The IRS may assess civil penalties against a U.S. taxpayer for failing to timely file complete and accurate international information returns required by the Internal Revenue Code.
U.S. taxpayers generally are taxed on their worldwide income and so are required to report related information for federal income tax purposes.
International information returns require U.S. taxpayers to report information relating to foreign assets, interests in business entities, certain transactions, and information relating to foreign-sourced income.
Information returns typically are attached to taxpayer’s annual income tax return. Information returns that are filed but that are not substantially complete and accurate are considered “not filed” and that kind of omissions may result in penalty assessments.
A U.S. taxpayer may have multiple reporting obligations for a specific tax year and thus may have exposure to multiple penalty assessments. Frequently, the information that was omitted by a failure to file any one of these information returns does not impact the taxpayer’s federal income tax liabilities. Yet, these omissions are subject to significant, harsh penalties under Sections 6038 and 6038A.
A single failure to file timely a single information return exposes the entire U.S. income tax return at issue to audit. It causes the statute of limitations for the taxpayer’s return to remain open indefinitely.
IRS Form 5471. Section 6038 requires U.S. taxpayers to provide certain information regarding foreign business entities they control. This information is furnished on Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) for foreign corporations and Form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships) for foreign partnerships.
Section 6038 penalties. The failure to timely file a Form 5471 or Form 8865 is generally subject to a $10,000 penalty per information return per tax year. If the taxpayer does not provide the required information within 90 days after the IRS notifies the taxpayer of the failure (after notification of assessment), an additional penalty of $10,000 applies to each 30-day period the failure continues. This continuation penalty applies at a maximum of up to $60,000 per return ($10,000 initial penalty plus $50,000 continuation penalty for the next five 30-day periods).
IRS Form 5472. Similarly, Section 6038A requires a 25% foreign-owned U.S. corporation (including a foreign-owned U.S. disregarded entity) to file Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business). A U.S. corporation is 25% foreign owned if it has at least one direct or indirect 25% foreign person as a shareholder at any time during the tax year.
Section 6038A penalties. The failure to timely file a Form 5472 penalty under Section 6038A begins at $25,000. If the taxpayer does not provide the required information within 90 days after the IRS notifies the taxpayer of the failure (after notification of assessment), an additional penalty of $25,000 applies to each 30-day period the failure continues. A major distinction between the Section 6038 penalty and the Section 6038A penalty is that the Section 6038A penalty applies without an upper limit.
National Taxpayer Advocate. In its 2020 Annual Report, the National Taxpayer Advocate identified the IRS’s treatment of the foreign information reporting penalties applying to Form 5471, Form 5472, and Form 8865 under Sections 6038 and 6038A as one the “most serious problems” facing taxpayers. Originally, the IRS assessed these penalties manually on taxpayers whose missing information returns were discovered during an audit. In recent years, the IRS has been applying summary assessments to these penalties (automatically via IRS computers). This automatic assessment has led to many more penalty assessments in this area.
The National Taxpayer Advocate recommends a restoration of manual assessment first-time penalty abatement for these penalties. Keep in mind that the National Taxpayer Advocate’s recommendations are not mandatory on the IRS. They carry the weight of only soft advice that the IRS has the option to choose to take into account.
We Fight and Appeal Penalties. Our firm assists clients with appeals and relief of Form 5471, Form 5472, and Form 8865 penalties.