Failure-To-File Form 5471 Penalties Against Farhy Valid, DC Court of Appeals Rules

On May 3, 2024, the DC Court of Appeals ruled that the IRS had the authority to automatically assess the $10,000 penalty for failure-to-file Form 5471 – overturning an April 2023 Tax Court decision to the contrary.The decision reinstates the nearly $500,000 in penalties assessed by the IRS against Alon Farhy, and is a set-back for taxpayers that may have filed a protective refund claim pursuant to the Tax Court’s 2023 decision.

As a factual refresher, Alon Farhy is a U.S. citizen residing in Israel and the owner of two corporations organized in Belize.Farhy willfully failed to disclose ownership of these corporations on Forms 5471 for the tax years 2003 through 2010. In 2012, the IRS assessed penalties under Internal Revenue Code section 6038(b)(1) for this failure-to-file, and penalties under section 6038(b)(2) for the years of continued noncompliance thereafter. Farhy appealed the assessment to the Tax Court on the grounds that the penalty was not “assessable” and therefore the IRS should have issued a Notice of Deficiency in the first instance. In an April 2023 decision, the Tax Court agreed. In overruling the Tax Court and concluding the penalty “assessable” by the IRS, the DC circuit court was guided by construction of the statute and congressional intent to increase information reporting compliance.The three-judge panel was further persuaded by the fact that such penalties have been assessed for approximately 40 years without congressional intervention.

While the 2023 Tax Court ruling was welcomed in the international business community and had taxpayers hopeful of the prospect of reduced foreign information reporting, this most recent decision reinforces the authority of the IRS to assess penalties for failure to file said information returns. Now, as in the past, it continues to be critical for taxpayers to file their foreign information returns to fully disclose all cross-border activity on a timely filed return. If you have a concern that you may have missed filing a foreign information return or want to discuss the various reporting requirement, please reach out to your Withum advisor. The IRS offers various Voluntary Disclosure programs which may result in the reduction or elimination of these penalties.

Authors: Manpreet Sangha | [email protected] and Marcus Dyer, JD, CPA, Principal and Co-Leader of Tax Controversy | [email protected]