Internal Revenue Code Sections Dealing With International Disclosure Compliance Should Be Amended to Allow for a Consistent Reasonable Cause Exception, a Consistent Maximum Penalty Amount, and to Require Notice Be Sent to the Taxpayers' Last Known Address

• Jurisdiction: United States,Federal
• Author: By Lisa O. Nelson & Jonathan T. Amitrano
• Citation: Vol. 26 No. 4
• Publication year: 2017

Internal Revenue Code Sections Dealing with International Disclosure Compliance Should Be Amended to Allow for a Consistent Reasonable Cause Exception, a Consistent Maximum Penalty Amount, and to Require Notice Be Sent to The Taxpayers' Last Known Address1

By Lisa O. Nelson & Jonathan T. Amitrano²

EXECUTIVE SUMMARY

The Internal Revenue Service ("IRS") is increasingly focusing on international tax compliance. The frequency of penalty assessments for failure to file information returns have greatly increased over recent years. At issue in our proposal are Internal Revenue Code ("Code") sections 6038, 6038A, 6038D, 6677, and 6679 (the "Code Sections at Issue"), and the continuation penalty associated with each of these Code sections. In situations where a taxpayer fails to file an information return as required by the Code Sections at Issue, the IRS may assess a penalty. All of these Code sections provide that if a taxpayer does not file the required Form(s),³ the taxpayer is liable for a $10,000 penalty.⁴ If notice is given to the taxpayer that they are required to file a specific information return, and if the taxpayer does not file the requested return within 90 days, the IRS may assess an additional penalty every 30 days thereafter. This penalty which continues to increase every thirty days is often referred to as a "continuation penalty".

The IRS should be required to mail the requisite notice telling the taxpayer that they need to file a specific Form, to the taxpayers' last known address, as defined in Treasury Regulation section 301.6212-2.

As currently drafted, the Code Sections at Issue do not apply the same reasonable cause exception to the applicable penalties. Additionally, the Code Sections at Issue should apply the same reasonable cause exception to both the initial penalty, and the continuation penalty.

Finally, we are proposing that a statutory maximum continuation penalty of $50,000 should apply to all of the Code Sections at Issue. As currently codified Code sections 6038, 6038D, and 6679, provide for a maximum $50,000 continuation penalty, Code section 6677 provides for a maximum penalty equal to the gross amount that was reportable to the IRS, and Code section 6038A does not contain any maximum penalty.

This proposal discusses the discrepancies found in the Code Sections at Issue, and proposes a resolution to these discrepancies.

DISCUSSION

I. INTRODUCTION

The IRS has increasingly stepped up their focus and enforcement of international tax compliance since the enactment of the Foreign Account Tax Compliance Act ("FATCA"). This proposal discusses the various Code sections which focus on ensuring international disclosure compliance. Since these Code provisions carry such substantial penalties, and because of the ever-increasing enforcement of international tax compliance, this proposal addresses a variety of discrepancies and issues that currently exist among the international disclosure compliance Code provisions.

The Code Sections at Issue, Code sections 6038, 6038A, 6038D, 6677, and 6679, penalize taxpayers who fail to timely file certain foreign information returns. Each of these Code sections assert a "continuation penalty," which is a penalty that increases if the taxpayer fails to file a required information return after the IRS gives notice to the taxpayer that the specific foreign information return is required. The IRS gives notice by the mailing of a notice to the taxpayer. The continuation penalty applies if the taxpayer fails to file the required information return within 90 days of the IRS notifying the taxpayer of their filing requirement, and ceases upon the taxpayer filing the requisite foreign information return or when the statutory maximum penalty limit has been reached.⁵

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Current law does not require the IRS to provide notice to the taxpayer of the requirement to file a foreign information return to the taxpayer's last known address, as defined in Treasury Regulation section 301.6212-2.⁶ Additionally, Code sections 6038, 6038A, and 6679 are inconsistent with the language of sections 6038D and 6677, in that sections 6038D and 6677 provide for a reasonable cause exception for failing to file an information return after the IRS sends notice to the taxpayer requesting that the information return be filed,⁷ while sections 6038, 6038A and 6679 do not have the same reasonable cause exception. Finally, Code sections 6038, 6038D, and 6679, each provide that the maximum continuation penalty that can be charged is $50,000, for a total maximum penalty of $60,000, while Code sections 6038A and 6677 do not limit the maximum continuation penalty.⁸ There is no reason why the Code Sections at Issue do not have the same reasonable cause exception, or the same maximum penalty amounts.

