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Is the Statute of Limitation for IRS Assessed Foreign Information Reporting Penalties for Collections Five or Ten Years?

Is the Statute of Limitation for IRS Assessed Foreign Information Reporting Penalties for Collections Five or Ten Years?

By Anthony Diosdi


Penalties for failing to timely file foreign information returns such as Form 3520, Form 5471, and Form 5472 with the Internal Revenue Service or IRS can be serious. Penalties for failing to timely file a foreign information return can range from a minimum of $10,000 to several million dollars. The authority to assess most international penalties can be found in Sections 6038 and 6039 of the Internal Revenue Code. Originally, these penalties were assessed manually against taxpayers during an audit. However, beginning January 1, 2009, the IRS began systematically assessing monetary penalties for failing to disclose interests in offshore/foreign assets and holdings on a foreign information return.

The IRS treats international penalties as summarily assessable, as they are not subject to deficiency procedures, wherein individuals 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 United States 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 resulted 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 of the Internal Revenue Code. In other words, typically the IRS is required to issue a taxpayer a notice of deficiency and permit the taxpayer the ability to challenge an assessment before initiating collection actions.

Chapter 61 of the Internal Revenue Code contains countless reporting requirements regarding foreign information filing obligations. Many of the sections under Chapter 61 impose significant penalties for the failure to comply with the reporting requirements. The more well known reporting requirements and penalties are found in Chapter 61 and are as follows:

The Internal Revenue Code requires certain persons to provide the Internal Revenue Service or IRS with information regarding foreign corporations. This information is typically provided on Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. The Form 5471 and schedules are used to satisfy the reporting requirements of Internal Revenue Code Section 6038 and 6046 along with the applicable regulations. Substantively, Form 5471 backstops various international provisions of the Internal Revenue Code such as Sections 901/904 (Foreign Tax Credit), Section 951(a) (Subpart F and Section 956), Section 951A (GILTI), Section 965 (transition Tax), Section 163(j) (interest deduction limitation), and Section 482 (transfer pricing). International information returns that often are associated with Form 5471s include Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation), Form 5713 (International Boycott Report), Form 8621 (PFIC), Form 8990 (Limitation on Business Interest Expense), and Forms 1116/1118 (Foreign Tax Credit).

In the Form 5471, at a minimum, the reporting agent must provide the following information regarding a foreign corporation:

i) Stock ownership, including current year acquisition and dispositions,

ii) The names of U.S. shareholders,

iii) GAAP income statement and balance sheet,

iv) An accounting of foreign taxes accrued and paid,

v) Current and accumulated earnings and profits, including any actual dividend distributions during the corporation’s taxable year,

vi) An accounting of each U.S. shareholder’s pro rata share of GILTI and Subpart F income, and

vii) Disclosure of any transactions between the foreign corporation and its shareholders or related persons.

The Form 5471 is ordinarily attached to a U.S. person’s federal income tax return.
The penalty for failure to file, or for delinquent, incomplete or materially incorrect filing is a reduction of foreign tax credits by ten percent and a penalty of $10,000, as well as a reduction in the taxpayer’s foreign tax credit. See IRC Sections 6038(b) and (c). An additional $10,000 continuation penalty may be assessed for each 30 day period that noncompliance continues up to $60,000 per return, per year.

Similarly, Internal Revenue Code Section 6038A requires 25 percent foreign-owned domestic corporations and limited liability companies to report specified information as an attachment to a corporate tax return. This is done on Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. In filing a Form 5472, the filer must provide information regarding its foreign shareholders, certain other related parties, and the dollar amounts of transactions that it entered into during the taxable year with foreign related parties. A separate Form 5472 is filed for each foreign or domestic related party with which the reporting entity engaged in reportable transactions during the year. The practical importance of the Form 5472 is that the IRS often uses this form as a starting point for beginning transfer pricing audits.  Any reporting corporation or limited liability company that fails to file Form 5472 may be subject to a penalty of $25,000. If the failure continues for more than 90 days after notification by the IRS, there is an additional penalty of $25,000 for each 30 day period or fraction. There is no upper limit on this penalty.

Another well known provision in Chapter 61 is Section 6039F. Section 1905 of the 1996 Tax Act created new reporting requirements under Section 6039F for U.S. persons (other than certain exempt organizations) that receive large gifts (including bequests) from foreign persons. The information 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 such 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)(discussed below) 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 (i) the tax consequences of the receipt of the gift will be determined by the Secretary and ii) the U.S. person will be subject to a penalty equal to 5 percent 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 percent 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 a Form 3520 with the IRS.

The IRS believes it has a grant of authority to assess international penalties under Internal Revenue Code Section 6201(a). 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 (2012), 546, the United States Supreme Court agreed that the plain language of Section 6201 places assessable penalties within the definition of a tax for purposes of granting the IRS the authority to assess those penalties. As a result, the IRS has taken the position that National Federation of Independent Business (NFIB) v. Sebelius authorized it to summarily assess and collect international penalties found in Chapter 61 of the Internal Revenue Code without the issuance of a notice of deficiency.

