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Posted by Brian Ketcham | Apr 04, 2023 | 0 Comments

For the past fifteen years—since the government's enforcement initiatives directed at foreign account reporting compliance—the IRS has often imposed massive financial penalties for a taxpayer's failure to include Forms 5471 with his or her tax return.  Form 5471 is filed annually to report one's interest in foreign corporations.  Often, a foreign financial institution established a foreign-based company to serve as a nominee owner of a client's offshore bank account.  These entities generally have no true business purpose or operations, and their corporate “officers and directors” are usually individuals who work or are otherwise associated with the asset management companies, accountants, or law firms who helped the client set up the offshore accounts at issue; they actually control nothing related to the company.  Many clients are totally unaware that they have some interest in a foreign company.  In many cases, the IRS will disregard corporate entities that lack a business purpose or any economic substance.  However, in Form 5471 cases, the IRS saw easy money on the table in the form of failure-to-file penalties and assessed a $10,000 penalty (per-year and per-violation) pursuant to IRC Sec. 6038(b)(1).  Moreover, the IRS would thereafter impose “continuation” penalties of up to $50,000 pursuant to IRC Sec. 6038(b)(2) if a taxpayer did not promptly file Form 5471 after receiving a notice from IRS to do so.  (It was often impossible for taxpayers to file delinquent Forms 5471, as the sham entities at issue lacked any form of traditional corporate books and records needed to properly prepare a Form 5471.)

For years, the IRS proceeded as above on the basis that Form 5471 penalties were “assessable penalties” under IRC Sec. 6201(a).  In Farhy v. Commissioner, 160 T.C. No. 6 (Apr. 3, 2023), however, the U.S. Tax Court ruled that Form 5471 penalties are not assessable (as “taxes” are assessable) and, therefore, the IRS cannot assess the penalties by simply issuing a notice and then pursuing collections using a proposed bank account levy.  Instead, the IRS must pursue penalties for a purported willful failure to file a Form 5471 by filing a traditional civil action against a taxpayer.

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