A Logical Program Made Unnecessarily Complicated: The IRS’ Approach to International Information Returns

The Difference Between Assessable Penalties and Deficiency Procedures

As outlined in the NFIB v. Sebelius, the difference between a penalty and a tax is not a matter of name but rather a matter of substance. A tax is an amount calculated to be owed based on the tax code and provided information by the taxpayer, while a penalty is an additional amount added to a predetermined tax liability. Penalties are generally determined in one of two ways: through summary assessment or deficiency procedures.

Applicable Forms and Code Sections

There are numerous codes and forms that are involved in the determination of deficiencies and penalties for international information returns.

Form 926

Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, is an information return that is required under Section 6038B for U.S. taxpayers who transfer property to foreign corporations, partnerships, or individuals who meet certain criteria therein.

Form 5471

Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, is an information return required under Sections 6038 and 6046 that provides details about a U.S. person’s involvement with a foreign corporation. This Form requires information like name, address, country of incorporation, undistributed earnings, balance sheet, and details about applicable transactions between the foreign corporation and the taxpayer as well as transactions between the U.S. person and any other entity either controlled or at least 10%-owned by that U.S. person. This Form is also required by those U.S. persons who own or purchase 10% or more of the stock, regardless of class, of a foreign corporation.

Form 8938

Form 8938, Statement of Specified Foreign Financial Assets, is required under Section 6038D for any taxpayer holding interest in foreign assets worth over an aggregated $50,000, including assets held by a financial institution like stocks, securities, and financial instruments as well as those not held by a financial institution. This form requires information about the asset, where it is held, and the maximum value.

The Reasonable Cause Defense

Taxpayers who forget to file, don’t realize they have to file, or do not file for any other reason are often frightened or angry when notices about payment come in the mail from the IRS. However, defenses do apply, and, as with all situations in the U.S. tax system, there’s always a chance to make a case.

Potentially Applicable Penalties and Additional Amounts Owed

Title 26, Subtitle F, Chapter 68, Subchapter B of the U.S. Code, called Assessable Penalties, gives the IRS freedom to assess additional penalties and collect them in the same manner as they would actual taxes. In the same vein, Title 26, Subtitle F, Chapter 68, Subchapter A, also known as Additions to the Tax and Additional Amounts, allows the IRS to apply penalties for those who fail to file, underpay taxes, understate income, or commit fraudulent acts when filing taxes. These amounts and forms of penalty are not uniform, but are interpreted in roughly the same way: an amount added to the balance of taxes due.

  • In Chapter 61 under Section 6707A(a): Per Section 6011, penalties are permitted for anyone who does not include a reportable transaction on a return in the amounts outlined in subsection (b).
  • In Chapter 1 under Section 527(j)(1)(B): As outlined in subtitle F, penalties granted in this section are to be collected in accordance with the policies set in Section 6652(c).
  • In Chapter 99 under Section 9707(f): Penalties allowed by the language in this section must be treated in the same way as taxes imposed by section 4980B.
  • In Chapter 77 under Section 7519(f)(1): Unless otherwise stated, payments required in this section must be assessed and collected in the same way as a tax imposed by subtitle C.
  • In Chapter 61 under Section 6039F(c)(1)(B): If provided demand and notice by the Secretary in the same manner as tax, any U.S. person must pay 5% of the amount of a foreign gift for each month a gift is not properly reported up to 25% of the aggregate amount of gifts.
  • In Chapter 61 under Section 6043(d): For issues related to a failure to file, see section 6652(c) or section 6652(1) as applicable.
  • In Chapter 61 under Section 6046(f) and Section 6046A(e): Violations in this section should be treated as outlined in sections 6679 and 7203.
  • In Chapter 61 under Section 5000A(g)(1): If provided demand and notice by the Secretary except as detailed in paragraph two, penalties under this section should be assessed and collected as those under subchapter B of chapter 68.
  • Section 6038: This Section states that if any U.S. person fails to furnish information with respect to foreign business entities as required in the time prescribed, a penalty of $10,000 for each annual accounting period is applied. Cross-references exist to Sections 7203 in regards to provisions for penalties and Section 7701(a)(30) for the definition of a U.S. person.
  • Section 6038B: This Section states that if any U.S. person fails to provide the information described in subsection (a) as stated in the regulations, a penalty equal to 10% of the fair market value of the applicable property at the time of the exchange will apply. If a contribution was made instead, gain must be recognized on the amount that would have been received had the property sold for fair market value on the date of the action.
  • Section 6038D: This Section states that if any U.S. person fails to provide the information described in subsection © in the ways described, a $10,000 penalty will be required.

