The IRS has a huge arsenal of penalties that can be imposed against unsuspecting taxpayers related to their foreign bank accounts and investments. In the past, however, these penalties were only assessed (asserted and legally owing) if the IRS found problems with the taxpayer’s compliance during a regular audit examination. Last year, the IRS made changes to its internal policies to make it much easier to detect problems with international investment filings and to automatically assess very punitive penalties. With this policy change, there is a significant increase in the international tax penalty assessments being made related to these disclosure forms. Accordingly, knowing the appeals process and standards for penalty abatement has never been more important.
On March 21, 2013, the IRS revised Internal Revenue Manual §22.214.171.124.3 to provide authority to systematically and automatically assess the very punitive $10,000/form international penalties. Specifically, the changes to the Internal Revenue Manual now authorize the IRS to automatically assess the punitive $10,000/form late filing penalty on any IRS Form 5471 (disclosure form for foreign corporations) and/or IRS Form 8865 (disclosure form for international partnerships) that is attached to a late filed U.S. corporate (IRS Form 1120) or partnership (IRS Form 1065) income tax return. This change is significant because it dramatically increases the Service’s ability to assess these international penalties. Specifically, rather than relying on IRS Revenue Agents and IRS Examiners to assess these penalties during an audit examination, the Service will automatically (and likely with computer assistance) be able to select late filed U.S. income tax returns that have IRS Forms 5471 and/or 8865 attached. When the underlying income tax return is filed late, the Service will systematically, and without warning or announcement, assess the taxpayer with the substantial $10,000/form late filing penalty.
Although these penalties are very substantial, there are ways to challenge the Service’s imposition of the international delinquency penalties. The penalties for failure to timely file the IRS Forms 5471 and/or the 8865 may be abated if the taxpayer can establish that the failure to timely file was due to reasonable cause. Treasury Regulation §1.6038-2(k)(3)(ii) provides that in order to show reasonable cause existed for the failure to file the IRS Forms 5471 and 8865, the taxpayer must make a showing reasonable cause for such failure and must do so in a written statement containing a declaration that it was made under the penalties of perjury. Importantly, ignorance of when returns are due or reliance on the advice (however erroneous) of a professional will never constitute reasonable cause.
Unfortunately, there has been little to no case law analyzing the reasonable cause exception as it relates to these international penalties under I.R.C. §6038 and §6038B. However, there is an abundance of controlling law interpreting similar reasonable cause provisions within other comparable sections of the Internal Revenue Code, including the failure to timely file penalties under I.R.C. §6651. Additionally, the IRS in Chief Counsel Advice Memorandum 200748006, suggests that the standards, legal authorities, and criteria that are applicable for purposes of determining whether an abatement of penalties assessed under I.R.C. §6651(a) should also be used in determining whether reasonable cause exists for purposes of abating these international penalties related to the IRS Forms 5471.
The IRS’s Internal Revenue Manual Section 126.96.36.199.2.2 defines “ordinary business care and prudence” as including “making provisions for business obligations to be met when reasonably foreseeable events occur.” Further, this section provides that in determining if a taxpayer exercised ordinary business care and prudence, the appeals officer should consider (1) the taxpayer’s reason for being unable to make a timely filing, (2) the taxpayer’s compliance history, (3) the length of time between the event cited as the reason for noncompliance and the subsequent compliance, and (4) whether the taxpayer could have anticipated the event that caused the noncompliance.
We have routinely and successfully obtained abatements of these automatic international penalties related to a late filed 5471 in cases where the taxpayers have exercised reasonable business care and prudence but nonetheless were unable to timely file the international disclosure forms and the related income tax returns. Very recently, we represented a taxpayer who was automatically assessed with substantial international penalties related to late filed IRS Forms 5471 that were appended to a late filed corporate income tax return. In this case, the taxpayer’s corporate income tax return was filed on September 17, 2012 pursuant to what it believed to be a valid extension of time to file. However, the taxpayer later learned, after the Service’s notice of automatic assessment of these penalties, that the extension of time to file was not timely received by the IRS. Fortunately, we were able to establish that the taxpayer had taken ordinary and business care and prudence to timely file the extension request and that ultimately this ordinary business care and prudence could extend to the untimely filed IRS Forms 5471. The IRS granted our abatement request and abated the very substantial late filing international penalties that were imposed against our client.
We find that in these types of abatement requests, it is very important to clearly set forth the circumstances surrounding the filing delinquency and to be able to establish that such circumstances still support that the taxpayer acted with ordinary business care and prudence in its efforts to timely file its returns with the IRS. Additionally, you also must be able to establish that despite the reasonably prudent steps taken by the taxpayer, it was still unable to timely file these forms with the IRS.
If you or your client is faced with the assessment of these very punitive international tax penalties, please contact the attorneys at Terrence A. Grady & Associates, Co., LPA to assist in obtaining penalty abatement.