In a recent decision, the U.S. Tax Court ruled against the IRS, preventing them from imposing penalties for not filing certain information related to a U.S. citizen or resident's ownership in foreign businesses. The case, Farhy v. Comm’r, involved a taxpayer who didn't file Forms 5471, which provide information on U.S. individuals with interests in certain foreign corporations. The court’s decision stated that the IRS cannot impose penalties under §6038(b), as it lacks the authority to do so.

Why does this matter and what does it mean for you? Let’s take a closer look.

What is Section 6038(b)? 

Section 6038(b) typically imposes a $10,000 penalty for not providing information about a foreign business entity, with additional $10,000 increments for each 30-day delay, up to a maximum of $50,000. This penalty has been applied to various foreign reporting forms, not just to Form 5471.

So, can I get a refund if I’ve paid penalties?

Taxpayers who’ve already paid penalties under §6038(b) might be able to claim a refund—but the IRS hasn't provided clear guidance on this yet. In fact, the IRS will likely challenge the court's decision, and refunds might not be granted during the appeal process.

Tell me more about the case

The case involved a taxpayer, Alon Farhy, who didn't report his ownership interests in two corporations he owned in Belize between 2003 and 2010. Though he admitted participating in a tax avoidance scheme and received immunity from prosecution in 2012 (after he signed an affidavit), the IRS assessed penalties against him, stating that he didn’t report his ownership interests and didn’t file Forms 5471 for the relevant years. 

Farhy argued that the IRS didn't have the authority to impose §6038(b) penalties, and the court agreed, stating that Congress needed to explicitly grant the IRS such authority, which hadn't been done in this case.

What’s the deal with assessable penalties?

For assessable penalties, the taxpayer will usually receive a notice and demand, at which point the penalties must be paid. These are different from penalties for failure to pay taxes in general, in which the taxpayer has the right to receive a 30-day letter, notice, or agreement form before the penalty is due. If assessable penalties are imposed, the taxpayer has no right to any of these—rather, they receive the notice and must pay immediately.

In this case, the IRS argued that §6038 penalties should be considered assessable unless the tax code says otherwise. The IRS also argued that §6201 gives it the power to assess penalties, even if Congress hasn’t specified that it has that authority for a particular penalty.

But the court disagreed, stating that several tax code sections describe specific penalties as being assessable. Because of this, the court decided that since Congress did not specifically allow the IRS to assess a §6038(b) penalty, the IRS does not have that power.