This three-part series takes a detailed look at civil penalties, particularly with respect to international information return Form 5471.
The statutory framework for civil penalties was discussed in Part One. We now focus on one specific penalty involving failure to furnish information to the IRS about certain foreign corporations that a U.S. person has an interest in. Part Two of this series focusses on penalty cases involving U.S. persons assessed an IRS Form 5471 penalty under §6038(b)(1), for failure to timely file the return.
Recent Developments
This is an evolving area of U.S. tax law. There have been notable developments in recent years, with several Form 5471 penalty cases having been seen by the United States Tax Court (‘tax court’).
Developments are being watched closely by taxpayers and their representatives, notably U.S. tax attorneys.
The heart of the current issue is whether the IRS has authority under §6038(b)(1) to automatically assess a penalty. This issue is contingent on developments expected to unfold during 2026 – and possibly later. This will depend on the timing of any appeals that the IRS might file in any one of the appellant courts. It also will depend on whether a case is taken to the U.S. Supreme Court. If so, it could take a number of years to be heard.
There is a lot at stake here for taxpayers with Form 5471 penalties which have been assessed but not paid.
When it comes to collection, the IRS and the filer of the return have a process to follow. In the case of the IRS, that process is aimed at collecting the penalty. In the case of the taxpayer, that process aims to abate the penalty.
As we close out 2025, there is division in court decisions on whether the IRS has the statutory authority it requires, to assess Form 5471 penalties.
At the least, this is unsettling for U.S. persons who have been assessed these penalties[1].
Where the taxpayer affected is located casts further uncertainty over any appeals court decision. This is due to the differences of opinion between the courts. At the moment, this has occurred through the 2024 reversal of a tax court case by the D.C. Circuit Court of Appeals [2].
This has led to nuances in the way cases are being handled. A 2024 D.C. Circuit Court decision ruled in favour of the IRS. Given this position, U.S. persons under the jurisdiction of the D.C. Circuit Court are unable to successfully appeal any tax court case to that court. However, U.S. persons who are under other appellant court jurisdictions, might have a different ruling. That said, the tax court has, to date, ignored the D.C. Circuit Court’s Farhy decision to some extent.
Past tax court cases are also having an impact on those which are still in the pipelines, putting at least one case into abeyance in anticipation of future appeal court outcomes.
In this article we address five cases where the IRS has assessed a §6038(b)(1) penalty.
The first case, Kelly, confirms the applicability of Neonatology & Associates as explained in Part One of this series.
The remaining cases test whether the IRS is statutorily authorized to impose Section 6038(b)(1)) penalties.
This article discusses the following Form 5471 penalty cases heard by the tax court over the past five years:
- Kelly v. Commissioner[3] 2021 USTC.
- Farhi v. Commissioner[4] 2023 USTC.
- Mukhi v. Commissioner[5] 2024 USTC.
- Safdieh v. Commissioner[6] 2024 USTC.
- Cauchon v. Commissioner [7] 2025 USTC.
Of the five cases,
- One relates to the ability to use reasonable cause defense for failure to file Form 5471.
- The four remaining cases deal with whether the IRS has automatic authority to impose penalties (versus having to take a civil case to court and obtain the approval from a federal judge to assess the penalty).
Also note that of the five cases,
- One case involves a U.S. person (Kelly), who filed his U.S. tax returns through a tax preparer (a CPA),
- The other four cases do not mention that the U.S. person used a tax preparer to file their U.S. tax returns.
Use of a tax preparer is usually highly relevant to the approach taken to challenge any penalty imposed in these circumstances.
Where, in the four cases there is an assumption that the U.S. person filed their own returns, and thus there was no preparer, the individual assessed a penalty won’t have reasonable cause as determined in the Neonatology case, to use as defense.
Therefore, they have challenged the penalty on other grounds, being the IRS’ ability to assess the penalty automatically – without taking civil action.
