On April 3, 2023, the U.S. Tax Court issued its opinion in Farhy v. Commissioner, 160 T.C. No. 6 (2023).  This case deals a major blow to the Internal Revenue Service (IRS) and its efforts to collect penalties related to certain international information returns.

Did the IRS assess a penalty against you related to an international information return?  If yes, you may be entitled to have the penalty removed (abated) or an IRS refund for any amounts you paid.  For more information, please continue reading below.

The Internal Revenue Code (I.R.C., or Title 26 of the U.S. Code) has many information return filing requirements that taxpayers must comply with.  In addition, if a taxpayer does not timely file the proper forms, then certain penalties can apply.  These forms (and penalties) include:

  • Form 5471 – Information return of U.S. persons with respect to certain foreign corporations (I.R.C. §§ 6038, 6046, 6679)
  • Form 8858 – Return of U.S. persons with respect to certain foreign partnerships (I.R.C. §§ 6038, 6038B, 6046A)
  • Form 5472 – Information return of a 25% foreign-owned U.S. corporation or a foreign corporation engaged in U.S. trade or business (I.R.C. §§ 6038A, 6038C)
  • Form 8938 – Statement of specified foreign financial assets (I.R.C. § 6038D)
  • Form 926 – Return by a U.S. transferor of property to a foreign corporation (I.R.C. § 6038B)
  • Form 8854 – Initial and expatriation statement (I.R.C. § 6039G)
  • Form 3520 – Annual return to report transactions with foreign trusts and receipt of certain foreign gifts (I.R.C. §§ 6048, 6677, 6039F)
  • Form 3520-A – Annual information return of foreign trust with a U.S. owner (I.R.C. §§ 6048, 6677)
  • (Also, FinCEN Form 114 – Report of foreign bank and financial accounts (FBAR), but this is technically not a filing obligation or penalty from the Internal Revenue Code.)

Many of these penalties are in a part of the Internal Revenue Code that does not contain any rules about how the IRS may “assess” or record the penalty in the IRS’s databases.  This includes penalties for failure to timely file Form 5471, Form 8858, Form 5472, Form 8938, Form 926, and Form 8854, as well as the penalty related to large foreign gifts on Form 3520.  On the other hand, the foreign trust penalties in I.R.C. § 6677 have their own statute that grants the IRS authority to assess the foreign trust penalties.  See I.R.C. § 6677 (foreign trust penalties); I.R.C. § 6671(a) (IRS assessment authority).

In Farhy v. Commissioner, the IRS assessed penalties against the taxpayer for failure to file a Form 5471 for a foreign corporation directly or indirectly owned by the taxpayer.  The taxpayer argued that the IRS did not have authority to assess these penalties, and the Tax Court agreed.  This means that the IRS cannot use federal tax liens, notices of federal tax lien, or IRS levies to collect these penalties.  However, the U.S. government still make bring a suit in U.S. district court under 28 U.S.C. § 2461(a) to reduce the penalty to a judgment.

While Farhy only addressed Form 5471 penalties, the same reasoning would apply to penalties for failure to file Form 5472, Form 8858, Form 8938, Form 926, Form 8854, and Form 3520 (as it relates to large foreign gifts).  Thus, the IRS does not possess the authority to assess penalties for failure to timely file Form 5472, Form 8858, Form 8938, Form 926, Form 8854, and Form 3520 (as it relates to large foreign gifts).  On the other hand, the Tax Court’s conclusion from Farhy would not apply to foreign trust penalties for failure to timely file Form 3520 (as it relates to foreign trusts) and Form 3520-A because there is a separate Internal Revenue Code section granting IRS authority to assess these foreign trust penalties.

Did the IRS assess any foreign international information return penalties against you?  If so, you may be entitled to have those penalties abated or a refund of amounts paid to the IRS.  Contact David J. Warner, Tax Attorney & Shareholder at Holtz, Slavett & Drabkin to discuss your situation.

David is a former IRS senior trial attorney (all the attorneys at Holtz, Slavett & Drabkin are former IRS attorneys).  While at the IRS for 9 years, David oversaw large international information return penalty cases, including advising the IRS revenue agents in the Special Enforcement Program (SEP) and LB&I International Individual Compliance (IIC) groups.  David now represents clients in sensitive domestic and international tax examinations, tax litigation, employment tax cases, criminal tax matters, and difficult tax collection matters. Please contact David at (949) 999-6606 to schedule a consultation.