By Anthony Diosdi
Recently the United States Tax Court held in Alon Farhy v. Commissioner of Internal Revenue, that the Internal Revenue Service or (“IRS”) lacked the authority to assess certain penalties against taxpayers under Internal Revenue Code Section 6038(b). In Farhy the petitioner was required to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, but he did not. The penalty for failure to file, or for delinquent, incomplete, or materially incorrect filing is a reduction of foreign tax credits by 10% and a penalty of $10,000. An additional $10,000 continuation penalty may be assessed for each 30-day period that noncompliance continues up to $50,000 per return. See IRC Section 6038(b) and (c). The IRS assessed penalties against the petitioner under Section 6038(b) of the Internal Revenue Code. The Tax Court determined that there is no law giving the IRS authority to assess penalties under Section 6038(b). For reasons discussed in this article, the IRS also lacks the authority to assess Section 6039F penalties associated with the failure to timely file a Form 3520.
IRS’s Assessment Authority of Penalties
Section 6201(a) authorizes and requires the Secretary of the Treasury to make assessments of all taxes, interest, additions to taxes, and assessable penalties imposed by the Internal Revenue Code. The Secretary of the Treasury has delegated these duties to the Commissioner of the Internal Revenue, who has delegated them in turn to other IRS officials. When a tax, interest, or assessable penalty is assessed, the IRS may take certain actions to collect the tax administratively through means such as liens and levies. If there is no law giving the IRS the authority to assess a penalty, the IRS’s only recourse to collect the penalty would be to ask the Department of Justice to sue the individual or entity assessed the penalty. This would involve bringing suit in a United States district court with proper venue and asking the court to liquidate the penalty assessment into a judgment. See IRC Section 2461(a).
The Section 6039F Penalty and the IRS’s Authority to Collect a Section 6039F Penalty
Section 6039F of the Internal Revenue applies to U.S. persons (other than certain exempt organizations) that receive large gifts (including bequests) from foreign persons. The Section 6039F reporting provisions require U.S. donees to provide information concerning the receipt of large amounts that the donees treat as foreign gifts, giving the IRS an opportunity to review the characterization of these payments and determine whether they are properly treated as gifts. Donees are currently required to report certain information about foreign gifts on Part IV of Form 3520.
Section 6039F(b) generally defines the term “foreign gift” as any amount received from a person other than a U.S. person that the recipient treats as a gift or bequest. However, a foreign gift does not include a qualified transfer (within the meaning of Section 2503(e)(2)) or any distribution from a foreign trust. A distribution from a foreign trust must be reported as a distribution under Section 6048(c) and not as a gift under Section 6039F. Section 6039F(c) provides that if a U.S. person fails, without reasonable cause, to report a foreign gift as required by Section 6039F, then 1) the tax consequences of the receipt of the gift will be determined by the Secretary and 2) the U.S. person will be subject to a penalty equal to 5% of the amount for the gift for each month the failure to report the foreign gift continues, with the total penalty not to exceed 25% of such amount. Under Sections 6039F(a) and (b), reporting is required for aggregate foreign gifts in excess of $100,000 during a taxable year. Once the $100,000 threshold has been met, the U.S. donee is required to file Form 3520 with the IRS.
The IRS treats Section 6039F penalties as summarily assessable, as they are not subject to the deficiency procedures, wherein taxpayers receive a notice of deficiency alerting them of the potential assessment and explaining the taxpayer’s options for contesting or complying with the penalty assessment. The notice of deficiency also informs taxpayers of the last day to petition the Tax Court for pre-assessment and prepayment judicial review.
Many penalties related to income tax filings are not summarily assessable (that is, they are generally subject to deficiency procedures). For example, deficiency procedures typically apply when the IRS determines noncompliance of a taxpayer resulting in an underpayment of some type of tax. Common penalties associated with the issuance of a notice of deficiency include an accuracy or negligence penalty under Section 6662.
Summarily assessable penalties are primarily found in Section 6671 through 6720C. Chapter 68, Subchapter B, titled “Assessable Penalties,” authorizes the IRS to assess and collect penalties “in the same manner as taxes” without first sending a notice of deficiency. Summary assessments are made without the issuance of a notice of deficiency and “shall be paid upon notice and demand and collected in the same manner as taxes.” Most of these “penalties” are included in Chapter 68 of the Internal Revenue Code. Chapter 68, Subchapter A, titled “Additions to the Tax and Additional Amounts,” allows the IRS to impose penalties for failure to file or pay taxes, understatements or underpayments of tax, and penalties for fraud. However, Chapter 61 penalties are not located in Chapter 68 of the Internal Revenue Code and are not therefore assessable penalties.