- Kelly vs. Commissioner
Kelly involved determination of whether the taxpayer had reasonable cause for failure to file Form 5471. It tested the application of the reasonable cause principles of the Neonatology[8] case.
During the 1990s, Kelly, a U.S. person and New York-based businessman, was investing in almost worthless businesses financed by non-performing loans.
He would acquire the businesses, improve the assets held in the business, and on-sell them.
During February 2008 he formed KY & C, a company incorporated in the Cayman Islands. KY & C’s asset was a Cayman Islands yacht which had been purchased from a distressed seller.
Kelly had a staff of employees, including accountants, employed by his various companies. However, he had engaged a U.S. based CPA firm to prepare his U.S. tax returns, including various S-Corporation returns,
Key to this case is that when it came time for Kelly’s 2008 U.S. tax return to be prepared, one of his staff accountants sent an email to the CPA firm stating that the IRS reporting requirements for KY & C weren’t clear.
The CPA firm did not identify that Kelly had a Form 5471 filing requirement. For the 2008 year onwards, no Form 5471 filing obligations were met by Kelly when filing his U.S. tax returns.
Following a series of multi-year write-offs and forgiveness of inter-company debt, Kelly declared bankruptcy.
In 2012 the IRS audited Kelly’s 2010 personal tax return. The IRS held that years 2007 through 2009 remained open, irrespective of the three-year statute of limitations[9], because the returns associated with those years were false or fraudulent with the intent to evade tax.
What’s more, said the government, the failure to file Form 5471 for 2008 and 2009 meant that those years remained open.
In the argument against penalties, the court said that he was entitled to use the normal provisions as defined, where taxpayers have been able to use reliance on a preparer as reasonable cause.
Kelly used reasonable cause to have his Form 5471 penalties abated. He successfully proved to the satisfaction of the tax court, that all three conditions were present:
1. He had relied on a competent preparer (CPA firm). This is key to the outcome of this case.
2. He had provided complete and accurate information to the accountant.
3. He had acted in good faith.
As mentioned, reliance on a competent and informed preparer was key to this case. The CPA involved was in good standing with the IRS, had never been disciplined, and had been in practice for decades.
Irrespective of the fact that §6038 filing obligations for Kelly weren’t identified by the CPA firm, this did not bar Kelly from successfully using reasonable cause for failure to file.
Kelly was, and remains, an important case. It is a remarkable outcome, given that the taxpayer was successful in proving good faith, the third limb of the reasonable cause test.
It seems to indicate that the tax court focused solely on the reasonable cause test for the purpose of determining whether Kelly should be assessed §6038(b)(1) penalties – notably in the context of his historical lack of overall compliance with his U.S. tax affairs spanning the 2007-2011 years.
Of equal significance is that the outcome of this case proved there does not need to be a tax return involved to use a reasonable cause defense. Form 5471 is an international information return – not a tax return.
Following is a discussion of cases which do not involve the doctrine of reasonable cause but the question of whether the IRS has automatic authority to assess §6038 penalties.
Once that matter is finally resolved (which, as mentioned earlier, could be in the U.S. Supreme Court), should the IRS be successful, U.S. persons with Form 5471 penalties have even more reason to rely on the Kelly case as defence.
The following four cases illustrate the current situation as regards uncertainty around the IRS’ authority to automatically assess §6038(b)(1) penalties.
- Farhy vs. Commissioner
Farhy, a U.S. person, formed two foreign corporations. He did not file Form 5471 for 2003-2010 on a timely basis. The IRS assessed Section 6038(b) penalties. When the IRS imposed further penalties followed by a levy to collect the unpaid penalties, Farhy petitioned the tax court.
Farhy argued that §6038(b)(1) did not give the IRS the statutory authority to assess the penalties.
The principle tested in this case was whether the IRS had authority to automatically assess penalties.
In 2025 the tax court upheld the opinion that penalties under section 6038 are not automatically assessable, thus making them invalid and void. If the penalty has not been paid, it’s void, and if beyond the statute for the IRS to collect, the IRS loses ability to collect it.
