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Tax Court Tells IRS It Cannot Assess or Collect Certain Tax Penalties

by , , and | Apr 26, 2023 | , , ,

On April 3, 2023, the US Tax Court issued its opinion in Farhy v. Commissioner, holding that the Internal Revenue Service (IRS) lacked the statutory authority to both assess tax penalties under Internal Revenue Code (Code) Section 6038(b) and collect said penalties via a levy against the taxpayer.

The decision in Farhy is significant because the IRS regularly assesses civil tax penalties for the late filing of international information return forms, such as Form 5471, Information Return of US Persons with Respect to Certain Foreign Corporations. Moreover, for any taxpayer who paid a penalty for filing Form 5471 late, arguably the assessment of that penalty was improper, and the taxpayer may be able to seek a refund of the penalty paid.

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Tax Court Rules That the IRS Cannot Assess or Collect Certain Tax Penalties

by , and | Apr 5, 2023 | , , ,

On April 3, 2023, the US Tax Court issued its opinion in Farhy v. Commissioner, ruling that the Internal Revenue Service (IRS) could neither assess tax penalties under Internal Revenue Code (Code) Section 6038(b) against Alon Farhy nor collect those penalties via a levy.

This is a significant development because the IRS automatically assesses these penalties on any late-filed Form 5471, Information Return of US Persons with Respect to Certain Foreign Corporations. This practice will presumably be immediately ceased. Moreover, any taxpayer who was assessed and paid a penalty on a late-filed Form 5471 may be able to obtain a refund on the penalty paid.

Farhy had failed to file Form 5471 with his US federal income tax return. Failure to timely file Form 5471 comes with a civil tax penalty of $10,000 for each year. (See IRC Section 6038(b)(1).) If the IRS sends the taxpayer notice of its failure to file Form 5471, the taxpayer has 90 days after the notice is mailed to comply with the filing requirement. Failure to comply within the 90-day period subjects the taxpayer to an additional penalty of $10,000 for each 30-day period, with a $50,000 maximum. (See IRC Section 6038(b)(2).)

Code Section 6201(a) permits the IRS to “assess” taxes and assessable penalties. Assessment is the act of formally recording a tax liability on the IRS’s records for a taxpayer. After assessment and failure to pay, the IRS can enforce the collection of tax, penalties and interest by asserting a lien on property or by levying (taking) property.

The Code provides statutes that permit the IRS to assess taxes (including interest, additional amounts and additions to tax) and certain types of penalties (assessable penalties). In Farhy, the Tax Court held that the Code does not contain any statute that permits the IRS to assess the penalty provided in Code Section 6038(b). As such, although the IRS correctly determined that Farhy should be penalized for failing to file Form 5471 with his return, the IRS lacked the statutory ability under the Code to assess and collect the penalty under traditional assessment and collection procedures that they use for other penalties (essentially treated similar to deemed taxes).

The Tax Court did note that the government had other tools at its disposal to collect the penalties, for example, 28 U.S.C. § 2461(a): “Whenever a civil fine, penalty or pecuniary forfeiture is prescribed for the violation of an Act of Congress without specifying the mode of recovery or enforcement thereof, it may be recovered in a civil action.”

Practice Point: Farhy is a major taxpayer victory and demonstrates that a technical deficiency in the Code can have substantial ramifications for the administration of our tax laws and the potential collection of penalties relating to violations thereof. Clearly, Congress intended to permit the IRS the ability to collect the penalties determined under the Code but failing to connect Code Section 6038(b) with the statutory provisions to assess tax and penalties makes the IRS unable to practically and efficiently collect said penalties. We expect (and are [...]

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Courts Split on Supervisory Approval Requirement for Tax Penalties

by , and | Sep 28, 2022 | , , ,

Since Chai v. Commissioner, an opinion by the US Court of Appeals for the Second Circuit subsequently followed by the US Tax Court in several opinions, there has been a substantial number of cases litigating issues involving supervisory approval of federal civil tax penalties. Two recent additions to that list include decisions from the Ninth and Eleventh Circuits, where both Courts departed from the Tax Court’s analysis and ruling on the issue. The disagreement centers on when approval must occur. (Some of our prior discussions on this topic are linked below.)

LAIDLAW’S AND THE NINTH CIRCUIT

In Laidlaw’s Harley-Davidson Sales, Inc. v. Commissioner, the Ninth Circuit, reversing the Tax Court’s ruling, applied a textualist approach and held that approval is required only before the assessment of a tax penalty and not before the Internal Revenue Service (IRS) communicates a proposed penalty to the taxpayer. The Court reasoned that the “language of [Internal Revenue Code (Code) section 6571(b)] provides no reason to conclude that an ‘initial determination’ is transformed into ‘something more like a final determination’ simply because the revenue agent who made the initial determination subsequently mailed a letter to the taxpayer describing it.” While the Court was “troubled” by the manner in which the IRS communicated the potential imposition of the penalty, it explained that a court’s role is to “apply the law as it is written, not to devise alternative language.” In reaching its decision, the Ninth Circuit disagreed with the position developed by the Tax Court in recent years.

