The US Tax Court Rules The IRS Lacks Statutory Authority To Assess International Information Return Penalties

Arnold & Porter


Arnold & Porter is a firm of more than 1,000 lawyers, providing sophisticated litigation and transactional capabilities, renowned regulatory experience and market-leading multidisciplinary practices in the life sciences and financial services industries. Our global reach, experience and deep knowledge allow us to work across geographic, cultural, technological and ideological borders.
On April 3, 2023, the Tax Court in Farhy v. Commissioner rejected IRS efforts to impose penalties on a taxpayer's failure to file Form 5471. According to the Tax Court, these foreign...
United States Tax
To print this article, all you need is to be registered or login on

On April 3, 2023, the Tax Court in Farhy v. Commissioner rejected IRS efforts to impose penalties on a taxpayer's failure to file Form 5471. According to the Tax Court, these foreign information return penalties are neither taxes nor "assessable penalties" and, therefore, the IRS did not have the statutory authority under Internal Revenue Code (I.R.C. or Code) § 6038 to assess and collect such penalties.

Though based on the definition of "assessable penalties," this decision has implications far beyond any failures to file Form 5471.


I.R.C. § 6038 requires certain U.S. persons to report information regarding foreign business entities that they control on Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, with their yearly federal income tax return, in respect of such entity. Treas. Reg. § 1.6038-2. The requirement applies to, among others, U.S. persons who control foreign corporations and U.S. shareholders of "controlled foreign corporations" (CFCs). Under I.R.C. § 6038(b), for each taxable year that U.S. persons fail to file, they are subject to a penalty of $10,000 per foreign corporation and further subject to a "continuation penalty" up to $50,000 if they continue to fail to file after receiving notice.

In Farhy, the taxpayer, Alon Farhy, had refused for at least five years to file Form 5471 providing information about his ownership interests in two foreign corporations incorporated in Belize. He did not have a reasonable basis for failing to file such forms. Indeed, a non-prosecution agreement that was introduced in the Tax Court established that Farhy's non-compliance with I.R.C. § 6038 was part of an "illegal scheme" to reduce his tax obligations. The IRS sent Farhy notice, and after he continued to refuse to file, the IRS assessed penalties under I.R.C. § 6038. The IRS then issued a final notice of intent to levy to collect the I.R.C. § 6038 penalties. Farhy filed a timely request for a Collection Due Process hearing in which he challenged the IRS's authority to assess the I.R.C. § 6038 penalties. The IRS sustained the collection action, and Farhy then filed a petition in Tax Court.

The Court's Reasoning

The issue before the Tax Court was whether the IRS had authority to automatically assess penalties under I.R.C. § 6038 after satisfying its administrative procedures. Before Farhy, in the normal course, the IRS had assessed civil penalties under I.R.C. § 6038 and collected them by administrative means, such as a notice of levy or lien. The Internal Revenue Manual provided that "information return penalties," such as those assessed under I.R.C. § 6038, are assessable penalties that must be paid upon notice and demand.

The IRS took the position that I.R.C. § 6038 penalties are assessable penalties under I.R.C. § 6201(a). Farhy argued that the IRS had no authority for treating I.R.C. § 6038 penalties as assessable penalties.

The Tax Court agreed with Farhy, reasoning that I.R.C. § 6038, which establishes the reporting requirement regarding foreign corporations and the consequent penalties, does not specify a mode of assessing the penalties. Notably, as the Tax Court observed, there are other code provisions establishing penalties that explicitly state that the respective penalties are assessable. Thus, the Tax Court found that the penalties for failure to file Form 5471 are not subject to the deficiency procedures. The Tax Court also rejected the IRS's argument that I.R.C. § 6201(a) applied to I.R.C. § 6038 penalties because they are a "tax." Since the Tax Court found that the penalties for failure to file Form 5471 under I.R.C. § 6038 are neither assessable penalties, nor subject to the deficiency procedures, the Tax Court concluded that the IRS can recover the penalties only through a civil action.

The decision was issued by the full Tax Court without any dissent. The IRS has the right to appeal the decision within 90 days of the Tax Court ruling.


The Farhy ruling overturns long-standing IRS practice and legal precedent that had taken for granted that I.R.C. § 6038 penalties for failure to file Forms 5471 were automatically assessable and subject to payment on notice and demand by the IRS. Courts had not been directly confronted with this question before in the context of I.R.C. § 6038, so Farhy represents a novel holding that will undoubtedly lead to further judicial consideration. The ruling further signals that there may be other penalties for which the IRS currently has a practice of automatically assessing and administratively collecting without clear statutory authority to do so — such as penalties relating to Form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships), Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business), Form 8938 (Statement of Specified Foreign Financial Assets), and Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation).

More broadly, the ruling constrains the government's ability to deter foreign business entities from concealing income, particularly those incorporated in "tax haven jurisdictions" where it may be difficult for the Treasury Department to otherwise obtain information. This deterrence was one of the legislative aims of I.R.C. § 6038. See Joint Comm. Tax'n, 104th Cong., General Explanation of Tax Legislation Enacted in the 104th Congress (Dec. 18, 1996).

Although the Commissioner may appeal the Tax Court's decision or seek a congressional fix for this issue, taxpayers who have paid I.R.C. § 6038 penalties for failure to file Form 5471 may wish to consult with their tax advisor to determine whether they should file a protective claim for refund.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

See More Popular Content From

Mondaq uses cookies on this website. By using our website you agree to our use of cookies as set out in our Privacy Policy.

Learn More