Relieved Taxpayers: US Tax Court Reaffirms that IRS Cannot Assess Failure-to-file Penalties

Every parent remembers when their child learns the meaning of the word “no.” That moment often comes as a shock because, up until that moment, most children are models of obedience and unconditional trust. When children learn to exercise free will, a more exasperating aspect of parenting opens. One suspects that the US Court of Appeals for the DC Circuit (the “DC Circuit”) had a parallel experience reading the Tax Court’s recent decisions in Mukhi v. Comm’r and in Safdieh v. Comm’r.¹ Taxpayers, however, will welcome the Tax Court’s sticking to its guns. In both Mukhi and Safdieh, the Tax Court followed the Golsen doctrine and declined to follow the appeals court’s decision in Farhy v. Comm’r,² reiterating its position that the Internal Revenue Service (IRS) lacks statutory authority to assess penalties when taxpayers fail to file Forms 5471 with respect to their ownership of stock in non-US corporations (and partnerships).

In Mukhi, the taxpayer formed a non-US corporation in 2001. The taxpayer did not file the required IRS Forms 5471 with his tax returns disclosing his interest in the non-US corporation in any of 2002 through 2013. His failure-to-file appeared to be intentional, as the taxpayer pleaded to guilty criminal tax violations in connection with his operation of the non-US corporation. The IRS then assessed civil failure-to-file penalties against the taxpayer under Code § 6038(b).³ After the taxpayer filed a Tax Court petition asking for penalty abatement, the Tax Court issued its decision in Farhy holding that the IRS lacked statutory authority to assess the failure-to-file penalties. Adhering to its holding in Farhy, the Tax Court granted summary judgment in favor of the taxpayer in Mukhi. Thereafter, the DC Circuit reversed the Tax Court’s holding in Farhy and the IRS filed a Motion for Reconsideration in Mukhi. An appeal by the taxpayer in Mukhi would lie with the Eighth Circuit, not the DC Circuit.

Although the Safdieh decision is scant on the penalty assessment, it is clear that essentially the same facts and results had played out, with respect to the failure-to-file penalty assessment. An appeal in Safdieh would be heard by the Second Circuit. It’s too early to know if the IRS will file an appeal in this case.

The Mukhi opinion recites the tried-and-true rule that the Tax Court adheres to the doctrine of stare decisis and gives precedential weight to its prior opinions. However, when one of their decisions is reversed by an appellate court, the Tax Court will “thoroughly reconsider the problem in light of the reasoning of the reversing appellate court and, if convinced thereby… follow the higher court.”⁴ If the Tax Court remains convinced that their original decision was right, under its Golsen opinion, it will apply its own precedent unless and until the Supreme Court holds otherwise (or additional appellate opinions convince it to change course). Nonetheless, if a case is “squarely on point” with a decision of an appellate court—to which an appeal would lie that contradicts their own precedent—then the Tax Court will follow the appellate court’s decision.⁵ The Tax Court noted that any appeal of their decision in Mukhi would lie in the US Court of Appeals for the Eighth Circuit, which has not yet issued a precedential, published opinion as to whether the Code § 6038(b)(1) penalty is assessable. Therefore, the Tax Court was not bound by the holding of Farhy in deciding Mukhi.

The Tax Court’s reasoning as to why the IRS does not possess the right to assess the failure-to-file penalty contained in Code § 6038(b)(1) was as follows. Code § 6201(a) authorizes and requires the IRS to assess “all taxes (including interest, additional amounts, additions to the tax, and assessable penalties)” imposed by the Code (emphasis added). Code § 6038(b)(1) does not contain language authorizing the IRS to assess the failure-to-file penalty.⁶ The Tax Court contrasted this omission with other penalty provisions that contain explicit language authorizing the IRS to assess a penalty.

Many types of penalties can be assessed after the issuance of a notice of deficiency, which gives a taxpayer the option of challenging the penalty in the Tax Court, but that is not the case with the Code § 6038(b)(1) penalty. The IRS argued to the Tax Court that the penalty would become effectively uncollectible since it was not subject to the notice of deficiency procedure. The Tax Court disagreed. The Tax Court held that the default rules of collection under 28 U.S.C. § 2461(a) must be used to collect the failure-to-file penalty. This rule states that when the mode of recovery is not specified in a statute, the penalty must be sought in a civil action initiated in federal district court. As noted, the Tax Court rejected the IRS’s position that administrative inconvenience of enforcement justifies departing from the statute’s clear text.⁷ As practitioners will immediately recognize, this holding renders the failure-to-file much more burdensome for the IRS to collect.

Take Aways

In our experience, taxpayers may fail to file Forms 5471 for reasons not having to do with an objective to avoid federal income tax. It appears that the Tax Court will adhere to its position that the IRS does not have the authority to assess the failure-to-file penalty unless and until the Supreme Court affirms the holding of Farhy (either in that case or in one raising the same issue). Accordingly, taxpayers facing such proposed assessments—and not residing in states to which an appeal to the DC Circuit lies—should consider challenging the purported assessment by following the post-assessment conference and Tax Court petition procedures followed by the taxpayer in Mukhi.

 

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* Mark Leeds (mleeds@mayerbrown.com (212) 506-2499) and Allison Taylor (ataylor@mayerbrown.com (212) 506-2760) are tax attorneys with the New York office of Mayer Brown. Mark and Allison frequently work with taxpayers facing Internal Revenue Service scrutiny of their tax filings.

¹ Mukhi v. Comm’r, 162 T.C. No. 8 (Nov. 18, 2024) and Safdieh v. Comm’r, Docket No. 11680-20L (Dec. 5, 2024).

² Farhy v. Commissioner, 160 T.C. 399, 403-13 (2023).

³ All “Code §” references are to the Internal Revenue Code of 1986, as amended.

⁴ Lawrence v. Commissioner, 27 T.C. 713, 716-17 (1957).

⁵ See Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 445F.2d 985 (10th Cir. 1971).

⁶ Id. at 7. The IRS noted that the Code § 6038(c) penalty is reduced by any penalty imposed under Code § 6038(b) and if the IRS was required to maintain a separate action for the Code § 6038(b) penalty, it would be precluded from assessing the Code § 6038(c) penalty until the civil action was completed.

⁷ Id. at 18.