By Anthony Diosdi
Internal Revenue Code Section 6038 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 is attached to a U.S. 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. 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 5471, 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. The penalty for failing to timely file a Form 5472 is $25,000 for each 30-day period. There is no upper limit on this penalty.
Originally, penalties associated with Form 5471 and Form 5472 (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. However, recently, the IRS began a systemic assessment of international penalties associated with the late filing of these returns. Penalties associated with Form 5471 and Form 5472 are classified as “assessable penalties” meaning that the IRS can assess and collect these penalties without providing an individual an opportunity for prepayment Tax Court judicial review.
Reasonable Cause Defense
It is common for taxpayers who have been assessed an international penalty to send the IRS a protest letter claiming they acted with “reasonable cause” and request the removal of the penalty. This is easier said than done. In order to obtain an abatement or removal of an international penalty, the individual assessed an international penalty must establish he or she acted with “reasonable cause.” Whether an individual or entity acted with “reasonable cause” is a question of fact. See Treas. Reg. Section 301.6651-1(c)(1). For example, reliance on a professional tax return preparer (such as a CPA or attorney) as to whether or not to file a Form 5471 should constitute “reasonable cause” for purposes of removing an international penalty.
Thus, in theory, if an individual assessed an international penalty can show that he or she exercised reasonable cause, an international penalty should not be assessed. The problem is for purposes of abating or removing an international penalty, for some reason, the IRS has recently taken a very narrow view as to what constitutes “reasonable cause.” In many cases, this has made it is extremely difficult to convince the IRS to remove an international penalty on reasonable cause grounds.
Does the IRS Have the Authority to Assess and Collect an International Penalty?
If a taxpayer disagrees with an international penalty assessment, he or she has the option to pay the international penalty in full, file an administrative refund claim, and sue the government for a refund of the penalty in either a United States district court or Court of Federal Claims. This solution is often easier said than done. In many cases, individuals assessed an international penalty do not have the financial ability to fully pay the penalty. In addition, there is a great deal of uncertainty if the federal courts will more generously apply the “reasonable cause” standard than the IRS for purposes of removing an international penalty.
Fortunately, individuals or entities that have been assessed international penalties may have another option to contest international penalties. That is, in the view of the National Taxpayer Advocate and others, international penalties are not the type that may be systematically assessed by the IRS. To better understand this argument, we will need to take a deeper dive into how the IRS is permitted to assess penalties under the Internal Revenue Code.
The authority to summarily assess a penalty related to international penalties is found in Chapter 68, Subchapter B, of the Internal Revenue Code titled “Assessable Penalties.” Chapter 68 permits the IRS to assess and collect penalties “in the same manner as taxes” without first sending a notice of deficiency to an individual or business assessed a penalty. See IRC Section 6671(a). According to Chapter 68 of the Internal Revenue Code, summary assessments are made without a deficiency determination and “shall be paid upon notice and demand…and collected in the same manner as taxes.” Chapter 68, Subchapter A of the Internal Revenue Code permits the IRS to assess penalties for the failure to file or pay tax, understatements or underpayments of tax, and assess civil fraud penalties. However, in the view of the National Taxpayer Advocate, penalties associated with international information returns are not located in Chapter 68 of the Internal Revenue Code and therefore cannot be assessed and collected by the IRS. See The IRS’s Assessment of International Penalties Under IRC Sections 6038 and 6038A Is Not Supported by Statute, and Systemic Assessments Burden Both Taxpayers and the IRS Taxpayer Advocate Service- 2020 Annual Report to Congress. Since assessment of international penalties are not authorized in Chapter 68 of the Internal Revenue Code, the IRS is not authorized to assess and collect international penalties. If Congress wanted the IRS to have the ability to assess and collect international penalties it certainly would have authorized the IRS to do so in the Internal Revenue Code. But this is not the case.
A number of highly respected legal commentators have questioned the IRS’s assessment and collection of international penalties. For example, on July 9, 2018, Tax Notes, published an article by Erin Collins and Garrett Hahn. See Collins and Hahn, “Foreign Information Reporting Penalties: Assessable or Not?” Tax Notes, July 9, 2018, p. 211. In their view, the IRS does not have the authority to collect international penalties discussed in Internal Revenue Code Sections 6038 and 6038A. The only way that the IRS can collect a foreign information reporting penalty is by authorizing the United States Department of Justice to sue an individual or entity to collect the penalty in a district court. Collins and Han also raise the possibility that the ten year assessment period is legally dubious and subject to challenge.
