Mukhi Opinion A Win For Holders Of Foreign Accounts – For Now

 

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The U.S. Tax Court has rejected two out of three arguments of a holder of foreign accounts regarding filing penalties. 

 

A taxpayer has been less successful than others recently in arguing that government penalties for failing to file tax returns and FBARs went against the U.S. Constitution.

 

In Mukhi v. Commissioner, the Court deliberated constitutional challenges to civil penalties for failing to file Forms 5471, 3520, and 3520-A. The Court rejected the arguments of Raju Mukhi, of St. Louis, Missouri, that his due process hearing was conducted by a partial appeals officer and that Mukhi’s non-filing penalties violated the U.S. Constitution’s Eighth Amendment’s Excessive Fines Clause.

 

Citing another recent case, the Court did agree with Mukhi’s argument that

U.S. Internal Revenue Service had lacked the authority to assess the penalties

for failing to timely file Forms 5471.

 

The case

Mukhi established a foreign corporation and two foreign trusts; the foreign entities held foreign brokerage accounts. Over multiple tax years, he transferred more than $9 million to the foreign entities. According to the U.S. Department of Justice, Mukhi failed to file an FBAR disclosing that he had financial accounts in Singapore and Switzerland for 2007 through 2010.

 

U.S. citizens are required to report income from foreign countries such as from bank accounts, securities and any other financial accounts on their tax returns. If the aggregate maximum value is more than $10,000, they are required to file a Report of Foreign Bank and Financial Accounts (FBAR). 

(Form 5471 is the U.S. Information Return of U.S. Persons With Respect to Certain Foreign Corporations; Form 3520 is the Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts; and Form 3520-A is the Annual Information Return of Foreign Trust With a U.S. Owner.)

 

In 2015, Mukhi pleaded guilty and was sentenced to three years’ probation, ordered to pay full restitution and agreed to a penalty in the amount of $838,439.

 

Counter arguments’ result

The IRS later assessed multiple international information return penalties: $120,000 for failing to report ownership of the foreign corporation; $5,072,449 for failing to file Forms 3520 to report transfers made and distributions received from the foreign trust; and $5,920,419 for failing to file Forms 3520-A to disclose interest in the foreign trust.

 

Mukhi initially countered with collection alternatives, including installment payment agreements and Offers in Compromise (OIC). Those payment proposals denied, he filed a collection due process (CDP) petition and then contended that the IRS violated his Fifth Amendment right to due process by not providing an impartial appeals officer, that the IRS lacked authority to assess the penalties (pursuant to a previous case, Farhy v. Commissioner) and that the penalties violated the Eighth Amendment clause regarding excessive fines clause.

 

Mukhi recently won one and lost two in his arguments in Tax Court.

 

Collection due process: Following debate of Mukhi’s income and expenses and rejection of his installment agreement of $2,000 per month, Mukhi submitted two alternative OICs, proposing a one-time payment of $1 million and withdrawal of 22 refund lawsuits or, in an alternative OIC, a global settlement of all outstanding tax issues by offering to liquidate specific assets and transfer the proceeds to the IRS, valued at approximately $2,672,717, and to withdraw 22 refund lawsuits. (Mukhi also sought to be absolved from any income tax generated from the liquidation of these assets.)

 

A new settlement officer conferred with other IRS officials familiar with the case and ultimately rejected the OIC. Mukhi asked for a review of this determination, alleging a jurisdictional defect in that the notice of determination he received failed to include two attachments and that the new case officer was “not independent” in the determination and could not have, according to work records on the case, performed a complete review of the underlying liability challenges. Mukhi also argued that the case officer violated Mukhi’s Fifth Amendment due process rights by consulting with an Appeals Officer in International Operations about the underlying liability.

 

The Tax Court opined that the case officer “exercised his independent authority to determine whether the foreign reporting penalties were properly assessed … [Mukhi] asserts that [case officer] could not have performed a complete review of the underlying liability challenges because he logged three hours on the issue.

 

“In addition to the three hours that petitioner highlights, [the officer] made other entries into his case report indicating he worked on the underlying liability issue but reported the time as zero … Consideration of the issues,” the Court said, “rather than the time spent, is the focus of our analysis.”

 

Nor did the case officer abuse his authority by rejecting Mukhi’s OIC because Mukhi’s offers, the Court found, were “significantly below” his reasonable collection potential.

