In May 2024, the U.S. Court of Appeals for the District of Columbia reversed the Tax Court in Alon Farhy v. Commissioner, No. 23-1179 (D.C. Circuit May 3, 2024), taking a reasonableness approach. Looking at the history of Code Sec. 6038, the D.C. The Circuit concluded that Congress was focused on simplifying the ability of the IRS to collect the penalties, not creating enforcement roadblocks by denying the IRS the ability to assess the penalty.
The D.C. The Circuit also determined that the reasonable cause defense provided for in the statute only made sense if the IRS had the ability to assess the penalties. As a practical matter, the D.C. The Circuit pointed out that the time and costs involved in seeking a court decision on penalties that may involve only $10,000 would discourage the IRS from taking that action and defeat the purpose of the penalty.
Contrary to the reversal of its position on conservation easements and the Administrative Procedures Act, the Tax Court continues to follow its original position in Farhy in cases arising outside of the D.C. Circuit, creating the potential for a conflict among the circuit courts of appeal.
The Tax Court approach may produce a split among the circuit courts, and the Supreme Court may take a case to resolve the split among the circuits. The Farhy case may be appealed; however, it is not clear that the Supreme Court would take the case until there is a split among the appellate courts. In the case of Mukhi v. Commissioner, 162 T.C. No. 8 (April 8, 2024), the Tax Court has already followed its decision in Farhy in a decision that the IRS is likely to appeal to the Eight Circuit.
Taxpayers outside of D.C. The Circuit may also follow the Farhy challenge to the authority of the IRS to assess penalties for foreign information returns, and perhaps other statutory penalties where the authority of the IRS to assess the penalty is not expressly stated in the Tax Code. They will have some assurance that they will be successful in the Tax Court, but also that the IRS will appeal the case to the relevant circuit court. Similar cases are already working their way through the Tax Court and federal district courts.
It is also possible that Congress could step in to clarify the authority of the IRS to assess penalties. It could be a while, however, before either Congress or the courts manage to finally resolve the issue.
Please contact Brian Schwam or Todd Hedgpeth @ 866-298-7829 for more information.
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