Deficiency Procedures

In addition to serving as outliers in regards to Chapter 68, Sections 6038, 6038B, and 6038D are also subject to deficiency procedures. As any amounts derived by these sections are not Assessable, it is actually more appropriate to consider them additional amounts under Section 6214 rather than penalties. All three of these Sections can trigger a 40% accuracy-related penalty under Section 6662 on any amount of underpayment from the understatement of foreign financial assets, adding to the amount reported on an income tax return.

Collection Due Process Proceedings Challenges in the Current System

If we accept the premise that Section 6038, 6038B, and 6038D violations are assessable rather than subject to deficiency proceedings, this raises questions in a collections due process (CDP) hearing.

Collateral Estoppel Complications

As noted, there are concerns related to res judicata that taxpayers may need to keep in mind. However, there may be additional issues to note related to collateral estoppel. Even if res judicata does not fully stand in the way of litigating a tax year in which previous issues have been resolved, issue preclusion, more formally known as collateral estoppel, may come into play. Collateral estoppel (CE), known in modern parlance as issue preclusion, is a common law estoppel doctrine that prevents a person from relitigating an issue. One summary is that, “once a court has decided an issue of fact or law necessary to its judgment, that decision … preclude[s] relitigation of the issue in a suit on a different cause of action involving a party to the first case.” See, San Remo Hotel, L.P. v. City and County of San Francisco, Cal., 545 U.S. 323 (2005). The rationale behind issue preclusion is the prevention of legal harassment and the prevention of overuse or abuse of judicial resources. See, Larson, Aaron (3 November 2017). “Issue Preclusion and Claim Preclusion: How Prior Litigation Can Block Your Claim”

Considerations Regarding Statute of Limitations

In general, the statute of limitations for assessing tax is three years. The IRS has a separate statute of limitations for international information returns, but in considering these, taxpayers may have questions.

Is Filing the Correct Form Necessary?

First, taxpayers may wonder whether requisite Forms need to be filed at all, or whether simply providing the information requested is adequate. Section 6501(c)(8)(A) states that the statute of limitations begins when the information required to be reported is received — which differs from other statutes that specifically mention filing a return. This lends credence to the idea that the rules in Sections 6038, 6038B, and 6038D can be met without actually filing the Forms outlined therein. This is particularly important for Section 6038D because this Section requires information that is duplicated across several Forms, providing grounds to argue that if an FBAR and Schedule B are filed, Form 8938 may not actually be required for the statute of limitations to begin. There may also be a distinction here to note in Beard v. Commissioner. This case stands for the idea that filing at all constitutes a valid return, even if the correct form is not used. This, in conjunction with Section 6501(c)(8)(A), is important to know as otherwise, the statute of limitations would essentially be open indefinitely until Forms 926, 5471, or 8938 are submitted.

What Is the True Statute of Limitations?

While the statute of limitations language appears to apply to Sections 6038, 6038B, and 6038D on the surface, a deeper reading may imply differently. Section 6501(c)(8)(A) contains language that says “…the time for assessment of any tax imposed by this title with respect to any tax return, event, or period…” but the penalties imposed by these Sections are not actually a form of tax. Of course, it could be argued that “tax” here is used as a colloquial reference to tax, interest, fees, and penalties, but this is not actually clearly stated.

Navigating the Challenges of International Information Returns

The current system for penalties related to international information returns is inefficient at best and costly and complicated at worst. With so many convoluted and complex policies related to assessing penalties and determining amounts due as well as the roadblocks in place for those attempting to fight back against the IRS, few taxpayers are in a position to make headway if mistakes are made.

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Michael DeBlis

Michael DeBlis

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Michael is an attorney specializing in entertainment law and a professionally-trained actor. He is a partner in the law firm of DeBlis Law.