Taxpayer is liable for penalties from failure to timely file Form 5471
TAX ALERT |
On Jan. 30, 2017, the U.S. Tax Court issued its opinion in Flume v. Commissioner, T.C. Memo 2017-21, in which it upheld a levy with respect to the taxpayer’s civil penalty liabilities resulting from failure to timely file Forms 5471. The court determined that the taxpayer did not show reasonable cause for his failure to file Forms 5471.
Throughout the time period at issue, 2001 through 2009, the taxpayer was a U.S. citizen who operated a real estate development and construction business in Mexico. In 2001, the taxpayer was the president and 50 percent owner of Franchise Food Services de Mexico (FFM). FFM was considered a controlled foreign corporation (CFC) for the 2001 and 2002 tax years. Also in 2001, the taxpayer and his wife incorporated Wilshire-Belize, a Belizean international business company. Wilshire-Belize initially issued two bearer shares to the taxpayer and his wife, resulting in each having a 50 percent interest in the entity.
The taxpayer hired a tax preparation firm in Mexico to prepare his tax returns during the years at issue. An employee at the tax preparation firm was in charge of preparing those returns. The taxpayer did not inform the tax preparer until approximately 2008 that he held interests in FFM and Wilshire-Belize. For the years at issue, the taxpayer timely filed all Forms 1040, US Individual Income Tax Return. However, the taxpayer did not attach Forms 5471, Information Return of US persons With Respect to Certain Foreign Corporations, to any of his originally-filed returns.
In 2012, the IRS began an examination of the taxpayer’s ownership and control of the foreign corporations. After being made aware of his failure to file Forms 5471, in January 2013 the taxpayer submitted delinquent original Forms 5471. The taxpayer subsequently submitted revised Forms 5471 in April 2013. Both the original and revised Forms 5471 were incomplete.
The IRS assessed penalties for the taxpayer’s failure to file Forms 5471 declaring his ownership interest in FFM during 2001 and 2002 and in Wilshire-Belize from 2001 through 2009. The taxpayer was assessed a penalty of $20,000 for 2001, two penalties of $10,000 each for 2002, and penalties of $10,000 for each year from taxable year 2003 through 2009 as a result of his failure to file.
Section 6038(a)(1) imposes information reporting requirements on any U.S. person who controls a foreign corporation or any U.S. person treated as a U.S. shareholder of a corporation that was a CFC for an uninterrupted period of 30 days during its annual accounting period and who owned stock in the CFC on the last day of the CFC’s annual accounting period. Form 5471 and the accompanying schedules are used to satisfy the section 6038 reporting requirement. Form 5471 must be filed with the U.S. person’s timely filed federal Income tax return. Section 6038(b) imposes a penalty for failure to file Form 5471 on time. The penalty is fixed and is assessed systemically. The amount of penalty is $10,000 per unfiled or delinquent Form 5741 per annual accounting period. Such penalty is assessed if the information return is not attached to the U.S. persons timely filed return.
Section 6038(c)(4)(B) provides that in order to avoid a section 6038(b) penalty, a taxpayer must make an affirmative showing that the failure to furnish the appropriate information with the original return was due to reasonable cause.
In Flume, the taxpayer argued that the penalties associated with his failure to file Forms 5471 should not apply due to reasonable cause through reliance on his tax advisor’s advice. The Tax Court relied on Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000), to determine whether the taxpayer established reasonable cause through his reliance on a tax advisor’s advice. The Tax Court in Neonatology held that to establish reasonable cause for the failure to file Forms 5471, the taxpayer must prove: (1) the advisor was a competent professional with sufficient expertise, (2) the taxpayer provided necessary and accurate information to the advisor, and (3) the taxpayer relied in good faith on the advisor’s judgment.
In support of his reasonable cause defense, the taxpayer argued that the tax advisor failed to advise him that he was required to file Forms 5471 for FFM for the tax years 2001 and 2002. However, as the court pointed out, the taxpayer testified that he was unaware of tax advisor’s qualifications and that he did not inform her of his interests in FFM and Wilshire-Belize. Accordingly, the taxpayer failed the second Neonatology prong because he did not provide his tax return preparer with all the necessary information, which barred him from reasonably relying on his tax return preparer’s advice. As a result, the Tax Court concluded that the taxpayer failed to show reasonable cause for his failure to file Forms 5471.
Penalties associated with a failure to file Form 5471 systemically assessed and are pretty hefty for those taxpayers who have interests in various foreign entities. Seeking relief from these penalties based on reasonable cause is a common approach. However, establishing relief from those penalties based on reasonable cause to the satisfaction of the IRS is sometimes challenging. Taxpayers who have an obligation to file Form 5471 and who think that an obligation might exist should discuss such filing requirements with their tax advisors. Similarly, taxpayers who were assessed a civil penalty for the late filing of the Form 5471 should also be seeking guidance from their tax professionals with regards to a possible abatement of such penalties.