By Anthony Diosdi
There are a number of cases challenging the IRS’s ability to assess and collect penalties associated with failing to timely disclose foreign gifts on a Form 3520 making their way through various federal courts. This article discusses the IRS’s statutory ability to assess and collect Section 6039F Penalties associated with failing to timely disclose a foreign gift on a Form 3520.
Introduction
Section 6039F of the Internal Revenue Code requires U.S. persons (other than certain exempt organizations) to furnish information regarding the gifts (including bequests) that such person receives from a non-U.S. donor if the U.S. person treats the property so received as a gift for tax purposes, and the aggregate value of such gifts from the donor in a taxable year exceeds an annual threshold, which varies depending on the donor. In the case of a donor who is a nonresident alien individual or foreign estate, the annual threshold is $100,000. In the case of a donor who is a foreign corporation or foreign partnership, the annual threshold is $10,000, as increased by cost-of-living adjustments. If the reporting requirement of Section 6039F applies to a gift, the U.S. person is to provide the required information regarding the gift on Form 3520 (Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts).
Section 6039F(d) 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. 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 percent of the amount for the gift for each month the failure to report 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. Section 6039F(c) provides that the donee shall pay the penalty “upon notice and demand by the Secretary and in the same manner as tax.”
Given its language, the penalty that Section 6039F(c) imposes on U.S. donees is not a “tax” under the Internal Revenue Code even though donees are required to pay the penalty in the same manner as a tax. At the same time, the Section 6039F penalty is not an “assessable penalty” under the Internal Revenue Code. Although Section 6039F(c) provides that the Secretary is to demand payment of the penalty by notice to donees, Section 6039F fails to state that the Secretary is to assess and collect the penalty from donees in the same manner as tax. In other words, Section 6039F(c) addresses only the manner in which donees are to pay the Section 6039F penalty (i.e., like a tax). It does not provide that the Secretary is to assess and collect the penalty (like a tax), which otherwise would have made the Section 6039F penalty an assessable penalty.
Since the Section 6039F Penalty is neither a tax nor an assessable penalty under the Internal Revenue Code, the Secretary’s authority under Section 6201 of the Internal Revenue Code to make assessments of taxes and assessable penalties (as well as of interest, additional amounts, and additions to the tax) does not “extend to or include” the Section 6039F Penalty. While the IRS, the agency to which the Secretary’s authority with respect to the Section 6039F Penalty has been delegated, is authorized to determine the amount of the penalty and to demand payment of such amount from donees by notice, it lacks the statutory authority to administratively collect the penalty from donees as either a tax or an assessable penalty. Consequently, the only recourse available for the IRS to collect, recover, or enforce a Section 6039F Penalty is through civil action. See 28 U.S.C. Section 2461(a).
The Section 6039F Penalty is Not a “Tax”
In National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), the Supreme Court upheld the Affordable Care Act (“ACA”). The Court addressed the Anti-Injunction Act (“AJA”), which prohibits injunctive relief in tax cases. See IRC Section 7421. Specifically, the Court addressed whether the ACA’s individual mandate penalty was a tax under the Internal Revenue Code and, thus, subject to the AIA. The Court held that although the penalty was to be assessed and collected in the same manner as taxes under the Internal Revenue Code, it was not a tax for purposes of the AIA. Therefore, the AIA did not apply, and taxpayers could bring suit to enjoin enforcement of the penalty without having paid the penalty.
The penalty for not complying with the individual mandate of the ACA is specified in Section 5000A(g)(1) of the Internal Revenue Code, which states that the penalty “shall be assessed and collected in the same manner as an assessable penalty under Subpart B of Chapter 68.” In turn, Section 6671(a) specifies that the “penalties and liabilities provided by this subchapter [B of Chapter 68] shall be. . . assessed and collected in the same manner as taxes.” Taken together, these two Code sections provide that the individual mandate penalty is an assessable penalty to which Section 6671(a) applies and, as such, is to be assessed and collected by the Secretary in the same manner as taxes.
The Supreme Court agreed with the view that the combined provision (i.e., Section 5000A(g)(1) and Section 6671(a)) imposing the individual mandate penalty was only a directive to the Secretary “to use the ‘same methodology and procedures’ to collect the penalty that [the Secretary] uses to collect taxes.” See Sebelius, 567 U.S. at 545. As drafted, the provision does not go so far as to transform the individual mandate penalty into a tax under the Code. Rather, it only authorizes and requires the Secretary to assess and collect the penalties as if it were a tax, despite it not being a tax. The provision does not alter the nature of the penalty, which remains something other than a tax. As noted by the Court, “[w]here Congress uses certain language in one part of a statute and different language in another, it is generally presumed that Congress acts intentionally. Id at 544 (citing Russello v. United States, 464 U.S. 16, 23 (1983)).
