, 6679, 6685, 6686, 6688, 6689, 6690, 6692, 6693, 6695, 6698, 6699, 6704, 6705, 6706, 6707, 6707A, 6708, 6709(c), 6710, 6712, 6714, 6717, 6718, 6719, 6720. In contrast, section 6038 contains only a cross-reference to a criminal penalty provision, section 7203. § 6038(f)(1).

    • Furthermore, 28 U.S.C. § 2461(a) expressly provides that “[w]henever a civil fine, penalty or pecuniary forfeiture is prescribed for the violation of an Act of Congress without specifying the mode of recovery or enforcement thereof, it may be recovered in a civil action.”

 The Distinction Between Penalties and Taxes 

• • • Respondent’s argument that the term “taxes” in section 6201(a) encompasses the section 6038(b) penalties (even if they are not assessable penalties) fares no better. Precedent firmly establishes that taxes and penalties are distinct categories of exactions, at least in the absence of a provision treating them as the same. See Grajales v. Commissioner, 156 T.C. 55, 61 (2021) (analyzing whether an exaction is a tax or penalty by reference to the label Congress chose to apply to it), aff’d, 47 F.4th 58 (2d Cir. 2022); see also Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519, 546 (2012) (“The Code contains many provisions treating taxes and assessable penalties as distinct terms. . . . There would, for example, be no need for § 6671(a) to deem ‘tax’ to refer to certain assessable penalties if the Code already included all such penalties in the term ‘tax.’”); Chadwick v. Commissioner, 154 T.C. 84, 93 (2020) (stating that sections 6665 and 6671 “do not characterize ‘penalties’ as something other than penalties” but instead simply specify the manner in which penalties within their scope are to be assessed and collected); cf. Liberty Univ., Inc. v. Lew, 733 F.3d 72, 87–89 (4th Cir. 2013) (holding that employer mandate exaction in section 4980H is not a tax for purposes of the Anti-Injunction Act in part because it is not included in subchapter B of chapter 68 and no other provision deems it a tax). Section 6665(a)(2) deems any reference in the Code to “‘tax’ . . . also to refer to the additions to the tax, additional amounts, and penalties provided by” chapter 68 of subtitle F, and a similar provision specifically applicable to the penalties in subchapter B of that chapter is found in section 6671(a).

Current Year vs Prior Year Non-Compliance

Once a taxpayer has missed the tax and reporting requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

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