U.S. Tax Court: Farhy vs. Commissioner Case Ruling
On April 3, 2023, in a win for taxpayers, the U.S. Tax Court ruled in favor of Mr. Alon Farhy against the IRS, deciding that the IRS does not have the authority under Section 6038(b) to assess penalties for a failure to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. The ruling suggests penalties must instead be recovered via civil claims.
Mr. Farhi was the sole owner of two foreign corporations in Belize from 2003-2010. The taxpayer had a reporting requirement under 6038(a) to file two Form 5471s, disclosures regarding the company and its activity per tax year. Under 6038(b), the penalty for willful failure to file is a minimum of $10,000 per form and continuation penalties of up to $50,000 for continued failure after notice per each year of issue.
The taxpayer willfully failed to file and was assessed the minimum and full continuation penalties. In their ruling, the U.S. Tax Court claimed that “Congress has explicitly authorized assessment with respect to myriad penalty provisions in the Code, but not for section 6038(b) penalties”. Examples of the authority to assess penalties can be found in Subchapter B of Chapter 68 of Subtitle F, which is referenced as IRC Sections 6671–6725.
The court further stated that they “loath to disturb this well-established statutory framework by inferring the power to administratively assess and collect the Section 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 ruling claims penalties from 6038(b) cannot be assessed. It also allows potential precedent for other authorizations that were assumed to be revoked if not explicitly granted. The ruling does not relieve taxpayers of filing 5471s or additional international reporting. It does not yet remove the authority to assess other penalties, nor does it remove the risk of willful failure penalties, as Section 6038(b) still provides for the initial and continuing penalty. However, they can still be recuperated through civil court. Furthermore, the IRS could explore penalties by involving the Department of Justice and sue under a civil action (28 USC 2461(a)).
Please reach out to McGuire Sponsel’s Global Business Services team to discuss any client situations where prior year filings are required. We can work with you to develop a strategic approach to remedy the situation.
Jason Rauhe, CPA is a Principal in the firm’s Global Business Services practice and is responsible for assisting clients and adding depth in all areas of the firm’s international tax consulting services including transfer pricing, and the firm’s compliance expertise.
Rauhe previously served as Director of International Tax at a Top 100 CPA Firm, where he was responsible for the firm’s international tax division and major industry alliance networks.