The ACA’s individual mandate penalty is a penalty that the Secretary is to assess and collect in the same manner as taxes. In contrast, the Section 6039F Penalty is a penalty that the U.S. donee of an unreported gift is to pay in the same manner as tax. Despite their differences in actors and the actions to be taken, both penalties arise under provisions that use the phrase “in the same manner as tax(es).” Due to this shared phrase, the Supreme Court’s reasoning in Sebelius applies equally to the 6039F Penalty. Language specifying that a penalty is to be treated in the same manner as taxes does not mean that the penalty itself is a tax. If Congress had intended both penalties to be considered taxes for all purposes under the Code, then Congress would have expressly said so, and there would be not need to prescribe that the penalties be treated as if they were taxes for the limited purpose of assessment and collection by the Secretary (in the case of the ACA Penalty) and payment by the U.S. donee (in the case of the 6039F Penalty).
The Court also rejected an argument that asserted that the individual mandate penalty was a tax because it was an assessable penalty, and Section 6021(a) uses the term “tax” to include assessable penalties (among other amounts payable by taxpayers). The Court held that Section 6201(a) was not controlling because it cannot be read in isolation from many other Code sections that all treat taxes and assessable penalties as distinct terms. See Sebelius, 567 U.S. at 546. The Court listed Sections 860(h)(1), 6601(e)(1)-(2), 6602, and 7122(b) as examples of these other Code sections. All of the examples expressly refer to “assessable penalties.” None of them contains language similar to that in Section 6039F, where the payor of the penalty is required to pay the penalty “upon notice and demand by the Secretary and in the same manner as tax.”
The 6039F Penalty Is Not an “Assessable Penalty”
In the recent case of Farhy v. Commissioner, 160 T.C. No. 6 (2023), the United States Tax Court held that the penalty imposed by Section 6038(b) for the failure to file Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) was not an assessable penalty under the Code. Accordingly, the IRS, as the delegate of the Secretary, lacked the statutory authority to collect the Section 6038(b) penalty as an assessable penalty.
According to the Tax Court, rules governing the application of assessable penalties are contained in Sections 6665 and 6671 of the Internal Revenue Code. Section 6665(a) provides that, except as otherwise provided in the Code, “the additions to the tax, additional amounts, and penalties provided by this Chapter [68] shall be paid upon notice and demand and shall be assessed, collected, and paid in the same manner as taxes.” Section 6671(a) provides that “[t]he penalties and liabilities provided by this Subchapter [B of Chapter 68] shall be paid upon notice and demand by the Secretary, and shall be assessed and collected in the same manner as taxes.” Both these sections expressly state that they apply to penalties and liabilities provided by Chapter 68. Neither section, however, states that it applies to penalties arising under any other chapter of the Code.
Notwithstanding the limited scope of Sections 6665 and 6671, the Farhy court identified three ways in which penalties for violations of Code sections outside of Chapter 68 may nonetheless be assessable penalties subject to the rules of Section 6665 or 6671. The three ways are where the Code sections (1) “contain their own express provision specifying the treatment and collection” or (2) “contain a cross-reference to a provision within Chapter 68 of subtitle F providing a penalty for their violation” or (3) “are expressly covered by a penalty provision within Chapter 68 of subtitle F.” See Farhy, 160 T.C. No. 6 at 7 (emphasis added).
According to Farhy, none of these three ways or methods was applicable to the Section 6038(b) penalty that was at issue in that case. Section 6038 contains only a cross-reference to a criminal penalty provision in Section 7203, which is in Chapter 75. The court listed several examples for each of the three methods. Examples provided for the first method are sections 527(j)(1), 856(g)(5)(C), 857(f)(2)(A), 4980H(d)(1), 5000A(g)(1), 5114(c)(3), 5684(b), 5761(e), and 9707(f). Section 6039F, which provides for the 6039 Penalty, is not one of the listed examples. Like Section 6038, Section 6039F is also in Chapter 61 and not in Chapter 68.
Neither the second nor third method applies to Section 6039F. Section 6039F does not contain any statement referring or directing the reader to another section in Chapter 68 for provisions relating to the applicable penalty arising from the failure to comply with Section 6039F’s reporting requirement. Similarly, there is no section in Chapter 68 (i.e., sections 6651-6751) that provides or imposes any penalty with respect to the failure to comply with Section 6039F’s reporting requirement.
