For many years, the international tax landscape in the United States has been reactionary. Treasury receives pressure to close a perceived gap or raise tax revenue by hastily rolling out a new law/reporting standard, businesses and individuals change economic direction to adjust and seemingly invasive reporting pervades the U.S. tax system. The international tax landscape in 2023, however, has shifted; gone is the blanket acceptance.
Taxpayers proceeded in 2023 with calculated pushback in the areas of foreign bank and foreign asset reporting penalties with surprising results. Additional areas also received pushback—namely the Internal Revenue Code Section 965 repatriation tax. Appeals and decisions are pending in some cases, so there are still changes to come. While we’ll explore the details below, one common thread is readily apparent: The taxpayer isn’t taking it anymore.
Bittner v. United States
The decision in Bittner v. U.S.1 was a boon to the international tax community because it showed the first step toward a more reasonable and measurable penalty structure for non-willful taxpayers looking to come into compliance. Though questions remain regarding what’s to be done in cases in which Foreign Bank Account Report (FBAR) penalties were agreed to but unpaid as of the date of this decision, the U.S. Supreme Court’s decision at least offers some optimism for a more generous interpretation of FBAR penalties moving forward.
Alexandru Bittner immigrated to the United States in 1982, working as a dishwasher and then as a plumber. Although Alexandru became a U.S. citizen, he returned to Romania in 1990. During this period outside of the United States, Alexandru failed to file FBAR forms. On his return to the United States in 2011, Alexandru became aware of his filing obligations and attempted to rectify the matter by preparing and filing the required reports for tax years 2007 through 2011.
The stated purpose of the Bank Secrecy Act (BSA) is:
to require certain reports or records where they have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities, including analysis, to protect against international terrorism.2
Section 5314 of the BSA directs U.S. residents or citizens to file reports when they maintain foreign and/or offshore bank accounts.
After Alexandru filed the FBAR reports, the government identified errors in the reports—namely, Alexandru didn’t disclose over 25 accounts he either had a “financial interest in” or “signature authority over.” After being notified of this error, Alexandru hired a new accountant to assist in amending these FBARs.
Despite regulations that allow filers with either a “financial interest in” or “signature authority over” more than 25 accounts to simply disclose the number of accounts, Alexandru and his new accountant reported details of every account—61 in 2007, 51 in 2008, 53 in 2009 and 2010 and 54 in 2011. Although the Internal Revenue Service didn’t question their accuracy, they accepted these updated filings and assessed a $2.72 million non-willful penalty under Section 5321 of the BSA. Section 5321 directs the Secretary of the Treasury to penalize those U.S. residents or citizens who violate the regulations, and Section 5318(a) gives the Secretary of the Treasury the authority to administer these penalties.
Alexandru challenged the penalty, arguing that the BSA authorizes a maximum penalty for non-willful violations of $10,000 per report, not $10,000 per account. The district court agreed with Alexandru, but on appeal, the U.S. Court of Appeals for the Fifth Circuit upheld the IRS’ $2.72 million assessment. In the decision, the Fifth Circuit noted that a penalty may be imposed for “any violation” of the provisions of Section 5314. The Fifth Circuit went on further to note that the term “violation” “most naturally reads as referring to the statutory requirement to report each account—not the regulatory requirement to file FBARs in a particular manner”3 (emphasis added). The Fifth Circuit’s interpretation, though seemingly harsh and punitive, appeared to be consistent with the text of the BSA and regulations.
The Supreme Court, in a decision delivered by Justice Neil Gorsuch, reversed the Fifth Circuit’s decision and held that under the BSA, a taxpayer’s failure to file a compliant FBAR should be treated as one violation—not as a separate violation for each foreign account not timely reported. The Court concluded that “best read, the BSA treats the failure to file a legally compliant report as one violation . . . not a cascade of such penalties calculated on a per-account basis.”4
The Court further noted that it was:
no surprise [that] the government seeks to turn this feature of the law to its advantage. Because Congress explicitly authorized per-account penalties for some willful violations, the government asks us to infer that Congress meant to do so for analogous non-willful violations as well.5
The Court was also unpersuaded by the IRS’ argument, noting:
when Congress includes particular language in one section of a statute but omits it from a neighbor, we normally understand that difference in language to convey a difference in meaning (expressio unius est exclusio alterius).6
In addition to the Court’s analysis of statute construction, stated purpose of the statute and legislative intent, it was interesting to see that the Court also considered the human side of the law’s application. Justice Gorsuch noted that “the answer makes a difference, especially for immigrants who hold accounts abroad and Americans who make their lives outside the country,”7 thereby acknowledging, to a certain extent, the compliance burdens for those with international pixels in their tax picture.
Many practitioners are left wondering what avenue, if any, is available to recover these now over-paid penalties from prior assessments. The answer to this remains to be seen. Regardless, one seemingly egregious penalty regime has been curtailed: Score one for the taxpayer.
