In depth
Generally, US Persons who control foreign corporations must file US IRS Form 5471, "Information Return of US Persons With Respect To Certain Foreign Corporations" to report their interest in the foreign corporation.1 Nevertheless, pursuant to section 6038(b)(1), the IRS imposes a penalty of USD 10,000 on the US Person for failure to file US IRS Form 5471 by the due date.2 If the IRS notifies the US Person of his requirement to file US IRS Form 5471 and he continues to not file the return after more than 90 days of receiving the IRS's notice, then the IRS imposes an additional penalty of USD 10,000 for each 30 day period the US IRS Form 5471 is not filed. However, any additional penalty imposed cannot exceed USD 50,000.3
While section 6038(b)(1) imposes penalties for failure to file US IRS Form 5471, the US Tax Court (the "Tax Court") first ruled in Farhy v. Commissioner4 that the IRS lacks the authority to assess the penalties under section 6038(b)(1) and, therefore, cannot proceed with the collection actions against the taxpayer related to those penalties via the typical levy or lien procedure as prescribed in the Internal Revenue Code. The IRS appealed the Tax Court's decision in Farhy to the US Court of Appeals for the District of Columbia Circuit (the "DC Circuit"). Pending the DC Circuit's decision in Farhy, the Tax Court again upheld its decision in Farhy and ruled in Mukhi v. Commissioner5 that the IRS lacks the authority to assess penalties under section 6038(b)(1).
However, on May 3, 2024, the DC Circuit reversed the Tax Court's decision in Farhy and held that the IRS has the authority to assess the penalties under section 6038(b)(1) and can proceed with collection actions related to those penalties via the proposed levy or lien as prescribed in the IRC.6 After the DC Circuit's decision in Farhy, the IRS filed on June 7, 2024, a Motion for Reconsideration in the Tax Court, asking the Tax Court to reconsider its decision in Mukhi. On November 18, 2024, the Tax Court reaffirmed its decision in Mukhi on the basis of the Golsen rule7, and reasoned that it was not bound to follow the DC Circuit's decision because "[a]n appeal from this decision would lie in the Eighth Circuit [Court of Appeals]."8
On December 5, 2024, in Safdieh v. Commissioner,9 another case involving section 6038(b)(1) penalties, the Tax Court applied stare decisis and ruled again in favor of the taxpayer, thereby granting summary judgment against the IRS. The Tax Court stated that:
"Our Court's tradition when we've been reversed is to reexamine our reasoning when the issue is next raised in a case appealable to a different circuit. As it turned out, Mukhi was not yet final and unappealable when the DC Circuit issued Farhy. Last week we issued Mukhi II […], in which we held that we still think we're right in our interpretation of section 6038, and expressly held that we would continue our disagreement with the DC Circuit in cases appealable to other circuits."10
Safdieh's case is appealable to the United States Court of Appeals for the Second Circuit (the "Second Circuit"), while Mukhi's case is appealable to the US Court of Appeals for the Eighth Circuit (the "Eighth Circuit"). It has yet to be determined whether the IRS will appeal Safdieh's and Mukhi's case to the Second Circuit and Eighth Circuit, respectively. As it stands, for taxpayers whose cases are appealable to the DC Circuit, the IRS has the authority to assess section 6038(b)(1) penalties and, therefore, can proceed with the collection actions against those taxpayers related to those penalties via the proposed levy or lien as prescribed in the Internal Revenue Code. However, it is questionable whether the IRS has that same authority with respect to taxpayers whose cases are appealable to another United States Court of Appeals circuit. Given the divide between the Tax Court and the DC Circuit, it is foreseeable that there will be more cases litigated in the future regarding the IRS's authority to assess penalties under section 6038(b)(1).
For a full discussion on the author's analysis regarding Farhy, please click here.
1 Section 6038(a).
2 Section 6038(b)(1).
3 Section 6038(b)(2).
4 Alon Farhy v. Commissioner, 160 TC No. 6 (2023).
5 Mukhi v. Commissioner, 162 TC No. 8 (2024).
6 Farhy, No. 23-1179 (DC Ct. App. 2024).
7 Generally, when the Tax Court's decision is reversed by an appellate court, the Tax Court will "reconsider the problem in the light of the reasoning of the reversing appellate court and, if convinced thereby, … follow the higher court." Mukhi, 163 TC No. 8 (2024). However, the Golsen rule is the exception to this rule. The Golsen rule provides that when a "decision of the appellate court to which an appeal would lie contradicts [the Tax Court's] precedent, [the Tax Court] will follow the appellate court's decision." Mukhi, 163 TC No. 8 (2024).
8 Mukhi, 163 TC No. 8 (2024). "An appeal from this decision" refers to Mukhi.
9 Safdieh v. Commissioner, No. 11680-20L (TC Dec. 5, 2024).
10 Safdieh, No. 11680-20L (TC Dec. 5, 2024).
