Farhy Tax Court ruling reversed

D.C. Circuit affirms IRS authority to assess penalties under section 6038(b)

July 12, 2024
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Tax controversy Business tax International tax

Executive summary

The United States Court of Appeals for the District of Columbia (D.C.) Circuit reversed the Tax Court’s Farhy decision. The D.C. Circuit held that the IRS could assess and collect section 6038(b) penalties, based on the text, structure and function of the applicable code sections. This recent decision affirms the IRS’ authority to administratively assess international information return penalties across the nation, though taxpayers should remain vigilant for evolving updates in other judicial circuits.


Background

On May 3, 2024, the United States Court of Appeals for the D.C. Circuit reversed and remanded a Tax Court ruling that the IRS could not administratively assess and collect penalties under section 6038(b). Section 6038(b) imposes a penalty of $10,000 on any U.S. person who fails to timely furnish the information required under section 6038(a),which is information returns with respect to foreign business entities controlled by U.S. persons (i.e., Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations).

Last year, in Farhy v. Commissioner, 160 T.C. No. 6 (April 3, 2023), the Tax Court ruled that, although a taxpayer may be liable for a section 6038(b) penalty, the IRS could not assess and collect the penalty without bringing a civil action in court to establish liability. This case was a dispute over IRS procedures for imposing information reporting penalties. Can the IRS assess penalties for failure to file, or must the Department of Justice sue and obtain a judgment from a federal district court to enforce collection?

The Tax Court followed the Farhy ruling in a recent case, Mukhi v. Commissioner, 162 T.C. No. 8 (April 8, 2024), citing the stare decisis doctrine, also concluding that the IRS could not proceed with collection actions related to section 6038(b) penalties because the IRS lacked the authority to assess such penalties.

D.C. Circuit reverses the Tax Court’s Farhy decision

The United States Court of Appeals for the D.C. Circuit reversed and remanded the Farhy decision, reaffirming the IRS’s longstanding practice of administratively collecting international information return penalties. The D.C. Circuit held that the text, structure, and function of section 6038 demonstrated that Congress authorized the assessment of penalties under subsection (b) and, therefore, the IRS can assess and administratively collect section 6038(b) penalties without filing a lawsuit in federal district court.

Implications of the opinion

The D.C. Circuit opinion reaffirms the IRS’ authority to assess section 6038 penalties.

As the Tax Court followed Farhy in its April 2024 Mukhi v. Commissioner decision, this opinion creates the potential for a circuit-split regarding the IRS’ assessment authority under section 6038(b). Should the IRS choose to appeal the Tax Court decision in Mukhi v. Commissioner, the United States Court of Appeals for the Eighth Circuit could create a split if it reaches a different conclusion than the D.C. Circuit. A disagreement amongst the circuit courts would mean that federal law would be applied differently depending on where a taxpayer lived, which would increase the likelihood of the Supreme Court’s involvement to resolve the differing interpretations.

The IRS may also file a “non-acquiescence” to the Mukhi Tax Court opinion. This means that the IRS would not appeal the particular result for the taxpayers in Mukhi, but would continue to assess and collect these taxes for other taxpayers. This strategy would leave the D.C. Circuit’s opinion in Farhy as the only appellate precedent on the issue.

Moving forward

Taxpayers looking for additional information on the Farhy Tax Court ruling can view RSM’s previous tax article (Tax Court rules that IRS lacks authority to assess penalties under section 6038(b)). Taxpayers facing issues of assessment or payment relating to penalties under 6038(b) should consult their tax advisor.

RSM contributors

  • Alina Solodchikova
    Alina Solodchikova
    Tax Controversy Leader
  • John Cardone
    Senior Director
  • Mandy Kompanowski
    Manager
  • Tiffany Mosely
    Manager, Tax Controversy

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