International information return penalties remain a significant issue for taxpayers and advisers.

• Author: Trivedi, Shamik

This item explores the risks to taxpayers and return preparers alike for certain delinquent or substantially incomplete international information returns that provide information to the 1RS to satisfy various reporting requirements under Sees. 6038 and 6038A. While no tax is directly due with the filing of these returns, the failure to timely file or substantially complete these international information returns can result in significant penalties, as well as indefinitely extend the statute of limitation on assessment for the taxpayer's entire return. This item addresses ways to attempt to mitigate these penalties, including the use of reasonable cause and first-time abatement (FTA). It should be noted that similar penalties exist for other international information returns, but they are not discussed in this item.

Congress imposes dozens of penalties for a variety of failures under the Internal Revenue Code. Some penalties relate to understating income or overstating basis, while others relate to the late filing of a tax return or the late payment of tax. The law typically imposes these penalties as a percentage of the tax owed, and they are usually increased if a taxpayer acted intentionally.

In other cases, however, the penalties may have no relation whatsoever to an underlying tax liability. For example, Congress has imposed steep penalties for the failure to timely file or substantially complete certain international information returns, such as Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, or Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. The failure to timely file or substantially complete one of these international information returns may result in a flat $10,000 penalty, per form, per year--even when no income tax was owed with the taxpayer's return.

In addition to carrying monetary penalties, the various failures noted above may have other ramifications. The statute of limitation on assessment--the IRS's time limit for collecting tax from a particular period--may be extended for several years if the failure is significant enough, or even potentially indefinitely in the case of certain international information returns. Of course, if the taxpayer acted fraudulently or never filed the return itself, then the statute of limitation on assessment also may remain open indefinitely.

In some cases, however, a taxpayer may obtain an abatement of penalties by affirmatively arguing reasonable cause. In fewer cases, a taxpayer may obtain an abatement of penalties automatically, through the use of the IRS's FTA administrative penalty waiver procedures outlined in Internal Revenue Manual (IRM) Section 20.1.1.3.6.1.

Although options are available, obtaining relief from the penalties by establishing reasonable cause may be a difficult, time-consuming endeavor and is never guaranteed. Worse still, the statute of limitation on assessment for the taxpayer's entire tax return may be extended or open indefinitely unless the taxpayer takes certain actions. With the 1RS systemically assessing many of these penalties, taxpayers have few options but to seek relief or pay the consequences. These, among others, are risks to otherwise compliant taxpayers and their advisers.

Remedies

As is customary in tax law, resolution of issues can be time-consuming, complex, or in some cases, unavailable. The ability to obtain abatement of penalties imposed under Sees. 6038 and 6038A (collectively, international information return penalties, or IIRPs), and related to late-filed Forms 5471 or 5472, depends on numerous factors. The two primary remedies for IIRPs are FTA and reasonable-cause relief.

FTA: Generally speaking, FTA, which is outlined under IRM Section 20.1.1.3.6.1, allows taxpayers to request abatement of certain failure-to-file penalties (e.g., Sec. 6651(a)(1)). To qualify, taxpayers must (1) have not previously been required to file a return or have no prior penalties (except the estimated tax penalty) for the preceding three years, and (2) have filed, or filed a valid extension for, all currently required returns and paid, or arranged to pay, any tax due. The taxpayer must also not have incurred an unreversed penalty for a "significant amount" during the tax period in the prior three years.

An FTA generally does not apply to "event-based" filing requirements such as with Forms 5471 and 5472. However, notably, the International Department at the Ogden Accounts Management Center will abate IIRPs if the "related Form 1120" penalty has been abated (through either an FTA or some other means of reasonable cause) and the required returns have posted to the 1RS Master File. IRM Sections 20.1.9.3.5 and 20.1.9.5.5 generally outline these procedures.

For most penalties, taxpayers generally can request an FTA by telephone or through writing. However, exhibits within the IRM for IIRPs instruct the agent to not...