• The case involved taxpayer Alon Farhy, a U.S. permanent resident who used Belizean corporations to underreport his income by generating losses through transferred funds exceeding $2 million. Farhy failed to file the required information returns (Form 5471) under Sec. 6038(a) to report his ownership of these foreign entities. In response, the IRS imposed initial penalties of $10,000 per year under Sec. 6038(b)(1) and additional continuation penalties totaling $50,000 for each year from 2003 to 2010 for one corporation and from 2005 to 2010 for the other.
• Initially, the Tax Court sided with Farhy, holding that since Congress had not explicitly authorized the IRS to assess penalties under Sec. 6038(b), the IRS would need to initiate a civil suit to collect them. This decision was based on the interpretation that penalties are not taxes and must be explicitly designated as assessable to fall under the IRS’s administrative collection powers.
• On appeal, the D.C. Circuit reversed the Tax Court’s ruling. The appellate court concluded that Congress intended for the IRS to have the authority to assess and collect penalties under Sec. 6038(b) through its administrative process. The court emphasized the broad language of Sec. 6201(a), which grants the IRS the power to assess and collect “all taxes” and, by extension, penalties associated with tax violations, even if not explicitly labeled as such.
• The court highlighted that Congress intended for the penalties under Sec. 6038(b) to be easily enforceable by the IRS, aligning them with similar penalties under Sec. 6038(c), which are also assessable. The decision further emphasized that requiring the IRS to pursue civil litigation for each $10,000 penalty would create unnecessary administrative burdens and undermine efficient tax enforcement.
• Another reason for the D.C. court to reverse the tax court ruling is that sections 6038(b) and (c) provide a reasonable-cause defense, requiring taxpayers to demonstrate that they exercised due diligence in fulfilling their obligations. The IRS has the authority to grant or deny this defense, affirming that penalties under Sec. 6038(b) are within the scope of Sec. 6201(a).
• By confirming that these penalties can be assessed administratively, the ruling prevents the IRS from initiating numerous civil suits, thereby enhancing administrative efficiency and ensuring timely enforcement of tax compliance.

The D.C. Circuit’s ruling underscores the IRS’s authority to administratively assess penalties for failing to report foreign entity ownership under Sec. 6038(b). This decision strengthens the IRS’s enforcement capabilities, simplifies the penalty collection process, and ensures that penalties for non-compliance with international tax reporting requirements can be effectively imposed and collected without resorting to lengthy civil litigation. The case has been remanded to the Tax Court with instructions to rule in favor of the IRS, thereby allowing the Service to proceed with collecting the assessed penalties.