Therefore, in order for the 6039F Penalty to be an assessable penalty under the Code, it must use the first method, which requires Section 6039F to contain its own express provision specifying the treatment of the 6039F Penalty as a tax or an assessable penalty for purposes of assessment and collection. The Section 6039F contains no such express provision. Section 6039F(c) only states that the U.S. donee of an unreported gift shall pay the 6039F Penalty “upon notice and demand by the Secretary and in the same manner as tax.” Indeed, neither the word “assessment” nor “collection” (nor any similar term) appears anywhere in Section 6039F.
While the word “tax” appears in Section 6037F(c) with respect to the 6039F Penalty, it does so only in the context of the U.S. donee paying the penalty in the same manner as tax. There is no express statement that the 6039F Penalty is, or is to be treated, as a tax (or an assessable penalty) for purposes of assessment and collection. Neither is there an express statement that upon demand for payment by notice, the Secretary (or anyone else) is to assess and collect the penalty in the same manner as a tax (or an assessable penalty). Section 6039F(c) expressly charges the Secretary only to demand payment of the penalty from U.S. donees by notice. It does not expressly charge the Secretary to assess and collect the penalty. Without such an express charge as to assessment and collection, the Section 6039F Penalty is not an assessable penalty under the Code.
Out of the nine examples provided by the Farhy court for the first method, three of them (i.e., Sections 856(g)(5)(C), 857(f)(2)(A), and 9707(f)) do not include the words “assessment” or “collection” (or similar terms) like Section 6039(f). Section 857(f)(2)(A)’s language is nearly identical to the language in Section 6039F(c)(1)(B), requiring a taxpayer to pay the penalty “on notice and demand by the Secretary and in the same manner as tax.” These three examples should not dictate the treatment of the 6039F Penalty. If these three examples were to stand for the proposition that having to pay a penalty like a tax is equivalent to charging the Secretary to assess and collect that same penalty like a tax, then this construction would not be consistent with Farhy’s observation that Code sections using the first method expressly provide for such treatment.
The requirement that assessment penalties be explicit, rather than implicit, in regard to their assessment and collection by the Secretary is particularly relevant for the 6039F Penalty. First, the U.S. donees who are subject to the penalty are disproportionately individuals. If any donees are entities, they typically are exempted from the application of Section 6039F because they are organizations described in Section 501(c) and exempt from tax under Section 501(a). In contrast, the payors of the penalties imposed by Sections 856(g)(5)(C), 857(f)(2)(A), and 9707(f) are entities (e.g., REITs and coal companies). Second, the 6039F Penalty accrues in monthly increments equal to 5 percent of the amount of the unreported gift until the aggregate penalty reaches 25 percent of the gift’s amount. Many foreign gifts are substantial, and many U.S. donees typically do not become aware of their obligation to report the gift until five or more months have elapsed the deadline to file the Form 3520. As a result, the 6039F Penalty imposed on the individual donee often exceeds the $50,000 and $25,000 penalties imposed on REITs by Section 856(g)(5)(C) and 857(f)(2)(A), respectively, and the $100 per day penalty imposed on coal companies by Section 9707(f). Third, the IRS is empowered to enforce the collection of assessable penalties by lien and levy. Accordingly, the statutory language that grants the IRS the use of these powers with respect to a penalty must be both explicit and clear in that grant. In view of these considerations, Section 6039F must be strictly construed. Since the section fails to expressly provide that the 6039F Penalty is to be assessed and collected by the Secretary in the same manner as tax, the 6039F Penalty is not an accessible penalty under the Code.
The IRS Can Only Enforce and Collect the Section 6039F Penalty 28 U.S.C Section 2461(a)
Neither a tax nor an assessable penalty under the Code, the 6039F Penalty is a penalty that the Secretary’s Section 6201 authority to make assessments of taxes and assessments (as well as of interest, additional amounts, and additions to the tax) does not apply. Lacking the statutory authority to administratively to collect the 6039F Penalty as either a tax or an assessable penalty under the Code, the IRS’s only resource to collect, recover, enforce a 6039F Penalty is to bring a civil action against the U.S. donee in accordance with 28 U.S.C. Section 2461(a), which provides that “[w]heever 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, it may be recovered in a civil action.
Anthony Diosdi is tax attorney at Diosdi & Liu, LLP. Anthony has litigated the 6039F Penalty before the United States Tax Court, United States District Court, and the United States Court of Federal Claims. Anthony also frequently represents clients before the IRS that have been assessed the Section 6039F Penalty.
Anthony Diosdi 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.