KRONER AND THE ELEVENTH CIRCUIT

In Kroner v. Commissioner, the Eleventh Circuit followed Laidlaw’s Harley Davidson Sales and similarly concluded that the IRS satisfies Code Section 6751(b) so long as a supervisor approves the penalty before it is assessed. The Court explained that this was the best reading of the statute because (1) it is more consistent with the meaning of the phrase “initial determination of such assessment,” (2) it reflects the absence of any express timing requirement in the statute, and (3) it is a workable reading in the light of the statute’s purpose. The Court suggested that the IRS may be wise “to have a supervisor approve proposed tax penalties at an early juncture…but the text of the statute does not impose an earlier deadline.”

The Eleventh Circuit was explicit in its departure from Chai and Tax Court precedent, stating that “the Chai court missed an important aspect of the statute’s purpose: it is not just about bargaining, it is also a check on the imposition of erroneous penalties.” The Court also explained that “appropriate penalties should be assessed and collected. Chai’s analysis of these competing interests leaned heavily on the former to the detriment of the latter when justifying its departure from the statutory text.”

Practice Point: It remains to be seen whether this issue will make its way to the Supreme Court of the United States given the apparent circuit split on the issue as [...]

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Exxon Prevails in $200 Million Tax Penalty Case

by and | Jan 26, 2021 | , , , ,

On January 13, 2021, the US District Court for the Northern District of Texas ruled in favor of Exxon Mobil Corporation (“Exxon”) in its battle against the government over tax penalties. Exxon filed amended returns for its 2006-2009 tax years seeking a $1.35 billion tax refund based upon a change of character of certain transactions (from mineral leases to purchase transactions). The government disallowed the refund claims and imposed a $200 million penalty pursuant to Internal Revenue Code (IRC) section 6676. Exxon paid the penalty and filed suit for a refund.

We have written extensively concerning IRC section 6676, warning taxpayers of this potential landmine. See, e.g., “Taxpayers Should Prepare for the Next Penalty Battleground” Roberson, Spencer and Walters, Law360 (May 21, 2019) and “Expect More Civil Tax Penalties—So, Now What?” Roberson and Spencer, Tax Executive (Sept. 27, 2019). To recap, IRC Section 6676 was enacted in 2007 in response to the high number of meritless refund claims being filed at the time. It imposes a 20% penalty to the extent that a claim for refund or credit with respect to income tax is made for an “excessive amount.” An “excessive amount” is defined as the difference between the amount of the claim for credit or refund sought and the amount that is actually allowable. For example, if the taxpayer claims a refund of $2 million and the Internal Revenue Service (IRS) allows only $1 million, the taxpayer can still be penalized $200,000.Significantly, IRC section 6676 does not require the IRS to show any fault or culpability on the part of the taxpayer—e.g., negligence, disregard of rules or regulations, etc. IRC section 6676(a) originally provided a “reasonable basis” defense (which is applicable to the Exxon case), but in 2015 Congress amended the statute and now requires a showing of “reasonable cause.” Neither the Code nor the regulations provide for any other defense to the IRC section 6676 penalty. Moreover, the penalty is immediately assessable, meaning taxpayers cannot fight the IRS in a pre-payment forum like the US Tax Court but must first pay the penalty and seek redress in a refund form.

In Exxon, the government argued that the court should overlay a subjective element on “reasonable basis,” as the US Circuit Court for the Eighth Circuit did in Wells Fargo & Co. v. United States, 957 F.3d 840 (8th Cir. 2020). Our prior coverage of this case can be found here. The Exxon court declined the invitation. Instead, the court explained IRC section 6676 “focuses on whether the claim had a reasonable basis, not on whether the taxpayer had a reasonable basis.” The court agreed with Exxon that its position in the refund claim that its transactions were purchases was reasonable based on the relevant authorities. It further found that the company had “colorable support for its legal contention that a change that affects whether, not when, an item comes into income is not [...]

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Weekly IRS Roundup September 7 – September 11, 2020

by | Sep 14, 2020 | ,

Presented below is our summary of significant Internal Revenue Service (IRS) guidance and relevant tax matters for the week of September 7, 2020 – September 11, 2020. Additionally, for continuing updates on the tax impact of COVID-19, please visit our resource page here.