This paper focuses on the following three issues related to the Code Sections at Issue as currently drafted: (1) the failure to require that notice be sent to the taxpayer's last known address; (2) the reasonable cause exception discrepancy found in the Code Sections at Issue; and (3) the failure to provide for a maximum continuation penalty of $50,000 in Code sections 6038A and 6677. Additionally, this paper discusses the reasons why a change is needed to the Code Sections at Issue, and proposes resolutions to the above highlighted issues.

II. BACKGROUND A. Overview of Code Sections at Issue

The Code Sections at Issue each serve a different purpose. Code section 6038 requires United States ("U.S.") persons to furnish information regarding certain foreign corporations, partnerships, and disregarded entities. In the case of an interest in a foreign corporation, this information is reported on Form 5471 which must be attached to the taxpayer's income tax return and filed by the due date (including extensions) for that income tax return. For a partnership interest in a foreign partnership, the information required pursuant to Code section 6038 must be reported on Form 8865 which also must be attached to the taxpayer's income tax return and filed by the due date (including extensions) for that income tax return. For an interest in a foreign disregarded entity, this information must be reported on Form 8858 which must be attached to the taxpayer's income tax return and filed by the due date (including extensions) for that income tax return.

Code section 6038A requires domestic corporations who have a foreign owner who owns more than 25 percent of the domestic corporation to file Form 5472. Foreign corporations engaged in a trade or business within the U.S. are also required to file Form 5472. The Form 5472 must be attached to the reporting corporation's income tax return by the due date (including extensions) of the return.⁹

Code section 6038D requires taxpayers to disclose information with respect to specified foreign financial assets whose aggregate value of all such assets exceeds $50,000, or such higher dollar amount as the Secretary may prescribe, on Form 8938.¹⁰

Code section 6677 provides that a penalty may be assessed against a taxpayer who fails to comply with Code section 6048. Code section 6048 requires that U.S. persons who are the owner of the assets of a foreign trust, or who receive a distribution or loan from a foreign trust, file Form 3520. This Code section also requires that a foreign trust with a U.S. owner file Form 3520-A.

Code section 6679 provides that a penalty may be assessed against a taxpayer who fails to comply with Code sections 6046 and 6046A. Code section 6046 requires taxpayers who are an officer or director of a foreign corporation in which a U.S. person has acquired ten percent of the stock of the corporation, or who has disposed of sufficient stock that the ownership is now less than ten percent, to file Schedule O of Form 5471. Code section 6046A requires that Schedule P of Form 8865 must be filed if a U.S. person contributed property during the tax year to a foreign partnership in exchange for an interest in the partnership, if that person owned at least a ten percent interest in the partnership immediately after the contribution, or the value of the property contributed exceeded $100,000.

All of the Code Sections at Issue provide that if a taxpayer does not file the required Form(s), the taxpayer is liable for a $10,000 initial penalty.¹¹

B. Continuation Penalty Found in the Code Sections at Issue

In addition to the initial $10,000 penalty, each of the Code Sections at Issue also contains a continuation penalty. As discussed above, a continuation penalty is assessed if the taxpayer fails to file a required information return after the IRS gives notice to the taxpayer that the specific foreign information return is required.

The Code Sections at Issue do not define or explain where the letter informing the taxpayer that they need to file a specific information return, thereby triggering the continuation penalty assessment if not complied with, must be sent.

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Each of the Code Sections at Issue contains a reasonable cause exception to the penalties asserted by the various Code Sections at Issue. However, the reasonable cause exception language is not the same in all of the Code Sections at Issue. Some of the Code Sections at Issue provide that the reasonable cause exception only applies to the initial penalty, while other Code sections provide that the reasonable cause exception applies to both the initial penalty and the continuation penalty.

Additionally, while Code sections 6038, 6038D, and 6679 provide for a maximum $50,000 continuation penalty, Code section 6677 provides for a maximum penalty equal to the gross amount that was reportable to the IRS, and Code section 6038A does not contain any maximum penalty.

Below we will discuss the continuation penalty and the reasonable cause exception for each of the Code Sections at Issue.

1. Code Section 6038

Code section 6038(b)(2) provides that in addition to the $10,000 penalty asserted by Code section 6038(b)(1), the IRS can assess an...