Pushback on Penalties ' 2024 Court Decisions Challenge International Penalty Enforcement
The year 2024 brought a breadth of noteworthy and significant tax decisions impacting both individual and corporate taxpayers. In the first of a recurring series, this article discusses tax cases from 2024 that we found intriguing and relevant to taxpayers.
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In our first installment, we focus on jurisprudence from the 2024 calendar year concerning penalties imposed pursuant to section 6038(b) of the Internal Revenue Code.1 Section 6038(a) concerns international information return reporting and requires U.S. persons to file information returns reporting their control of any foreign business. Penalties are imposed under sections 6038(b) and 6038(c) for the failure to file such information returns. The question presented in these cases was whether the Code provided authority for the IRS's long-standing practice of summarily assessing the penalty and commencing collection if the taxpayer fails to pay the penalty within 90 days of the date of the collection notice. The issue raises important statutory interpretation questions, because summarily assessable penalties are found under Subchapter B of chapter 68 of the Code, and international information return penalties under section 6038 are not among the many assessable penalties found under chapter 68 and are instead found under chapter 61. Accordingly, taxpayers argued that Congress did not explicitly authorize assessment of section 6038 penalties, and therefore the Internal Revenue Service (IRS) is required to ask the Department of Justice (DOJ) to reduce penalties to judgment for collection in district court actions.
This issue has been percolating since at least 2020, when it was highlighted by the Taxpayer Advocate Service. See Taxpayer Advocate Service, National Taxpayer Advocate Annual Report to Congress 124-26 (2020) (noting that in 2018, 90% of section 6038 penalties and section 6038A penalties were systemically assessed upon receipt of a late international information reporting return without any review or action from IRS personnel rather than manually).
Below we outline three notable cases decided in calendar year 2024 and highlight the conflicting rulings observed between the Tax Court and the Court of Appeals regarding this issue.
Father, I wish you'd try a little love and compassion instead of these harsh punishments. - That would be nice.
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Case 1: Farhy v. Comm'r of Internal Revenue, 100 F.4th 223 (D.C. Cir. 2024)
In Farhy, the taxpayer, a U.S. permanent resident, failed to disclose his ownership of Belizean corporations to the IRS in violation of section 6038(a).
While Section 6038(a) requires U.S. persons to file information returns regarding their control of any foreign business., Section 6038(b) imposes monetary penalties'typically $10,000 per violation'on any U.S. person who fails to furnish the information required under section 6038(a) in a timely manner; specifically, forms such as Form 5471, reporting information about certain foreign corporations. Although Farhy acknowledged his violation, Farhy challenged the IRS's authority to assess and collect these penalties directly, without first going through judicial processes, arguing that the IRS lacked statutory authority to assess and administratively collect section 6038(b) penalties. Farhy contended that the IRS was required to collect liabilities under section 6038(b) through a civil action under 28 U.S.C. ' 6038(b) brought in federal district court.
The Tax Court agreed with petitioner Farhy, ruling in its April 2023 decision that the IRS lacked express statutory authority to assess and administratively collect penalties under section 6038(b). The decision was a major departure from longstanding IRS practice, which had routinely assessed these penalties administratively. The court reasoned that while Congress had authorized assessment for penalties under sections 6671 through 6725, no such express authorization existed for penalties under section 6038(b).
On appeal, the U.S. Court of Appeals for the District of Columbia Circuit (D.C. Circuit) reversed the Tax Court's prior decision and held that Congress intended for these penalties to be assessable.
The court delved into the legislative history of section 6038 and concluded that the "text, structure, and function of Section 6038 demonstrate that Congress authorized assessment of...
