Federal Appellate Court Decision Bolsters IRS’ Enforcement Authority Over Foreign Information Return Penalties
06/04/2024Farhy v. Commissioner – Taxpayer Victory Overturned
The U.S. Court of Appeals for the D.C. Circuit recently reversed a Tax Court decision which had limited the IRS’s authority to penalize taxpayers for the delinquent reporting of foreign-owned entities.
The Farhy case has been intensely followed because it was initiated as a challenge to a longstanding, entrenched policy of the Service to automatically penalize taxpayers for failing to file certain tax forms involving non-U.S. entities.
The penalty at issue starts at $10,000 (subject to increase for “continuing” violations after the IRS notifies the taxpayer), and can be assessed by the IRS for each year the requisite form is not filed on time, or otherwise is incomplete or materially incorrect.
When Congress amended the Tax Code in 2010 to provide for this penalty, numerous commentators characterized the resulting change as ‘‘audacious,” ‘‘egregious, ‘‘draconian,” and ‘‘devastatingly destructive.’’ The National Taxpayer Advocate has criticized the IRS’ “aggressive” deployment of its enforcement program under these rules as problematic and unfair.
Potential for Substantial Penalty, Extended Limitations Period and Passport Revocation
Although the delinquent information reporting at issue in this case involved two Belize companies, the overturned Tax Court decision had potentially broader application to an array of (often overlapping) tax information forms taxpayers are obligated to file, including for example, forms related to interests in foreign entities, foreign financial assets and bank accounts, as well as, foreign investment activities and large gifts from foreign persons (including beneficial interests in trusts).
In addition to possible substantial civil tax penalties (where there are multiple entities involved and more than one year under review, the resulting penalty can be a significant multiple of the $10,000 amount), and less protection under the statute of limitations, it is conceivable that Treasury may also seek to revoke a taxpayer’s passport in cases involving these information reporting penalties, under a 2015 change in the Tax Code.
Procedural Issue at the Heart of the Case
The specific legal issue litigated in this case hinged on the interpretation of certain Tax Code provisions regarding the required procedures the IRS needs to follow in seeking to enforce these penalties. The Tax Court had circumscribed, to a certain extent, the IRS’ relatively broad and unconstrained ability to impose these penalties and administer its collections enforcement.
The federal appellate decision may not be the final judicial determination in this case (there is a possibility of further appeal), and technically, this latest development may only apply to taxpayers
in the District of Columbia. However, the decision essentially restores the relatively unfettered ability of the IRS to penalize taxpayers for not properly reporting their foreign holdings and limits the opportunity to challenge the IRS’ aggressive enforcement of these penalties to agency-level proceedings and to paying the penalty and filing a refund claim in federal district court.
Going forward, taxpayers should consult their tax professionals on a more immediate basis if assessed international information reporting penalties and interested in pursuing their appeal rights.
