Last April, in Farhy v. Commissioner, the Tax Court held that the IRS did not actually have authority to assess penalties under IRC § 6038. The result was devastating for the IRS, as it meant it did not have authority to assess penalties for failure to file Forms 5472, 8865, 926, and 3520. In a well-reasoned opinion, Judge Marvel held that Congress has been clear in identifying which penalties are assessable penalties and which are not. Since Congress did not clearly state that the IRS has the ability to assess penalties under IRC § 6038 but did so with other penalties, then the IRS does not have authority to assess such penalties. Instead, DOJ would be required to sue to collect any penalties.
Following this monumental case, many tax professionals advised penalized taxpayers to file claims for refund. These claims could be based on the holding of Farhy – as in the IRS improperly assessed penalties for failing to file these forms, and therefore taxpayers were entitled to refunds for the penalties they already paid.
However, on May 3, 2024, the D.C. Circuit Court of Appeals overturned the Farhy decision. The Court focused not on the plain text of IRC § 6038, which does not explicitly grant IRS the authority to assess applicable penalties, but instead on the fact that Congress intended to give the IRS such authority. The Court of Appeals seemingly glossed over Congress’ deafening silence in IRC § 6038(b) regarding assessability versus Congress’ explicit grant of authority in other Code provisions. The Court’s rationale seems to run contrary to normal cannons of statutory construction – as in, Congressional intent should be considered only when a statute is ambiguous. See, e.g., Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1983).
This circuit court win will give the IRS confidence to continue asserting penalties under IRC § 6038 and put any relevant claims for refund in jeopardy. However, there are other cases that will likely be appealed to other circuit courts. For example, the Tax Court recently relied on Farhy to reject the IRS’s assessment of penalty under IRC § 6038 in Mukhi v. Commissioner. That case is appealable to the Eighth Circuit Court of Appeals. If Mukhi is appealed, then the Eighth Circuit will have to consider the same issue as the D.C. Circuit. If the Eighth Circuit upholds the Tax Court, then there will be a circuit split, which would lead to even more confusion on the issue. Therefore, the story is not over yet and practitioners will have to keep an eye on what other circuits do with the issue. In the meantime, claims for refund remain viable options to protect Taxpayer claims going forward.
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