In the recently decided case of Farhy v. Commissioner, the U.S. Tax Court determined the IRS’s efforts to collect assessments for failure to file Form 5471 were unlawful. On July 12, 2023, the IRS filed notice of its intention to appeal the Tax Court’s ruling. The article addresses questions taxpayers might have about Farhy as the case heads into appeals.
The Farhy Case in a Nutshell
Farhy is a case about a taxpayer who simply refused to comply with his foreign information return filing obligations. From 2003 through 2010, he owned 100% of two Belize corporations.
For each such year, Farhy was required under Internal Revenue Code (“IRC”) Section 6038(a) to file Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations), but he did not file them.
On November 5, 2018, the IRS assessed an initial penalty under section 6038(b)(1) of $10,000 for each year he owned the corporations. On November 12, 2018, the IRS assessed an additional $50,000 per year of continuation penalties f section 6038(b)(2).
The IRS notified Farhy of its intent to levy to collect the assessments. Farhy objected and filed suit against the IRS. He argued the Service lacked the statutory authority under IRC Sec. 6038(b) to assess the penalties.
The Court agreed with Farhy. Acknowledging the IRS possessed explicit authority to assess with respect to myriad penalty provisions in the Code, the Court held no authority exists for the Service to assess the penalties laid out in IRC Section 6038(b)(1) and (2).
Podcast: Exploring the Farhy Tax Case and What It Means for Taxpayers
In this Taxing Topics episode, we examine the impact of the Farhy Case on the IRS’s penalty notice procedure and what it means for taxpayers. We’ll also discuss IRS Form 5471 filing requirements, and taxpayer obligations to disclose foreign shareholdings, assets, and transactions.
Commonly Asked Questions
What actions should taxpayers take who have paid Form 5471 Failure-to-File penalties?
Taxpayers who have paid assessments for Failure-to-File Form 5471 may want to consider filing a protective claim. Now that the IRS has elected to appeal the Tax Court’s decision, whether the government lawfully assessed the penalties remains an open question, and it’s not uncommon for a case to linger on unresolved for years in the Federal appeals court system. If the IRS lacked authority, Section 6511(a) of the Internal Revenue Code, governing the time a taxpayer has to claim a refund may come into play. Generally, under Section 6511, a taxpayer has three years from the time a return was filed or two years from the time the tax was paid, whichever of such periods expires the later, to claim a refund. By filing a protective claim, taxpayers can essentially pause the “refund statute of limitations” until the questions about the legitimacy of the government’s actions can be answered definitively.
What should taxpayer’s who have been assessed Form 5471 Failure-to-File penalties do?
Taxpayers who late file Form 5471 should pursue whatever actions they would have before the Farhy decision was rendered. They should consider whether grounds for penalty relief exist and write to the government to explain why the penalties should be abated. Taxpayers with a history of complying with federal tax filing requirements may qualify for the IRS’ first-time abatement (“FTA”) program. Taxpayers who don’t qualify for the FTA may be able to get penalty relief by establishing with the IRS reasonable cause for filing form 5471 untimely.
Do taxpayers still have an obligation to file Form 5471?
Yes, the requirement to file Form 5471 derives from IRC Section 6038(a)(1). The Court does not maintain that provision is invalid. Its decision only calls into question the IRS’s power to assess and collect under Section 6038(b) when taxpayers fail to comply with the filing requirement. Moreover, the IRS has the power to enforce that requirement to file through a civil action under 28 U.S.C. Section 2461(a).
Do the above recommendations also apply to late filers of other forms?
Yes, the recommendations apply equally to the noncompliance penalty provisions associated with Forms 5472, 8938, 926, and in certain cases, Form 8865. Statutory authority under Section 6038(b) is apparently lacking in assessing penalties for failure to file these forms.
It should be noted, however, the noncompliance penalties associated with Form 5471 category 2 and category 3 filers; Forms 3520 (Parts I, II, and III) and 3520-A; or, in certain instances, Form 8865 are different. Those penalties are imposed under Sections 6677(a) and 6679(a) of the tax code, which are assessable penalties.
The battle over the IRS’s enforcement actions as they relate to Form 5471 is just beginning.
Contact Us
For additional questions concerning the Farhy case, please contact Withum’s Tax Controversy Team.
