Fahry Appeal Court Rules IRC 6038(b) Is An Assessable Penalty Without Regard To IRC 6201

Part A Prologue Fahry, the issue and the tax court decision:

The significance of the Fahry decision in the Tax Court – Per Arnold Porter commentary:

“Many penalties related to income tax filings are not assessable penalties. The IRS took the position that Section 6038 penalties are assessable penalties under IRC Section 6201(a). Farhy argued that the IRS had no authority for treating Section 6038 penalties as assessable penalties. The Tax Court agreed with Farhy, reasoning that Section 6038, which establishes the reporting requirement regarding foreign corporations and the consequent penalties, does not specify a mode of assessing the penalties. Notably, as the Tax Court observed, there are other code provisions establishing penalties that explicitly state that the respective penalties are assessable. Thus, the Tax Court found that the penalties for failure to file Form 5471 are not subject to the deficiency procedures.”

https://www.arnoldporter.com/-/media/files/perspectives/publications/2023/05/howforeign-info-return-penalty-case-may-benefit-t.pdf

The issue in the Tax Court: IRC 6201 and the issue of assessable penalties – dose 6201 imply that some penalties are NOT assessable and that some penalties are assessable?

26 U.S. Code § 6201 – Assessment authority

(a) Authority of Secretary The Secretary is authorized and required to make the inquiries, determinations, and assessments of all taxes (including interest, additional amounts, additions to the tax, and assessable penalties) imposed by this title, or accruing under any former internal revenue law, which have not been duly paid by stamp at the time and in the manner provided by law. Such authority shall extend to and include the following:

https://www.law.cornell.edu/uscode/text/26/6201JR Note: If “assessable penalty then IRS can assess the penalty.

How does one determine whether a penalty is assessable?

Part B – Summary of the United States Court Of Appeal For The District Of Columbia May 3, 2024 decision

The government appealed the decision in Fahry on the basis that the $10,000 penalty in IRC 6038(b) IS an assessable penalty. On May 4, 2024 the Court Of Appeals reversed the Tax Court ruling that 6038(b) penalties ARE NOT assessable. The Court Of Appeals ruled that:

1. IRC 6038(b) penalties are “assessable penalties”; and

2. The ruling that 6038(b) penalties is based on an inference that the history, context and language of 6038(b) compels the conclusion of “assessable penalties without having to interpret any other section of the Internal Revenue Code.

Because 6038(b) penalties ARE “assessable penalties” they are clearly authorized by IRC 6201!

The problem of international information return penalties continues

The Taxpayer Advocate has taken a lead role in highlighting the unfairness, complexity and ambiguity in international information penalties. A series of blog posts from the Taxpayer Advocate are included in Appendix A of this post.

General thoughts on the decision …

The decision from the United States Court Of Appeal is analysis of 6038(b) from the perspective of lawyers/judges and NOT from accountants/tax preparers. The decision is a purposive analysis which analyzes the history of the 6038 penalty, the purpose of the penalty and how 6038(b) relates to the rest of the section. In addition, the decision emphasizes the importance of the penalty regime in the U.S.tax system and in U.S. culture.


Specific thoughts on the decision include:

1. The court ruled that a penalty can be “assessable” even if the statute does NOT specifically state that the penalty is assessable!

2. The court ruled that the penalty provision in 6038(b) could be interpreted (by reading and understanding ONLY 6038) to be an “assessable” penalty.

Generally this is because of its history and context (how 6038(b) relates to 6038(c). The court summarized this conclusion in the following introductory paragraph on page 2:

“We hold that the text, structure, and function of section 6038 demonstrate that Congress authorized assessment of penalties imposed under subsection (b), and so reverse and remand to the Tax Court with instructions to enter decision in favor of the Commissioner.”

