Tax Notes reporter Andrew Velarde discusses the penalty dispute in Farhy v. Commissioner and the case’s implications for different penalties and future refund selections.

This transcript has been edited for size and readability.

David D. Stewart: Welcome to the podcast. I am David Stewart, editor in chief of Tax Notes Immediately Worldwide. This week: no penalty on the play.

There’s been an issue of late over when and the way the IRS can require taxpayers to pay penalties for some violations. This concern lately made its technique to the Tax Court docket the place a taxpayer efficiently pushed again on the IRS’s interpretation of its authority.

So what does this case imply, and the place do issues go from right here?

Right here to speak extra about that is Tax Notes senior authorized reporter Andrew Velarde.

Andrew, welcome again to the podcast.

Andrew Velarde: Thanks, Dave. It is good to be right here.

David D. Stewart: Now, earlier than we get into the specifics of the case that we’re speaking about, may you inform us concerning the penalty concern extra broadly?

Andrew Velarde: Positive. It mainly boils down as to if the IRS has evaluation authority over worldwide info return penalties.

Let me stage set right here. Some penalties below the code are topic to deficiency procedures. For these, the IRS should concern a discover as deficiency, and the taxpayer can petition the Tax Court docket for evaluate of the penalty earlier than they must pay it. Some penalties below chapter 68 of the code are assessable penalties, penalties that aren’t topic to note of deficiency. For these penalties, taxpayers should pay the penalties earlier than they’ll get judicial evaluate in district courtroom or the Court docket of Federal Claims.

David D. Stewart: OK, so we’ve got these two classes with completely different procedures. So why is there confusion? Why is there controversy right here?

Andrew Velarde: For years the IRS has been partaking in systemic and abstract evaluation of worldwide info return penalties after returns are filed late. Practitioners have been complaining concerning the operation of this method for years, arguing that they can not avail themselves of deficiency procedures and that a lot of their shoppers could have cheap trigger to excuse nonfiling.

These cheap trigger statements are going unread by the company, no less than initially, and for a number of years the taxpayer advocate has recognized the evaluation of penalties below part 6038 and 6038A as probably the most severe issues taxpayers encounter and that systemic assessments of those penalties are legally unsupportable. Their phrases.

It has beneficial laws that may topic these reporting penalties to deficiency procedures. Now, simply as an apart, part 6038 and 6038A take care of info reporting associated to overseas companies and partnerships, and people sections are discovered below chapter 61 of the code.

David D. Stewart: All proper, so inform us about this case that simply got here up within the Tax Court docket.

Andrew Velarde: Positive. It is Farhy v. Commissioner. Resolution was handed down simply final month. As I discussed, although, this concern has been on the market for some time.

In Alon Farhy’s case, he managed to boost solely this concern earlier than the Tax Court docket so {that a} Tax Court docket reply as to if the IRS may use its evaluation powers for part 6038 penalties was unavoidable in any choice it handed down. Farhy’s case concerned the failure to well timed file Kind 5471 for his Belize overseas companies, for which he was assessed $60,000 in penalties per yr from 2003 by way of 2010.

At its core, the argument from the taxpayer may be very easy and easy. As Farhy’s lawyer, Ed Robbins, succinctly summarized to me final fall once I first spoke about this case with him, it boils all the way down to, “If it ain’t within the code, it do not exist.”

Farhy did not argue that his penalties had been topic to deficiency procedures since part 6038 shouldn’t be topic to these related code provisions. However, he additionally identified that abstract evaluation penalties are in chapter 68 of the code, and there’s no corresponding authority within the code for evaluation of part 6038 penalties.

He argued that with out evaluation or deficiency procedures, the IRS wanted to ask the Justice Division to cut back the penalties to judgment for assortment by way of a district courtroom motion. This may be comparable to what’s finished within the case for overseas checking account reporting penalties.

The federal government, however, argued that assessable penalties are any penalties within the code not topic to deficiency procedures, and nothing in part 6201 associated to the IRS’s evaluation authority restricted it to chapter 68 penalties.

For the federal government, it basically grew to become an either-or proposition between assessable penalties and people topic to deficiency procedures. It additionally argued that the time period “taxes,” discovered below part 6201, ought to be learn broadly sufficient to use to part 6038 penalties.

David D. Stewart: All proper, so this went earlier than the Tax Court docket, and the way did they interpret this?

Andrew Velarde: Positive. Properly, the Tax Court docket rejected the federal government’s view, with Decide Paige Marvel noting that Congress had been particular about evaluation authority in different contexts. I need to quote from the courtroom right here as a result of I feel that is good language: “Congress has explicitly licensed evaluation with respect to myriad penalty provisions within the code, however not for part 6038(b) penalties. We’re loath to disturb this well-established statutory framework by inferring the ability to administratively assess and gather the part 6038(b) penalties when Congress didn’t see match grant that energy to the Secretary of Treasury expressly because it did for different penalties within the code.”

