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U.S. Tax Court Rules IRS Lacks Authority to Assess Penalties for Late or Unfiled Form 5471

Farhy v. Commissioner decision limits the IRS’s power to impose penalties for failure to file or filing late Form 5471

In a recent U.S. Tax Court opinion, Alon Farhy v. Commissioner, 160 T.C. 6 (Apr. 3, 2023), the court ruled that the Internal Revenue Service (IRS) lacks the statutory authority to assess or collect civil penalties under Internal Revenue Code (IRC) §6038(b) for failure to file or filing late Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” The case has significant implications for U.S. taxpayers with international business activities and could impact the enforcement of penalties related to Form 5471.

Form 5471 is an information return that U.S. citizens and residents who are officers, directors, or shareholders of certain foreign corporations must file. The form provides the IRS with information about the foreign corporation’s financial activities and is aimed at preventing tax evasion through offshore activities.

The petitioner, Mr. Farhy, was a U.S. citizen who failed to file Form 5471 for the years 2011 and 2012. The IRS assessed a civil penalty of $10,000 for each year under IRC §6038(b). Mr. Farhy argued that the IRS lacked the authority to assess the penalties as there was no delegation order issued by the Secretary of the Treasury to the IRS permitting it to impose such penalties.

The court agreed with Mr. Farhy’s argument, stating that the IRS’s authority to assess penalties under IRC §6038(b) depends on a delegation order from the Secretary of the Treasury. The court noted that no such delegation order exists, and therefore, the IRS lacks the authority to assess the penalties. The court further concluded that the absence of a delegation order cannot be remedied by the IRS’s general authority to administer and enforce the tax laws.

This ruling could have far-reaching implications for U.S. taxpayers with foreign corporations who are subject to penalties for failing to file or filing late Form 5471. It may provide a basis for challenging assessed penalties in similar situations and could also impact the IRS’s ability to enforce compliance with the filing requirements of Form 5471.

The IRS has not yet issued a public response to the decision or provided guidance on how it will address the court’s ruling. It is unclear whether the agency will seek a delegation order from the Secretary of the Treasury or pursue other avenues to remedy the issue. In the meantime, taxpayers facing penalties related to Form 5471 should consult with their tax advisors to understand the potential implications of this ruling on their specific situation.

If you have questions on how this or other laws affect your tax situation, call The Tax Defenders’ experienced tax attorneys at (312) 345-5440 for a FREE consultation.