Procedure & Administration
The IRS has established a strategic goal to improve tax administration to deal more effectively with the increased globalization of individual and business taxpayers. To accomplish this goal, the IRS has made it a priority to improve voluntary compliance with the international tax provisions and to reduce the tax gap attributable to international transactions. This focus on international compliance has led to increased enforcement of international information-reporting requirements and the associated penalties.
Automatic Assessment of Penalties
In August 2008, the IRS began issuing letters to taxpayers in the Large and Mid-Size Business Division (now the Large Business and International Division) who may not have timely filed their corporate returns and/or Forms 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, to notify them about the implementation of new procedures that would result in the automatic assessment of penalties for late-filed Forms 5471. These procedures were a significant change because late-filed penalties related to Form 5471 had previously been assessed at the discretion of an examiner after a return was selected for examination. Effective January 1, 2009, the IRS began its automatic assessment of penalties for late-filed Forms 5471 attached to a late-filed Form 1120, U.S. Corporation Income Tax Return.
The increased focus on international compliance, along with the new automatic penalty assessment regime, created some confusion as to how taxpayers could administratively appeal the penalties and whether payment of penalties was required prior to Appeals’ review. On August 27, 2010, the IRS added Internal Revenue Manual (IRM) Section 8.11.5, which sets forth new procedures for international penalty appeals. IRM Section 8.11.5 was effective immediately.
Overview of the New International Penalty Appeals Procedures
The international penalty appeals procedures allow taxpayers who have been assessed an international penalty under chapter 61 of the Internal Revenue Code, such as for failure to file Forms 5471; 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business; or 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships, to seek reconsideration of the penalty assessment by Appeals prior to paying the assessment. Under certain circumstances, the new procedures allow some taxpayers to use an accelerated Appeals review process.
International Penalty Appeals Procedures Differ Depending on Type of Taxpayer
The new procedures separate taxpayers who have been assessed international penalties into two groups, Category 1 and Category 2. Category 1 taxpayers are those that have been assessed international penalties during an examination and either hold assets of $100 million or more or have been specifically designated as Category 1 taxpayers by IRS compliance and Appeals personnel. Taxpayers who do not meet the requirements of Category 1 are considered Category 2 taxpayers. Different time frames for Appeals consideration of assessed international penalties apply to each group.
Under the new procedures, Category 1 taxpayers may elect accelerated, prepayment review of assessed international penalties. The accelerated process allows taxpayers that dispute the applicability of international penalties assessed during an examination to exercise their appeal right immediately and to have that dispute resolved by Appeals during the examination. Under the accelerated review process, Appeals will render a decision within 120 days of receiving the taxpayer’s protest and Compliance’s rebuttal. Category 2 taxpayers are eligible for nonaccelerated Appeals review of penalties after the assessment but before any payment is required.
International Penalties Eligible for Prepayment Appeal
The procedures outlined in the IRM apply to the following penalties for both Category 1 and Category 2 taxpayers:
- Sec. 6038(b): Failure to provide information with respect to certain foreign corporations or partnerships (Forms 5471 and 8865).
- Sec. 6038A(d): Failure to provide information or maintain records with respect to certain foreign-owned U.S. corporations (Form 5472).
- Sec. 6038B(c): Failure to provide information relating to transfers or exchanges to foreign persons (Forms 926, Return by a U.S. Transferor of Property to a Foreign Corporation, and 8865).
- Sec. 6038C(c): Failure to provide information or maintain records with respect to foreign corporations engaged in U.S. business (Form 5472).
- Sec. 6038D: Failure to provide information with respect to foreign financial assets.
In addition, the procedures apply to the following penalties for Category 2 taxpayers:
- Sec. 6039E(c): Failure to provide statement concerning resident status.
- Sec. 6039F(c)(1)(B): Failure to file information relating to gifts from foreign persons (Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts).
- Sec. 6039G(d): Failure to provide tax return statement for year of termination by individual losing U.S. citizenship (Form 8854, Initial and Annual Expatriation Information Statement).
Impact of Choosing to Appeal Penalties on a Prepayment Basis
If a taxpayer chooses to appeal international penalties on a prepayment basis, it will be the taxpayer’s only opportunity to contest that penalty before Appeals. Therefore, if the taxpayer disagrees with the results of the appeal, the taxpayer will not receive any additional Appeals consideration before or after paying that penalty.
If a taxpayer does not appeal the international penalty before payment, the taxpayer may dispute the penalty before Appeals under standard claim procedures following payment. The new procedures are taxpayer favorable because they allow taxpayers the opportunity to have a penalty removed without having to pay potentially significant amounts prior to obtaining a review of the penalty assessment.
This publication contains general information only, and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this publication.
Valrie Chambers is a professor of accounting at Texas A&M University in Corpus Christi, TX. John Keenan, Julia Lagun, and Kathy Petronchak are with Deloitte Tax LLP in Washington, DC. Prof. Chambers and Ms. Petronchak are members of the AICPA Tax Division’s IRS Practice and Procedures Committee. For more information about this column, contact Prof. Chambers at Valrie.Chambers@tamucc.edu.