In November 2018, Frank Agostino and Phillip J. Colasanto published an article suggesting that international penalties should be subject to the deficiency procedures. See Agostino and Colasanto, “The International Information Reporting Penalties: Is the IRS’s Failure to Embrace a One-Stop Shopping Paradigm Inefficient and Statutorily Deficient? Agostino & Associates (Nov. 2018). Agostino and Colasanto essentially take the position that since a Form 5471 and Form 5472 is attached to a tax return, the deficiency procedures for these penalties. In other words, an individual assessed a penalty associated with a Form 5471 or Form 5472 should have the right to petition the Tax Court and challenge these penalties before the IRS can collect an international penalty.
On January 31, 2019, Tax Notes published an article by Robert Horwitz arguing that the IRS that international penalties are not a tax and are not therefore collected in the same way as a tax. Thus, the IRS is not authorized to assess international penalties and the IRS cannot file tax liens or collect them through a levy. See Robert Horwitz, Can the IRS Assess or Collect Information Reporting Penalties? Tax Notes Today (Jan. 31, 2019) 301-305.
Although each of these legal commentators follow slightly different analytical paths, they all arrive at the same conclusion- the IRS lacks the legal authority to assess and collect most if not all international penalties. See The IRS’s Assessment of International Penalties Under IRC Sections 6038 and 6038A Is Not Supported by Statute, and Systemic Assessments Burden Both Taxpayers and the IRS Taxpayer Advocate Service- 2020 Annual Report to Congress. “ To sum it up, the argument is very simple to these types of penalties, “if it ain’t in the [Internal Revenue Code], it doesn’t exist.” Consequently, it appears that the IRS has been illegally using its collection powers for quite some time to automatically assess a penalty that has not been granted to it by the Internal Revenue Code. See Information Return Penalty Assessment Fight Coming to a Head, Tax Notes, November 28, 2022. The fact that the IRS has been illegally using its powers to assess and collect international penalties provides taxpayers assessed these penalties a very real possibility to challenge these assessments.
Unfortunately, challenging the IRS’s legal authority to assess an international penalty cannot probably be done through a simple protest letter. Taxpayers facing an international penalty will probably either need to challenge these penalties through an administrative hearing (such as an appeals conference or a Collection Due Process Hearing) or may need to litigate these penalties in court. In some cases, this may impose an unreasonable burden on taxpayers. The only “good news” – if you want to call it good news- is that in many cases taxpayers assessed an international penalty will not need to pay the penalty in full before challenging the IRS’s legal authority to contest the penalty.
Conclusion
The IRS has recently begun to automatically assess penalties associated with not timely filing a Form 5471 or Form 5472. These penalties are stiff and can range from a few thousand dollars to several million dollars. For many, paying these penalties is not an option. In certain cases, individuals and entities can attempt to challenge the IRS’s legal authority to assess international penalties in a federal court. Anyone considering petitioning a federal court to contest an international penalty should begin preparing right after the penalty is assessed. Preparation should include investigating any possible defenses to the international penalty.
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.
FAQs
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. 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.
What is the penalty for not filing 5471? ›
In the case, Alon Farhy willfully failed to file required Form 5471s. Failure to timely file Form 5471 is subject to an initial $10,000 penalty under Internal Revenue Code (Code) Section 6038(b).
What is reasonable cause penalty 5472? ›
Reasonable cause generally means that a taxpayer exercised ordinary business care and prudence but nevertheless failed to comply with its tax obligations. The regulations applicable to Form 5472 penalties contain some guidance on the reasonable cause standard.
What are the penalties for Form 5471? ›
Any person who fails to file or report all of the information requested by section 6046 is subject to a $10,000 penalty for each such failure for each reportable transaction.
How do I request an abatement of penalties from the IRS? ›
Use Form 843 to claim a refund or request an abatement of certain taxes, interest, penalties, fees, and additions to tax.
What is the penalty for filing 5471 and 5472? ›
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. 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.
What is the penalty for international information return? ›
An International Information Reporting Penalty may apply if you have financial activity from foreign sources and you don't follow tax laws, rules, and regulations. We mail you a notice if you owe a penalty and charge monthly interest until you pay the amount in full.
What is the difference between Form 5471 and 5472? ›
What is the difference between Form 5471 and Form 5472? The main difference between Form 5471 and Form 5472 is that Form 5471 is filed by a U.S. taxpayer while Form 5472 is filed by any foreign corporation engaged in a U.S. trade or business or a U.S. corporation that is 25% foreign-owned.
