ARGUMENTS IN FARHY DEBATE LANGUAGE FOR PENALTY ASSESSMENT IN FOREIGN OWNERSHIP

Arguments In Farhy Debate Language For Penalty Assessment In Foreign Ownership

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Recent arguments concerning IRS authority to assess and collect after an owner of foreign companies fails to file could play out in many similar, future cases.

The District of Columbia Circuit Court recently heard oral arguments in Farhy v. Commissioner during both sides bantered on Section 6201(a) and other provisions that might be caught up in a decision finding that the IRS couldn’t assess penalties under section 6038(b) for failure to file Forms 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.”

Last year in Farhy, the U.S. Tax Court distinguished between a penalty that the IRS is authorized to issue and a penalty that has been improperly assessed.

For the tax years 2003 through 2010, Alon Farhy owned 100% of Katumba Capital Inc. and for the tax years 2005 through 2010 was also the 100% owner of Morningstar Ventures Inc. Both companies were foreign corporations incorporated in Belize.

Farhy had a reporting requirement under Section 6038(a) to report his ownership interests in both companies using Form 5471 to disclose interest or ownership in a foreign corporation. Failure to do incurs penalties starting at $10,000 per form per year. The IRS assessed an initial penalty of $10,000 per year under section 6038(b)(1) for each year and an extra $50,000 per year as continuation penalties under section 6038(b)(2).

Farhy countered with success that no law gives the IRS authority to assess penalties under Sec. 6038(b) and that while the U.S. may be able to collect liabilities for these penalties through a civil action the IRS can’t assess or administratively collect these penalties.

Observers say Farhy could affect taxpayers to various other, similar penalties – perhaps so far as requiring that the Internal Revenue Service having to ask the U.S. Justice Department to bring civil suits in the future to collect a penalty for which there is no assessment authority or deficiency proceedings.

Definition of ‘assessable’

Sec. 6201(a) of the U.S. Tax Code authorizes the IRS to make assessments on taxes and assessable penalties, which can be followed, after assessment and failure to pay, by liens and levies. Sec. 6212 requires that a notice of deficiency be sent before a liability assessment; Sec. 6213 allows a taxpayer to petition the Tax Court for review. Taxpayers must pay the penalties before judicial review is allowed in a district court or the Court of Federal Claims.

In the recent oral arguments in Farhy:

• The U.S. government argued that the language in 6201(a), which allows Treasury to assess “all taxes (including interest, additional amounts, additions to the tax, and assessable penalties) imposed by this title,” should be read broadly and that “all taxes” should include the Sec. ?6038 penalty.
• The judge acknowledged that the U.S. Congress had drafted language for statutes that refers to assessment and that under Farhy’s counter-theory, those penalties could not be assessed.
• Farhy’s counsel contended about potential IRS inability to assess that similar language isn’t present regarding foreign information return penalties: Any catch-all phrasing for the justifiability of assessment is related to a tax and not to international information return penalties, which address only factual reporting. If the U.S. government wants assessment and penalty, it must sue in court.

Others see a problem

Many expect the IRS will appeal, but what could eventually happen to those who must file 5471s and similar foreign-ownership filings or risk penalties?

Observers reportedly said the court in the ongoing case should address surplus language and that the judges appeared to have some concern over whether a taxpayer with a penalty like Farhy is given a real opportunity to contest the penalty’s merits.

A recent report from the National Taxpayer Advocate also advised that IRS treatment of IRC 6038 and 6038A foreign information reporting penalties “as systemically assessable is legally unsupportable, administratively problematic, and imposes costs, delays and stress for taxpayers.”

“Because the penalties are immediately assessed, taxpayers’ only recourse is to rely on IRS discretion and request a reasonable cause abatement of the penalties or pay them and seek a refund in federal court,” the report read. “This approach is particularly unsuited to these penalties … both taxpayers and the IRS are expending significant time, energy, and money addressing penalties that ideally should not be assessed in the first instance.”

Your tax specialist needs to stay on top of this and many other issues of wealth, foreign income and tax enforcement. If we can help, please let us know.

About the Author?

Alicea Castellanos is the CEO and Founder of Global Taxes LLC. Alicea provides personalized U.S. tax advisory and compliance services to high-net-worth families and their advisors.

Alicea has more than 20 years of experience. Prior to forming Global Taxes, Alicea founded and oversaw operations at a boutique tax firm, worked at a prestigious global law firm and CPA firm.

Alicea specializes in U.S. tax planning and compliance for non-U.S. families with global wealth and asset protection structures which include non-U.S. trusts, estates and foundations that have a U.S. connection.

Alicea also specializes in foreign investment in U.S. real estate property, and other U.S. assets, pre-immigration tax planning, U.S. expatriation matters, U.S. persons in receipt of foreign gifts and inheritances, foreign accounts and assets compliance, offshore voluntary disclosures/tax amnesties, FATCA registration, and foreign companies wanting to do business in the U.S.

Alicea is fluent in Spanish and has a working knowledge of Portuguese.

Alicea is an active member of the Society of Trusts & Estates Practitioners (STEP), the New York State Society of Certified Public Accountants (NYSSCPAs), the American Institute of Certified Public Accountants (AICPA), the International Fiscal Association (IFA), a member of Clarkson Hyde Global, a world-wide association of accountants, auditors, tax specialists and business advisors and the Global Referral Network (GRN).

Distinctly, in 2020, Alicea was awarded with a prestigious NYSSCPA?Forty?Under 40 Award.?She was selected as someone that has notable skills and is visibly making a difference in the accounting profession.

In 2021 and 2022, Alicea was the Gold and Silver Winner, respectively, of Citywealth's Powerwomen Awards in the category USA - Woman of the Year - Business Growth (Boutique). In 2023, she continued her winning streak by receiving the Gold award for Company of the Year Female Leadership (Boutique) and the Silver award for Accountancy Firm of the Year at the Magic Circle Awards. Furthermore, Alicea has consistently secured her position in the Global Elite Directory for four consecutive years, being recognized as a Private Client Global Elite Advisor and is currently listed for 2024 as a Non-Legal Adviser. This exclusive directory annually highlights the world's elite lawyers and outstanding wealth advisors serving ultra-high net-worth clients.

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