D.C. Appeals Court Reverses Farhy, Foreign Information Penalty

Appeals Court Reverses Farhy on Foreign Information Penalty

D.C. App. Reverses Farhy, Rules Foreign Information Penalties Valid

Unfortunately, U.S. taxpayers across the globe who are required to report their foreign assets to the IRS on various international information reporting forms were dealt a heavy blow by the DC Court of Appeals, when the Appellate Court reversed the Tax Court’s ruling in Farhy. In Farhy, the Tax Court had previously ruled the IRS lacked the authority to issue assessable penalties for Form 5471. Now, the IRS again has the right to issue ‘automatically assessable’ penalties for Form 5471. Thus, chances are the IRS will begin issuing CP15 notices for taxpayers who are out of compliance with reporting their foreign businesses to the U.S. government.

There is an ancillary impact to this ruling as well, which is that many Taxpayers hoped the Farhy tax court ruling could extend to Form 3520 penalty abatement as well — but based on the outcome in the Court of Appeals, chances are that Form 3520 penalties will remain ‘automatically assessable’ as well — at least in the short term.

Let’s look at the court’s ruling:

Are the Penalties Assessable?

• • • The text of section 6038 does not explicitly say whether the penalties imposed for violating section 6038(a) are assessable. The parties principally argue from dueling presumptions that they contend generally apply to all penalties across the Internal Revenue Code. Each claims support from a distinct reading of I.R.C. § 6201(a), which grants the Treasury Secretary broad authority to assess “all taxes (including interest, additional amounts, additions to the tax, and assessable penalties).” Although none of the terms in section 6201(a)’s parenthetical are defined by the statute, the three categories of penalties listed after “interest” in the text correspond with—but are not necessarily limited to—the penalties that are set out in I.R.C. Subtitle F, Chapter 68, which is titled “Additions to the Tax, Additional Amounts, and Assessable Penalties.” All exactions in Chapter 68 are explicitly directed to “be assessed . . . in the same manner as taxes” by a subsection contained therein. I.R.C. § 6665(a)(1).

The Court Rules they are Assessable

• • • A close reading of section 6038 with an eye to the role of subsection (b) within it reveals that the Congress that amended the Code in 1982 intended the subsection (b) penalty to be assessable. For the same underlying failure to file, the section originally authorized only a percentage-based, assessable penalty imposed as a reduction of the taxpayer’s foreign tax credit (now codified as subsection (c)). Two changes effected by the amendment are particularly relevant: First, in response to difficulties experienced in applying that original penalty, Congress added (as subsection (b)) a fixed-dollar penalty that could be more simply and consistently collected. Second, Congress required (in subsection (c)(3)) that the two penalties be coordinated. The subsection (b) penalty must be offset from any subsection (c) penalty in cases in which both penalties apply. All agree the IRS may assess subsection (c) penalties, and those two objectives of the amendment—that recovery of subsection (b) penalties be more streamlined than recovery of subsection (c) penalties, and that any subsection (c) penalty be reduced by the amount of the subsection (b) penalty—make plain that subsection (b) penalties must also be assessable. Section 6038’s express authorization of the IRS rather than a district court to evaluate a taxpayer’s defense to penalties imposed under the section reinforces that conclusion.

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    • If subsection (b) penalties are not assessable, the IRS cannot collect them at all without going first to court in each and every case. But it is unlikely the government will file lawsuits to recover from taxpayers the flat, $10,000 penalty authorized by subsection (b). Farhy concedes as much: As his counsel put it, the “Justice Department wouldn’t touch that with a ten-foot pole.” Oral Arg. Rec. 57:52-55. If subsection (b) penalties are that hard to recover, they may not be worth the candle. It would be “highly anomalous” for Congress to have responded to the identified problem of the underuse of subsection (c) penalties by promulgating a penalty that, while simpler to calculate, is much harder to enforce. IRS Br. 21; see also S. Rep. No. 97-494, vol. 1, at 299. Farhy has no persuasive rebuttal to that point. To the contrary, he suggests that Congress purposely made section 6038(b) penalties nonassessable—and therefore largely ornamental—because it wanted to “withhold the IRS’s super-charged collection powers” that flow from assessment. Oral Arg. Rec. 44:32-42. That view is contradicted by the clear congressional purpose behind the enactment of subsection (b).

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    • We conclude, based on the statute’s text, structure, and function, that penalties imposed under section 6038(b), like the related penalties under section 6038(c), are assessable. This conclusion is buttressed by more than forty years of congressional acquiescence to the IRS’s practice of assessing section 6038(b) penalties. “It is well established that when Congress revisits a statute giving rise to a longstanding administrative interpretation without pertinent change, the ‘congressional failure to revise or repeal the agency’s interpretation is persuasive evidence that the interpretation is the one intended by Congress.’”

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    • Since adding subsection (b) in 1982, Congress has amended section 6038 seven times; each time, it has left undisturbed the IRS’s practice of assessing and administratively collecting penalties imposed under section 6038(b).

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    • For the foregoing reasons, we reverse the judgment of the Tax Court and remand with instructions to enter decision in favor of the Commissioner

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.