What are reasonable cause and good faith penalty exceptions? ›
Circ*mstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of all of the facts and circ*mstances, including the experience, knowledge, and education of the taxpayer.
Does first time abatement apply to Form 5472? ›
As a general matter, the first time penalty abatement procedures do not apply to event-based filing requirements, such as a Form 5471, Form 5472, or Form 3520.
Form 5471 Statute of Limitations
In general, the IRS has three years to assess taxes and penalties against a Taxpayer — which starts from the filing of the tax return.
What IRC sections are penalties? ›
Section 10 provides penalty and interest policy guidelines, processing codes and additional information from the Office of Servicewide Penalties (OSP) and the Office of Servicewide Interest (OSI).
What is a possible consequence of assessment by IRS of a preparer penalty under IRC Sec 6694? ›
Understatement of Taxpayer's Liability
Applies to tax preparers who understate taxpayers' liabilities on tax returns: Understatement due to unreasonable positions — IRC § 6694(a): The penalty is $1,000 or 50% (whichever is greater) of the tax preparer's income to prepare the tax return or claim.
Does the IRS ever forgive penalties? ›
You may qualify for penalty relief if you tried to comply with tax laws but were unable due to circ*mstances beyond your control. If you received a notice or letter, verify the information is correct. If the information is not correct, follow the instructions in your notice or letter.
Is there a way to get tax penalties waived? ›
If you have reasonable cause, we may waive penalties. You may file a reasonable cause - claim for refund to request that we waive a penalty for reasonable cause.
Will the IRS negotiate penalties and interest? ›
The IRS may abate your penalties for filing and paying late if you can show reasonable cause and that the failure wasn't due to willful neglect. Making a good faith payment as soon as you can, may help to establish that your initial failure to pay timely was due to reasonable cause and not willful neglect.
Is form 5472 required if no reportable transactions? ›
(e) Exceptions—(1) No reportable transactions. A reporting corporation is not required to file Form 5472 if it has no transactions of the types listed in paragraphs (b) (3) and (4) of this section during the taxable year with any related party. (2) Transactions solely with a domestic reporting corporation.
What is the threshold for form 5472? ›
Who files Form 5472? Who has to file? A U.S. corporation with 25% or more foreign ownership, or foreign corporations that do business or trade in the U.S. are required to file IRS Form 5472.
What are the penalties for foreign disclosure? ›
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.
What is the penalty for non return? ›
According to existing income tax ordinance, if an individual fails to file a tax return without reasonable cause, then he will have to pay a penalty at a rate of 10% of the previous year's income tax or Tk5,000 whichever is higher. If this continues further, then this penalty will increase.
The delinquent international information return procedures are designed to help safely bring people into compliance without an “offshore penalty.” IRS International Information Returns typically include documents, including: 3520 (Gifts and Foreign Trust Distributions) 5471 (Foreign Corporations)
Can form 5471 be filed separately from the tax return? ›
Form 5471 Penalties
The form must be submitted with the taxpayers' tax return and a separate form must be completed for each foreign company for which it is applicable.
What are reportable transactions for form 5472? ›
Form 5472 Reportable Transaction
“A reportable transaction is: – Any type of transaction listed in Part IV (for example, sales, rents, etc.) for which monetary consideration (including U.S. and foreign currency) was the sole consideration paid or received during the reporting corporation's tax year; or.
Does an LLC need to file form 5472? ›
If your LLC has Reportable Transactions with more than one Related Party, you must file a Form 5472 for each Related Party. For example, if your LLC has Reportable Transactions with yourself and another Related Party, you need to file two Forms 5472.
What is a reasonable cause to waive the IRS penalty? ›
Examples of valid reasons for failing to file or pay on time may include: Fires, natural disasters or civil disturbances. Inability to get records. Death, serious illness or unavoidable absence of the taxpayer or immediate family.
What is the honest mistake rule? ›
Leon (1984), the Court carved out the good faith exception: if the police make an honest mistake in conducting a search—that is, if the police act on the basis of a search warrant which a court later declares invalid—the seized evidence is still admissible.
What are some examples of good faith exception? ›
For example, if an officer made in error while maintaining their databases of warrants and a police officer searches the wrong person, good faith can be invoked. Also, if an officer does rely on a law that later changes, good faith can be invoked in that circ*mstance too.
