Case background

During the tax years from 2003 through 2010, the Taxpayer was the sole owner of a corporation organized in Belize, Katumba Capital Inc., and from 2005 through 2010 was the sole owner of another corporation organized in Belize, Morningstar Ventures, Inc. While the Taxpayer knew of his reporting obligation under section 6038 and to file Form 5471 to report his ownership interests in the non-US corporations, he was willful in his decision to not file the form. The IRS notified the Taxpayer regarding his failure to file Form 5471 and subsequently assessed penalties. When the Taxpayer failed to respond to the IRS notices, the IRS issued a final notice of intent to levy. The taxpayer submitted a request for a collection due process hearing under section 6330. After conducting a hearing, the IRS sent the Taxpayer a Notice of Determination upholding the collection of the section 6038 penalties previously assessed. The Taxpayer then petitioned the Tax Court to determine whether the IRS has the authority to assess penalties under section 6038(b).

The Taxpayer argued that the IRS lacks the authority to assess penalties under section 6038(b). The Taxpayer contended that as section 6038(b) does not grant the IRS the authorization to collect the penalties, it is not an assessable penalty and the IRS cannot assess or administratively collect the penalties.

In its rebuttal, the IRS made the following four arguments in support of why the section 6038(b) penalty is an assessable penalty:

1. The term "assessable penalties" is not limited to penalties found in subtitle F, subchapter B, chapter 68 of the Code. The term also includes any penalties found in the Code that are not subject to the Code's deficiency procedures.
2. The term "taxes" in section 6201(a) encompasses the section 6038(b) penalties (even if they are not assessable penalties).
3. The Tax Court's holding in Ruesch² supports the assessment and collection of the section 6038(b) penalties.
4. The legislative history of section 6038(b) also supports the assessment and collection of the section 6038(b) penalties.

The Tax Court ultimately ruled in favor of the Taxpayer and held that the IRS may not proceed with the collection of these penalties from the Taxpayer via the proposed levy because the United States Congress did not explicitly authorize the assessment of penalties under section 6038(b).

Assessable penalties

The IRS argued that the term "assessable penalties" is not limited to penalties found in subtitle F, subchapter B, chapter 68 of the Code. While the Tax Court agreed with the IRS's statement, the Tax Court stated that the term "assessable penalties" does not apply to all penalties in the Code not subject to deficiency procedures. The Tax Court quoted itself that "[a]n assessable penalty must be paid upon notice and demand and assessed and collected in the same manner as taxes."³ The Tax Court further stated that while section 6038(b) does grant the authority to impose penalties, it does not grant the authority to assess them.

The Tax Court reasoned that other sections in the Code explicitly authorize the IRS to assess and collect penalties. Section 6038(b) fails to include the same or similar language. The Tax Court compared section 6038(b) to other Code sections under which the penalties imposed are assessed and collected in the same manner as taxes.⁴   

The Tax Court also referred to a non-tax statutory provision:

Whenever a civil fine, penalty or pecuniary forfeiture is prescribed for the violation of an Act of Congress without specifying the mode of recovery or enforcement thereof, it may be recovered in a civil action.

The Tax Court looked at the legislative history of section 6038 and concluded that while the provision has been subsequently amended, none of the amendments prescribed a "mode of recovery or enforcement."

The IRS contended that the term "taxes" in section 6201(a) encompasses the section 6038(b) penalties (even if they are not assessable penalties). The Tax Court disagreed with the IRS's argument because there is a distinction between taxes and penalties in the absence of a provision equating them.

The IRS further argued that the Tax Court's holding in Ruesch supports the assessment and collection of the section 6038(b) penalties. In Ruesch, the taxpayer failed to pay his section 6038(b) penalties after the IRS sent him a notice and demand. The IRS certified the liability for the penalties to the Secretary of State as "seriously delinquent tax debt," pursuant to section 7345(b). The taxpayer timely submitted a request for a collection due process hearing and challenged the IRS's certification of delinquency contention as well as the liability for the penalties. Upon realizing that the taxpayer timely submitted a request for a collection due process hearing, the IRS suspended the collection of the penalty, which no longer made it delinquent, and notified the Secretary of State of its reversal of the certification. In addition, the IRS filed a motion to dismiss for lack of jurisdiction regarding the section 6038(b) penalties, which the Tax Court granted.

The Tax Court ruled in favor of the IRS, holding the following:

1. It had no jurisdiction under section 7345 or its deficiency jurisdiction to consider the taxpayer's underlying liability for the penalties in the absence of a notice of determination.
2. Section 6038 penalties are not subject to deficiency procedures.

Due to the facts and the issue of law in Ruesch, the Tax Court found that Farhy and Ruesch are distinguishable. Even if a penalty is not subject to a deficiency procedure, this does not mean that it is an assessable penalty.

The legislative history of section 6038(b)

The IRS contended that the following three statements relating to section 6038(c) in the Senate Finance Committee report accompanying the enactment of section 6038(b) supported its assessment and collection of section 6038(b) penalties:

1. Reducing creditable foreign taxes is of no use if the US person required to report paid no foreign income taxes during the year in question.
2. Where both penalties are applied, the amount of the reduction in the foreign tax credit is reduced by the amount of the fixed dollar penalty imposed. It is intended that the reduction in foreign tax credit penalty may be waived in some cases where the flat USD 1,000 penalty will be imposed.
3. The penalty is not commonly imposed because it is complicated.⁵

The Tax Court disagreed, highlighting that these excerpts do not mention how section 6038(b) penalties are collected.

Conclusion and takeaways

The Tax Court found that the IRS lacked authority to assess penalties under section 6038(b) and, therefore, the IRS was not able to collect the penalties for failure to file Form 5471 from the Taxpayer under the proposed levy. This judgment is a favorable outcome for taxpayers who are subject to Form 5471 penalty assessments. Furthermore, this decision should impact other information filings, such as Form 926, Return by a US Transferor of Property to a Foreign Corporation, and Form 8938, Statement of Specified Foreign Financial Assets. Similar to section 6038(b), the Code does not explicitly authorize the IRS to assess penalties for failure to file Forms 926 and 8938.⁶ However, the penalties on Form 5471 can still be pursued through a separate civil action.⁷