Court ruling strengthens IRS ability to assess penalties for noncompliance with foreign business disclosure requirements under Section 6038.

The DC Circuit Court ruled that the IRS has statutory authority to assess penalties for failing to report control of foreign businesses under Section 6038(b). This decision overturns a Tax Court ruling in favor of petitioner Alon Farhy and strengthens the IRS’ ability to enforce penalties for noncompliance.

Case Background

Alon Farhy, a U.S. taxpayer, failed to disclose his controlling interest in two Belizian corporations from 2003 to 2010. The IRS discovered he had transferred over $2 million to a sham foreign entity, which later funneled funds to a corporation created solely for this purpose. Farhy did not file Forms 5471, required for reporting foreign business interests, even after receiving a notice from the IRS.

The IRS imposed $60,000 in penalties for each year under Code Sec. 6038(b), totaling $480,000. The Tax Court previously ruled these penalties were not assessable, requiring the IRS to seek judicial enforcement. The DC Circuit disagreed, ruling in favor of the IRS.

DC Circuit’s Rationale

The court’s decision relied on the “text, structure, and function” of Section 6038. It emphasized that Congress intended penalties under subsection (b) to be assessable administratively.

1. Legislative History:
   Section 6038 was first enacted in 1960 and initially imposed penalties as a percentage reduction of a taxpayer’s Foreign Tax Credit (FTC). In 1982, Congress shifted to a fixed-dollar penalty for simplicity and consistency. This change reflects Congress’ intent to make penalties more enforceable.
2. Coordination of Penalties:
   The DC Circuit noted that Congress coordinated subsection (b) and subsection (c) penalties. Subsection (b) penalties must offset subsection (c) penalties if both apply, further supporting the IRS’ authority to assess them administratively.
3. Administrative Efficiency:
   Allowing the IRS to assess subsection (b) penalties aligns with Congress’ goal of simplifying penalty enforcement. The court stated that requiring district court proceedings would undermine this purpose.

Implications for Taxpayers

The ruling highlights the importance of compliance with foreign reporting requirements. Noncompliance can lead to significant penalties, now enforceable without court involvement.

Taxpayers should:

• File Required Forms: Submit Forms 5471 and other foreign reporting forms on time.
• Understand Penalty Risks: Section 6038(b) penalties are steep, starting at $10,000 and increasing for continued noncompliance.
• Consult Professionals: Engage tax advisors to ensure compliance with complex reporting obligations.

Conclusion

The DC Circuit’s decision reinforces the IRS’ authority to assess Section 6038(b) penalties. Taxpayers controlling foreign businesses must stay vigilant and adhere to reporting requirements to avoid costly penalties.

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