Due process requires that matters be resolved according to established rules and principles and that taxpayers be treated fairly. The international information return (IIR) penalty regime under IRC Chapter 61, Subchapter A, Part III, Subpart A does not adhere to this fundamental mandate. Now is the time for Congress to fix this broken system by providing a clear path for implementation of these penalties. This fix, which would provide much-needed clarity and finality, will require legislation.

The need for this legislation has been brought to a head by the U.S. Tax Court’s recent decision in Farhy v. Commissioner, which holds that the IRS lacks statutory authority to assess and collect penalties under IRC § 6038(b). In part one of this series, I provide a discussion of this decision and a recommendation that would protect the rights of both taxpayers and the government.

Since assuming the role of National Taxpayer Advocate, I have recommended that the IRS cease systemic assessment of these penalties, and I have requested that Congress enact legislation providing the IRS the ability to utilize deficiency procedures for IIR penalties. Among other things, deficiency procedures allow for judicial review in the Tax Court prior to the assessment and payment of the asserted penalties.

Compared to other courts, the Tax Court is more accessible for taxpayers and is by far the least expensive and easiest to navigate for low-income taxpayers. Amending the IRC to implement deficiency procedures would solve the problem highlighted by the Tax Court in Farhy. Nevertheless, there remains a separate and important issue regarding Chapter 61 IIR penalties that also needs a legislative fix.

Chapter 61 International Information Return Penalties Require Finality

Taxpayers are entitled to finality and a fair and just tax system. Protection of these rights is a bedrock aspect of quality tax administration.
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This blog specifically addresses information reporting penalties in Chapter 61, Subchapter A, Part III, Subpart A (hereafter referred to as Chapter 61 for brevity’s sake).

Taxpayers who receive foreign gifts or control certain foreign corporations and partnerships and fail to file required information returns are subject to penalties under IRC §§ 6038 and 6039 (which are in Chapter 61 of the IRC). IRC § 6038 is one of several code sections that require similar filings and provide for similar penalties for taxpayers with various types of foreign corporations, partnerships, assets, and accounts. These Chapter 61 penalties are peculiar in that each section specifically imposes the penalties but provides no authority to assess and collect the penalties. I raised this concern in my 2020 Annual Report to Congress and recommended that the IRS take steps to protect the government fisc and also taxpayer rights by maximizing taxpayers’ access to administrative and judicial review.

Farhy v. Commissioner
The ability of the IRS to assess a Chapter 61 penalty was recently challenged before the U.S. Tax Court in Farhy v. Commissioner and, in a precedential decision, the court held that the IRS lacks statutory authority to assess and collect penalties under IRC § 6038(b).

In Farhy, the taxpayer had a reporting requirement under IRC § 6038(a) to report his ownership interests in two foreign corporations but failed to file required Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, for multiple tax years. The IRS assessed an initial penalty under IRC § 6038(b)(1) for each year and continuation penalties under IRC § 6038(b)(2). The IRS sought to collect the penalties via levy, and the taxpayer timely filed a petition with the Tax Court challenging the IRS’s authority to assess and attempt to collect via levy.
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