3. On page 14 the Court explained its general conclusion as follows:

“A close reading of section 6038 with an eye to the role of subsection (b) within it reveals that the Congress that amended the Code in 1982 intended the subsection (b) penalty to be assessable. For the same underlying failure to file, the section originally authorized only a percentage-based, assessable penalty imposed as a reduction of the taxpayer’s foreign tax credit (now codified as subsection (c)). Two changes effected by the amendment are particularly relevant: First, in response to difficulties experienced in applying that original penalty, Congress added (as subsection (b)) a fixed-dollar penalty that could be more simply and consistently collected. Second, Congress required (in subsection (c)(3)) that the two penalties be coordinated. The subsection (b) penalty must be offset from any subsection (c) penalty in cases in which both penalties apply. All agree the IRS may assess subsection (c) penalties, and those two objectives of the amendment—that recovery of subsection (b) penalties be more streamlined than recovery of subsection (c) penalties, and that any subsection (c) penalty be reduced by the amount of the subsection (b) penalty—make plain that subsection (b) penalties must also be assessable. Section 6038’s express authorization of the IRS rather than a district court to evaluate a taxpayer’s defense to penalties imposed under the section reinforces that conclusion.”

4. The discussion in the Tax Court revolved around the proper interpretation of IRC 6201.

On this point the court:

(A) Recognizes that each of the IRS and Fahry were arguing for different interpretations of 6201. On page 11 the Court observes that:

“The text of section 6038 does not explicitly say whether the penalties imposed for violating section 6038(a) are assessable. The parties principally argue from dueling presumptions that they contend generally apply to all penalties across the Internal Revenue Code. Each claims support from a distinct reading of I.R.C. § 6201(a), which grants the Treasury Secretary broad authority to assess “all taxes (including interest, additional amounts, additions to the tax, and assessable penalties).” Although none of the terms in section 6201(a)’s parenthetical are defined by the statute, the three categories of penalties listed after “interest” in the text correspond with—but are not necessarily limited to—the penalties that are set out in I.R.C. Subtitle F, Chapter 68, which is titled “Additions to the Tax, Additional Amounts, and Assessable Penalties.” All exactions in Chapter 68 are explicitly directed to “be assessed . . . in the same manner as taxes” by a subsection contained therein. I.R.C. § 6665(a)(1).”

(B) Specifically rules that it is NOT necessary to resolve how 6201 is to be interpreted (in determining whether 6038(b) is assessable,) noting on page 13 that:

“We need not embrace either party’s tax code-wide default rule to resolve this case. We accordingly do not pass on those broader theories beyond explaining why Farhy’s does not preclude assessment of section 6038(b) penalties. Instead, we conclude that a narrower set of inferences suffices to show that Congress intended to render those penalties assessable. Read in light of its text, structure, and function, section 6038 itself is best interpreted to render assessable the fixed-dollar monetary penalties subsection (b) authorizes. As a result, the Commissioner’s authority to assess all “assessable penalties” encompasses the authority to assess penalties imposed under section 6038(b).”

(C) Explains its reasoning for why 6038(b) is assessable beginning on page 14. Of particular interest on page 16 is:

“Another feature of the process contemplated in section 6038 drives home that Congress expected the IRS, not a federal district court, to assess subsection (b) penalties. Consider what section 6038 says about the determination of specified defenses to the penalties the section imposes. As with many penalties imposed across the tax code, penalties under sections 6038(b) and (c) are subject to a “reasonable cause” affirmative defense, which courts describe as requiring the taxpayer to establish that she “exercised ordinary business care and prudence” in attempting to adhere to her reporting obligations. Flume v. Comm’r, Dkt. No. 15772-14L, 2017 WL 394541, at *5 (T.C. Jan. 30, 2017) (quoting United States v. Boyle, 469 U.S. 241, 246 (1985)). And section 6038 empowers the Service—not a court—to grant or deny that defense. See I.R.C. § 6038(c)(4)(B) (requiring reasonable cause to be “shown to the satisfaction of the Secretary”).

Various IRC provisions excuse taxpayers for conduct otherwise subject to penalty based on a showing of “reasonable cause” for the noncompliance. If a taxpayer experienced a debilitating health condition constituting “reasonable cause” severe enough to interfere with her ability to file, for example, the IRS could not impose penalties unless the taxpayer’s noncompliance persisted once she had recovered. See, e.g., Remisovsky v. Comm’r, Dkt. No. 11945-20L, 2022 WL 3755390, at *3-4 (T.C. Aug. 30, 2022). Putting the IRS in charge of determining whether a taxpayer has demonstrated reasonable cause only makes sense in circumstances in which it is the IRS that assesses the penalty. Where Congress requires the government to file a civil action to enforce a violation of the tax code, the court rather than the Service would decide whether the taxpayer proved that the defense excuses his or her violation.

