In Mukhi v. Commissioner, 163 T.C. No 8 (slip op.) (Nov. 18, 2024), the U.S. Tax Court reaffirmed its decision in Farhy v. Commissioner, 160 T.C. 399 (2023) that the IRS lacks authority to assess a penalty for failure to file Form 5471.
The U.S. Tax Court held in Mukhi v. Commissioner, 163 T.C. No. 8 (slip op.) (Nov. 18, 2024) that the IRS does not have the authority under IRC Section 6038(b)(1) to assess a penalty for failure to file Form 5471 (Information Return of U.S. Persons With Respect To Certain Foreign Corporations) and to administratively collect it, reaffirming its prior decision with respect to the same issue in Farhy v. Commissioner, 160 T.C. 399 (2023). Instead, the IRS may collect the penalty through a civil action in a district court by referring the case to the U.S. Department of Justice, which must sue and obtain judgment in a federal district court before the penalty can be enforced.
Background
In Mukhi, a taxpayer failed to file timely Forms 5471 from 2002 through 2013 tax years. The IRS assessed penalties for failure to file Form 5471 under IRS Section 6038(b)(1) and initiated collection actions. After the taxpayer received the IRS Notice of Determination not in his favor, which resulted from the Collection Due Process Hearing, he timely filed a petition to the U.S. Tax Court asking for review of the Notice of Determination.
The Tax Court ruled in favor of the taxpayer based on its reasoning in Farhy v. Commissioner, 160 T.C. 399 (2023). After the Tax Court granted a summary judgment in favor of the taxpayer, the D.C. Circuit reversed the Tax Court’s decision in Farhy v. Commissioner, 160 T.C. 399 (2023), and concluded that the IRS has authority to assess the penalty under IRC Section 6038(b)(1). Afterwards, the IRS filed the Motion for Reconsideration of Findings or Opinion requesting reconsideration of the Tax Court opinion in the light of the U.S. Court of Appeals for D.C. In turn, the taxpayer filed a Response to Motion for Reconsideration of Findings or Opinion.
Tax Court Reasoning
In Mukhi,the Tax Court reaffirmed its decision in Farhy v. Commissioner, 160 T.C. 399 (2023) that the IRS lacks authority to assess a penalty for failure to file Form 5471 under IRC Section 6038(b)(1) and disagreed with the D.C. Circuit decision in Farhy v. Commissioner, 100 F.4th 223 (D.C. Cir. 2024), which ruled in favor of the IRS on the same issue.
1. Plain Text Statute Interpretation and Legislative History
In its decision, the Tax Court relied on the plain text of the statute interpretation of IRC Section 6038(b)(1) and rejected the IRS argument that the IRS has authority to assess discussed penalties under IRC Section 6201(a) by reaffirming its prior decision that the IRS’s interpretation of the statute was too broad. Under IRC Section 6201(a), the IRS has authority to assess “all taxes (including interest, additional amounts, additions to the tax, and assessable penalties).” The Tax Court’s reasoning is that the taxes and penalties are two distinguished categories of the exactions, and if Congress intended that all exactions, including penalties, were to be assessable by the IRS, then the adjective “assessable” would not be necessary in the language of the statute. The Tax Court also determined that there is no need to consider legislative history to interpret the intent of Congress because “the text of the statute is clear” and that “nothing in the text of section 6038(b)(1) expressly authorizes the IRS to assess the IRC Section 6038(b)(1) penalty.”
2. Interaction between 6038(b) and 6038(c)
The Tax Court also rejected the IRS’s arguments regarding the interaction between IRC Section 6038(b)(1) and IRC Section 6038(c) by taking the position that the text of the statute is clear.
3. Reasonable cause
The Tax Court also disagreed with the IRS argument that holding the IRC Section 6038(b)(1) penalty as not assessable prevents the IRS from determining whether a taxpayer meets the reasonable cause exception under IRC Section 6038. The Court stated that, “there is nothing in the statute text that demands the IRS make the reasonable cause determination after assessment of the penalty.”
4. Administrative Burden
Additionally, the Tax Court disagreed with the IRS’s argument that if the IRS cannot assess automatically and cannot collect the IRS Section 6038(b)(1) penalty administratively, it imposes a significant burden on the IRS in collecting penalties, given that the IRS will need to collect the IRC Section 6038(b)(1) penalty through a civil action in a district court by referring the case to the U.S. Department of Justice, and it will create separate proceedings for the IRC Section 6038(c). The Tax Court takes the position addressed in its prior decisions that the IRS administrative inconvenience never justifies departing from the statute’s clear text. The Tax Court clarified that the IRS has to go through lengthy deficiency procedures even if the IRS has authority to assess and collect penalties administratively.
Key Takeaway
Taxpayers should continue monitoring the legal development of the IRS’s authority to assess a penalty for failure to file Form 5471 under IRC Section 6038(b)(1), given that the IRS authority is unsettled. If the IRS appeals Mukhi v. Commissioner to the U.S. Court of Appeals for the 8th Circuit, and the Court rules in favor of the IRS, this will create a split circuit and will likely result in review of the IRS authority in the Supreme Court.