September 4, 2020: The IRS published Competent Authority Arrangements between the United States and the Republic of Serbia and the United States and the Commonwealth of the Bahamas. Each country previously signed an intergovernmental agreement (IGA) to implement the Foreign Account Tax Compliance Act (FATCA). The new arrangements establish procedures for IGA-related automatic exchange obligations and for the exchange of information.

September 9, 2020: The IRS publishing news release reminding self-employed individuals, investors, retirees and others with income not subject to withholding that third-quarter estimated tax payments for 2020 are due September 15.

September 9, 2020: The IRS announced that, as part of a larger effort to reach underserved communities, it is taking a number of aggressive steps to expand information and assistance available to taxpayers in additional languages, including providing the Form 1040 in Spanish for the first time.

September 10, 2020: The IRS published a notice and request for comments concerning United States gift (and generation-skipping transfer) tax return (Form 709). Form 709 is used by individuals to report transfers subject to the gift and generation-skipping transfer taxes and to compute these taxes. The IRS uses the information to collect and enforce these taxes, verify that the taxes are properly computed and compute the tax base for the estate tax. Comments are due on or before November 9, 2020.

September 10, 2020: The IRS published a notice and request for comments concerning Form 15254 (Request for Section 754 Revocation) which is a new form for a partnership to submit a revocation request from an election to adjust the basis of partnership property. Comments are due on or before November 9, 2020.

September 10, 2020: The IRS published a practice unit focusing on audit techniques for examiners assigned foreign earned income exclusion cases.

September 10, 2020: The IRS published a news release urging individuals who owe taxes but have not yet filed for 2019 to act now to avoid larger penalties that, by law, start after September 14.

September 11, 2020: The IRS released Internal Revenue Bulletin 2020-38, dated September 14, 2020, containing the following highlights: (1) Announcement 2020-15 (Exempt Organizations); (2) Announcement 2020-16 (Exempt Organizations); (3) Notice 2020-65 (Administrative, Employment Tax); (4) Notice 2020-68 (Employee Plans); (5) Revenue Procedure 2020-40 (Employee Plans); and (6) TD 9907 (Income Tax).

September 11, 2020: The IRS released its weekly list of written determinations (e.g., Private Letter Rulings, Technical Advice Memorandums and Chief Counsel Advice).

Special thanks to Robbie Alipour in our Chicago office for this week’s [...]

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Internal Revenue Service Updates Golden Parachute Payments Audit Technique Guide, Signaling Key Items IRS May Review on Audit

by , and | Aug 24, 2017 | ,

In early 2017, the IRS updated its Golden Parachute Payments Audit Technique Guide for the first time since its 2005 issuance. While intended as an internal reference for IRS agents conducting golden parachute examinations, the Audit Technique Guide offers valuable insight for both public and private companies, and recipients of golden parachute payments, into how IRS agents are likely to approach golden parachutes when conducting an audit.

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Fifth Circuit Rejects Substantial Authority Defense to Penalties

by | May 23, 2016 | ,

Prudent taxpayers analyze the relevant tax law while structuring and implementing transactions.  The most obvious reason to do so is to ensure that the taxpayer’s proposed tax treatment is accepted by the Internal Revenue Service (IRS).  Another reason is to ensure that, if such treatment is not accepted, the taxpayer will not be subjected to penalties.

The most common penalty asserted by the IRS in this regard is the accuracy-related penalty under IRC Section 6662.  Among the many defenses to this penalty is the “substantial authority” defense, which looks at whether the weight of authorities supporting the return position is substantial in relation to the weight of authority supporting contrary treatment.  The types of authorities that may be considered is broad, and includes the Internal Revenue Code, Treasury Regulations (proposed, temporary and final), other IRS published guidance, case law, tax treaties, legislative materials and certain IRS private guidance.

The U.S. Court of Appeals for the Fifth Circuit’s recent decision in Chemtech Royalty Associates, L.P. provides some guidance on how courts view the substantial authority defense.  In Chemtech, the taxpayer argued that it had substantial authority for its position based on two U.S. Tax Court cases, a published Tax Court opinion from 1949 and an unpublished memorandum opinion from 1990.  The Fifth Circuit found that both cases, even if not materially distinguishable, were not substantial authority because a 1989 Fifth Circuit opinion was more apposite than the two Tax Court opinions.  The court also noted that the published Tax Court opinion was “old” and the memorandum opinion was “unpublished.”

The Fifth Circuit’s opinion illustrates the difficulties that taxpayers may face when relying on the substantial authority defense.  Although the applicable Treasury Regulations on the substantial authority defense do not distinguish between published and unpublished cases or the age of the authorities, the court’s approach indicates that these are relevant factors to consider.  Taxpayers that intend to rely on the substantial authority defense should review the Fifth Circuit’s opinion in Chemtech, as well as the applicable authority in their relevant circuit.



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