By Anthony Diosdi
Tax practitioners have long known it. Now, many with foreign financial assets are becoming painfully aware of it. The Internal Revenue Service or IRS automatically and systemically assess penalties against individuals and businesses that fail to timely disclose interests in offshore/foreign assets and holdings on Form 3520, Form 3520-A, Form 5471, Form 5472, or Form 8938. Penalties for failing to timely file these information returns can range from $10,000 to several million dollars.The Internal Revenue Code provides the IRS with the discretion to abate or remove an international penalty if a taxpayer acted with “reasonable cause.” Therefore, in theory at least, if an individual or business assessed an international penalty can show the failure to timely file a Form 3520, Form 3520-A, Form 5471, Form 5472, or Form 8938 was the result of reasonable cause, an international penalty should be removed or never assessed in the first place.
The problem is that the IRS is neglecting to review many reasonable cause statements submitted by taxpayers who failed to timely file an international return. This was confirmed by Dan Price, formerly of the IRS Office of Chief Counsel. Dan Price recently spoke at an event sponsored by the San Francisco Tax Club. At this event, Dan Price stated “the IRS is not analyzing reasonable cause when it is attached to a late filing. No IRS person reviews reasonable cause on the front end. They simply see if it’s late. If it’s perceived late, it’s penalized even if you have a beautiful reasonable cause statement attached.”
The IRS’s failure to review and consider reasonable cause statements can be very frustrating for taxpayers assessed international penalties. The situation is not much better with the IRS appeals division assigned the task of settling international penalties. Given the IRS’s heavy handed approach in assessing international penalties and the IRS’s overall “sloppy environment,” many individuals assessed international penalties will be forced to turn to courts to challenge international penalties. Many of these cases will be litigated in either a federal district court or Court of Federal Claims.
The government will probably not have the resources to litigate all these disputes to trial and may attempt to settle a sizable number of these cases. The process involved in settling an IRS penalty assessment is complicated and a discussion regarding the settlement process is beyond the scope of this article.
Once a settlement is reached between the government and an individual challenging a penalty assessment, the parties must ask the court to dismiss the case. The standard practice is for the parties involved in the dispute to file a joint stipulation with the court requesting the case be dismissed. Such joint stipulation is typically done without disclosing the terms of the settlement. Keeping settlements confidential is good public policy. It encourages the government to negotiate settlements with individuals with similar cases. Keeping settlements confidential are also beneficial to the litigants challenging a penalty. These individuals often do not want the details of their financial settlement with the government made public.
Although it may make good sense to keep the details of a settlement confidential, some courts may disagree and order the parties to disclose the terms of the settlement to the court. The terms of the settlement will then become public record. This begs the question, can a federal district court or Court of Federal Claims order the disclosure of the terms of the settlement?
In order to attempt to answer this question we must review the Rules of Federal Civil Procedure and case law. Rule 41(a)(1)(A)(ii) of the Federal Rules of Civil Procedure grants the parties a unilateral right to withdraw a case from a federal court’s consideration. So long as the parties stipulate in writing, they need not explain their reason. In Smith v. Phillips, 881 F.2d 902, 903 (10th Cir. 1989), the Tenth Circuit Court of Appeals considered a district court’s ability to order the disclosure of settlement terms that led to a stipulated dismissal under Rule 41. The Court of Appeals explained that “[a]llowing the district court to force the disclosure of a settlement agreement that was not part of the record or subject to any court order effectively would deprive the parties of their right to unconditional dismissal under Rule 41(a)(1)(ii). This is because Rule 41(a)(1)(ii) does not require the district court to approve the settlement; the settlement need not be filed with the court; and the stipulation need not recite the terms of the settlement. Instead, a voluntary dismissal is self-executing, it is effective at the moment the notice is filed with the court and no judicial approval is required. See De Leon v. Marcos, 659 F.3d 1276, 1283 (10th Cir. 2011). However, in Goodeagle v. United, 145 Fed. Cl. 646 (2019), the trial court declined to keep settlement terms confidential.
Although it appears that the general rule is that federal courts will keep the terms of a settlement confidential, there is no clear consensus in the federal circuits regarding this matter. What all this means is that at this point it is unclear whether a district court or Court of Federal Claims can compel the parties to make settlement terms public.
We have substantial experience advising clients ranging from small entrepreneurs to major multinational corporations in foreign tax planning and compliance. We have also provided assistance to many accounting and law firms (both large and small) in all areas of international taxation.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.
He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.