Tax Court Principles IRS Does Not Have Statutory Authority To Assess Penalties For Failure To File Sort 5471

Every single now and once again, a situation will come across your desk that tends to make you say, “Whoa.”

Alon Farhy v. Commissioner is just such a circumstance.

The U.S. Tax Court gave Farhy a get, ruling that the IRS could not gather from him in this instance—the IRS had no statutory authority to assess penalties beneath area 6038.


For the tax years 2003 as a result of 2010, Alon Farhy owned 100% of Katumba Funds, Inc., a overseas corporation included in Belize. For the tax years 2005 by way of 2010, Farhy was the the 100% proprietor of Morningstar Ventures, Inc., another foreign corporation integrated in Belize.

For the decades at situation, Farhy experienced a reporting requirement less than part 6038(a) to report his ownership passions in each Katumba Funds and Morningstar Ventures. The requirement usually signifies that taxpayers much file Type 5471, Information Return of U.S. Persons With Respect to Specific International Businesses, to disclose an interest or ownership in a foreign company. If a taxpayer does not satisfy the prerequisites, area 6038(b) presents for penalties starting at $10,000 for each kind per calendar year.

Farhy did not report—the Court docket famous that the failure was performed “willfully.”

And so, the IRS assessed penalties beneath section 6038(b)(1) of $10,000 each and every yr. The IRS later assessed continuation penalties under portion 6038(b)(2) totaling $50,000 for each individual yr at concern. The continuation penalty is $10,000 for just about every 30 times the taxpayer doesn’t comply right after an preliminary 90-working day detect time period, matter to a maximum of $50,000.

When Farhy didn’t pay back up, the IRS attempted to levy his belongings.


Farhy did not dispute that he did not file, nor that he experienced not compensated. In its place, he challenged irrespective of whether the IRS experienced the legal authority to assess segment 6038 penalties.

One more code portion is essential here—part 6201(a) authorizes and needs the Secretary of Treasury to make assessments of all taxes, which includes fascination, supplemental amounts, additions to tax, and assessable penalties. The Secretary delegated these responsibilities to the IRS.

Here’s wherever terms make any difference. The IRS contended that the expression “assessable penalties” includes any penalties located in the Code that are not matter to the Code’s deficiency methods. The IRS also argued that “taxes” in portion 6201 is broad sufficient to consist of segment 6038 penalties. They further claimed that the legislative history supported this posture.

The Courtroom disagreed.

It’s vital to understand the difference at perform in this article. When a tax—including an extra amount of money, addition to tax, assessable penalty, or interest—is assessed, the IRS could just take certain actions to gather the tax administratively—that’s very clear from the statute. That can include things like levies, as was attempted here.


The phrase “assessable penalties” is essential. The Tax Court agreed that “assessable penalties” as used in segment 6201(a) is not constrained to penalties located in subchapter B of chapter 68 of subtitle F (truly titled “Assessable Penalties”), but that doesn’t necessarily mean, the Courtroom mentioned, that it does not routinely utilize to all penalties in the Code not topic to deficiency methods. In other terms, “assessable penalties” is not a phrase used to distinguish among penalties subject matter to deficiency methods and these that are not.

More, the Tax Court located that Congress explicitly licensed evaluation for “myriad penalty provisions in the Code” (citing, amid other issues, penalties beneath sections 6671-6725 and sections 6651-6751)—but not for section 6038(b) penalties.

The question then was not irrespective of whether the penalties ended up involved in the statute (they are) but irrespective of whether the IRS can evaluate and accumulate people penalties by administrative usually means. The Tax Court didn’t invest in the IRS’ argument that it has the authority to levy these penalties systematically, nor that the company did not need to have to choose extra ways, this sort of as civil litigation, to acquire. “Simply put,” the Courtroom wrote, “while segment 6038(b) provides for penalties, it does not present for assessable penalties.”

The Courtroom even further noted it was “loath to disturb this nicely-set up statutory framework by inferring the electric power to administratively assess and gather the portion 6038(b) penalties when Congress did not see match to grant that electric power to the Secretary of the Treasury expressly as it did for other penalties in the Code.”

Relocating Forward

That signifies that, though the authorities may perhaps be equipped to acquire liabilities for these penalties through a civil action underneath area 2461(a), the IRS may well not evaluate or administratively gather these penalties. It’s crucial, as the Courtroom manufactured obvious, that the holding below issues only the applicable fashion of assortment for portion 6038(b) penalties.

This doesn’t necessarily mean that taxpayers do not have an obligation to file Kind 5471—or any other type. Again, this scenario is centered on technique and collections.

Farhy may well have received in Tax Court, but the issue is not totally fixed for other taxpayers. It’s unclear regardless of whether the IRS will enchantment (I would hope them to) and, if so, how lengthy that might choose. It is also not particular how this ruling could effects taxpayers if not issue to section 6038. We’ll possible see this—or relevant issues—back in Courtroom soon.