Edward Flume was looking at penalties for failing to file Forms 5471 from 2001 through 2009, with the total penalties the IRS was looking to collect over that time amounting to $110,000. In the case of Flume v. Commissioner, TC Memo 2017-21 the taxpayer argued as one defense that he should be excused from any penalties based on reasonable cause for reliance on a tax professional.
As the Tax Court notes, the Internal Revenue Code imposes a requirement for a U.S. person who controls a foreign corporation to report certain information each year, with Form 5471 being used to report that information. The Court goes on to explain:
A person controls a foreign corporation if he owns or constructively owns stock that is more than 50% of the total combined voting power of all classes of voting stock or owns more than 50% of the total value of shares of all classes of stock. Sec. 6038(e)(2). A U.S. person must furnish, with respect to any foreign corporation which that person controls, information that the Secretary may prescribe. Sec. 6038(a)(1). Form 5471 and the accompanying schedules are used to satisfy the section 6038 reporting requirements. The Form 5471 must be filed with the U.S. person’s timely filed Federal income tax return. Sec. 1.6038-2(i), Income Tax Regs.
Additionally, the information reporting requirements prescribed in section 6038(a)(1) also are imposed on any U.S. person treated as a U.S. shareholder of a corporation that was a CFC for an uninterrupted period of 30 days during its annual accounting period and who owned stock in the CFC on the last day of the CFC’s annual accounting period. Secs. 951(a)(1), (b), 6038(a)(4); see also Rev. Proc. 92-70, sec. 2, 1992-2 C.B. 435, 436. A U.S. shareholder, with respect to any foreign corporation, is a U.S. person who owns under section 958(a), or is considered as owning under section 958(b), 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. Sec. 951(b).
Section 6046 requires information reporting by each U.S. citizen or resident who is at any time an officer or director of a foreign corporation, where more than 10% (by vote or value) of stock is owned by a U.S. person. Sec. 6046(a)(1)(A). The stock ownership threshold is met if a U.S. person owns 10% or more of the total value of the foreign corporation’s stock or 10% or more of the total combined voting power of all classes of stock with voting rights. Sec. 6046(a)(2). A U.S. person who disposes of sufficient stock in the foreign corporation to reduce his interest to less than the stock ownership requirement is required to provide certain information with respect to the foreign corporation. Sec. 1.6046-1(c)(1)(ii)(c), Income Tax Regs.
A failure to comply with the requirements exposes the individual to substantial penalties. As the Court notes:
When a taxpayer, who was required to do so, fails to complete and file a Form 5471 on time, a fixed penalty of $10,000 per foreign corporation per annual accounting period is imposed. Secs. 6038(b)(1), 6679. If any failure to provide the required information continues for more than 90 days after the day on which the Secretary mails notice of the failure to the U.S. person, the person shall pay a penalty (in addition to the amount required under section 6038(b)(1)) of $10,000 for each 30-day period, or fraction thereof, during which the failure continues with respect to any annual accounting period after the expiration of the 90-day period; however, the increase in any penalty under section 6038(b)(2) shall not exceed $50,000. Sec. 6038(b)(2). Similar penalties apply for failure to timely file Form 5471 or otherwise provide the information required by section 6046 with respect to an annual accounting period. See secs. 6046(f), 6679(a).
The Court determined that Mr. Flume had been required to file such forms but, in fact, failed to do so for the years in question.
Mr. Flume argued that he should not penalized, as his behavior should qualify as his failure to provide the information was due to “reasonable cause” as provided for in IRC §6038(c)(4)(B).
The Tax Court determined the bar that Mr. Flume would have to clear to show reasonable cause which it described as follows:
Although there are no regulations defining “reasonable cause” within the specific context of section 6038, the few cases that have confronted this issue have adopted the Supreme Court’s definition as stated in United States v. Boyle, 469 U.S. 241, 246 (1985). See, e.g., Congdon v. United States, No. 4:09-CV-289, 2011 WL 3880524, at *2 (E.D. Tex. Aug. 11, 2011); In re Wyly, 552 B.R. 338, 442 (Bankr. N.D. Tex. 2016). That is that a taxpayer must demonstrate that he exercised ordinary business care and prudence but nevertheless was unable to file within the prescribed time. Boyle, 469 U.S. at 246. Similar rules apply with respect to the civil penalties imposed under section 6679 for failure to file information required under section 6046. Sec. 6679(a)(1); sec. 301.6679-1(a), Proced. & Admin. Regs. If a taxpayer exercises ordinary business care and prudence and is nevertheless unable to obtain and provide the required information, a failure to file will be considered to be due to reasonable cause. Sec. 301.6679-1(a)(3), Proced. & Admin. Regs.
The taxpayer attempted to show that he had exercised such ordinary business care and prudence since he had hired a tax professional to prepare his returns for the years in question. As the opinion notes:
Petitioner hired Leonard Purcell, a tax preparation firm in Mexico, to prepare his tax returns during the years in issue. Adriana Luna, a Leonard Purcell employee, prepared petitioner’s tax returns.
Ms. Luna had not prepared Forms 5471 nor had she advised Mr. Flume that he needed to file such forms.
However, the Court found that there were problems with his claimed reliance on Ms. Luna. One key fact was that Mr. Flume had not actually informed Ms. Luna that he owned interests in the corporations until approximately 2008. He also testified that he was not aware of Ms. Luna’s qualifications.
To be able to show reasonable cause in such matters, the taxpayer generally must show that:
- The taxpayer had engaged the prepare to advise him/her on the matter in question;
- He/she had made reasonable inquiries to assure him/herself that the selected preparer had the proper expertise to give advice on the matter in question;
- The taxpayer provided the preparer with all information necessary for the preparer to advise on the situation and
- The taxpayer actually relied on the advice given.
In this case the taxpayer had neither shown he had made a reasonable inquiry to determine Ms. Luna was qualified to advise on this issue, nor had given her the information necessary for her to provide advice on the matter. Thus, the Court found that Mr. Flume had not demonstrated reasonable cause for his failure to file the Forms 5471.