Originally, penalties associated with Form 5471, Form 5472, and Form 3520 (hereinafter “international penalties”) were assessed manually on individuals and entities whose missing filings were discovered during an audit. The IRS is still assessing international penalties during audits. Several years ago the IRS began a systemic assessment of international penalties associated with the late filing of these returns. The systemic assessment of international penalties is controversial. This is because many taxpayers are unaware of their international reporting obligations until they learn of their filing obligations after the due date of the filing obligation has already passed. Many of these same taxpayers often try to comply with their international filing obligations by filing an international informational return (i.e. Form 5471, Form 5472, and Form 3520) late. The IRS typically rewards these same taxpayers “trying to do the right thing” by automatically assessing international penalties or foreign information reporting penalties against them. These penalties can range from a minimum of $10,000 to several million dollars.

Does the IRS Have the Legal Authority to Assess and Collect International Penalties?

The IRS treats international penalties as summarily assessable, as they are not subject to 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 United States 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 resulted 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 of the Internal Revenue Code. In other words, typically the IRS is required to issue a taxpayer a notice of deficiency and permit the taxpayer the ability to challenge an assessment before initiating collection actions.

Summarily assessable penalties are primarily found in Internal Revenue Code 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,” which allows the IRS to impose penalties for failure to file or pay tax, 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 international penalties under Internal Revenue Code Section 6201(a). 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 (2012), 546, the United States Supreme Court agreed that the plain language of Section 6201 places assessable penalties within the definition of a tax for purposes of granting the IRS the authority to assess those penalties. As a result, the IRS has taken the position that National Federation of Independent Business (NFIB) v. Sebelius,  567 U.S. 519 (2012) authorized it to summarily assess and collect international penalties found in Chapter 61 of the Internal Revenue Code without the issuance of a notice of deficiency.

This interpretation has been criticized by the National Taxpayer Advocate as being  overbroad and misplaced. The IRS’s ability to assess a penalty and collect an assessment are two distinct matters. See Erin Collins and Gerrett Hahn, Foreign Information Reporting Penalties: Assessable or Not? Tax Notes Today (July 9, 2018) 211-213. Section 6201 authorizes the collection of assessable penalties found in Chapter 68, Subchapter B. Section 6201 does not provide the IRS with the authority to assess and collect international penalties authorized in Chapter 61 of the Internal Revenue Code. The IRS also does not have the authority to assess or collect international penalties found in Chapter 61 of the Internal Revenue Code because these penalties cannot be classified as a tax. Since international penalties cannot be characterized as a tax, these penalties cannot be assessed or collected in the same way as a tax. See Robert Horwitz, Can the IRS Assess or Collect Foreign Information Reporting Penalties? Tax Notes Today (Jan. 31, 2019) 301-305.

When Does the Statute of Limitations on Collections Expire for a Foreign Information Reporting Penalty?

If foreign information reporting penalties cannot be assessed or collected in the same manner as a tax, how does the statute of limitations for collections apply to assessed international penalties? As a general rule, once the IRS assesses a tax, the assessed tax must be collected within ten years after the date of the assessment. See IRC Section 6502(a). Collection may be made through a levy or judicially by liquidating the tax assessment into a judgment in a district court. If the IRS fails to collect an assessed tax by levy before the expiration of the collection period or fails to liquidate the tax to a judgment within the ten-year period, the IRS is generally forever barred from collecting the assessment.

If a foreign reporting penalty cannot be characterized as a tax, the above discussed statute of limitations under Section 6502(a) would not apply. Congress has chosen not to provide a specific statute of limitations on collections associated with an international penalty. Since there is no specific statute of limitations for the collection of an international penalty on point, the only method the IRS could utilize to collect an international penalty is to ask the United States Justice Department to sue the taxpayer in a district court and to request that the court reduce the foreign information reporting penalty to a judgment. On January 21, 2019, Tax Notes published an article by Robert Horwitz discussing this matter. Robert Horwitz argued that since the Internal Revenue Code does not contain a statute of limitations for international penalties, the period of time in which the Justice Department has to sue is contained in a “catch-all statute of limitations” of 28 U.S.C. Section 2462 which provides:

“Except as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.”

Applying 28 U.S.C. Section 2462 to foreign information reporting penalties, liability for the penalty would take place on the date a taxpayer properly disclosed a foreign asset on foreign information return and filed the return with the IRS. The IRS would have five years from the date of filing to authorize the Justice Department to sue to collect the penalty.

Conclusion

Given the large number of international penalties the IRS has assessed and the length of time it takes for the IRS to consider abatements of these penalties, the statute of limitations will likely become a highly litigated area in the very near future.

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.

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