The IRS appealed the case to the DC Circuit Court. The DC Circuit Court’s view was that the penalties did not need the approval of Congress and that the structure of the penalty sections, the text, and the function of §6038 already demonstrates Congress’ implied approval of penalty assessment.
On 3 May 2024, the DC Circuit Court reversed the tax court’s decision. On June 4, 2024, the taxpayer filed a petition for a panel rehearing that the District Court had erred in its decision and was wrong in its conclusion of Congress’s intent. This request was denied by the tax court on June 13,2024.
- Mukhi vs. Commissioner
Mukhi, a U.S. person, formed Sukhmani Partners II Ltd, a foreign corporation, during 2021. He did not timely file Form 5471 for the 2002 to 2013 years.
In September 2017 the IRS assessed Form 5471 penalties under §6038(b)(1). At $10,000 per year, these totalled $120,000 for twelve years.
On 18 November 2024, the tax court held that the IRS lacks authority to assess the 6038(b)(1) penalty. Mukhi didn’t pay the penalties, and the IRS, following due process, issued a notice of determination upholding its collection activities (levy and lien). Mukhi petitioned the tax court, and, using the same arguments that Farhy had, the tax court upheld the decision in the Farhy case – which was that the IRS did not have the automatic ability to assess the penalties.
During 2024, the Farhy case was being appealed by the IRS in the DC District Court, and as explained above, the D.C. District Court ruled that the IRS does have statutory authority to assess 6038(b)(1) penalties.
Pursuant to this development the IRS filed a motion for reconsideration of findings [10] with the tax court in respect of Mukhi. The tax court doubled down on its previous ruling and reconfirmed that the IRS lacks statutory authority to assess §6038 penalties.
What followed was that the IRS could not proceed with collection. The issue is that the wording of §6038(b)(1) is that if any person fails to furnish within the time prescribed, any information with respect to any foreign business entity, such person shall pay a penalty of $10,000 for each annual accounting period with respect to which such failure exists. The tax court expressed that nothing in the text expressly authorizes the IRS to assess the penalty or provides the procedures the IRS must use to collect it.
As a result, the tax court said, the IRS doesn’t have authority to assess it, and, because there is no provision as to how the penalty is to be enforced, the default rules of collection under 28 U.S. C. Section 2461(a) apply. Those rules state that the IRS is required to enforce the penalty through a civil action.
If the IRS appeals, the case is probably going to be heard in the Eighth Circuit Court of Appeals, (Missouri).
- Safdieh vs. Commissioner
Safdieh, a U.S. person, had a Form 5471 filing obligation for U.S. tax years 2005 to 2009. He failed to timely file form 5471 for those years, and the IRS imposed §6038(b)(1) penalties totaling $50,000.
Safdieh successfully used the argument that the IRS needed judicial intervention to impose penalties, that the IRS did not have automatic authority to do so. The tax court reaffirmed its position in the Farhy case, that the IRS doesn’t have authority under §6038(b)(1) to impose the penalties.
- Cauchon vs. Commissioner
Cauchon, a U.S. person, was issued a penalty for failure to file Form 5471. He petitioned the tax court. The decisions in Farhi and Mukhi were upheld.
The IRS filed an appeal on 15 May 2025 in the Second Circuit Court of Appeals. The case is currently on abeyance, as of June 2025.
Judge Holmes’ order and decision for this case, dated February 2025 gives an effective summary:
This case was on the Court’s June 12, 2023 trial calendar for Buffalo, New York. It arises from the determination by the IRS to proceed with collection by levying against petitioner’s property for section 6038(b) penalties. Both parties moved for summary judgment but then agreed in a phone call with the Court that it made sense to wait until a fundamental issue in this murky corner of tax law-whether the Commissioner could assess section 6038(b) penalties, or had to resort to suit in district court-was sorted out in other cases.
