In Farhy v. Commissioner, the U.S. Tax Court agreed with the taxpayer that the IRS did not follow the correct procedure and, therefore, could not impose a penalty under Section 6038(b) for failure to file Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” The Tax Court held that to impose the penalty, the IRS must file a lawsuit against the taxpayer rather than using its assessment authority. On May 3, the U.S. Court of Appeals for the District of Columbia Circuit overruled the Tax Court’s decision in Farhy and held that the IRS’ use of assessment authority to impose the penalty was the correct procedure. The D.C. Circuit denied the taxpayer’s request for a rehearing on June 13.
Mukhi v. Commissioner
While the Farhy appeal was pending before the D.C. Circuit, the Tax Court ruled in favor of the taxpayer in Mukhi v. Commissioner, again holding that the IRS lacked authority to assess the penalty under Section 6038(b) for failure to file Form 5471 and instead must file a lawsuit to impose the penalty. However, the court upheld the IRS’ assessment of penalties under Section 6677 for failing to file forms to report transfers made and distributions from foreign trusts and to disclose an interest in a foreign trust.
An appeal in Mukhi would go to the 8th U.S. Circuit Court of Appeals under the rule in Golsen v. Commissioner, creating a potential split in the circuits and possible consideration by the Supreme Court.
Crowe observation
Regardless of whether the Tax Court changes its position, it is likely that litigation regarding the IRS’ assessment authority in the case of Section 6038(b) and similar penalties will continue.
Looking ahead
Currently, the procedures for the IRS to impose and collect the Section 6038(b) penalty remain unsettled. Taxpayers who receive a notice regarding the Section 6038(b) or similar penalty and those who previously received or paid these penalties should consult with their tax advisers to consider how to proceed.