 

Mukhi’s additional Fifth Amendment argument the Court found vague, that IRS assertion of the penalties was improperly inconsistent with its position in a prior proceeding involving Mukhi and that the IRS did therefore not violate Mukhi’s Fifth Amendment due process rights or his rights under Sec. 6320 or Sec. 6330 of the U.S. Internal Revenue Code.

 

Excessive fines: Mukhi argued that the international information return penalties violated the Eighth Amendment’s excessive fines clause.

 

With respect to the Form 3520 and Form 3520-A penalties under IRC Sec. 6677, the Tax Court rejected the argument on grounds that the 6677 penalties were not “fines” for purposes of the Eighth Amendment because they were enacted to encourage voluntary compliance, not to punish taxpayers; and, even if they were fines, the penalties were not disproportionate.

 

IRS authority: The Tax Court did agree with Mukhi that Farhy v. Commissioner prevented the IRS from automatically assessing the Form 5471 penalties,

reiterating the Court’s prior position: Last year, the Tax Court did distinguish in Farhy between a penalty that the IRS is authorized to issue and one that it isn’t without a lengthier process.

 

Will the latest Tax Court opinion stand? Mukhi is appealable to the Eighth Circuit; observers say that the case shows the Tax Court may continue to apply Farhy to 5471 penalty cases “in circuits where the case has not been addressed on appeal.”

 

Considering, though, that the Tax Court’s Farhy decision was more recently reversed by the Washington, D.C., Circuit Court of Appeals, — a win for the IRS and a potential green light for easier enforcement in future cases resembling Farhy – taxpayers’ constitutional challenges to the international information return penalties, as in Mukhi, may be weaker in the future.

 

Your tax specialist needs to stay on top of this and many other issues of wealth, foreign income and tax enforcement. If we can help, please let us know.

 

About the Author 

Alicea Castellanos is the CEO and Founder of Global Taxes LLC. Alicea provides personalized U.S. tax advisory and compliance services to high-net-worth families and their advisors.

 

Alicea has more than 20 years of experience. Prior to forming Global Taxes, Alicea founded and oversaw operations at a boutique tax firm, worked at a prestigious global law firm and CPA firm.

Alicea specializes in U.S. tax planning and compliance for non-U.S. families with global wealth and asset protection structures which include non-U.S. trusts, estates and foundations that have a U.S. connection.

 

Alicea also specializes in foreign investment in U.S. real estate property, and other U.S. assets, pre-immigration tax planning, U.S. expatriation matters, U.S. persons in receipt of foreign gifts and inheritances, foreign accounts and assets compliance, offshore voluntary disclosures/tax amnesties, FATCA registration, and foreign companies wanting to do business in the U.S.

 

Alicea is fluent in Spanish and has a working knowledge of Portuguese.

 

Alicea is an active member of the Society of Trusts & Estates Practitioners (STEP), the New York State Society of Certified Public Accountants (NYSSCPAs), the American Institute of Certified Public Accountants (AICPA), the International Fiscal Association (IFA), a member of Clarkson Hyde Global, a world-wide association of accountants, auditors, tax specialists and business advisors and the Global Referral Network (GRN).

 

Distinctly, in 2020, Alicea was awarded with a prestigious NYSSCPA Forty Under 40 Award. She was selected as someone that has notable skills and is visibly making a difference in the accounting profession.

 

In 2021 and 2022, Alicea was the Gold and Silver Winner, respectively, of Citywealth’s Powerwomen Awards in the category USA – Woman of the Year – Business Growth (Boutique). In 2023, she continued her winning streak by receiving the Gold award for Company of the Year Female Leadership (Boutique) and the Silver award for Accountancy Firm of the Year at the Magic Circle Awards. Furthermore, Alicea has consistently secured her position in the Global Elite Directory for four consecutive years, being recognized as a Private Client Global Elite Advisor and is currently listed for 2024 as a Non-Legal Adviser. This exclusive directory annually highlights the world’s elite lawyers and outstanding wealth advisors serving ultra-high net-worth clients.

Please note: This content is intended for informational purposes only and is not a replacement for professional accounting or tax preparatory services. Consult your own accounting, tax, and legal professionals for advice related to your individual situation. Any copy or reproduction of our presentation is expressly prohibited. Any names or situations have been made up for illustrative purposes — any similarities found in real life are purely coincidental.