April 5, 2023

Refund Opportunity: US Tax Court Rules Against IRS on International Tax Penalties

By David Shuster, Partner, National Leader - Tax Controversy

Refund Opportunity: US Tax Court Rules Against IRS on International Tax Penalties International Tax

If you recently paid certain penalties in connection with IRS Forms 5471, 5472, 8938, or 926, is there an opportunity for a refund following the United States Tax Court’s decision in Farhy v. CIR (April 3, 2023)?

In that case, the Court determined that the noncompliance penalties applicable to Form 5471 category 4 and category 5 filers are not assessable penalties. What this means is that the IRS cannot assess the penalties and thereafter proceed with administrative collection activity. The Court’s reasoning and analysis would apply equally as well to penalties associated with Forms 5472, 8938, 926 and, in certain instances, Form 8865. The IRS apparently would have to request the US Justice Department to sue taxpayers in federal district court to reduce the penalties to judgment to collect on them.

The Tax Court’s reasoning and analysis, however, would not apply to the noncompliance penalties associated with Form 5471 category 2 and category 3 filers, or Forms 3520 and 3520-A, nor, in certain instances, Form 8865. Thus, the Court’s decision in Farhy would not provide a basis for halting administrative collection of penalties summarily assessed where those forms or instances are involved.

The IRS is likely to appeal the decision. In the meantime, however, should refund claims be considered if you have paid these penalties without the Justice Department first having the penalties reduced to judgment?

While there is authority that a refund may be issued for tax paid following an invalid assessment, see, e.g., United States v. Yellow Cab Co., 90 F.2d 699 (7th Cir. 1937), ultimately, as a practical matter, a taxpayer must prove that there is an overpayment before a refund is authorized. The IRS might believe it is entitled to retain payments received for penalties as to which there is no dispute about the merits of their imposition. See Lewis v. Reynolds, 284 U.S. 281 (1932).

For additional information, contact Dave Shuster, Marcum’s National Leader for Tax Controversy, at [email protected], or your Marcum international tax professional.