I have written earlier on the case of Farhy v. Commissioner. There the Tax Court held that the IRS does not have the authority to assess and collect penalties asserted under Internal Revenue Code Section 6038(b). In the Farhy case, the assessed penalties were imposed for failure to file Form 5471, the IRS form required to report certain interests in foreign corporations.
The Tax Court decision in Farhy was viewed as a sweeping win for taxpayers who had not been filing Form 5471 as well as some other forms relevant to foreign assets and transactions. The Tax Court re-affirmed Farhy just last month in the case of Raju J. Mukhi (my blog post here).
To remind readers of the importance of these decisions: If subsection 6038(b) penalties are not “assessable”, the IRS cannot collect them at all without going first to court in each and every case. Of course, it is unimaginable that the Department of Justice would file lawsuits to recover from taxpayers the flat, $10,000 penalty authorized by subsection (b).
Tax pro’s were feeling cautiously optimistic. I did not think the taxpayer euphoria would last very long, however, as the IRS appealed the decision, as expected. My hunch was confirmed.
A Big Loss for Taxpayers Abroad
Just yesterday, May 3, the DC Circuit reversed the Tax Court’s Farhy decision. It held that the text, structure, and function of IRC section 6038 demonstrate that Congress authorized assessment of penalties imposed under subsection (b). The court took the position that it was the “clear Congressional purpose” that such penalties be assessable.
“[we] conclude that a narrower set of inferences suffices to show that Congress intended to render those penalties assessable. Read in light of its text, structure, and function, section 6038 itself is best interpreted to render assessable the fixed-dollar monetary penalties subsection (b) authorizes. As a result, the Commissioner’s authority to assess all ‘assessable penalties’ encompasses the authority to assess penalties imposed under section 6038(b).”
Overseas taxpayers will be the biggest losers, as it is very common for the American abroad to form a non-US corporation (typically in the foreign country where he or she resides) to transact business or to have a visa to reside in that country.
This decision in combination with the recent Treasury Department proposal (March 11, 2024), spells particular hardship for the taxpayer abroad. In its fiscal year (FY) 2025 Green Book Treasury has a proposal that will essentially eliminate almost all remaining requirements for IRS agents to obtain written supervisory approval for penalties. This was noted by the National Taxpayer Advocate as a serious concern in its recent blog posting.
The US tax rules that apply to the typical American abroad are so complex that every tax practitioner I know struggles in one or more ways to advise those living overseas. Put another way, the US tax rules seem to hate Americans overseas (don’t believe me? Read this), so these recent developments are not good news.
Posted May 4, 2024
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