June 25, 2024

D.C. Circuit Lets Stand its Decision Allowing IRS to Assess International Information Return Penalties

By David Shuster, Partner, Tax & Business Services

D.C. Circuit Lets Stand its Decision Allowing IRS to Assess International Information Return Penalties International Tax

The District of Columbia Circuit Court of Appeals let stand its recent ruling that could have wide-ranging implications for enforcing IRS collection of penalties on international information reporting. On June 13, 2024, the court denied the taxpayer’s requests for panel and full court rehearing of the court’s earlier decision from May 2024 in the case of Farhy v. Commissioner of Internal Revenue (CIR). This decision reversed a previous determination by the Tax Court, effectively granting the IRS the authority to administratively assess and collect Form 5471 category 4 and 5 penalties.

Originally, the Tax Court had ruled in favor of the taxpayer, asserting that the IRS lacked the statutory authority to assess and thereafter administratively collect such penalties. Under the Tax Court’s determination, the IRS would first have to engage the Department of Justice (DOJ) to initiate legal action against the taxpayer and obtain a court judgment before enforcing collection.

The implications of the Tax Court’s analysis were far-reaching, suggesting that penalties related to Forms 5472, 8938, 926, and 8865 (categories 1, 2, and 3) might also be shielded from direct assessment by the IRS, necessitating DOJ litigation for enforcement. The D.C. Circuit’s analysis of the issue, however, seemingly opens the door for the IRS to potentially assess penalties on Form 8938 and Form 8865 (categories 1 and 2) without a court’s prior approval. Its analysis, however, leaves open whether the IRS would still need DOJ action for violations involving Forms 5472, 926, and 8865 (category 3).

The backdrop to this legal saga includes the Tax Court’s affirmation in the case of Mukhi v. CIR on April 8, 2024, which reinforced its original stance in Farhy before being reversed by the D.C. Circuit. With Mukhi appealable to the 8th Circuit, an inter-circuit conflict looms should the 8th Circuit rule inconsistently with the D.C. Circuit—if the government appeals the Mukhi decision.

For the moment, the Tax Court’s decisions in both Farhy and Mukhi continue to serve as a valuable precedent for taxpayers outside the D.C. Circuit. This ongoing legal tension underscores the evolving landscape of the IRS’s administrative penalty enforcement and serves as a critical point of interest for both taxpayers and tax professionals.