Monday, April 3, 2023

Tax Court Holds that IRS Has No Authority to Assess § 6038(b) Penalties for Form 5471 Delinquencies (4/3/23; 4/23/23)

In Farhy v. Commissioner, 160 T.C. No. 6 (4/3/23), TN here and GS here, the Tax Court held in a CDP case that collection efforts for the § 6038(b) penalties for initial and continuation failure to file Forms 5471 were not authorized because there was no assessment authority for § 6038(b) penalties. Section 6038(b) is here. Assessments are required for IRS collection actions such as liens and levies, thus the collection action failed.

My comments:

1. I find the Farhy holding odd; indeed. I think it is wrong. The statute is clear that Congress intended the § 6038(b) penalties to apply. The penalty for the initial failure seems to be automatically imposed by the statute's literal terms without any action by the IRS. § 6038(b) (“If any person fails to furnish, within the time prescribed under paragraph (2) of subsection (a), [the Form 5471] such person shall pay a penalty of $10,000 for each annual accounting period with respect to which such failure exists.”) There is no authority—and the Tax Court in Farhy cites none—for the proposition that Congress intended to exclude the § 6038(b) penalty from usual IRS collection tools. Instead, at best, the Tax Court finds a footfault in the interlocking statutory provisions.

2. The Code treats penalties as taxes, and 6201(a), here, authorizes “assessments of all taxes (including interest, additional amounts, additions to the tax, and assessable penalties) imposed by this title.”  (Emphasis supplied by JAT.) “Including” at least suggests that, so long as the tax (penalty) is imposed by Title 26, assessment authority can include more than the types of liabilities specifically listed. More importantly, it would not facially exclude the § 6038(b) penalties and should be capacious enough to cover the § 6038(b) penalties, particularly because there is no reason Congress intended otherwise.

3. An Assessment is simply a recording on the IRS books that a taxpayer owes a liability. In Hibbs v. Winn, 542 U.S. 88, 100 (2004), here, the Supreme Court described assessments (cleaned up):

          As used in the Internal Revenue Code (IRC), the term “assessment” involves a recording of the amount the taxpayer owes the Government. 26 U.S.C. §6203. The “assessment” is essentially a bookkeeping notation. Section 6201(a) authorizes the Secretary of the Treasury “to make . . . assessments of all taxes . . . imposed by this title.” An assessment is made “by recording the liability of the taxpayer in the office of the Secretary in accordance with rules or regulations prescribed by the Secretary.” §6203. n2 See also M. Saltzman, IRS Practice and Procedure ¶10.02, pp. 10-4 to 10-7 (2d ed. 1991) (when Internal Revenue Service signs “summary list” of assessment to record amount of tax liability, “the official act of assessment has occurred for purposes of the Code”).
   n. 2 Section 301.6203-1 of the Treasury Regulations states that an assessment is accomplished by the “assessment officer signing the summary record of assessment,” which, “through supporting records,” provides “identification of the taxpayer, the character of the liability assessed, the taxable period, if applicable, and the amount of the assessment.” 26 C.F.R. §301.6203-1 (2003).

If the statute says a delinquent filer is subject to the penalty, it makes no sense that the IRS can’t record the liability on its books—easily meeting the definition of an assessment. And, what logic is it that the IRS cannot record on its books a clear liability such as § 6038(b)?

4. I am aware of no other instance where the IRS has authority to determine a tax or tax-like (including penalty) liability without authority to assess so is relegated to enforcing collection by a collection suit in district court?

5. Why would requiring a DOJ Tax collection suit for these penalties be more “taxpayer friendly?”  To be sure, given its priorities, DOJ Tax might not bring collection suits in some cases, but forcing taxpayers into litigation as the first collection step after the liability is determined seems counterintuitive when the IRS has collection measures that are more intuitive, more private, and may permit settlement and perhaps OIC alternative (with CDP rights) short of a district court collection suit.

6. I am agnostic as to whether the § 6038(b) penalties should be subject to pre-assessment judicial review like the notice of deficiency. 