In Farhy v. Commissioner,160 T.C. 399, 403-13(2023)we finally held that those penalties are not assessable, but likely recoverable only in a civil action..The government then appealed Farhy to the D.C. Circuit. SeeFarhy v. Commissioner, 100 F.4th 223(D.C. Cir.2024).
While that appeal was pending, we declined to overrule Farhy in a case appealable to the Eighth Circuit.Mukhi v. Commissioner, No. 4239-22L, 162 T.C., slip op. at 18(Apr. 8, 2024).Our citation to Golsen v Commissioner, 54 T.C. 742, 757(1970)aff’d, 445 F.2d 985(10th Cir.1971) meant that we would not wait on the appeal in Farhy for cases appealable other than to the D.C. Circuit.
But then the D.C. Circuit reversed our decision in Farhy.SeeFarhy v. Commissioner, 100 F.4th 223(D.C. Cir.2024).Our Court’s tradition when we’ve been reversed is to reexamine our reasoning when the issue is next raised in a case appealable to a different circuit.As it turned out, Mukhi was not yet final and unappealable when the D.C. Circuit issued Farhy. The Commissioner moved to reconsider our decision in Mukhi itself.We then issued Mukhi II, No 4329-22L, 163 T.C.(Nov. 18, 2024), in which we held that we still think we’re right in our interpretation of section 6038, and expressly held that we would continue our disagreement with the D.C. Circuit in cases appealable to other circuits.
Mr. Cauchon was a New York resident when he filed his petition, so appellate venue presumptively lies in the Second Circuit. Applying the holding of Mukhi II to this case would require entry of decision in Mr. Cauchon’s favor. We spoke with the two parties today about how to enter decision in this case as efficiently as possible. We told them that we regarded all arguments made in Mukhi II and Farhy has having been made in this case. Petitioner is content with this; respondent wanted to make sure, and had filed on January 23, 2025, a response to petitioner’s motion for summary judgement. That response is also part of the record in this case.
The question raised in these motions is a pure question of law, and one that will likely need to be sorted out by the circuit courts.
It is therefore ordered that respondent’s April 6, 2023 motion for summary judgment is denied.
Conclusion
The doctrine of reasonable cause, notably the reliance on preparer defence, provides filers of all U.S. tax returns, not just Forms 5471 and 8865, reason to use a paid tax preparer to prepare and file their U.S. tax returns.
Use of paid preparers, such as accountants and CPAs will provide an opportunity to use the reasonable cause provisions. This is necessary in the unfortunate event that any transgression in their U.S. tax filings is later identified.
This is not just limited to unfiled information returns, but to any situation involving an underpayment of tax involving civil penalties.
The current divisiveness in the various U.S. court opinions explained in this article means that anyone subject to §6038 penalties could be either advantaged, or disadvantaged, depending on their location.
IRS authority to assess Form 5471 penalties using §6038(b)(1) is yet to be resolved. Developments are coming, with industry expectations that the issue will be heard by the Supreme Court.
This now concludes Part Two of this series. In Part Three we will take a deep dive into Form 5471 itself.
Disclaimer: The information provided in this blog post reflects current tax laws and regulations as of the date of publication. Readers should consult with a qualified tax professional guidance before making any tax-related decisions.
[1] 26 §6038 requires U.S. persons with shareholdings in certain foreign corporations, and interests in certain foreign partnerships, to file information about those shareholdings annually to the IRS.
[2] Farhy v. Commissioner D.C. Circuit Court of Appeals
[3] TC Memo 2021-76
[4] 160 T.C. 399, 403-13 (2023)
[5] 163 T.C. No 8 (Nov. 18, 2024)
[6] Safdieh v. Commissioner, 11680-20L (T.C. Apr 16, 2024)
[7] CAUCHON v. COMMISSIONER OF INTERNAL REVENUE No. 23863-22L February 14, 2025
[8] US Court of Appeals for the Third Circuit – 293 F.3d 128 (3d Cir. 2002)
[9] 26 US Code §6501 – Limitations on assessment and collection
[10] Rule 161 of the Tax Court Rules of practice and Procedure
