A new court case now allows the IRS to immediately collect $10,000 penalties from U.S. owners of foreign corporations who fail to file Form 5471. For taxpayers with foreign corporations, the IRS just strengthened its hand in collecting reporting penalties without going to court.
The so-called “Farhy defense” suffered another major blow on February 27, 2026. In Safdieh v. Commissioner, the U.S. Court of Appeals for the Second Circuit reversed the United States Tax Court holding that IRS has the authority to administratively assess Form 5471 penalties. This means the IRS does not have to sue the taxpayer in order to collect those penalties. This holding aligns with the U.S. Court of Appeals for the D.C. Circuit.
For taxpayers in the Second Circuit (New York, Connecticut, or Vermont) or the D.C. Circuit, the argument that the IRS lacks authority to administratively assess Form 5471 penalties is, for all practical purposes, over. For U.S. citizens and residents living abroad, the rulings hit especially hard. The D.C. Circuit is the appeals venue for Tax Court cases involving taxpayers abroad, since they do not reside in any U.S. judicial district.
Form 5471: What Is It? Why Does It Matter?
For business owners and investors engaged in cross-border activity, Form 5471 is a complicated tax compliance requirement, enacted to prevent the shifting or concealing of income offshore. It is an information return required when a U.S. person owns shares in certain foreign corporations. It does not calculate tax. Instead, it reports detailed financial information about the foreign company, including balance sheets, income statements, ownership changes, and transactions between related parties. A separate Form 5471 is required for each foreign corporation in which the U.S. taxpayer has a qualifying interest. Since the penalty for failing to file is $10,000 per form, per year, it can add up very quickly if multiple foreign corporations are involved. The reporting penalties can apply even if no additional tax is due.
The Long Story Of The “Farhy Defense,” Made Short
The controversy began with the Tax Court’s April 2023 decision in Farhy v. Commissioner, fully discussed in my earlier article. In that case, the court held that Internal Revenue Code Section 6038(b), the law imposing Form 5471 penalties, did not authorize the IRS to “assess” those penalties. Instead, the IRS would need to file a civil action in federal district court to collect the penalty. This mandate significantly raised the procedural bar for the government.
When the IRS advises a taxpayer that he owes taxes and penalties, this is called an “assessment”. When a penalty is an “assessable” penalty, it must be paid upon notice and demand and assessed and collected in the same manner as taxes. An “assessable” penalty is one the IRS may assess directly, without first issuing a notice of deficiency that gives the taxpayer the right to petition the Tax Court before payment. In other words, assessable penalties are generally not subject to the deficiency procedures that apply to income tax adjustments.
Once assessed, the IRS may proceed with its administrative collection tools to collect the penalty by placing a lien on the taxpayer’s property (e.g., a residence, bank account, brokerage account) or garnishing the taxpayer’s wages. The taxpayer’s remedies typically shift to post-assessment options, such as collection due process proceedings or refund litigation.
In May 2024, the U.S. Court of Appeals for the D.C. Circuit reversed the United States Tax Court in Farhy, concluding that it was implausible Congress intended to create a penalty the IRS could impose but not efficiently collect. The appellate court held that assessment authority was implicit in the statutory framework governing international information reporting.
The story did not end there, however.
Under the Tax Court’s so-called Golsen rule, it must follow the precedent of the appellate court to which a particular case is appealable, but this applies only to that circuit. As a result, outside the D.C. Circuit, the Tax Court continued to adhere to its original reasoning. Applying that rule, the Tax Court reached the same conclusion in Raju J. Mukhi v. Commissioner of Internal Revenue, because the case was appealable to a circuit other than the D.C. Circuit. My earlier article discusses the Mukhi ruling. It likewise followed its prior holding in Safdieh, again determining that the IRS lacked authority to “assess” the Form 5471 penalty administratively.
Safdieh Case Now Reversed By The Second Circuit
The Second Circuit reversed and has now joined the D.C. Circuit. In reversing the Tax Court in Safdieh, the appellate court focused on legislative purpose. If the government was required to bring a full federal lawsuit to collect a fixed $10,000 penalty this would severely undermine the Congressional goal of efficient enforcement of international reporting rules.
Why This Matters For Business Owners And Investors
Two federal appellate courts are now in agreement that the IRS has implied authority to assess Section 6038(b) penalties. Until a split arises in the circuit courts that may involve resolution by the U.S. Supreme Court, the momentum clearly favors the IRS.
Form 5471 filing obligations very commonly arise and filing failures can result in an open-ended statute of limitations for the taxpayer’s entire tax return, meaning the IRS may audit items otherwise closed to examination. Filing Form 5471 is often required when U.S. entrepreneurs establish foreign operating companies, when Americans invest in foreign startups, when families hold legacy foreign corporations, or when private investment structures include offshore entities. In many cases, the failure to file is not willful and typically arises from misunderstanding complex ownership attribution rules or relying on incomplete advice.
For such taxpayers and their advisors, the technical argument that the IRS lacks authority to assess penalties for filing failures is losing strength. The focus should instead turn to substantive defenses, such as demonstrating “reasonable cause.” Demonstrating reasonable cause is not an easy win for taxpayers since the IRS has made substantial efforts to educate taxpayers about their filing duties for offshore assets and transactions. It now expects taxpayers to have a certain degree of awareness.
Conclusion
The message for taxpayers is increasingly clear. Form 5471 compliance is critical. With two appellate courts now backing the government, the IRS does not need to step into a courtroom to impose a $10,000 penalty for each missing or incomplete Form 5471. It can assess the penalty administratively and move directly to collection tools such as liens and levies.
This is particularly significant for Americans abroad and internationally active business owners, especially in jurisdictions where D.C. Circuit precedent governs. What might once have seemed like a technical reporting oversight can result in substantial financial exposure.
Posted March 12, 2026
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First published on Forbes February 28, 2026
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