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Publish Date

Apr 13, 2023

Farhy v. Commissioner: Potential Reporting Penalty Refund Opportunity

A&M Tax Advisor Weekly

In My Cousin Vinny, Mona Lisa Vito (played by Marisa Tomei) asked Attorney Vinny Gambini (played by Joe Pesci): “Didn’t they teach you [procedure] in law school?” In response, Gambini replied: “No. That’s not what they teach you. They teach you contracts, precedents, interpretations. Then the firm that hires you, they teach you procedures. Or you could go to court and watch.” In the recent Tax Court case of Farhy v. Commissioner, 160 T.C. 6 (2023), the IRS “went to court and watched,” only to learn that its long-held position on a procedural rule for certain information reporting penalties was incorrect.

The Farhy case involved the penalties for failure to timely file Forms 5471 (“Information Return of U.S. Persons With Respect to Certain Foreign Corporations”). Like Vinny Gambini, the IRS was correct on the substance of the applicable law (i.e., that the taxpayer owed the penalties in question). The only issue before the Tax Court was whether the IRS had followed proper procedure in attempting to assess and collect those penalties by levy. The IRS maintained, as it has for several years, that it has statutory authority to systematically levy penalties for failure to file some international information returns without (1) having to pursue civil litigation to collect the penalties or (2) providing deficiency procedures that otherwise allows taxpayers, before making a payment, to contest the penalties before the Tax Court. However, Judge Marvel disagreed and prevented the IRS from proceeding with the collection of the penalties by levy because they were not “assessable penalties” under the Code.

While this taxpayer victory may not be the panacea that some have suggested for anyone who has ever paid a penalty for the late filing (or failure to file) of a Form 5471, it may represent a real opportunity for taxpayers whose claims for a “reasonable cause” exception to the penalty for failing to timely file international information returns were summarily rejected by the IRS. (Although reasonable cause was not at issue in Farhy, and in fact was apparently not present, taxpayers who have paid penalties in the absence of reasonable cause for failure to file are unlikely to succeed in seeking refunds.)

The implications of the Farhy case are uncertain but could be far-reaching — it is potentially applicable to numerous other penalties for failure to file international information returns that the IRS has systematically assessed following the same procedures it followed in Farhy. Some intriguing issues being analyzed to assess the implications for a myriad of clients include determining:

  • The complete list of information returns for which the IRS may have improperly assessed penalties in the past;
  • The running of the statute of limitations with respect to penalty refund claims;
  • Whether the IRS is legally obligated to refund any improperly assessed and collected penalties upon receipt of a properly filed refund claim;
  • The proper procedure for claiming a refund for penalties that were improperly assessed and collected in the past;
  • The likelihood that the IRS would prevail on appeal of the Tax Court’s decision in Farhy; and
  • Whether the IRS will proceed with civil litigation to recover the penalties.

A&M Tax SAYS

Unfortunately, to resolve at least some of the interesting issues emanating from the Farhy case, we may all have to “go to court and watch” how judges address these questions. However, the recent decision could present a refund opportunity for some taxpayers, such as some U.S. owners of foreign corporations, who may have to act soon before the statute of limitations expires (potentially two years after paying penalties in 2021). Also, if the IRS appeals the Farhy decision, by the time a court reaches a final conclusion, the limitations period may have expired for other refund claim opportunities. In the meantime, A&M Tax advisors are available to assist you in considering whether to file protective refund claims.

https://www.alvarezandmarsal.com/insights/farhy-v-commissioner-potential-reporting-penalty-refund-opportunity