By Anthony Diosdi
U.S. persons with business interests outside of the United States are subject to an expanding universe of reporting requirements. U.S. persons are required to disclose foreign assets and transactions not only on FinCen 114 (“FBAR”) but in many cases foreign assets and transactions must be disclosed on Form 5471, Form 3520, Form 3520-A, Form 8938, Form 926, Form 8865, and Form 8858. Specific civil sanctions, sometimes referred to as “International Penalties,” may be assessed against individuals for any unexcused failure to disclose foreign assets and transactions on the above discussed information returns. The monetary element of the International Penalties can be quite substantial.
Most tax penalties and other civil sanctions for noncompliance with internal revenue laws are located in Chapter 68 of the Internal Revenue Code. Chapter 68 authorizes the assessment of civil sanctions for fraud, negligence, and delinquency. The authority to assess most International Penalties is embedded in Chapter 61 of the Internal Revenue Code. Notwithstanding these differences in geography, all of the International Penalties are “assessable penalties,” meaning that they may be assessed and collected without the IRS having to resort to the deficiency procedures of Subchapter B of Chapter 63.
The civil penalty assessable against certain U.S. persons pursuant to Section 6038(b) is a prime example of an International Penalty located in Chapter 61 of the Internal Revenue Code. Internal Revenue Code Section 6038(a) imposes an obligation on U.S. persons who directly or indirectly own an interest in certain foreign corporations are required to file a Form 5471 with the IRS. These reports are required to be attached to an individual’s annual federal income tax return. Under Internal Revenue Code Section 6038(b), the IRS may assert a $10,000 penalty for each failure for each applicable annual accounting period, plus an additional $10,000 for each month the failure continues, beginning 90 days after a taxpayer is notified of the delinquency, up to an annual maximum of $60,000 for each violation. Internal Revenue Code Section 6038(c)(4)(B) allows a reasonable cause defense to the assessment of this penalty.
The monetary reporting penalty provided in Internal Revenue Code Section 6677(a) is another example of an International Penalty assessable under Chapter 61. Under Internal Revenue Code if any United States Person beneficiary receives (directly or indirectly) a distribution from a foreign trust, that person is required to make a return with respect to such a trust using Form 3520, and show thereon the name of the trust, the amount of the aggregate distribution received, and any other data the IRS may require. A foreign gift, bequest, or inheritance that exceeds $100,000 must also be disclosed on a Form 3520. The IRS may assess an annual penalty equal to 35 percent of the gross value of the trust or 35 percent of the gross value of the transferred property if a Form 3520 is not timely filed. The only defense to a Form 3520 penalty can be found in Internal Revenue Code Section 6677(a). The code section provides that no penalty will be imposed on the responsible party if the failure was due to reasonable cause and not due to willful neglect.
Litigating an International Penalty before the United States Tax Court
Generally, when the IRS makes an assessment of a Chapter 68 penalty, the IRS is not permitted to collect the assessment until a notice of proposed assessment (i.e. notice of deficiency) is issued to the taxpayer and the taxpayer is given the opportunity of Tax Court review. If a taxpayer chooses to file a petition before the United States Tax Court, the IRS may not take action to collect assessment until the Tax Court has reached a final decision. On the other hand, the IRS is not required to issue notices of proposed assessments of International Penalties under Chapter 61 of the Internal Revenue Code. This means taxpayers are not automatically afforded the opportunity of prepayment Tax Court review of International Penalties. It would appear that once the IRS finalizes an International Penalty assessment, a taxpayer does not have an opportunity to obtain prepayment Tax Court review. Rather, if taxpayer would like to obtain judicial review of an International Penalty, he or she must first pay the International Penalty and then, after filing an administrative claim for refund with the IRS, sue for a refund in either a federal district court with proper venue or the United States Court of Federal Claims.
Although the Internal Revenue Code does not require the IRS to issue a notice of proposed assessment against a taxpayer, a taxpayer may still have the opportunity to obtain prepayment Tax Court review of an International Penalty through a Collection Due Process Hearing (“CDP”). Generally, the IRS may issue a Notice of Intent to Levy and Right to Request a Hearing before it can proceed with enforced collection actions. If a taxpayer requests a CDP hearing within 30 days of the date of its mailing, the IRS may not proceed with enforced collection actions until the taxpayer was offered a hearing. At the hearing, if a taxpayer did not have an opportunity to contest an International Penalty, he or she may dispute the penalty. See IRC Section 6330(c)(2)(B). If at the conclusion of the hearing, the International Penalty assessment has not been resolved, the IRS is required to issue a Notice of Determination. The Tax Court has held that once a Notice of Determination is issued from a CDP hearing, like a notice of deficiency, it is valid for purposes of obtaining jurisdiction of the court.
Therefore, through a CDP, a taxpayer may have the opportunity to obtain prepayment Tax Court review of an International Penalty. However, the Tax Court will only have jurisdiction in an International Penalty case if he or she did not have an opportunity to contest the penalty prior to the CDP hearing. For this purpose, a prior opportunity includes “a prior opportunity for a conference with Appeals.” See Sec. 301.6330-1(e)(3), Q&A-E2, Proced. & Admin. Regs. The Tax Court has consistently precluded a taxpayer from raising a liability challenge in an assessable penalty CDP case when he had an opportunity to present that challenge to the Appeals Office before the IRS commenced collection actions. See Mangum v. Commissioner, T.C. Memo 2016-24, 111 T.C.M. (CCH) 1099, 1102.
International Penalty assessments can be substantial. I have represented many taxpayers before the IRS in International Penalty cases. In my experience, the IRS takes these type of cases very seriously and routinely assesses significant International Penalties. Absent compelling reasons, the IRS Appeals Division tends to uphold these penalty assessments. In some difficult cases, the opportunity to obtain prepayment Tax Court review or even the threat of Tax Court review may be invaluable. Sometimes when a taxpayer or taxpayer’s representative receives an IRS audit report reflecting a large International Penalty there may be a “knee-jerk” reaction to request a conference with IRS appeals. Before such a request is demanded, a careful review of the facts and circumstances of the case must be done. Taxpayers and their representatives must understand that demanding a conference with IRS Appeals could result in the preclusion of the opportunity to obtain prepayment Tax Court review of an International Penalty.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP. He represents clients in federal tax controversy matters and federal white-collar criminal defense throughout the United States. Anthony Diosdi may be reached at 415.318.3990 or by email: firstname.lastname@example.org.
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.