Citing a fuzzy definition, the American Tax Court holds that the IRS lacks authority to assess and collect after an owner of foreign companies fails to file or pay penalties. How will this play out in future cases?
The U.S. Tax Court, in Farhy v. Commissioner, has distinguished between a penalty that the IRS is authorized to issue and a penalty that has been properly assessed.
For the tax years 2003 through 2010, Alon Farhy owned 100% of Katumba Capital Inc., a foreign corporation incorporated in Belize. For the tax years 2005 through 2010, Farhy was 100% owner of Morningstar Ventures Inc., also a foreign corporation incorporated in Belize.
Farhy had a reporting requirement under Section 6038(a) to report his ownership interests in both companies: Taxpayers must usually file Internal Revenue Service Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations,” to disclose interest or ownership in a foreign corporation. Failure to do incurs penalties starting at $10,000 per form per year.
During the years at issue, Farhy participated in an illegal scheme to reduce the amount of income tax that he owed and, in February 2012, signed an affidavit describing his role in that scheme. He was granted immunity in a non-prosecution agreement that he signed that September. Four years later, the IRS notified Farhy of his failure to file the 5471s; the Tax Court has acknowledged that Farhy’s failure to file was willful and not due to reasonable cause.
In late 2018, the IRS assessed an initial penalty (under Internal Revenue Code Sec. 6038(b)) of $10,000 for each year at issue and continuation penalties totaling $50,000 per year. The IRS did comply with the written supervisory approval requirements for the penalties. A few months later, the IRS levied to collect the penalties.
Goldberg v. Comm’r, T.C. Memo. 2021-119 | October 19, 2021 | Paris, J. | Dkt. No. 12871-18L
Short Summary: Mr. Goldberg was an investor and partner in two oil and gas partnerships. The two partnerships were subject to TEFRA audits, and the IRS timely assessed taxes and penalties related to the TEFRA audits against Mr. Goldberg. Later, the IRS issued notices of federal tax lien (NFTL) with respect to the taxes and penalties. Mr. Goldberg failed to timely challenge the NFTL. Later, after the IRS issued a notice of intent to levy, Mr. Goldberg timely filed a request for a Collection Due Process (CDP) hearing. During the CDP hearing, Mr. Goldberg challenged the amount of taxes and penalties that he owed.
- Whether Mr. Goldberg is prohibited from challenging his underlying tax liabilities in the CDP hearing?
When I was a kid we lived across the street from the Wolfermans. The Wolfermans got a dog. One day I was in my yard, and their dog was barking. Mr. Wolferman came out, clapped his hands and called the dog. The dog joyfully bounded to Mr. Wolferman. Mr. Wolferman then proceeded to spank the dog, apparently for barking. I remember thinking what a fool Mr. Wolferman was for doing that – the dog would never come to him again when called.
A couple of weeks ago I described the traumatic experience of a client who had received a $10,000 penalty notice from the IRS for a completely invalid purpose. As the owner of a foreign trust, my client had done all she could have done to comply with the filing requirements of a foreign trust owner. She was compliant, yet was slapped with a $10,000 penalty. See Foreign Trusts: IRS Penalty Notices For Late Forms 3520-A Traumatize Many Innocent Taxpayers!
Since then, I have learned firsthand of dozens of similar notices, and I suspect there have been thousands issued for the same invalid purpose. Then, this week, another client contacted me about receiving the exact notice under the exact circumstances.
Below is the letter I wrote to the IRS on behalf of the client who received the latest notice. The recipients of these notices represent foreign trust owners who are doing their best to obey the law (the Wolfermans’ dog) only to be punished by a formidable but misguided tax collection agency (Mr. Wolferman). Would one blame the dog for wandering off to find someone kinder and wiser to pledge allegiance to (as in expatriation)?
IRS penalty relief brings big business opportunities for astute tax practitioners as the IRS does indeed have the authority to provide relief from various penalties if you know how to do the dance.
In 2014 the IRS abated either in part or in full approximately 12.3% of the 40.3 million penalties issued reducing penalty assessments paid by US Taxpayers up to $9.8 billion.
According to the IRM, relief from penalties can fall into one of four separate categories.
- Reasonable cause.
- Statutory exceptions.
- Administrative waivers.
- Correction of IRS error.
This post drills down into Reasonable Cause. The IRS bases reasonable cause on all the facts and circumstances of each individual case file and it allows for relief of penalties as per IRM 22.214.171.124.2.
The IRS grants reasonable cause relief when you exercised ordinary business care and prudence in determining your tax obligations but nevertheless were unable to to timely comply with those obligations.
IRS Policy Statement 3-2 provides a very limited list of ’causes’ which can be ‘reasonable’ for late filing of a return or failure to deposit or pay tax when due (IRM 126.96.36.199.2).
Examples of sound causes for delay which can be accepted as reasonable cause include: