Many people imagine the IRS as a kind of huge and powerful being, “whose frown, and wrinkled lip, and sneer of cold command” regularly oversees enforcement of what many believe are outrageous penalties for errors in complying with increasingly twisted reporting requirements.

Today we learn a lesson about possible limits of the IRS powers to assess some of these reporting penalties, specifically the ones found in §6038 (titled “Information reporting with respect to certain foreign corporations and partnerships”).

In Raju J. Mukhi v. Commissioner, 163 T.C. No. 8 (Nov. 18, 2024) (Judge Greaves), the Tax Court reaffirmed its conclusion that the IRS has no authority to assess §6038 penalties.  Instead, the only way for the government to impose those penalties is by filing suit in court.  We learn that, at least in the Tax Court’s view, neither §6038 itself nor any other part of the Internal Revenue Code give the IRS authority to assess §6038 penalties.

Today’s case also teaches a lesson about the Tax Court’s relationship with other federal courts.  Often labeled “the Golsen rule” that relationship is not a simple one.  See e.g. Lesson From The Tax Court: The Rules For Penalty Approval Depend On Geography, TaxProf Blog (Oct. 20, 2023).  The Tax Court’s decision in this case directly conflicts with the D.C. Circuit’s interpretation of §6038.  See Farhy v. Commissioner, 100 F.4th 223 (2024) (overruling Tax Court’s interpretation of §6038).  Under the Golsen rule, however, the Tax Court is not bound by any Circuit Court of Appeals decision.  It is free to disagree with any other federal court … except the U.S. Supreme Court!  So whether you are teaching students, advising clients, or litigating in Tax Court, you gotta pay close attention to what the Tax Court says.

Details below the fold.

Law: The Authority to Assess Penalties
In §6201 Congress both authorizes and requires the IRS to make “the inquiries, determinations, and assessments of all taxes (including interest, additional amounts, additions to the tax, and assessable penalties.”  The act of assessment is the linchpin of tax administration.  It is both the summation of the tax determination process and the start of the enforced collection process.

The structure of tax administration traces back to the Revenue Act of 1862.  It is important to start there to understand two points relevant to today’s lesson.  First, Congress has always structured revenue collection as a pay-first-litigate-later structure.  Second, in contrast, Congress did not at first integrate collection of tax-related penalties into that pay-first-litigate-later structure.  The idea that an administrative agency—such as what was then called the “Bureau of Internal Revenue“ (BIR)—could administratively assert and collect penalties to enforce compliance with the law is a more modern idea, not an idea that would have been familiar to those who created the foundation of tax administration way back in 1862.

Thus, when you read the Revenue Act of 1862 (at least those of you with time on your hands—hey, at least I linked it for you!), you will see that it created two different types of civil monetary consequences for taxpayer non-compliance.  The first monetary consequence was an “additional tax” of 50% for all types of taxes if the taxpayer, after having been reminded to provide a return, continued to fail to make the required list or return.  “Bad taxpayer!  Here’s an “additional tax” for you to pay.  Pay it first, we’ll litigate it later.”

Note that this first monetary consequence had nothing to do with fraud.  No fraud was needed for the BIR to assert this first monetary consequence for non-compliance.  Not only were the assistant assessors authorized to make up the return in that situation, they were also authorized to increase the tax by the additional 50%.  Again, this was “just “ an “addition to tax” a kind of ad valorum tax.  As such, it did not require judicial process.  Congress did not label it a penalty.  It just became part of what the assessor assessed and the collector then collected.  If the taxpayer objected, the taxpayer had to pay the complete assessment and then sue the Collector (since the United States had made itself immune from suit).  It became part of the pay-first-litigate-later structure.

The second monetary consequence for non-compliance was different.  It was a consequence that Congress did label as a penalty.  And there were a bunch of different penalties in the 1862 Act for various violations of duties.  Notice that that all of these penalties were with respect to excise or estate taxes.  That is because the Revenue Act of 1862 was mostly about creating excise taxes on internal revenue; the “income duty” was just three page of the 58 page Act.  So all the penalties were for bad behaviors like undercounting, under-weighing, mis-labeling, and stuff like that.

Ahhhh, but for these penalties, the structure was flipped: asserting penalties was a litigate-first-pay-later structure.  That is, to recover these civil penalties, §31 of the 1862 Act required filing the appropriate suit in court to collect penalties.

You see both monetary consequences at work in §11.

First, §11 provided that if a taxpayer failed to submit a list of taxable items, the assessor was to give them notice and give them another chance.  If the taxpayer still failed to provide a the list, the statute authorized the assessor to make one up “according to the best information which he can obtain” and “add fifty per centum to the amount”  as an “additional tax.”  By the way, do you see here the early substitute for return procedure now found in §6020?  Section 93 of the 1862 Act addressed the income tax return and provided that the assessor was to deal with those returns “in the same manner as is provided for in or refusal other cases of neglect and refusal to furnish lists or schedules in the general provisions of this act, where not otherwise incompatible.”

Second, §11 also imposed a penalty.  It provided that a person who failed to submit a list of taxable items “shall, moreover, forfeit and pay the sum of one hundred dollars…to be recovered for the use of the United States, with costs of suit.”  This language of §11 has survived the years: it can be found to this very day over in §5761(a) (with the amount of $100 now reading $1,000 and the requirement of suit made explicit instead of being merely implied).  In its current form, however, Congress has added exceptions in §5761(b) and (c) to the “must file suit” requirement.  They are big enough to drive a truck through, with the result that, as a practical matter, I can find no reported cases where the government has filed suit to collect the §5761(a) penalty.  Your research skills may be better.  But don’t trust AI on this.

It did not take Congress long to create more penalties, in the 1864, 1866 and subsequent Revenue Acts.  Many of these penalties were for fraudulent or other bad behavior.  And it did not take Congress long to incorporate those new penalties into the pay-first-litigate-later structure in the same way it did the “additional tax.”  For gory details, see Bryan Camp, The Impact of Jarkesy on Civil Tax Fraud Penalties, forthcoming in 27 Fla. Tax Rev. ___ (2024).

Congress has consistently put all of the new penalties created since 1962 into the pay-first-litigate later structure.  The IRS assesses the penalties and the taxpayer either gets the deficiency process, the CDP process, or the traditional pay-first-then-litigate process in which to contest the penalties.  In the various codifications of the income statutes over the years Congress has generally created that structure through one or more deemer provisions that state how various monetary consequences for non-compliance—whether labeled as additions to tax or penalties—are to be assessed and collected in the same manner as taxes and that the word “tax” used anywhere in the Tax Code includes these types of monetary consequences.

Currently, you find that deemer language in both §6665 and, somewhat confusingly, §6671.  What is confusing is that §6665(a) says it applies to all “the additions to the tax, additional amounts, and penalties provided by this chapter” where “this chapter” refers to Chapter 68.  But §6671 says this language applies to all “the penalties and liabilities provided by this subchapter,” which is Subchapter B of…Chapter 68!  I chalk that confusion up to the Congressional restructuring of Chapter 68 in the Omnibus Budget Reconciliation Act of 1989, §7721, 103 Stat. 2106.

Part of the difficulty with Congress adding new penalties all the time is that the writers do not always think about consistently putting the penalties into Chapter 68 either directly or by cross-reference.  For example, no one apparently thought about the confusing overlap between §6665 and §6671.

You also see this difficulty when you look at the penalties Congress created for failures to comply with various information reporting requirements.  Congress has grouped information reporting requirements over in Chapter 61, Subchapter A (sections 6031-6060).  Then over in Chapter 68, in §6652, Congress has imposed various penalties for failure to comply with some of those information reporting statutes.  But for other information reporting statutes, Congress has just put the penalty right in the information reporting statute itself.

Section 6038 is one of those statutes.  Let’s take a look.

