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Posted On November 10, 2021
Defending Against IRS Penalties Under Section 6038

Defending Against IRS Penalties Under Section 6038

A taxpayer may avoid section 6038 penalties by proving that he or she had no reportable interests in a foreign country. The taxpayer can also avoid these penalties by proving that he or she wasn’t a “United States person” and demonstrating that the delayed or failed filing wasn’t substantial.

Section 6038 requires a taxpayer to file Form 5471 for any reportable interests in foreign corporations, or Form 8865 for reportable interests in foreign partnerships. Failure to file on time attracts civil penalties of up to $10,000 per year.

Common Defenses Against Section 6038 IRS Penalties

No Reportable Interests in a Foreign Country

Reportable interests in foreign corporations can be either share capital or share premium. Share capital is the original capital invested in a company through the issuance of shares. Share premium is the excess paid over the par value of a share that has been issued at a premium. If such interests were held by nominee entities, the taxpayer can stand a better chance at avoiding section 6038 penalties for untimely and failed filing.

The Tax Payer Was Not a “United States Person”

If it’s established that there was no reportable interest, the penalty may not occur. If it did, then step two of the defenses would be to argue whether the taxpayer was a “United States person” in relation to such interests. Section 7701(a)(30) defines a “United States Person” as any US citizen, resident alien, or a domestic legal entity, such as a partnership, trust, or estate.

The Failure to File Was Not Substantial

If the taxpayer is shown to be a “United States person,” then step three would be to consider whether the failure to file Form 8865 or Form 5471 was ‘substantial’. A taxpayer may argue that he or she had no reportable interests. The taxpayer, therefore, didn’t have to file Form 8865 or Form 5471.

Failure to file may also be pardoned if the taxpayer acted in good faith. Contracts, bank statements, income withholding documents, and share certificates of a company can play a big role in proving the taxpayer acted prudently and in good faith.

Seeking Legal Support

A tax attorney knowledgeable in resolving IRS tax problems can assess the situation of a taxpayer and provide tax debt help that suits the taxpayer’s unique situation. The attorney can also develop a strong defense against section 6038 IRS penalties on the taxpayer’s behalf.