IRS Penalties for Late-Filed Forms 5471
The Dewees v. United States, 16-cv-01579 (D.D.C. 2017) case is a good reminder that late-filed Forms 5471 should include reasonable cause statements. These statements can be submitted under the IRS’s Delinquent International Information Return Submission Procedures to avoid penalties being assessed.
The Facts and Circumstances in Dewees
Dewees is a U.S. citizen who lived in Canada. He owned a consulting business that was operated in Canada. The business was organized as a corporation. Dewees didn’t file Forms 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, with the IRS to report his ownership of the corporation for over 10 years. The IRS assessed a $120,000 of Sec. 6038 penalties, $10,000 for each of 10 years. Dewees challenged the penalty and, when unsuccessful, he refused to pay the penalty. The Canadian tax authority then held Dewees’ Canadian tax refund under the terms of the U.S.-Canada Tax Treaty pending the resolution of the IRS penalty liability.
Section 6038 Penalties, Generally
Section 6038 imposes a penalty for failing to timely file certain information returns. This includes the Form 5471. The Form 5471 is filed by annually U.S. persons who have a controlling interest in a foreign corporation. It is to be included with the owner’s U.S. income tax return. The Section 6038 penalty is $10,000 for each late-filed Form 5471. The penalty does not apply if the taxpayer can show reasonable cause for the late filing.
Since 2009, the IRS has taken the position that all late-filed Forms 5471 are subject to the Section 6038 penalty. The IRS automatically assesses the penalty when the late filed return is filed. It is then up to the taxpayer to ask the IRS to abate the penalty. The request has to be submitted in writing.
Reasonable Cause for Sec. 6038 Penalties
The IRS often does abate the Section 6038 penalty if the taxpayer can show reasonable cause for the late filing. So what is reasonable cause? The term “reasonable cause” is not defined in the Code or regulations for the Section 6038 penalty. Instead, there is a body of case law that has developed for late filing penalties, generally, that has been applied to Section 6038 penalties. These court cases relate reasonable cause to acting with good faith and with ordinary business prudence.
The Sec. 6679 regulations also add that reasonable cause includes the inability to obtain the information needed to provide the information to the IRS. Like the court cases, these regulations do not specifically apply to late-filed Forms 5471, but they are thought to apply generally in concept.
Both of these sources of law have been cited in the handful of other court cases that have considered reasonable cause for Sec. 6038 penalties. In those other court cases, the courts have generally found that reasonable cause was not established under the facts presented. The Flume v. Commissioner, T.C. Memo. 2017-21 from earlier this year is a good example. In that case, the taxpayer was not able to show that he relied on his tax advisor for this issue as he did not disclose the existence of the foreign corporation to his tax return preparer.
The typical dispute is whether reasonable cause is established. The Dewees case did not address reasonable cause. The case was over the Canadian tax authority holding Dewees’ Canadian tax refund.
It should also be noted that Dewees probably did not submit his late-filed Forms 5471 under the IRS’s procedures for submitting delinquent international tax returns. These procedures are not available if the taxpayer is under audit, which may have been the case, and they were not available until more recently.
The IRS’s Delinquent International Information Return Submission Procedures
Knowing that a penalty abatement request must be submitted for late filed Forms 5471, one might wonder if they can just submit the request with the forms. The IRS has sent mixed messages on this over time, but the answer currently, is “generally, yes.” The late-filed Forms 5471 can be submitted under the IRS’s Delinquent International Information Return Submission Procedures.
These procedures are available if the taxpayer:
- has not filed one or more required international information returns,
- has reasonable cause for not timely filing the information returns,
- is not under a civil examination or a criminal investigation by the IRS, and
- has not already been contacted by the IRS about the delinquent information returns.
Under these procedures, the taxpayer is to submit a detailed reasonable cause statement. The statement is very similar to a traditional penalty abatement request, except it follows the format of the IRS’s submission procedures and it is submitted with the tax return rather than being submitted separately.
It has been our experience that the IRS is not assessing the Sec. 6038 penalty when a detailed reasonable cause statement is included with the late-filed Form 5471 under this program.