A recent decision by the U.S. Tax Court will prevent the IRS from assessing penalties for failing to file some information returns related to a U.S. citizen or resident’s ownership interest in foreign businesses. The court’s decision in Farhy v. Comm’r, 160 T.C. No. 6 (T.C. 2023), addresses the case of a taxpayer who willfully failed to file Forms 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, but the court issued a broad decision stating that the IRS lacks the authority to assess any penalties under §6038(b).

Section 6038(b) provides for a $10,000 penalty for failing to furnish information regarding a foreign business entity that increases by $10,000 for each 30-day period the information is not provided, up to a maximum of $50,000. In addition to Form 5471, the IRS has been applying the penalty to persons who have not filed other foreign reporting forms, including Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.

Taxpayers who have already paid penalties under §6038(b) may be eligible to claim a refund, but the IRS has yet to provide any guidance on the issue. The IRS is expected to appeal the court’s ruling and it is unlikely that the IRS will grant refunds while the case is on appeal.

Failure to report Belize businesses
The taxpayer in the case, Alon Farhy, failed to file Forms 5471 reporting his interests in two corporations he owned in Belize from 2003 through 2010. Farhy admitted he participated in a scheme to avoid taxes during the years at issue and was granted immunity from prosecution in 2012 after signing an affidavit describing his role in the scheme. However, the IRS still assessed penalties against Farhy, based on his failure to report his ownership interests in the corporations, and had willfully failed to file Forms 5471 for the years at issue.

Farhy appealed the IRS penalties to the court, arguing that §6038(b)’s penalty provisions did not specifically give the IRS authority to assess them. Assessable penalties are usually due and payable when the taxpayer receives a notice and demand. Unlike penalties subject to deficiency procedures, a taxpayer subject to an assessable penalty has no right to a 30-day letter, agreement form or notice requirement prior to assessment.

The IRS maintained that §6038 penalties should be treated as assessable penalties unless the tax code specifies that the penalties are subject to deficiency procedures. The IRS explained that §6201 gives the IRS broad authority to assess penalties, even when Congress has not provided a specific statutory grant of authority regarding a particular penalty.

The court agreed with Fahry, finding that a number of tax code sections specifically describe certain penalties as assessable penalties. Therefore, the court determined that Congress knew it needed to specify when penalties are assessable. Because Congress did not specify that the IRS has the power to assess a §6038(b) penalty, the agency lacks the authority to do so.

For more information on penalties, check out our self-study on understanding common IRS penalties.