Each every so often, a case comes throughout your desk that makes you say, “Whoa.”

Alon Farhy v. Commissioner is simply such a case.

The U.S. Tax Court docket gave Farhy a win, ruling that the IRS couldn’t gather from him on this occasion—the IRS had no statutory authority to evaluate penalties underneath part 6038.

Info

For the tax years 2003 by 2010, Alon Farhy owned 100% of Katumba Capital, Inc., a international company included in Belize. For the tax years 2005 by 2010, Farhy was the the 100% proprietor of Morningstar Ventures, Inc., one other international company included in Belize.

For the years at subject, Farhy had a reporting requirement underneath part 6038(a) to report his possession pursuits in each Katumba Capital and Morningstar Ventures. The requirement usually signifies that taxpayers a lot file Kind 5471, Data Return of U.S. Individuals With Respect to Sure International Firms, to reveal an curiosity or possession in a international company. If a taxpayer doesn’t meet the necessities, part 6038(b) offers for penalties starting at $10,000 per kind per 12 months.

Farhy didn’t report—the Court docket famous that the failure was executed “willfully.”

And so, the IRS assessed penalties underneath part 6038(b)(1) of $10,000 every year. The IRS later assessed continuation penalties underneath part 6038(b)(2) totaling $50,000 for every year at subject. The continuation penalty is $10,000 for every 30 days the taxpayer doesn’t comply after an preliminary 90-day discover interval, topic to a most of $50,000.

When Farhy didn’t pay up, the IRS tried to levy his property.

Arguments

Farhy didn’t dispute that he didn’t file, nor that he had not paid. As a substitute, he challenged whether or not the IRS had the authorized authority to evaluate part 6038 penalties.

One other code part is necessary right here—part 6201(a) authorizes and requires the Secretary of Treasury to make assessments of all taxes, together with curiosity, extra quantities, additions to tax, and assessable penalties. The Secretary delegated these duties to the IRS.

Right here’s the place phrases matter. The IRS contended that the time period “assessable penalties” consists of any penalties discovered within the Code that aren’t topic to the Code’s deficiency procedures. The IRS additionally argued that “taxes” in part 6201 is broad sufficient to incorporate part 6038 penalties. They additional claimed that the legislative historical past supported this place.

The Court docket disagreed.

It’s necessary to grasp the excellence at play right here. When a tax—together with a further quantity, addition to tax, assessable penalty, or curiosity—is assessed, the IRS might take sure actions to gather the tax administratively—that’s clear from the statute. That may embrace levies, as was tried right here.

Findings

The time period “assessable penalties” is essential. The Tax Court docket agreed that “assessable penalties” as utilized in part 6201(a) just isn’t restricted to penalties present in subchapter B of chapter 68 of subtitle F (really titled “Assessable Penalties”), however that doesn’t imply, the Court docket mentioned, that it doesn’t robotically apply to all penalties within the Code not topic to deficiency procedures. In different phrases, “assessable penalties” just isn’t a time period used to differentiate between penalties topic to deficiency procedures and people that aren’t.

Additional, the Tax Court docket discovered that Congress explicitly approved evaluation for “myriad penalty provisions within the Code” (citing, amongst different issues, penalties underneath sections 6671-6725 and sections 6651-6751)—however not for part 6038(b) penalties.

The query then wasn’t whether or not the penalties have been included within the statute (they’re) however whether or not the IRS can assess and gather these penalties by administrative means. The Tax Court docket didn’t purchase the IRS’ argument that it has the authority to levy these penalties systematically, nor that the company didn’t must take extra steps, equivalent to civil litigation, to gather. “Merely put,” the Court docket wrote, “whereas part 6038(b) offers for penalties, it doesn’t present for assessable penalties.”

The Court docket additional famous it was “loath to disturb this well-established statutory framework by inferring the facility to administratively assess and gather the part 6038(b) penalties when Congress didn’t see match to grant that energy to the Secretary of the Treasury expressly because it did for different penalties within the Code.”

Shifting Ahead

That signifies that, whereas the federal government might be able to gather liabilities for these penalties by a civil motion underneath part 2461(a), the IRS might not assess or administratively gather these penalties. It’s necessary, because the Court docket made clear, that the holding right here issues solely the relevant method of assortment for part 6038(b) penalties.

This doesn’t imply that taxpayers should not have an obligation to file Kind 5471—or every other kind. Once more, this case is targeted on process and collections.

Farhy might have received in Tax Court docket, however the matter isn’t totally resolved for different taxpayers. It’s unclear whether or not the IRS will enchantment (I might anticipate them to) and, in that case, how lengthy which may take. It’s additionally not sure how this ruling may influence taxpayers in any other case topic to part 6038. We’ll probably see this—or associated points—again in Court docket quickly.