The IRS recently suffered a defeat in the U.S. Tax Court regarding civil penalties and automatic assessments, thanks to the ruling in Alon Farhy v. Commissioner of Internal Revenue. The decision in Mukhi v. Commissioner of Internal Revenue raised similar questions to Farhy, and the Tax Court upheld the ruling in Farhy.
In Farhy, the taxpayer failed to report his ownership interests in foreign corporations and was penalized under section 6038. The IRS assessed penalties totaling $10,000 per year under section 6038(b)(1) and continuation penalties totaling $50,000 per year under section 6038(b)(2). Farhy challenged the IRS’ authority to assess these penalties, leading to the court’s decision that the IRS cannot systematically levy such penalties without additional steps, such as civil litigation.
In Mukhi, the taxpayer established foreign entities that required him to file various information returns. Following a guilty plea for tax-related offenses, the IRS assessed civil tax penalties for failure to file forms such as Form 3520, Form 3520-A, and Form 5471. The taxpayer challenged these penalties through a Collection Due Process (CDP) Hearing, ultimately leading to a ruling by the Tax Court.
The Court found that the penalties assessed under section 6038(b) were not enforceable, citing the Farhy ruling. The Court declined to address the constitutional argument that the penalties violated the Excessive Fines Clause, as there was a nonconstitutional basis to resolve the issue. The Court also rejected the taxpayer’s Eighth Amendment arguments related to section 6677 penalties, determining that they were not excessive or punitive.
The ruling in Mukhi has significant implications for taxpayers facing Form 5471 penalties, as it upholds the decision in Farhy. Despite an appeal pending, the impact of the ruling in Farhy on taxpayers remains and may potentially change after further court rulings. Taxpayers should stay informed and updated on developments in this area.
Overall, the Mukhi v. Commissioner of Internal Revenue case highlights the ongoing legal battles surrounding civil penalties for tax-related offenses and the importance of understanding IRS assessment and collection procedures. The ruling underscores the need for taxpayers to seek professional guidance and stay informed about potential penalties they may face for noncompliance with tax laws.
