Another Circuit Rejects the Tax Court's Position on Collecting Sec. 6038 Penalties

(Parker Tax Publishing April 2026)

In a case of first impression, the Second Circuit vacated the Tax Court's judgment and held that, when a taxpayer fails to report control of a foreign business, the IRS may collect penalties under Code Sec. 6038(b) through administrative assessment rather than obtaining a judgment in federal district court as the Tax Court had ruled. Thus, the Second Circuit joins the D.C. Circuit in pushing back on the Tax Court's theory that the Code does not permit the assessment of Code Sec. 6038 penalties by the IRS. Safdieh v. Comm'r, 2026 PTC 45 (2d Cir. 2026).

Facts

Joseph Safdieh allegedly violated Code Sec. 6038 by failing to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, to report his control of a foreign business. Code Sec. 6038 was enacted in 1982 and requires every U.S. person to furnish, with respect to any foreign business entity which such person controls, such information as the IRS may prescribe. Code Sec. 6038(b) imposes a $10,000 penalty for each year during which such a reporting failure exists. For Safdieh, who allegedly failed to file reports in tax years 2005 - 09, the penalties added up to $50,000.

When Safdieh did not pay the penalties, the IRS filed a federal tax lien notice. Safdieh challenged the lien in a Collection Due Process (CDP) hearing and when he lost that appeal, he petitioned the Tax Court for relief. The Tax Court observed that it is the obligation of the appeals officer conducting a CDP hearing to verify that the requirements of applicable law or administrative procedure have been met. In this case, the court said, verification was a legal impossibility since the Tax Court had, in Mukhi v. Comm'r, 163 T.C. No. 8 (2024), and Farhy v. Comm'r, 160 T.C. 399 (2023), held that the Code does not permit the assessment of Code Sec. 6038 penalties by the IRS. According to the Tax Court, Congress had not statutorily authorized the IRS to collect the Code Sec. 6038(b) penalty through assessment and, if the IRS wanted to penalize Safdieh's reporting failures, it had to go to the federal district court. The IRS appealed to the Second Circuit. While Safdieh's case was before the Tax Court, an appeal of the Tax Court's decision in Farhy was before the Eighth Circuit and the Eighth Circuit subsequently overturned that decision in Farhy v. Comm'r, 2024 PTC 141 (D.C. Cir. 2024).

Observation: The IRS normally does not have to go to a federal district court to take taxpayers' money. Only in rare instances is a lawsuit necessary. Instead, the IRS usually collects taxpayers' liabilities through an assessment, which is commonplace in tax collection.

Analysis

The Second Circuit vacated and remanded the Tax Court's decision after concluding that Code Sec. 6038(b) allows the IRS to assess the penalties incurred under Code Sec. 6038(b). Critical to its decision, the court said, was the text of Code Sec. 6201(a) which provides that the IRS's assessment power extends beyond "all taxes" to include "assessable penalties." There was no question, the court said, that the dollar amount at issue was a "penalty" because the statute said so outright. The only doubt, the court observed, was whether the penalty was "assessable."

The court then addressed Safdieh's contention that Code Sec. 6038(b) is an exception to the IRS's assessment of the penalty and pointed out that Code Sec. 6038(b)'s text is silent as to whether the penalty is assessable. In this sense, the court said, it is unlike the provisions in the Code that expressly allow, or bar, assessment. Noticing that Code Sec. 6201(a), which covers the IRS's assessment authority, is likewise silent, the court focused on Code Sec. 6038(b)'s history, purpose, and structure - including the text of a key coordination clause - which lead it to three reasons why the Code Sec. 6038(b) penalty is assessable.

First, the court said, the history of Code Sec 6038(b) strongly suggests that the penalty is assessable. At the time of its enactment in 1982, there already existed a penalty for a taxpayer's failure to report control of a foreign business and, while that provision was assessable, it was too hard to use and under-enforcement resulted. To supplement this assessable tax-credit penalty, Congress enacted Code Sec. 6038(b)'s dollar penalty and, the court observed, in the 43 years since enacting the provision, Congress had not questioned the IRS's practice.

Second, the court said, requiring the IRS to sue for Code Sec. 6038(b) penalties would badly disrupt the provision's overall enforcement scheme, defeating Congress's design as Congress expected Code Sec. 6038(b) to work in concert with Code Sec. 6038(c). Code Sec. 6038(c) penalizes the failure to report control of a foreign business with a 10-percent reduction of the taxpayer's foreign tax credit. But, the court noted, that penalty does not work in isolation as the coordination clause reduces the amount of the foreign tax credit reduction by the amount of the penalty imposed by Code Sec. 6038(b) - that is, by the yearly dollar penalty. The coordination clause suggested to the Second Circuit that Congress meant for the IRS to be able to impose the Code Sec. 6038(b) and Code Sec. 6038(c) penalties at the same time.

Third, the court asked, if the IRS cannot assess the Code Sec. 6038(b) penalty, what litigation authority does he have to sue for it? While Safdieh cited 28 U.S.C. Section 2461(a) as the IRS's "only" collection authority, the court found that one problem with this argument is that Section 2461(a) is not in the Internal Revenue Code. Congress instead directed that it be codified in Title 28, which concerns the judiciary.

Even more revealingly, the Second Circuit noted that in the 34 years between this provision's enactment in 1948 and the dollar penalty's enactment in 1982, the provision was never used to collect a tax or tax penalty. The court concluded that it was doubtful that Congress silently meant to require the IRS to look for the first time to this provision outside the Internal Revenue Code to be able to do its job. In sum, the court determined that Code Sec. 6038(b)'s history, purpose, and structure all pointed to the same conclusion: the penalty is assessable.

For a discussion of information reporting for certain controlled foreign business entities and the requirement to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, see Parker Tax ¶203,120.

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