The DC Circuit Court of Appeals has ruled unanimously that the IRS has the authority to directly assess penalties for failure to file international information returns. In so doing, the court reversed the decision of the Tax Court that had held the IRS lacked that power.
Issue on Appeal
The issue on appeal before the D.C. Circuit Court was whether the penalty for failure to file could be assessed by the IRS, or whether the Department of Justice had to sue and obtain a judgment from a federal district court before it could enforce a taxpayer penalty assessment. Ruling in favor of the IRS, and overturning the US Tax Court decision, the D.C. Circuit Court held that "based on the statute's text, structure, and function, that penalties imposed under § 6038(b), like the related penalties under § 6038(c), are assessable."
The holding centered on four primary conclusions:
- first, the Court reasoned that the amended code in 1982 intended for § 6038 (b) to be assessable based on a reading of the section's legislative history noting that it was amended with the goal of streamlining the penalty recovery process;
- second, requiring a federal court's entry of judgement prior to penalty collection would run contrary to the Congressional intent of streamlining the collection process outlined in the legislative history;
- third, the penalties under § 6038(b) and (c) are subject to a "reasonable cause" affirmative defense which requires the taxpayer to establish that she "exercised ordinary business care and prudence" in attempting to adhere to her reporting obligations. § 6038(c)(4)(B) empowers the IRS, not a court, to grant or deny a defense by requiring reasonable cause to be "shown to the satisfaction of the (IRS) Secretary."; and
- fourth, the court declined to adopt a reading of § 6038(b) which would create a potential bifurcation of the review of penalties arising from the same violation. Such a view would produce parallel and substantively overlapping judicial tracks for determination of twinned penalties for the same noncompliance: federal district court for the subsection (b) penalties, and Tax Court for the subsection (c) penalties. Based on the legislative history, such a reading of § 6038 (b) would be both ineffective and counterproductive to the Congressional intent.
Background of Appeal
The case on appeal centered around Alon Farhy, who, during tax years 2003 to 2010, had failed to file IRS Form 5471 Information Return of U.S. Persons With Respect to Certain Foreign Corporations detailing his foreign corporation ownership interests as required under IRS § 6038(a).
In response to the failure to file, the IRS imposed USD 10,000 per year in initial penalties under § 6038(b) and USD 50,000 per year in continuation penalties with a total assessment of well over USD 500,000 in failure to file penalties.
Upon receipt of the IRS levy notice, Fahry submitted a request for a collection due process hearing arguing that the issued assessment was unlawful as the IRS did not have the legal authority as § 6038(b) did not have a provision authorizing assessment. Rejecting Fahry's argument, the IRS issued a notice of determination and continued its proposed collection action upon which Farhy filed a petition with the US Tax Court for review. Siding with Fahry, the US Tax Court agreed that § 6038(b), unlike many other penalty sections, did not include a provision authorizing assessment of the penalty and found that the § 6038(b) penalty is not an assessable penalty. The IRS appealed the decision to the D.C. Circuit Court.
IRS Assessment of Penalties
The IRS computer system has been programmed to systematically assess penalties under § 6038(b) when it receives delinquent income tax returns with Forms 5471 attached. In the last decade alone, the IRS has assessed nearly 10,000 § 6038 penalties per year, with an average abatement rate of 69% per year.
In light of this, taxpayer advocates argue that a Congressional fix as matter of resource management and efficiency is needed to make international information returns subject to deficiency procedures. Legislation subjecting these reporting penalties to deficiency procedures rather than assessments would additionally allow for situations where taxpayers have reasonable cause for non-filing. The current ruling leaves open the remote possibility for such forthcoming legislation.
Source: IBFD Tax Research Platform News