Law: Section 6038 Penalties
Section 6038 requires certain U.S. persons to file information returns reporting their control of foreign businesses.  To understand the penalties, you need to know a little history.

Congress first enacted §6038 in 1960.  The only monetary consequence it put into that section at that time is what you now find in §6038(c): a 10% reduction in any otherwise applicable foreign tax credit.  Well, you can easily see how that involved just a re-assessment of an applicable income tax!

But after a few years—22 to be exact—Congress became concerned that just reducing a foreign tax credit was doing diddly to enforce compliance.  So Congress rewrote §6038 to add a second monetary consequence, labeled a penalty, now found in §6038(b): a $10,000 hit per reporting failure per year with an additional $10,000 hit (up to a $60k max) for continued failure after the IRS sends a love letter requesting compliance.  Tax Equity and Fiscal Responsibility Act of 1982, 96 Stat. 324, 631.

The two monetary consequences are coordinated.  That is, §6038(c)(3) provides that the amount of the foreign tax credit reduction shall be “reduced by the amount of the penalty imposed by subsection (b).”  Thus, as currently written, §6038 imposes two monetary consequences for failure to comply with its reporting requirements: a reduction in the applicable foreign tax credit and a straight-up penalty.

No one disputes that the IRS can impose the first consequence by adjusting what it assesses as the proper tax liability of the person failing to report.  But taxpayers have disputed the IRS’s ability to simply assess the subsection (b) penalty.  They argue that the penalty is not an “assessable penalty” within the scope of §6201 because Congress did not stick it in Chapter 68, either directly or by cross-reference.

The Tax Court agreed with this taxpayer argument in Farhy v. Commissioner, 160 T.C. 399 (2023).  It held that the IRS had no authority to assess the §6038(b) penalty.  If the government wanted to impose the penalty it would have to sue the taxpayer in court.  Litigate-first-pay-later.

But the D.C. Circuit Court of Appeals agreed with the government that the §6038(b) penalty was indeed an assessable penalty.  If the taxpayer wanted to dispute the penalty the taxpayer would need to follow the general pay-first-litigate-later structure.  Well, that is not quite true.  Thanks to §6630, taxpayers can get pre-payment review of an assessable penalty in a Collection Due Process hearing, if they can catch the CDP butterfly.

After winning in the D.C. Circuit Court of Appeals—considered by many second in prestige only to the United States Supreme Court because of the impact of its decisions of federal laws—the government still had to convince the Tax Court.  That is because of the Golsen rule.  Under Golsen the Tax Court will follow a Circuit Court’s decision only for disputes that would be appealed to that Circuit Court from Tax Court.  But it reserves the right, as a court of nation-wide jurisdiction, to stick to its own opinion in any other circumstance.

That’s how today’s lesson comes about.  After he plead guilty to criminal tax violations, Mr. Mukhi got dinged $120,000 in penalties under §6038(b).  He got to Tax Court via CDP and argued that, per the Tax Court’s ruling in Farhy, the IRS had no authority to make that assessment.  Mr. Mukhi would take any appeal to the Eighth Circuit Court of Appeals, and not the D.C. Circuit.  So under the Golsen rule, the Tax Court was not bound to follow the D.C. Circuit unless it believed the D.C. Circuit got it right and the Tax Court’s prior Farhy decision got it wrong.

Spoiler alert: the Tax Court does not think it was wrong.  The reasons why give us our Lesson From The Tax Court.

Lesson: Words Matter

1. The Words in §6201

The government and the taxpayer first fought over the scope of authority granted the IRS in §6201.  Recall that §6201(a) authorizes and requires the IRS to make “the inquiries, determinations, and assessments of all taxes (including interest, additional amounts, additions to the tax, and assessable penalties.” 

