The IRS does not have the authority to assess penalties for failure to file Form 5471

Farhy v. Commissioner

The taxpayer in Farhy was a US person who held a 100% interest in two foreign corporations for the taxable years 2003-2010.  The IRS assessed an initial penalty of $10,000 for each year that the taxpayer failed to file Form 5471, and then assessed the maximum secondary penalty of $50,000 for each corresponding year.  The taxpayer filed a petition with the Tax Court challenging the penalties.

Pursuant to IRC § 6038(a) and the associated Treasury regulations, all US persons who are in control of a foreign corporation are required to file Form 5471 on an annual basis.  The taxpayer contended that section 6038(b), unlike other sections in the Code, contains no provision authorizing assessment of the penalty it provides for.  Therefore, the taxpayer argued, a section 6038(b) penalty is not an assessable penalty, although it may be collected through a civil action. The US Tax Court concluded that the taxpayer’s reading of the code is the correct one as Congress had explicitly authorized assessment with respect to myriad penalty provisions in the Code, but not for section 6038(b) penalties.

Mazars’ insight

This decision is an important win for US persons who control foreign entities because the IRS must bring a civil action in order to collect penalties related to the failure to timely file Form 5471. 

US persons in control of foreign entities should still timely comply with all US tax laws, as this decision merely restricts the IRS’s course of action, it does not eliminate any penalties.

US persons who have previously paid penalties that had been assessed against them for the failure to timely file Form 5471 may be able to file refund requests on the ground that the IRS lacked the statutory authority to assess those penalties.

Farhy  may apply to other foreign filings that are governed by code sections structured similar to section 6038. Further analysis is required.

The decision is subject to appeal by the IRS.            

Please contact your Mazars professional for additional information.

Authors 

Timothy Evans, Principal
Eduardo Chung, Partner
Kevin Harkins, Manager
Victoria Manakova, Manager

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.