Tax Court Reaffirms Decision That the IRS Lacks Authority to Assess IRC Sec. 6038(b) Penalties

On November 18, 2024, the Tax Court once again held that the IRS lacks the statutory authority to assess certain information return penalties under IRC. Sec. 6038(b) for failing to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. This decision directly contradicts the recent D.C. Circuit Court of Appeals case, Farhy v. Commissioner, in which that court overruled the Tax Court’s same decision regarding the IRS’s authority to assess this penalty.  

Background of Mukhi v. Commissioner 

Prior to the Mukhi decision, the Tax Court considered the question of whether the IRS has the statutory authority to assess penalties under IRC Sec. 6038(b) in the case Farhy v. Commissioner. In Farhy, the Tax Court held the IRS was not statutorily authorized to assess this penalty. However, in an appeal of the Tax Court’s decision in Farhy, the D. C. Circuit Court of Appeals found in favor of the IRS.  

The taxpayer, Raju Mukhi, failed to file multiple international information forms he was required to file for foreign trusts and a foreign corporation for tax years 2002 through 2013. During audit, the IRS assessed $120,000 in penalties under IRC. Sec. 6038(b) for his failure to file Form 5471, as well as over $10 million in penalties under IRC Sec. 6677 for failure to file other forms. Mukhi bought a suit before the Tax Court, which granted summary judgment in favor of Mukhi based on the court’s decision in Farhy.  

Tax Court’s Holding 

In light of the D.C. Circuit decision in Farhy, the IRS requested the Tax Court reconsider its decision in Mukhi. The Tax Court rejected the arguments made by the D.C. Circuit; in particular that court’s discussion of legislative history. In a 15-1 decision, the Tax Court instead held that:

1. IRC Sec. 6021(a) does not authorize the IRS to assess “all exactions” in the Code, and 
2. IRC Sec. 6038(b) is not an assessable penalty based on the plain statutory language. 

The court rejected both the government’s and the D.C. Circuit’s reasoning that the legislative history of IRC Sec. 6038(b) indicates Congressional intent for the penalty to be assessable. Instead, the Court held that the text of the statute is unambiguous, which precludes the need to turn to legislative history to determine its meaning.   

Next Steps in Mukhi 

The Mukhi case is appealable to the Eighth Circuit Court of Appeals. Under Golsen v. Commissioner, the Tax Court is only required to follow circuit court precedent when an appeal of a case would lie in that circuit. It is possible that the Eighth Circuit Court will agree with the Tax Court, which will result in a Circuit Split. If that happens, the case will almost certainly end up before the Supreme Court to resolve the issue. In the meantime, the holding in Farhy will continue to be prevailing law for the D.C. Circuit, while the holding in Mukhi will control elsewhere.  

Safdieh v. Commissioner 

On December 5, 2024, the Tax Court applied its decision in Mukhi in the case Safdieh v. Commissioner. The Court granted summary judgment against the Commissioner, holding once again that the IRS lacks the ability to assess penalties under IRC Sec. 6038. The Court noted in its summary judgment that it will “continue our disagreement with the D.C. Circuit in cases appealable to other circuits.” Safdieh is appealable to the Second Circuit, and therefore, the Tax Court used Mukhi as the controlling law as permitted under Golsen. 

Impacts of Mukhi 

The D.C. Circuit avoided addressing the question as to whether the IRS needed to have express authority to assess penalties, and for its part, the Tax Court has not extended its interpretation to other code provisions. Accordingly, the decision in Mukhi is limited to IRC Sec. 6038(b). However, it may have opened the door for challenges to other provisions in the code where the IRS is not given express authority to assess a penalty.  

On November 20, 2024, a taxpayer filed a similar suit alleging that the IRS lacked statutory authority to automatically assess penalties against her under IRC Sec. 6039F for her failure to file Form 3520. While that case, Zhang vs. Commissioner, does not cite either Farhy or Muhki, the arguments made against the IRS’ authority to assess a penalty under IRC Sec. 6039F are similar to the Tax Court’s reasoning in these cases.   

A holding that express authority is required would have significant impacts on other penalties, while a holding for the IRS could dramatically increase the agency’s authority to assess international information reporting penalties. A third option may be that courts consider each code section individually.  

While the Tax Court has now repeatedly held the IRS does not have the authority to assess IRC Sec. 6038(b) penalties, the statutory requirement to file still remains. Taxpayers who are required to file foreign information returns should contact a trusted tax advisor to remain in compliance. 

If you need help assessing your information return obligations, EisnerAmper has a depth of resources to help our clients. Contact us today to find out how we can assi