7. Bottom line, it makes no sense that certain penalties that Congress meant the IRS to apply is outside the normal collection channel for tax and tax-like liabilities. On the available evidence, there is no reason to believe Congress intended that, and the mere failure to include § 6038(b) in the "including" parenthetical is a weak reed to extrapolate such an intent. If that is right, then wouldn’t a court find sufficient flexibility in the current framework to put the § 6038(b) penalties in the assessment authority in § 6201(a)

8. Even accepting the holding, however, is Farhy is a pyrrhic victory. Reading § 6038(b) literally, the liability exists without any assessment by the IRS. That means that, if the IRS cannot assess but must proceed by collection suit, the IRS can proceed by such a suit against Mr. Farhy. Section 6502, here, the statute of limitations for collecting assessments, doesn’t apply because it requires an assessment, which means that there is no statute of limitations to sue to collect a Title 26 nonassessment liability.


Les Book, here, reminded me of 28 USC 2462, here, that provides:

28 U.S. Code § 2462 - Time for commencing proceedings

Except as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.

Section 2462 does not apply in tax cases where the Code penalty was subject to assessment which invokes the 10-year collection period in § 6502, here, titled “Collection after assessment.” (Emphasis supplied.) In the language of § 2462, § 6502 “otherwise provide[s]” for an assessed penalty. Further, the assessment period is not counted for § 2462 purposes because assessment is a predicate to the Code nonjudicial collection tools but assessment itself is not a collection proceeding—i.e., the right to enforced collection does not “accrue” until the assessment is made. Federal Tax Procedure (Practitioner Ed. 2022), p. 238.

Farhy holds that there can be no assessment of the § 6038(b) penalties. Hence, by its terms, § 6502 cannot apply and no other statute otherwise provides a different limitations period than § 2462. So the focus is on § 2462's “first accrued” term that starts the 5-year period. Normally, at least where an assessment is required, a tax penalty does not accrue until assessed; only then does the taxpayer owe the penalty, and the Government can take collection (administrative or judicial) 1action on the penalties.

Are the § 6038(b) penalties different in that, even without an IRC required assessment, the IRS must still do something (such as recording the § 6038(b) penalty liabilities on its books) for the § 6038(b) penalty liabilities to accrue under § 2462? I would think so, but have not researched that question. So I just caveat the issue for readers. I would love to hear from others who may have researched the issue or have live § 6038(b) penalty disputes and need to research the issue.

Added 4/4/23 5:00pm:

I just communicated with a colleague about the § 2462 issue. In the communication, I added some nuance beyond the above. Here is the nuance slightly massaged, for whatever it is worth, in case any reader might want to dive into the issue.

I think the § 2462 issue will turn upon whether the § 6038(b) penalties “accrued” at one of the following times: (i) the time of the act being penalized (failure to file the Form 5471), (ii) when the IRS discovered or should have discovered the failure giving rise to the liability, or (iii) when the IRS asserted the penalties.  The general rule is that a taxpayer cannot self-assess IRC penalties. Extending that to a nonassessable penalty, logic would tell me that a taxpayer cannot self-report the 6038(b) penalties. So, at a minimum, the starting date would not run until the IRS discovered the penalized conduct. And practically speaking, since the taxpayer cannot self-report penalties, the starting date should not run until the IRS discovers and asserts the penalties.  Although Farhy held that these § 6038(b) penalties are not “assessed,” the failed assessment date would be that assertion date. [CAVEAT: SEE THE ENTRY IMMEDIATELY BELOW ADDED 4/23/23 1:30 PM]

Added 4/23/23 1:30pm:

I recommend to readers this article: Cory Stigile & Michael Greenwade, The IRS Cannot Assess or Collect Certain International Penalties--Now What? (Hochman Salkin Toscher Perez P.C.), here. Most importantly for present purposes, it discusses Gabelli v. S.E.C., 568 U.S. 442 (2013) which holds "the Supreme Court held the five-year clock does not start ticking on the date the Government discovers or should have discovered the misconduct that gives rise to their enforcement action seeking civil penalties; rather, the clock starts ticking when the misconduct occurs."

Added 4//23 2:15pm:

A colleague just advised me that the § 6038(b) penalties almost always are asserted upon receipt of delinquent 5471s regardless of whether there is a reasonable cause statement. So, in those cases, the date the IRS discovered or should have discovered is the same date the IRS asserts the § 6038(b) penalties. (I think, however, the IRS could assert that the "automatic" assertion of the penalty was not a substantive determination that the penalty applied, but with the taxpayer having the right to contest the penalty through a claim for abatement, so that the final action for those who contest is when the date the claim for abatement is denied (which is the first IRS determination that the penalty actually applies).)

The § 6038(b) penalties may be asserted without the taxpayer filing a delinquent 5471 as I think occurred in Farhy. The penalty assertion date for each delinquency in this category would be the penalty assertion date.

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