Farhy v. Commissioner
With the stage set, the decision in Farhy v. Comm’r8 certainly raised eyebrows; the court took the statutory interpretation of Bittner a step further by holding that the IRS didn’t, in fact, have statutory authority to assess penalties under IRC Section 6038(b).
The taxpayer, Alon Farhy, owned 100% of a foreign corporation in Belize and failed to report the same on Form 5471 for tax years 2005 through 2010. The IRS mailed Alon a notice of this failure to file, but Alon never remedied the situation. The IRS subsequently assessed a Section 6038(b)(1) penalty of $10,000 for each year at issue and an additional failure penalty under Section 6038(b)(2) for the continued noncompliance, which totaled $50,000.
The court found that Alon’s failure to file Form 5471 was willful and not due to reasonable cause. Further, the court even noted that Alon participated in an illegal scheme to reduce the amount of income tax that he owed and signed an affidavit describing his role in that illegal regime. This means Alon had zero chance of a reasonable cause argument. Why is this good, though? The statutory arguments in the case and resulting ruling don’t hinge on a finding of reasonable cause.
Alon’s main argument was that the IRS didn’t have the statutory authority to assess Section 6038(b) penalties. The court broke that argument down, however, and I’ll review each section, as the analysis has much more far-reaching implications than just the Form 5471.
To start with the basic threshold assumptions, IRC Section 6201(a) authorizes and requires the Secretary of the Treasury to make assessments of all taxes—including interest, additional amounts, additions to tax and assessable penalties—imposed under the IRC. Under Treasury Regulations Sections 301.6201-1(a), 301.7601-1 and 301-7701-9, the Secretary of the Treasury has delegated these duties to the IRS Commissioner, who has, in turn, delegated them to the IRS officials. When a tax is assessed, the IRS may seek to take certain actions to collect those taxes administratively. Section 6201(a(1) authorizes the IRS to immediately assess the tax determined on a taxpayer’s return as well as certain assessable penalties that aren’t subject to IRC deficiency procedures.
The key to this part of the argument as to why this is inapplicable to Section 6038(b)(1) or (b) penalties is because the term “assessable penalties” isn’t defined with regard to Section 6201(a). As such, there’s uncertainty about which penalties the IRS may assess and ultimately collect.
Alon asserted that while Section 6201(a) is extensive in its grant of authority on “assessable penalties,” it doesn’t include Chapter 61 penalties. He further contended that the Section 6038(b) penalties contain no provision authorizing the IRS to assess or collect the same and so shouldn’t be considered an “assessable penalty.”
The court found that this argument held merit, noting that Congress explicitly authorized the assessment with respect “to myriad penalty provisions of the Code, but not for Section 6038(b) penalties.”9 This is where the analysis starts to get very intense—so hold on tight as I break it down.
- Section 6671(a) provides that the numerous penalties found in subchapter B of Chapter 68 of subtitle F (that is, in Sections 6671-6725) “shall be assessed and collected in the same manner as taxes,” subjecting those penalties to the Secretary’s assessment authority under Section 6201. In more common terms, they’re “summarily assessable.”
- IRC Section 6665(a)(l) contains a similar statement that the additions to tax, additional amounts and penalties provided in Chapter 68 of subtitle F (that is, in Sections 6651-6751) “shall be assessed, collected, and paid in the same manner as taxes.” Again, meaning they’re “summarily assessable.”
The court noted that IRC sections outside of Chapter 68 of subtitle F, whose violations the IRC specifically penalizes, all commonly:
- Contain their own express provision specifying the treatment of penalties or other amounts as a tax or an assessable penalty for purposes of assessment and collection;
- Contain a cross-reference to a provision within Chapter 68 of subtitle F providing a penalty for their violation; or
- Are expressly covered by a penalty provision within Chapter 68 of subtitle F.
In contrast, Section 6038 contains only a cross-reference to a criminal penalty provision, IRC Section 7203, that is, it doesn’t expressly specify the treatment of penalties or other amounts for the purposes of assessment. Further, there’s no provision that provides that these penalties must be paid on notice and demand and assessed and collected in the same manner as any taxes. So, while Sections 6038(b)(1) and (2) allow for a penalty, they fail to provide how it can be assessed or collected.
The court further noted that because no mode of recovery or enforcement is specified for these penalties, unlike for myriad other penalties in the IRC, they were loath to “disturb a well-established statutory framework.”10
The IRS argued, counter to the above, that the term “assessable penalties” as used in Section 6201(a) is applicable to all penalties found in Subchapter B of Chapter 68, not subject to deficiency procedures —that is, those that are “summarily assessable.” The court was unmoved.
The court noted that there’s no provision in the IRC that provides that these penalties must be paid on notice and demand and assessed and collected in the same manner as taxes. As the court stated, “simply put, while section 6038(b) provides for penalties it does not provide for assessable penalties.”11 As such, this argument was found to be baseless.
