We welcome back Megan Brackney for part two in her three-part series discussing penalties imposed on foreign information returns. Keith
For all of the foreign information return penalties, reasonable cause is a defense. See I.R.C. §§ 6038, 6038A(d)(3), 6038D(g), 6039F(c)(2), 6677(d); Treas. Reg. § 1.6038-2(k)(3)(ii). The IRS applies the same standards for reasonable cause for failure to file income tax returns under I.R.C. § 6651 to failure to file foreign information returns, i.e., the exercise of ordinary business care and prudence. See e.g., Chief Counsel Advisory 200748006.
In determining whether taxpayers satisfy the reasonable cause standard, the IRS also applies the holding of United States v. Estate of Boyle, 469 U.S. 241 (1985), to the failure to file foreign information returns. Boyle articulates a non-delegable duty to file tax returns. In that case, the executor of an estate relied on a tax advisor to file the estate tax return, but the advisor missed the deadline. The Supreme Court explained that determining the due date and ensuring that the return was filed did not require any special tax expertise, and that taxpayers have a non-delegable duty to make sure that their returns are timely filed. Any other rule, according to the Supreme Court, would not be administrable. Id. at 249.
However, the Supreme Court specifically contemplated that a taxpayer can rely on a tax professional’s advice as to whether to file a particular return. As stated by the Supreme Court, “Courts have frequently held that ‘reasonable cause’ is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return, even when such advice turned out to have been mistaken.” Id. at 250. Other courts have reached similar conclusions. See e.g., Estate of Liftin v. United States, 101 Fed. Cl. 604, 608 (2011) (an expert’s advice concerning a substantive question of tax law as to whether a return was required to be filed was reasonable cause). Accordingly, a taxpayer should be able to rely on the advice of a tax professional as to whether a foreign information return is required (as opposed to merely meeting a known deadline).
Challenging Foreign Information Return Penalties
Foreign information return penalties are “assessable penalties,” meaning that they are “paid upon notice and demand” and are not subject to the deficiency procedures, and thus cannot be challenged in Tax Court (with one narrow exception discussed below). I.R.C. § 6671(a).
The Internal Manual states that the taxpayer is entitled to post-assessment, but pre- payment, Appeals review of the penalty. See Internal Revenue Manual 188.8.131.52. As we will see, the IRS does not automatically suspend collection activity in order to provide taxpayers with this pre-payment right to appeal, and routinely fails to respond to taxpayers’ requests to suspend collection during their appeals. I have recently learned that the IRS’s failure to suspend collection may be due to an error in inputting the right code. In one case, the Service Center told me that the collection hold had mistakenly been put on the 1040 account, rather than the civil penalty account. I do not know how often this occurs, but it is concerning that a taxpayer could be subject to levy because of this type of an error.
In any event, as we will see below, the notice of the right to appeal is cryptic, provides a short time to submit the appeal, and does not provide the taxpayer with information on whether or how to extend this deadline if the taxpayer needs more time.
If the appeal is unsuccessful, the taxpayer’s only option for judicial review is to pay the penalty in full and file a refund claim, and if the refund claim is not granted (or acted upon within six months of receipt by the IRS), the taxpayer could then file a refund action in federal district court or the court of claims. See I.R.C. § 7422; 28 U.S.C. § 1346(a)(1).
If the IRS does not offer Appeals rights before issuing a final notice of intent to levy, the taxpayer can file a CDP request with IRS Appeals, and at that point, should be able to raise defenses to the penalties, such as he or she acted with reasonable cause. I.R.C. § 6330(c)(2)(B); Treas. Reg. § 601.103(c)(1); Interior Glass Systems, Inc. v. United States, 927 F.3d 1081, 1087 (9th Cir. 2019). If Appeals does not grant relief during the CDP hearing, the taxpayer could file a Petition for Lien or Levy Action Under I.R.C. § 6330(d), in the United States Tax Court.
Procedures to Get Into Compliance
The IRS has established the Delinquent International Information Return Submission Procedures, which may be helpful for some taxpayers in avoiding penalties, but there is no guarantee. A taxpayer is eligible to use these procedures if he or she has reasonable cause for not timely filing the information returns, is not under a civil examination or a criminal investigation by the IRS, and has not already been contacted by the IRS about the delinquent information returns. Under this procedure, the taxpayer sends in the delinquent return as directed by the IRS, along with a statement of facts establishing reasonable cause for the failure to file.
The IRS makes no express promises on the outcome under these procedures, but it is generally understood by tax practitioners that the IRS will not assess penalties if there is no tax liability related to the failure to file and the taxpayer has reasonable cause. Nevertheless, we have seen the IRS assess penalties against taxpayers who have submitted their foreign information returns under these procedures, but as the IRS provides no acknowledgement that the taxpayer attempted to use the procedure, it is unclear if this is due to mistakes in processing or is intentional.
The Delinquent International Information Return Submission Procedures are not difficult to locate if you already know to look for them. However, there is no reference to these procedures or links to them on the other pages of the IRS’s website that discuss the foreign information return penalties themselves. The average layperson, and even many tax practitioners, are not aware of the procedures. On several occasions, clients have come to us after they have received notices of penalty assessments for late filing of Form 5471 or 3520, when no tax was due and they had a reasonable cause defense to late-filing, because their CPA’s filed the forms without a reasonable cause statement in the form required by the Delinquent International Information Return Submission Procedures.
For individuals who made non-willful errors in their foreign information reporting, the Streamlined Voluntary Filing Compliance Procedures, may provide some relief. Also, for taxpayers who acted willfully, or are concerned that that the IRS will view their non-compliance as willful, the IRS’s voluntary disclosure practice may be an option.
Even though these procedures are available to allow certain taxpayers to limit their penalty exposure, they are not a substitute for the IRS applying the penalty provisions as required by the Internal Revenue Code and following its own administrative procedures.
Part III will explore some examples of foreign information return horror stories. Unlike other genres of horror, these stories do not derive from rare events, but represent the day to day conduct of the IRS in this area. These are not isolated examples, and I could have described numerous other cases of my own clients, and on an almost daily basis, I hear similar stories from other attorneys and CPA’s who are seeing the systematic assessment of significant and, sometimes life altering, penalties against taxpayers for negligible errors and delinquencies.