Tax Court reaffirms IRS lack of authority to assess Form 5471 penalties

ARTICLE | December 08, 2024

Authored by RSM US LLP

Executive summary:

In a procedural victory for taxpayers and despite an adverse decision from a federal appeals court, the Tax Court has reaffirmed that the IRS lacks authority to assess penalties under section 6038(b)(1) for failure to file Form 5471. This decision requires the IRS to pursue civil action rather than administrative assessment and collection to enforce this international reporting penalty.

Case Background

In a procedural victory for taxpayers and despite an adverse decision from a federal appeals court, the Tax Court has reaffirmed that the IRS lacks authority to assess penalties under section 6038(b)(1) for failure to file Form 5471. In Raju J. Mukhi v. Commissioner, 162 T.C. No. 8 (Nov. 18, 2024), the Tax Court effectively required the IRS to pursue civil action rather than administrative assessment and collection to enforce this international reporting penalty.

In Mukhi, the taxpayer established three foreign entities between 2001 and 2005, through which he managed several foreign brokerage accounts. After the taxpayer plead guilty in 2014 to filing false U.S. individual tax returns and failing to file required Foreign Bank and Financial Accounts Reports (FBARs), the IRS assessed approximately $11 million in penalties against him. While the Tax Court upheld almost all of these penalties, including $10.9 million under Section 6677 for failure to file Forms 3520 and 3520-A, it maintained that the IRS lacked authority to assess $120,000 under Section 6038(b) for Form 5471 violations.

Jurisdictional implications and enforcement landscape

The significance of the Mukhi decision stems from the Tax Court's national jurisdiction. While the D.C. Circuit reversed a similar holding in Alon Farhy v. Commissioner, 160 T.C. No. 6 (April 3, 2023), that decision is binding only on taxpayers who must litigate in the District of Columbia. Most taxpayers can choose to litigate outside of the D.C. Circuit. Given the broad reach of this decision, the government may appeal.

Looking Forward: Implications for tax practitioners

This decision affects U.S. persons with foreign reporting obligations, who often face substantial penalties for compliance failures. While the $10,000 per year penalty under section 6038(b)(1) remains unchanged, the enforcement mechanism per Mukhi now requires the IRS to pursue civil action rather than administrative assessment. The IRS will likely disagree with the decision in Mukhi and will continue to systemically assess penalties for late filed forms 5471. But this decision remains a hazard of litigation for the IRS.

Section 6038 is part of Subpart A of Part III of Subchapter A of Chapter 61 of Subpart F of the Code. Other penalties in this Subpart A, such as those found in sections 6038A, 6038B, 6038C, 6038D, 6039E, 6039F and 6039G, similarly contain no language which would make them assessable by the Commissioner. Thus, it would not be surprising to see taxpayers facing such penalties argue, that the Commissioner has no authority to collect the penalty without first filing a lawsuit.

The IRS has not issued any administrative guidance on this issue, nor has it yet filed an appeal in the Mukhi case.

Mukhi does not address a taxpayer’s legal liability for the penalties under section 6038(b), only the enforcement mechanisms.