The United States Court of Appeals for the D.C. Circuit reversed the Tax Court’s decision in Farhy v. Commissioner (160 T.C. No. 6) on May 3, 2024, ruling on the IRS’s authority to assess penalties under Section 6038(b).
The petitioner, Alon Farhy, was required but failed to file Forms 5471 for two controlled foreign corporations. The Service assessed penalties for the failure to file the forms under Sections 6038(b)(1) (initial penalty) and (b)(2) (continuation penalty). In April 2023, the Tax Court ruled in favor of the taxpayer, holding that the Service lacked statutory authority to assess penalties under Section 6038(b) and instead must pursue the collection of such penalties through a civil action in court. (See our prior tax alert.)
On appeal, the D.C. Circuit has reversed the Tax Court’s decision, holding that the text, structure, and function of Section 6038 demonstrate that Congress authorized the assessment of penalties under Section 6038(b). The D.C. Circuit observed that Section 6038(c) also imposes a penalty in the form of a reduction to the foreign tax credit for failure to file information required under Section 6038(a). The D.C. Circuit stated there was no dispute that the penalty under subsection (c) was assessable, and that subsections (b) and (c) are coordinated. For instance, the subsection (c) penalty is reduced by any subsection (b) penalty when both penalties apply. The D.C. Circuit also reasoned those penalties under both subsections (b) and (c) are subject to a reasonable cause defense, and that former Section 6038(c)(4)(B) (as in effect during the tax years at issue) contemplated that the Service, rather than a court, first determine whether a taxpayer has demonstrated reasonable cause. Finally, the D.C. Circuit stated that the lack of a cross-reference to Chapter 68 (which provides express statutory authority for the assessment of penalties) or explicit language in Section 6038 that the penalty “shall be assessed” was not determinative, and that Congress could make a penalty assessable by implication.
The Golsen rule requires the Tax Court to follow circuit precedent when the appeal of a particular case would lie in that appellate circuit, even if the Tax Court might otherwise rule differently. See Golsen v. Commissioner, 54 T.C. 742 (1970), affirmed, 445 F.2d 985 (10th Cir. 1971). Appeals from the Tax Court go to the appellate circuit that has jurisdiction based on the taxpayer's residence or principal place of business. For taxpayers without a U.S. address, the D.C. Circuit Court of Appeals has jurisdiction (see Section 7482(b)(1)(B)). Under the Golsen rule, the Tax Court will have to follow the D.C. Circuit’s decision in Farhy in cases appealable to the D.C. Circuit. The D.C. Circuit’s decision in Farhy is not controlling in Tax Court cases appealable to other circuits, but it could impact future decisions in other circuits and ultimately in the Tax Court.
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