Is Now the Time to Fix Your Unfiled Form 5471, 5472, 8938, and 3520 Foreign Reporting Form Tax Problems?

As described later in this article not filing Forms 5471, 5472, 8938, and 3520 Foreign Reporting Forms can be an expensive mistake. On April 3, 2023, the Judge Paige Marvel of the U.S. Tax Court issued its opinion in Fahy v. Commissioner, 160 T.C. No. 6 (2023). It is interesting to note that although this was a groundbreaking decision it was not reviewed by the full Tax Court. Judge Marvel held that the IRS was without the authority to assess the Form 5471 imposed by Internal Revenue Code Section 6038(b). Although the opinion doesn’t explicitly address penalties for Forms 5472 or 8938, those penalties are both imposed under the authority of Internal Revenue Code Section 6038(b). Therefore, the IRS will have similar problems with assessing penalties for those forms. The penalties for failure to file Form 3520 with respect to gifts from foreign persons are not imposed under Internal Revenue Code Section 6038(b). However, the Tax Court’s logic in deciding that Form 5471 penalties cannot be assessed applies equally with respect to the penalties for not filing 3520.

If the penalty cannot be assessed that means that the IRS can’t collect the tax by issuing a levy, nor may it file a federal tax lien. It does not mean that the IRS can’t collect the tax. It just means that in order to collect the tax it will need to file suit in federal court. As a practical matter it seems unlikely that the IRS is going to start filing lawsuits against every individual who incurs a tax penalty, even with “80,000 new IRS agents.”

Before everyone starts celebrating, it’s important to keep in mind that the IRS is likely to file an appeal of the Tax Court’s ruling. The IRS has 90 days to appeal under Tax Court Rule 190. The case is appealable to the D.C. Circuit Court of Appeals. The IRS is also likely to head to Congress to get Congress to overrule the Tax Court decision. Given the partisan nature of taxes it is anyone’s guess if a bill of this nature would pass any time soon.

If Congress changes the statute will the change, be retroactive? If so, what is the statute of limitations on the IRS making the assessment? It’s hard to answer these questions. Specifically, since the according to the Tax Court there is no authority to assess the Form 5471 penalty, the statute of limitations that might be allowed to assess would seem dependent on changes, if any by Congress.

First, the IRS might appeal to the U.S. Supreme Court. The Supreme Court doesn’t hear a lot of tax cases, so it might not agree to hear this one.

Second, if the D.C. Circuit Court of Appeals were to reverse the Tax Court, and the Supreme Court didn’t accept an appeal then the statute of limitations as set forth in Internal Revenue Code Section 6501(b)(8) would seem to apply.

You might wish to consider filing a claim for refund. Generally, you will have two years from the date of payment to file a claim for refund. You may not file a claim for refund if you signed a closing agreement with the IRS related to these penalties.

There are many unknows, but this may be a good time to file previously unfiled Forms 5471, 5472, 8938, and 3520. If the Tax Court’s decision is upheld and not reversed by Congress, the chances of the IRS suing for penalties is fairly remote in most instances. If the Tax Court’s decision is later reversed filing the Forms now may start the statute of limitations running.

Forms 5471, 5472, 8938, and 3520 are used to report information on certain foreign financial assets, transactions, and ownership interests. Keep in mind that this is just a general outline. You will want to refer to the instructions to the IRS Forms, or a tax professional knowledgeable about foreign information reporting forms, for the full story.

Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, is used by certain U.S. persons to report their ownership interests in foreign corporations. The form also provides information about the financial activities of the foreign corporation.

A U.S. person may need to file Form 5471 if they are:

1. A person who was a U.S. shareholder of a foreign corporation that was a section 965 specified foreign corporation (SFC) at any time during the foreign corporation’s tax year ending with or within the U.S. shareholder’s tax year;
2. A U.S. shareholder (owning 10% or more) in a Controlled Foreign Corporation (CFC);
3. A director or officer of a foreign corporation with at least one 10% U.S. shareholder;
4. A U.S. person who acquires or disposes of stock in a foreign corporation, resulting in 10% or more ownership; or
5. A U.S. person who had control of a foreign corporation for at least 30 days during the tax year.

Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, is used to report certain transactions between a 25% foreign-owned U.S. corporation or a foreign corporation engaged in a U.S. trade or business and its foreign shareholders or other related foreign parties.

Form 8938, Statement of Specified Foreign Financial Assets, is used by U.S. taxpayers to report their ownership of specified foreign financial assets if the total value exceeds certain reporting thresholds.

U.S. taxpayers, including individuals and certain domestic entities, must file Form 8938 if they have an interest in specified foreign financial assets and the total value of those assets exceeds the reporting threshold for their filing status. Thresholds vary depending on filing status and whether the taxpayer lives in the U.S. or abroad.

Individuals:

1. Single or married filing separately, living in the U.S.: $50,000 on the last day of the tax year or $75,000 at any time during the tax year
2. Married filing jointly, living in the U.S.: $100,000 on the last day of the tax year or $150,000 at any time during the tax year
3. Single or married filing separately, living abroad: $200,000 on the last day of the tax year or $300,000 at any time during the tax year
4. Married filing jointly, living abroad: $400,000 on the last day of the tax year or $600,000 at any time during the tax year

Domestic entities must file Form 8938 if they hold specified foreign financial assets with a total value of more than $50,000 on the last day of the tax year or $75,000 at any time during the tax year.

Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, is used by U.S. persons to report certain transactions with foreign trusts and to report the receipt of certain gifts or bequests from foreign persons.

A U.S. person must file Form 3520 if they:

1. Are the responsible party for reporting certain transactions with foreign trusts, such as the creation of a foreign trust by a U.S. person, the transfer of money or property to a foreign trust, or the death of a U.S. person who was an owner of a foreign trust.
2. Have received a gift or bequest from a foreign person that exceeds the reporting threshold:
   • Gifts or bequests valued at more than $100,000 from a nonresident alien individual or foreign estate
   • Gifts valued at more than $16,815 (for 2021, adjusted annually for inflation) from foreign corporations or foreign partnerships

Failure to file these forms can result in outrageous penalties:

Form 5471: A penalty of $10,000 may be imposed for each tax year a required Form 5471 is not filed on time or is incomplete. If the failure to file continues for more than 90 days after notification from the IRS, an additional $10,000 penalty may be imposed for each 30-day period (or part of a period) the failure continues, up to a maximum of $50,000 per form, for a total of $60,000 per year.

Form 5472: A penalty of $25,000 may be imposed for each tax year a required Form 5472 is not filed. If the failure to file continues for more than 90 days after notification from the IRS, an additional $25,000 penalty may be imposed for each 30-day period (or part of a period) the failure continues with no apparent limit on the total amount due per year.

Form 8938: A penalty of $10,000 may be imposed for failure to file Form 8938. If the failure to file continues for more than 90 days after notification from the IRS, an additional $10,000 penalty may be imposed for each 30-day period (or part of a period) the failure continues, up to a maximum of $50,000, for a total of $60,000 per year. This is on top of any penalties for not filing a Foreign Bank Accounting Reporting (FBAR).

Form 3520: The penalty for not filing Form 3520, which is used by U.S. persons to report gifts or trust distributions (including inheritance) received from a foreign person, can be quite onerous; especially considering that the gift isn’t taxable if properly reported. If the form is filed late, the penalty is 5% of the value of the unreported gift for each month that passes after its due date, with a maximum penalty of 25% of the amount of the gift.

Conclusion:

Fahy v. Commissioner case has brought attention to the problems that the IRS may have in assessing penalties for Forms 5471. While the Tax Court's ruling on Form 5471 may have implications for penalties related to other forms, it's important to note that the IRS is likely to appeal this decision. Taxpayers should still be aware of the requirements and penalties associated with these forms and can contact us to review the implications of Fahy v. Commissioner to their individual circumstances.