All You Need to Know: U.S. Tax Court Rules IRS Lacks Statutory Authority to Assess Form 5471

The U.S. Tax Court recently made a decision in the case of Farhy v. Commissioner on April 3, 2023. They found that the IRS doesn't have the legal power to charge penalties for not filing Form 5471 correctly or on time. This means that the IRS can't demand payment of these penalties from the taxpayer. The IRS has been strict in enforcing penalties for foreign information returns in recent years, including the Form 5471 penalty.

Read the Tax Court's Opinion (PDF)

Background
Farhy v. Commissioner was a recent tax court case involving a taxpayer who owned two foreign corporations and failed to report their interests on Forms 5471 from 2003 to 2010. The IRS assessed multiple penalties for each unreported entity, including a $10,000 penalty for each tax year under I.R.C. § 6038(b)(1) and a $50,000 penalty for each tax year under I.R.C. § 6038(b)(2). When the IRS issued the taxpayer a final notice of intent to levy to collect the penalties, the taxpayer contested the IRS's legal authority to assess them. The sole issue for the Tax Court's determination was whether the IRS had the authority to automatically assess the penalties under I.R.C. § 6038.

Tax Court Ruling
The Tax Court ruled in favor of the taxpayer, stating that there is no specific statutory provision authorizing the assessment of I.R.C. § 6038 penalties, and that legal precedent distinguishes between taxes and penalties unless a statute provides otherwise. The Tax Court rejected the IRS's broad interpretation that I.R.C. § 6201(a) applied to I.R.C. § 6038 penalties because they are a "tax." As a result, the IRS cannot proceed with the collection of the I.R.C. § 6038 penalties against the taxpayer and must recover them through a civil action. This decision may have significant implications for taxpayers who have paid or are contesting Form 5471 penalties.

Conclusion
In short, Form 5471 penalties still exist but the IRS has no authority to collect them at the moment aside from suing a Taxpayer.  It is highly unlikely that the IRS will take legal action to sue for a $10,000 penalty. However, we anticipate Congress and the IRS are working quickly to close this loophole. If you have questions on your international tax forms, or are facing Form 5471 penalty notices or collections, please contact us and we are happy to talk with you on your specific issues and how to resolve them.