The Tax Court tells us to take the words seriously.  The current language in §6201 came in 1054 when Congress re-codified the Internal Revenue Code of 1939 and it became the Internal Revenue Code of 1954.  Before 1954, the statute had authorized the IRS to make “the inquiries, determinations, and assessments of all taxes and penalties imposed by this title.”  After reviewing the history of the 1954 enactment, Judge Greaves concludes that we must take the change in wording seriously.  Nothing in the history, he tells us, suggests that Congress intended the new wording to have the same scope as the prior wording.  To the contrary, the change in wording “clearly reduced the scope of the IRS’s assessment authority as the text no longer provided a blanket power to assess all penalties.” Op. at 10. 

Words matter.

2. The Words Not in §6038

While §6201 does not authorize the assessment of all penalties, its plain text does authorize assessment of “assessable penalties.”  So the second fight was whether the §6038(b) penalty was an assessable penalty.  That is, did Congress give the IRS authority to assess that penalty in §6038 itself?

Here, the Tax Court tells us again to take words seriously.  This time, however, it is the absence of words that matter.  First, Judge Greaves observes that “[n]othing in the text of section 6038(b) expressly authorizes the IRS to assess the … penalty.”  Op. at 11.  Second, he explains that [t]his absence of text becomes even more pronounced when compared to the text of other penalty statutes.”  Id.

Judge Greaves goes on to explain how Congress has expressly authorized assessment for a whole bunch of penalties listed or cross-referenced in Chapter 68.  He then notes that even “[o]utside chapter 68, Congress takes several approaches to expressly indicate that a penalty is assessable.  These statutes provide clear text regarding the assessment or mode of recovery.” Id.  He gives multiple examples where the particular penalty has surrounding text that “could plausibly indicate that the IRS has authority to assess a penalty.”  Op. at 12 (giving excerpts from §527(j)(1); §856(g)(5)(C); §857(f)(2)(A); §4980H(d)(1); §5000A(g)(1); §5684(b); §5761(e); and §9707(f)).

Hard as we might, Judge Greaves says, we can find no text, no words, in §6038 to support the idea that Congress was permitting the IRS to impose the penalty by assessment and collection, the way it does every other penalty in the 10,000 pages (if you use small 10 pt. font) of the Tax Code.  And we know Congress pays close attention to every single word it writes … or fails to write!

With that, Judge Greaves stops.  He’s done.  He does go on to consider the reasons that the D.C. Circuit believed §6038 authorizes the IRS to assess the (b) penalty but he does so only “for sake of completeness.”  Op. at 13.  That is because none of those reasons can overcome the Lesson: Words matter.

Comment 1: The Golsen Rule
I wonder why this was not a reviewed opinion.  Quite often when the Tax Court is taking a position contrary to that of a Circuit Court, it will issue a reviewed opinion to show the world the entire Tax Court’s opinion.  See e.g. Bryan Camp, The Tax Court As An Excellent Conversationalist, TaxProf Blog (Oct. 25, 2017).  The D.C. Circuit’s opinion in Farhy is very well-reasoned and may well influence other appellate courts.  That is one reason Judge Greaves does in fact take pages 13-25 to rebut the D.C. Circuit’s opinion even while saying he is doing so only “for sake of completeness.”  

Comment 2:  The Merits
I also teach a course in statutory interpretation, so it’s fascinating to me to compare the Tax Court’s approach to interpreting §6038 with the D.C. Circuit’s approach.  I won’t get into the merits, although by my snarky remark above you can see that I side with the D.C. Circuit.  No shade on Judge Greaves’s opinion though!  He does a good job pointing out some of the gaps in the D.C. Circuit’s opinion.  What interests me is how text-bound the Tax Court’s approach is compared to the D.C. Circuit’s approach.  The Tax Court takes a “words über alles” approach whereby the text (or lack of text) creates an almost irrebuttable presumption of meaning.  The D.C. Circuit takes a less rigid approach, an approach often described as “practical reasoning.” See William Eskridge, Jr. & Philip Frickey, Statutory Interpretation as  Practical Reasoning, 42 Stan. L. Rev. 321 (1989). 

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return on the first Monday of each month (or Tuesday if Monday is a federal holiday) to TaxProf Blog for another Lesson From The Tax Court.

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