In a monumental opinion, the Tax Court recently held that the IRS lacks authority to assess penalties imposed by IRC § 6038(b)(1) or (2). In Fahry v. Commissioner, the taxpayer failed to file Forms 5471 reporting his interest in a foreign corporation. The IRS assessed a $50,000 penalty (which includes continuation penalties) for each of the eight years Mr. Fahry failed to file. As is the norm with penalties under IRC § 6038, the IRS automatically assessed the penalty without deficiency procedures, meaning to get to Tax Court, Mr. Fahry had to wait for collections notices, attend a collections due process hearing, and then file a petition with the US Tax Court . Mr. Fahry’s only other option would be to pay the penalty in full and file a refund suit in District Court or the Court of Federal Claims.
Mr. Fahry argued that the IRS did not actually have the ability to assess tax because Congress didn’t specifically authorize the IRS to assess tax under IRC § 6038. Generally, penalties are either those subject to deficiency procedures (i.e. penalties subject to statutory notices of deficiency and corresponding Tax Court review) or assessable penalties not subject to deficiency procedures (i.e. not subject to Tax Court review).
The IRS argued that penalties under IRC § 6038 (which also include penalties for failure to file Forms 5472, 8865, 926, and 3520) are assessable penalties since all penalties are assessable penalties unless the Code states they are subject to deficiency procedures. The IRS contends that IRC § 6201 provides it with broad authority to assess penalties, even when there is no specific statutory grant of authority from Congress with respect to a particular penalty.
The Tax Court disagreed with the IRS. The Court pointed to a number of Code Sections where Congress specifically described penalties as assessable penalties. Thus, Congress is clear in identifying which penalties are assessable penalties. Since Congress did not state that the IRS has the ability to assess the IRC § 6038 penalty, the IRS does not have authority to assess such penalties.
The Tax Court’s opinion highlights a major gap in the Code. IRC § 6038 provides penalties for failure to file certain informational returns, such as Forms 5471 (for certain filers), 5472, 8865, 926, and 3520 to name a few, but does not provide the IRS with the ability to actually assess such penalties. What does mean for taxpayers who have been assessed penalties under IRC § 6038? The opinion is fresh and the IRS has not yet made a public announcement regarding its view of the issue. However, the IRS will likely appeal the decision to the D.C. Circuit Court. While an Appeal is pending, taxpayers can unfortunately expect the IRS to continue status quo enforcement. In the meantime, and if the decision is ultimately upheld, taxpayers can use this case to argue that the IRS cannot assess penalties. Taxpayers who have already paid penalties under IRC § 6038 may be able to file a claim for refund. Taxpayers should not expect the IRS to grant any claims for refund while the Court of Appeals considers the issue. However, this should not deter taxpayers from filing claims for refund so that they can keep their refund statutes open.