Section 6038(c)(4)(B) expressly treats the reasonable cause showing for failure to file the relevant informational returns as within the purview of the Service. A taxpayer facing a subsection (b) penalty may submit to the IRS a written statement attesting that reasonable cause excused the filing failure, see Treas. Reg. § 1.6038-2(k)(3)(ii), and “provide a reasonable cause narrative during the CDP hearing” to an IRS employee acting with delegated authority from the Secretary, who makes a determination that can be appealed to the Tax Court. Flume, 2017 WL 394541, at *6; see Treas. Reg. § 1.6038-2(k)(3)(ii). The 1982 Senate Report confirms that the reasonable-cause defense to subsection (b) penalties was intended to operate “[a]s under present law,” meaning as under subsection (c); in either case, a showing made “to the satisfaction of the Secretary” would mean that “no penalty is due.” S. Rep. No. 97-494, vol. 1, at 299.

If the subsection (b) penalty were not assessable, there would be no post-assessment administrative process in which the taxpayer could make a reasonable cause showing to the Secretary. On Farhy’s reading, it would be for the district court rather than the Secretary to determine the taxpayer’s liability for the penalty, subject to any reasonable-cause defense. It is hard to see what purpose would be served by the statutory requirement that the taxpayer’s reasonable-cause defense be “shown to the satisfaction of the Secretary” if the claim subject to that defense must be decided in the first instance by a district court judge. I.R.C. § 6038(c)(4)(B).

Congress’s specification that the Secretary, not the district court, evaluates taxpayers’ assertions of reasonable-cause defenses to section 6038(b) penalties dovetails neatly with section 6201(a). In addition to empowering and requiring the Secretary to make assessments, section 6201(a) calls on the Secretary to “make the inquiries [and] determinations . . . of all taxes (including . . . assessable penalties).” As just discussed, one familiar set of secretarial “determinations” is whether a taxpayer has “shown to the satisfaction of the Secretary” that he had reasonable cause for failing to file required information, per I.R.C. § 6038(c)(4)(B). Farhy’s insistence that section 6201(a) is inapplicable to section 6038(b) penalties would leave the Secretary without power under section 6201(a) regarding not only the assessment of section 6038(b) penalties, but “inquiries” and “determinations” into them as well. Section 6038’s express contemplation that the Secretary will determine the reasonable-cause defense—whether penalty is sought under subsection (b) or (c)—supports treating both section 6038 penalties as assessable. The unworkability of rendering inquiry-and-determination authority not equally applicable to the penalties under those tandem subsections bolsters our conclusion that Congress intended both penalties to be assessable within the meaning of section 6201(a).”

JR Commentary: This suggests that any time a defense of “reasonable cause” must be demonstrated to the Secretary that there is a strong presumption of an assessable penalty!!

5. What does the decision mean?

The appellate court ruled that 6038(b) penalties ARE assessable. The decision did NOT extend beyond IRC 6038(b). That said, the suggestion that “reasonable cause” = “assessable penalty” is dangerous. The appellate court did NOT disturb the Tax Court’s reasoning that IRC 6201 should be understand/interpreted to mean that “some” penalties are NOT assessable. Therefore, taxpayers are free to continue to argue that certain penalties ARE not assessable penalites.

To put it simply:

Although Fahry loses most of the decision in the Tax Court remains intact. Taxpayers (with respect to certain penalties) are still able to argue that a penalty is NOT assessable. That said, there is strong suggestion that:

If reasonable cause is a defense then the penalty is assessable!

The complete Fahry decision is here:

23-1179-2052712

John Richardson – Follow me on X.com at @Expatriationlaw


Appendix – Taxpayer Advocate series of posts discussing penalties for foreign information returns

Part 1 – Taxpayers and Tax Administration Need a Legislation Fix
https://www.taxpayeradvocate.irs.gov/news/ntablog/nta-blog-chapter-61-foreign-informationpenalties-part-one/2023/04/

Part 2 – Taxpayers and Tax Administration Need Finality, Which Requires Legislation
https://www.taxpayeradvocate.irs.gov/news/ntablog/nta-blog-chapter-61-foreign-informationpenalties-part-two/2023/04/

Part 3 – Keeping a Watchful Eye on the FBAR Guard Dog
https://www.taxpayeradvocate.irs.gov/news/ntablog/nta-blog-chapter-61-foreign-informationpenalties-part-three/2023/05/

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