Finally, the IRS argued that the term “taxes” in Section 6201(a) encompasses Section 6038(b) penalties, even if they’re not assessable penalties. The court, again unmoved, stated that precedent firmly establishes that taxes and penalties “are distinct categories of exactions, at least in the absence of a provision treating them as the same.”12 The court further noted that the IRC has detailed provisions governing the circumstances in which amounts are deemed to be a “tax” for assessment; none of these limited inclusions include a fixed dollar information reporting penalty. As such, the court found that penalties aren’t “taxes” for purposes of assessable penalty characterization.
This case is a big win for the U.S. international tax community and provides a roadmap of sorts for further arguments on this point when dealing with other information reporting penalties. Additionally, many tax practitioners are discussing if the same analysis applies to Form 5472 penalties.
The IRS appealed this decision, so we’ll need to wait to find out the final resolution.
Moore v. U.S.
With the above wins in the taxpayers’ favor, it was almost no surprise when the Supreme Court granted petition for certiorari in Moore v. U.S. In their petition, the Moores claimed that the 2017 IRC Section 965 repatriation tax was unconstitutional. Specifically, the Moores argued that the 16th Amendment doesn’t authorize Congress to tax unrealized sums without apportionment among the states.
Charles and Kathleen Moore, the petitioners, own a 13% stake in an India corporation, KisanKraft Machine Tools Private Limited. This corporation supplies affordable equipment to farmers in impoverished regions of India, and the Moores’ initial investment made in 2005 was $40,000.
KisanKraft earned profits each year and reinvested all earnings to grow the business, while no funds or other payments/dividends were made to the petitioners. The Moores learned that under Section 965, they would be subject to tax on their share of the reinvested earnings at a 15.5% tax rate, resulting in a tax bill of $14,729. The Moores paid the tax due and then sued for a refund. The main question would appear to be: Does income have to be realized to be taxed? The Moores believe so.
The district court disagreed with the Moores’ assertion and granted the government’s motion to dismiss, holding that the Section 965 transition tax falls within Congress’ power under the 16th Amendment. On appeal, the Ninth Circuit affirmed, noting that “realization of income is not a constitutional requirement”13 (emphasis added).
Based on the initial petition, the Moores’ arguments were originally seen as far-reaching, and some dismissed the petition as an overbroad argument attacking too many areas of the IRC. Experts pointed to Subpart F, global intangible low taxed income and passive foreign investment company (PFIC) mark-to-market elections as examples of the provisions that would be affected by this decision as they don’t rely on realization for taxing—essentially, an argument sure to fail. However, the overbroad argument that was expected didn’t appear.
The Moores’ argument in their August 2023 brief is laser-focused, which is essentially that the Section 965 tax is based on mere ownership of property and not the realization (or constructive realization) of income. The argument as set out in the brief focuses on the lack of either an actual or constructive realization requirement—thereby distinguishing Section 965 from both Subpart F and PFIC income. Further, the argument notes the Section 965 tax rates are based on assets owned by the corporation, not on the income recognized by the shareholder—a distinguishing fact from any other tax imposed by the IRC. In fact, shareholders of U.S. corporations are only taxed on a corporation’s profits when they’re distributed in the form of dividends—otherwise the corporation’s profits remain in the ownership of the corporation rather than that of the shareholder.
Based on this petition, there are some international tax practitioners who are now calling for those still paying Section 965 installments to file protective claims for refunds—a very different reaction from the initial petition. It will be an interesting uphill battle for the IRS to overcome these arguments. This is certainly a case to keep watching.
What’s Next?
The landscape of international tax has changed so frequently in just the decade I’ve been practicing that I very nearly expect a new law or form every tax season. My watch word since 2017 has been “pivot!” It’s refreshing to see, however, that the apparent days of blanket acceptance are gone—though still complicated and complex, international reporting is slightly less intimidating after the above.
But the question must be asked: What else in the international tax field remains unfinished business?
Endnotes
1. Bittner v. United States, No. 21-1195 (S. Ct. 2023).
2. www.govinfo.gov/content/pkg/USCODE-2012-title31/pdf/USCODE-2012-title31-subtitleIV-chap53-subchapII-sec5311.pdf.
3. Bittner v. U.S., Case 20-40597 (5th Cir. 2021), at p. 16.
4. Supra note 1, at p. 16.
5. Ibid., at p. 7.
6. Ibid., at p. 2.
7. Ibid., at p. 1.
8. Farhy v. Commissioner, 160 T.C. 6 (April 3, 2023).
9. Ibid., at p. 7.
10. Ibid., at p. 8.
11. Ibid., at p. 9.
12. Ibid.
13. Moore v. U.S., 36 F.4th 930, 936 (9th Cir. 2022).