The IRS believes it has a grant of authority to assess Section 6039F penalties under Section 6201(a). As discussed above, this provision of the Internal Revenue Code permits the IRS to assess tax as well as interest and penalties. In NFIB v. Sebelius, 567 U.S. 519, 546 (2012), the U.S. Supreme Court agreed that the plain language of Section 6201(a) places within the definition of tax for the purpose of granting the IRS the authority to assess Section 6039F. The IRS’s interpretation of Section 6201(a) is overbroad and misplaced.The term “assessable penalties” used in Section 6201 does not automatically apply to all penalties in the Internal Revenue. The term taxes and penalties are distinct categories of exactions, at least in the absence of a provision treating them as the same. See Grajales v. Commissioner, 156 T.C. 55, 61 (2021). The Internal Revenue Code contains many provisions treating taxes and assessable penalties as distinct terms…There would, for example, be no need for Section 6671(a) to deem ‘tax’ to refer to certain assessable penalties if the Internal Revenue Code already included all such penalties in the term ‘tax.’ See Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519, 546 (2012). Thus, the term “taxes” in Section 6201(a) cannot encompass Section 6039F penalties.
Internal Revenue Code Section 6039F Does Not Contain an Express Provision, Cross Reference to, or is Otherwise Covered by the Penalty Provisions With Chapter 68, Subtitle F
In determining the term “assessable penalties” and holding that the Section 6038(b) penalty (located outside Chapter 68 Subtitle F) was not subject to the IRS’s assessment authority under Section 6201(a), the Tax Court in Farhy compared Section 6038(b) to penalty code sections outside Chapter 68, Subtitle F. The Tax Court in Farhy noted that code sections outside Chapter 68 of Subtitle F whose violations the Internal Revenue Code specifically penalizes, commonly contained a reference to the treatment of the assessable penalty in one of three ways:
1) The statute contains their own express provision specifying the treatment of penalties as a tax or an assessable penalty for purposes of assessment and collection (e.g. See IRC Section 527(j)… “1) Penalty for failure….For purpose of Subtitle F, the amount imposed by this paragraph shall be assessed and collected in the same manner as penalties imposed by Section 6652(c);” IRC Section 5684(b)… “(b) Applicability of Section 6665. – The penalties imposed by subsection (a) shall be assessed, collected, and paid in the same manner as tax, as provided in Section 6665(a);” See IRC Section 5751 “(e) Applicability of Section 6665 – The penalties imposed by subsections (b) and (c) shall be assessed, collected, and paid in the same manner as taxes, as provided in Section 6665(a).
2) The statute contains a cross reference to a provision within Chapter 68 of Subtitle F providing a penalty for their violation, (e.g. IRC Section 1275(c)(4) “(4) Cross reference – For civil penalty for failure to meet requirements of this subsection, see Section 6706. See IRC Section 6033(o), “(o) Cross reference – For provisions relating to penalties for failing to file a return required by this section, See Section 6652(c).”
3) The statute is expressly covered by a penalty provision within Chapter 68 of Subtitle F (e.g. See IRC Sections 6652(c) (Failure to file certain information returns, registration statements); 6674 (Fraudulent statement or failure to furnish statement to employee); 6677 (Failure to file information with respect to certain foreign trusts)).
In comparison, Section 6039F contains no mention- either by express provision, cross-reference, or otherwise- to the treatment of the penalty. Furthermore, Section 2461(a) expressly provides that “[w]henever a civil fine, penalty or pecuniary forfeiture is prescribed for the violation of an Act of Congress without specifying the mode of recovery or enforcement thereof, if may be recovered in a civil action. The Section 6039F penalties were enacted by Section 1905 of the 1996 Tax Act. However, there is no mode of recovery or enforcement specified for Section 6039F penalties.
Section 6039F is Devoid of any Statutory ‘Connectors’ to Chapter 68 Subtitle F
In holding that the IRS lacked statutory authority under Section 6201(a) to assess the Section 6038(b) penalty, the Tax Court in Farhy drew a contrast to Section 6038(b) which contains none of the three “connectors” (discussed above) to Chapter 68 of Subtitle F, stating, “In contrast, Section 6038 contains only a cross-reference to a criminal penalty provision, Internal Revenue Code Section 7203. Internal Revenue Code Section 6039F mirrors Internal Revenue Code Section 6038(b). Both statutes are devoid of any express provision or cross-reference to a statute specifying the treatment of the penalty as a tax or assessable penalty. Unlike the myriad of other penalties in the Internal Revenue Code, both Internal Revenue Code Sections 6038(b) and 6039F provide no mode of recovery or enforcement. Given the foregoing, the IRS clearly lacks statutory authority to proceed with the assessment and the collection of a Section 6039F penalty.
Conclusion
Challenging the IRS’s statutory authority to assess penalties provided by Section 6039F is a very powerful defense that can be raised in an appeals conference, collection due process hearing, or in refund litigation. However, challenging the IRS’s statutory authority to assess a 3520 penalty must be timely and correctly raised. If a challenge to the IRS’s statutory authority to assess a Section 6039F penalty is not timely and correctly raised, this defense could be forever waived.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on providing tax planning domestic and international tax planning for multinational companies, closely held businesses, and individuals. In addition to providing tax planning advice, Anthony Diosdi frequently represents taxpayers nationally in controversies before the Internal Revenue Service, United States Tax Court, United States Court of Federal Claims, Federal District Courts, and the Circuit Courts of Appeal. In addition, Anthony Diosdi has written numerous articles on international tax planning and frequently provides continuing educational programs to tax professionals. Anthony Diosdi is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.