Your Best Defense Against Form 5471 Violations, Tax Guidance
A Defense to Form 5471 Violations
One of the most unfair types of penalties that have become a key focus for the Internal Revenue Service in the past few years is the Form 5471 penalty. The penalty is assessed against taxpayers who have ownership in a foreign corporation but did not timely report their ownership to the IRS — and have now become subject to significant fines and penalties by the Internal Revenue Service. In this type of scenario, the taxpayer is not being penalized for having any unreported income, but simply for not reporting an ownership interest in a foreign corporation. And, oftentimes the ownership interest is not in a major foreign conglomerate, but rather ownership in a family business abroad — and they may have even received the interest as a result of a foreign gift or inheritance while they are considered a U.S. Person and were unaware of any reporting requirements. If a taxpayer has been assessed a Form 5471 penalty (or will be filing a late form 5471), one of the first defenses to consider is reasonable cause.
26 CFR § 1.6038-2 (Information returns required of certain foreign corporations)
The laws involving gorm 5471 violations are codified in 26 USC 6038, with reasonable cause found under 26 CFR 1.6038-2:
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(3) Reasonable cause.
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(i) For purposes of section 6038 (b) and (c) and this section, the time prescribed for furnishing information under paragraph (i) of this section, and the beginning of the 90-day period after mailing of notice by the Director of Field Operations under paragraphs (k)(1)(ii) and (2)(iv)(A) of this section, shall be treated as being not earlier than the last day on which reasonable cause existed for failure to furnish the information.
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(ii) To show that reasonable cause existed for failure to furnish information as required by section 6038 and this section, the person required to report such information must make an affirmative showing of all facts alleged as reasonable cause for such failure in a written statement containing a declaration that it is made under the penalties of prejury. The statement must be filed with the district director for the district or the director of the service center where the return is required to be filed. The district director or the director of the service center shall determine whether the failure to furnish information was due to reasonable cause, and if so, the period of time for which such reasonable cause existed. In the case of a return that has been filed as required by this section except for an omission of, or error with respect to, some of the information required, if the person who filed the return establishes to the satisfaction of the district director or the director of the service center that the person has substantially complied with this section, then the omission or error shall not constitute a failure under this section.
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Reasonable Cause and Not Willful Neglect
The key verbiage in this code section is for the taxpayer to be able to show that reasonable cause existed. Depending on whether the taxpayer has already been penalized or not will determine whether they should submit the reasonable cause letter upfront along with the late-filed form or if they have already been penalized and it will serve as the crux of the protest letter that the taxpayer usually files within 30 days of receiving the Form 5471 violation CP-15 Notice.
How to Prove Reasonable Cause
There is no one-size-fits-all argument when it comes to reasonable cause. It is based on a totality of the circumstance test and while two different taxpayers may have similar circumstances, they will not have an identical set of facts.
The letter should be detailed and focus on the facts that illustrate reasonable cause.
For example:
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Was it the first time the taxpayer was required to File Form 5471?
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Did the taxpayer use a CPA or other tax professional when filing?
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Did the taxpayer conduct their own due diligence?
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Has the taxpayer been penalized on this type of issue previously?
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Has the taxpayer been filing timely tax returns for the past years?
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Has the taxpayer filed their other international information returns timely?
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The 5471 Dispute Process is Long (and Winding)
There are many steps a taxpayer may have to take to resolve a Form 5471 reporting issue, from filing the form to reaching a resolution with the IRS. These types of penalties are referred to as assessable penalties and are normally issued once the IRS is put on notice that the international reporting form was filed late –– and generally not issued in scenarios such as audits or examinations. This puts the taxpayer at an immediate disadvantage because they do not have a chance to dispute the penalty before it is issued to them by the IRS. The first step in challenging the penalty is usually the filing of a protest letter –– but if it is not successful, the taxpayer must continue onto other alternatives such as an appeal, collection due process hearing, tax court, or federal court (each with their own sets of pros and cons).
Hire Experienced Form 5471 Counsel
You should be working with a Board-Certified Tax Law Specialist that specializes exclusively in offshore tax matters. The firm should offer a flat-fee, and full-service representation. Realizing, that the IRS is very disorganized and understaffed and it can take many, many hours to even resolve the simplest issues with the IRS, and if you are being charged hourly, those hours can quickly add up and far surpass what you would have paid in a flat-fee situation.
About Our International Tax Law Firm: Golding & Golding
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance with getting compliant.