Under Section 6038 of the Internal Revenue Code, some U.S. taxpayers must comply with information reporting requirements regarding their interests in certain foreign corporations and partnerships. In the recent case of Alon Farhy v. Commissioner, the U.S. Tax Court was tasked with deciding whether the IRS can assess failure-to-file penalties in relation to Sec. 6038.
Forms Not Filed
For several years, the taxpayer in the case failed to file required Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations,” to report his controlling interest in two foreign corporations located in Belize. His failure to file these information returns was found to be willful and not attributable to reasonable cause. In fact, it was deemed to be part of a scheme to hide income from the IRS.
The IRS assessed Sec. 6038(b) failure-to-file penalties against the taxpayer for each year he failed to file a Form 5471. When the assessments went unpaid, the IRS proposed to collect the penalties by levy.
An IRS levy permits the legal seizure of property to satisfy an individual’s tax debt. A levy can garnish wages; take money in a bank or other financial account; and seize and sell vehicle(s), real estate and other personal property. A business may also receive a levy against an employee, vendor, customer or other third party. In such cases, the company must turn over to the IRS any property it has that belongs to the person levied against.
After an appeals officer sustained the levy, the taxpayer filed a petition with the Tax Court. The petitioner argued that the IRS lacked authority to assess the Sec. 6038(b) penalties against him because there’s no law giving the IRS authority to do so. So, while the IRS may be able to collect these penalties through a civil action, he contended, the tax agency may not assess or administratively collect these penalties from him because they’re not “assessable penalties.”
The IRS argued that the term “assessable penalties” includes any penalties found in the tax code that aren’t subject to the applicable deficiency procedures. The tax agency also argued that, in any case, the term “taxes” in Sec. 6201 is broad enough to encompass these penalties, and that the legislative history surrounding the enactment of Sec. 6038(b) provides support for this position.
The Court’s Decision
The Tax Court noted that Sec. 6038(b)(1) imposes a $10,000 penalty for each failure to file Form 5471. In addition, Sec. 6038(b)(2) imposes a $10,000 penalty for each 30-day period that such a failure continues, up to a $50,000 maximum.
However, “no mode of recovery or enforcement is specified for these penalties” and the court didn’t want to disturb a well-established framework “by inferring the IRS had the power to administratively assess and collect the Section 6038(b) penalties when Congress did not see fit to grant that power.”
The court also rejected the IRS’s arguments that the Sec. 6038(b) penalties are necessarily assessable penalties because they aren’t subject to the deficiency procedures. The mere fact that a penalty isn’t subject to deficiency procedures doesn’t automatically make it an assessable penalty, the court stated, if Congress hasn’t given the IRS the authority to assess the penalty.
The Tax Court also noted that the legislative history cited by the IRS said nothing about the way the IRS should collect Sec. 6038(b) penalties.
Probably Not Over
The IRS may not be finished with the individual in question. Although the Tax Court’s decision means the tax agency can’t collect the penalties via levy, it can still file a civil collection suit under the applicable regulation in the U.S. Code. To learn more about the information reporting requirements of Sec. 6038, consult the professionals at Sol Schwartz & Associates.