The courtroom has additionally held that the time period “assessable penalties” doesn’t robotically apply to all penalties not topic to deficiency procedures, basically rejecting the federal government’s either-or proposition.

David D. Stewart: That appears to be a reasonably thorough rejection of the IRS’s interpretation right here. So how vital does it appear like this will probably be?

Andrew Velarde: In accordance with many practitioners I’ve spoken with about this, very vital, assuming after all it’s upheld. There may be going to be lots of litigation on this — and lots of taxpayers affected by the fallout from it, presumably numbering within the hundreds.

First, you could have lots of Kind 5471 filers that may very well be affected. That is the identical type at concern in Farhy. Some practitioners are advising their shoppers seeking to make the most of the choice to file protecting declare for refund earlier than the two-year statute of limitations for such claims expires.

However there are considerations from practitioners that the IRS could possibly preserve penalty cash already collected with invalid assessments because the IRS could argue that the declare itself shouldn’t be invalid, and a few practitioners suppose that the federal government could take no motion on refund claims. If the taxpayer information swimsuit, the federal government could counterclaim for the penalty.

Outdoors the code is 28 U.S.C. part 2462. It is a common statute of limitations provision, and it states {that a} swimsuit to implement penalties should be commenced inside 5 years from the date a declare accrued. That might loom massive within the authorities’s capability to carry fits to gather illegally assessed penalties since many of those penalties have been at IRS appeals for longer than that time-frame.

Some practitioners are arguing the federal government ought to abate penalties equally assessed that aren’t below chapter 68, which are actually at Appeals. Others have beneficial taxpayers amend abatement requests or refunds claims now being thought-about by the IRS in order that they particularly point out the Farhy choice.

Now, to go just a little past 5471s, you could have many different worldwide info return penalties that the logic of the choice from Farhy may likewise be utilized to, since there isn’t any express evaluation authority within the code for them.

So simply to run down a listing of those proper now, you could have Kind 5472, “Data Return of a 25 % International-Owned U.S. Company or International Company Engaged in a U.S. Commerce or Enterprise”; Kind 8865, “Return of U.S. Individuals With Respect to Sure International Partnerships”; Kind 8938, “Assertion of Specified International Monetary Belongings”; Kind 926, “Return by a U.S. Transferor of Property to a International Company”; Kind 8858, “Data Return of U.S. Individuals With Respect to International Disregarded Entities”; and Kind 8854, “Preliminary and Annual Expatriation Assertion.”

Some practitioners have additionally argued the choice may very well be utilized to Kind 3520, “Annual Return to Report Transactions With International Trusts and Receipt of Sure International Presents.”

David D. Stewart: Now, provided that there appears to be a major amount of cash concerned right here — you talked about Farhy alone has a reasonably large quantity of penalties that had been at concern. Is there any sense of how this might finally get resolved?

Andrew Velarde: It is a good query, Dave. I feel there’s lots of uncertainty at this level. However first, everybody I’ve spoken with about this case expects an attraction. I have never gotten the IRS on the file, however each practitioner and skilled I’ve spoken with on this expects an attraction from this case. The stakes are simply too excessive for the IRS to not attraction. Within the meantime, a former IRS official advised me that he expects that for instances pending evaluate by IRS Appeals, Farhy is not going to be seen as controlling regulation but.

Secondly, whereas it is by no means a good suggestion to guess on laws with a divided Congress, that may be a risk. Any laws probably would not have an effect on refund claims since that may be ruled by the regulation that existed when the penalties had been assessed.

Following the choice in Farhy, the nationwide taxpayer advocate (NTA), Erin Collins, reiterated her place that Congress ought to take up laws to make worldwide info returns topic to deficiency procedures. It isn’t only a authorized level for the NTA, but additionally a problem of useful resource administration.

They offered some numbers right here that I feel are attention-grabbing. Over nearly the final decade the IRS has assessed almost 10,000 part 6038 penalties per yr, with a median abatement charge of 69 p.c per yr. Put one other method, $281 million of the $354 million in penalties was abated throughout that point. This charge of abatement was far increased than the abatement of manually assessed penalties.

And not using a legislative repair, and if the choice is upheld on attraction, then you could have the very actual prospect that the federal government would wish to begin a swimsuit to cut back a declare to judgment for these penalties. That will require a referral from the IRS to chief counsel and from chief counsel to the Justice Division Tax Division. That may very well be a major burden on the federal government going ahead. Within the phrases of Erin Collins in a current weblog submit, “The scenario cries out for a congressional repair.”

David D. Stewart: Properly, all proper, I assume there’s going to be loads to observe right here. We have got the attraction, we have the potential for congressional motion on this. Andrew, thanks very a lot for being right here.

Andrew Velarde: Thanks, Dave. It has been nice.