In a departure from its usual criticism of the Foreign Account Tax Compliance Act, a recent column focused on another international information reporting rule that has been causing frustration due to its administration. Section 6038 requires U.S. persons to provide information about foreign business entities they control, encompassing both corporate and noncorporate entities. Failure to comply with these reporting requirements can result in penalties, including a $10,000 initial penalty for each violation and additional continuing penalties.
The statute does not specify how U.S. persons should comply with the reporting requirements, but the IRS has introduced Form 5471 for this purpose. Unlike other reporting forms, Form 5471 must be attached to the taxpayer’s federal income tax return. Failure to comply with section 6038 reporting requirements can lead to various penalties, including the accuracy-related penalty under section 6662(j), in addition to the penalties outlined in section 6038.
A recent case involving U.S. citizen Alon Farhy, who failed to report his foreign company interests, has brought attention to the issue of penalties imposed under section 6038. The Tax Court ruled in Farhy’s favor, questioning the IRS’s authority to assess these penalties. The case has implications beyond Farhy’s specific situation and raises concerns about the process of summarily assessing penalties without offering taxpayers the opportunity for prepayment judicial review.
The National Taxpayer Advocate has also highlighted concerns about the assessment of international information reporting penalties without prior review and the disproportionate impact on lower-income taxpayers and small businesses. Calls for reforming the penalty regime to make them subject to deficiency procedures could provide a fairer process for taxpayers and ensure access to due process. While a decision in favor of Farhy could pave the way for reforms, a reversal could maintain the status quo and limit opportunities for change.
The IRS’s interpretation of its authority to assess penalties outside of chapter 68 raises questions about the appropriateness of summarily assessing penalties without affording taxpayers the opportunity for judicial review. The potential implications of the Farhy case extend beyond his individual circumstances and could impact the future assessment of international information reporting penalties. Ultimately, the outcome of the case will likely influence potential reforms to the penalty regime and access to due process for affected taxpayers.
