Farhy v. Commissioner is the federal tax case that settled — at least within the D.C. Circuit — how the IRS can collect penalties from U.S. taxpayers who fail to file Form 5471 for their foreign corporations. In May 2024, the D.C. Circuit Court of Appeals held that the IRS may directly assess and collect penalties under Internal Revenue Code Section 6038(b) without first issuing a notice of deficiency, reversing a 2023 Tax Court decision that had reached the opposite conclusion.1Justia. Farhy v. Cmsnr. IRS The practical result: if you owe these penalties, the IRS can move straight to liens and levies, and your only route to challenge the amount in court is to pay first and sue for a refund.
What the Case Was Actually About
Alon Farhy, a U.S. citizen, owned two Belize corporations and knowingly failed to file Form 5471 for tax years 2003 through 2010. The IRS assessed the initial $10,000 penalty for each unfiled form, added continuation penalties, and eventually issued a notice of intent to levy his property.2Office of the Law Revision Counsel. 26 US Code 6038 – Information Reporting With Respect to Certain Foreign Corporations and Partnerships
Farhy did not dispute that he owed the penalties. He challenged the method the IRS used to collect them. That distinction — between owing money and how the government can take it — is what makes the case matter to anyone facing similar penalties.
Why the Collection Method Matters
Federal tax law gives the IRS two very different ways to collect money, and which one applies decides how much protection you have as a taxpayer.
Deficiency procedures are the more protective route. The IRS must send a formal notice of deficiency by certified mail, and you can petition the U.S. Tax Court to challenge the amount before paying anything.3Office of the Law Revision Counsel. 26 US Code 6212 – Notice of Deficiency Tax Court filing fees are low and taxpayers can often represent themselves.
Direct assessment skips that step. The IRS records the penalty, sends a bill, and can proceed with liens, levies, and wage garnishment if you don’t pay. To dispute the amount in court, you have to pay in full first and then file a refund suit in federal district court or the U.S. Court of Federal Claims.4Internal Revenue Service. 2024 Purple Book – Provide That Assessable Penalties Are Subject to Deficiency Procedures Those courts charge higher fees, run on more complex rules, and usually require an attorney. For penalties in the tens or hundreds of thousands of dollars, the pay-first requirement puts meaningful judicial review out of reach for many people.
Farhy argued the IRS needed explicit statutory authority to assess Section 6038(b) penalties directly and that Congress had never granted it. IRC Section 6201 gives the IRS authority to assess “assessable penalties,” but Section 6038(b) never uses the word “assess” or labels its penalties as assessable.5Office of the Law Revision Counsel. 26 US Code 6201 – Assessment Authority The IRS countered that a penalty is assessable unless Congress says otherwise, and that the agency had assessed these penalties this way for decades without objection.
The Tax Court Ruling and the D.C. Circuit Reversal
In April 2023, the Tax Court sided with Farhy. Reading the statute strictly, the court concluded that Congress had explicitly authorized assessment for many other penalties throughout the tax code and its silence on Section 6038(b) meant the authority the IRS claimed simply wasn’t there.1Justia. Farhy v. Cmsnr. IRS Under that ruling, the IRS could collect only by referring the case to the Department of Justice for a civil lawsuit — a slow, resource-heavy process the agency had never used for these penalties.
The IRS appealed, and the D.C. Circuit reversed in May 2024. The appellate court looked at the text, structure, and history of Section 6038 rather than the presence or absence of a single word. It found that the penalty provision’s design — fixed dollar amounts triggered by specific failures, with no tie to a tax deficiency — fit the pattern of an assessable penalty. The court also weighed the fact that the IRS had assessed these penalties for more than 40 years without Congress stepping in to say the agency was wrong.1Justia. Farhy v. Cmsnr. IRS
Within the D.C. Circuit’s jurisdiction, that decision is binding. The IRS is applying it nationwide as confirmation of its long-standing practice.
Which Penalties This Affects
The reasoning in Farhy isn’t limited to Form 5471. Several other international information return penalties share the same statutory structure — fixed dollar amounts for filing failures without an explicit “assessable” label. That group includes penalties for failing to file Form 5472 (foreign-owned U.S. corporations), Form 8865 (foreign partnerships), and Form 8938 (foreign financial assets). Form 5472 penalties start at $25,000 per failure with no statutory cap on continuation penalties.6Internal Revenue Service. International Information Reporting Penalties
Under the D.C. Circuit’s reasoning, all of these penalties are likely assessable. Under the Tax Court’s view, none of them are. Until a higher authority resolves that conflict, the IRS will keep assessing across the whole set, and taxpayers will have limited ability to challenge the process on procedural grounds.
Whether the Law Might Still Change
The Tax Court hasn’t accepted the D.C. Circuit’s reversal. In Mukhi v. Commissioner, the Tax Court reconsidered its position after the D.C. Circuit’s Farhy decision came down and reaffirmed its original conclusion that the IRS lacks authority to assess Section 6038(b) penalties.7United States Tax Court. Mukhi v. Commissioner
Mukhi is appealable to the U.S. Court of Appeals for the Eighth Circuit, which hasn’t ruled on the question.7United States Tax Court. Mukhi v. Commissioner If the Eighth Circuit sides with the Tax Court against the D.C. Circuit, the result would be a circuit split — federal law applied differently depending on where the taxpayer lives — and that is the kind of conflict the Supreme Court typically resolves. Whether and when that appeal moves forward will likely determine whether the country gets a single answer.
The Reasonable Cause Defense Still Exists
Farhy addressed how the IRS collects, not whether the penalties apply in the first place. Treasury regulations still let you avoid the initial $10,000 Section 6038(b) penalty by showing reasonable cause — a legitimate reason for the failure, such as reliance on a tax professional who gave incorrect advice, or a genuine misunderstanding of the filing requirement.
One catch trips people up. Reasonable cause only delays the start of the 90-day clock for continuation penalties. Once that clock starts and the 90 days pass, the continuation penalties cannot be reduced for reasonable cause.2Office of the Law Revision Counsel. 26 US Code 6038 – Information Reporting With Respect to Certain Foreign Corporations and Partnerships Responding quickly to any IRS notice about unfiled international returns matters more than most taxpayers realize.
What to Do About Unfiled International Returns
If you have unfiled Forms 5471 or similar international information returns and the IRS hasn’t contacted you yet, two programs may limit your exposure.
The Delinquent International Information Return Submission Procedures let you file the missing forms through normal channels, attached to amended returns, with a reasonable cause statement. The IRS may still assess penalties during processing, and you may need to separately argue reasonable cause in response to a penalty notice, but coming forward before the IRS finds you puts you in a much better position.8Internal Revenue Service. Delinquent International Information Return Submission Procedures
The Streamlined Filing Compliance Procedures are designed for taxpayers whose failure to file was non-willful — the result of negligence, mistake, or a good-faith misunderstanding rather than a deliberate choice to ignore the requirement. Streamlined lets you file amended returns and delinquent information returns under more favorable terms. You’re not eligible if the IRS has already started a civil examination or criminal investigation of your returns.9Internal Revenue Service. Streamlined Filing Compliance Procedures
Neither program guarantees penalty-free treatment. Both close the moment the IRS initiates contact. Given how much harder Farhy makes it to challenge these penalties after assessment, getting into one of these programs before the IRS finds the gap is the strongest move most taxpayers in this position can make.