How often can you request first time penalty abatement from the IRS? ›
Taxpayers can get an FTA over $10,000 but generally requires the request in writing. Furthermore, the IRS allows the FTA once every four years.
How long does it take for IRS to approve abatement? ›
Write a letter requesting reasonable cause abatement, or send Form 843, Claim for Refund and Request for Abatement. The IRS decision usually takes about three to four months.
What is first time penalty abatement? ›
You can request First Time Abate for a penalty even if you haven't fully paid the tax on your return. However, the Failure to Pay Penalty will continue to increase until you pay the tax in full. Example: You didn't fully pay your taxes in 2021 and got a notice with the balance due and penalty charges.
Background. Each tax assessment has a Collection Statute Expiration Date (CSED). Internal Revenue Code section 6502 provides that the length of the period for collection after assessment of a tax liability is 10 years. The collection statute expiration ends the government's right to pursue collection of a liability.
How long does it take to complete 5471? ›
Form 5471 is due with the income tax return of the affected shareholder. For most corporations, that would March 15th or the extended due date. For most individuals, that would be April 15th or the extended due date.
What is the 6 year IRS statute limitation? ›
The statute of limitations is six years if your return includes a “substantial understatement of income.” Generally, this means that you have left off more than 25 percent of your gross income.
What is a Section 6721 penalty? ›
IRC 6721 provides for a penalty when an information return or statement is not timely and/or correctly filed by the due date of the return. IRC 6722 provides for a penalty when a payee statement is not timely and/or correctly furnished.
What is IRC 6656 penalty? ›
Program Scope and Objectives. Purpose: IRC 6656 provides for the failure to deposit penalty if a taxpayer doesn't deposit tax in the correct amount, within the prescribed time period, and/or in the required manner per IRC 6302.
What are IRC 409A penalties? ›
Penalties for violations of Section 409A may include: Income inclusion at the time of vesting even if the benefit has not yet been paid. A 20% penalty tax on the deferred amounts. An increased interest rate on the late payment of the income tax due on the compensation.
What happens to a paid preparer who fails to meet the due diligence requirements IRC 6695 G? ›
IRC §6695(g) states: Any person who is a tax return preparer with respect to any return or claim for refund who fails to comply with due diligence requirements imposed by the Secretary by regulations with respect to determining eligibility for, or the amount of, the credit allowable by section 32 shall pay a penalty of ...
Is tax preparer responsible for errors? ›
If your tax preparer makes a mistake resulting in you having to pay additional taxes, penalties or interest, you have to pay these fees — not your tax preparer. Since it is your tax returns, it's your responsibility.
What is the maximum penalty for due diligence? ›
It can apply to each tax benefit claimed on a return. That means if you are paid to prepare a return claiming all three credits and HOH filing status, and you fail to meet the due diligence requirements for all four tax benefits, the IRS may assess a penalty of $560 per failure, or $2,240.
How far back can IRS assess penalties? ›
If an audit is not resolved, we may request extending the statute of limitations for assessment tax. The statute of limitations limits the time allowed to assess additional tax. It is generally three years after a return is due or was filed, whichever is later.
Tax penalties may be negotiated, reduced, or even totally eliminated in some cases. There are a number of IRS programs that can be used when you have significant tax penalties and want some kind of relief.
What are IRS accuracy penalties? ›
How We Calculate the Penalty. In cases of negligence or disregard of the rules or regulations, the Accuracy-Related Penalty is 20% of the portion of the underpayment of tax that happened because of negligence or disregard.
How do I get the IRS to remove my penalties? ›
Use Form 843 to claim a refund or request an abatement of certain taxes, interest, penalties, fees, and additions to tax.
How do I write a IRS penalty abatement letter? ›
State the type of penalty you want removed. Include an explanation of the events and specific facts and circ*mstances of your situation, and explain how these events were outside of your control. Attach documents that will prove your case.
Who qualifies for IRS fresh start? ›
To be eligible for the Fresh Start Program, you must meet one of the following criteria: You're self-employed and had a drop in income of at least 25% You're single and have an income of less than $100,000. You're married and have an income of less than $200,000.
What happens if you don't file 1040NR? ›
If you don't submit IRS Form 1040NR by the due date, you can receive a tax that's 5% of your unpaid taxes for each month that you do not file the necessary form. This penalty maxes out at 25% of your unpaid taxes. The second penalty is known as the failure to pay penalty.
