Welcome to the second annual review of the most significant tax court cases affecting U.S. citizens living abroad. Building on the success of last year’s article, this year’s compilation delves into the rulings and legal battles that defined 2024, focusing on international tax compliance and the challenges expatriates face.

This specialized review takes inspiration from the work of Tony Nitti, who has long set the gold standard for covering the top tax cases in general. While his work casts a wide net over all major tax-related rulings, we aim to zoom in on the unique issues confronting U.S. taxpayers abroad.

These include navigating foreign reporting obligations, understanding treaty interpretations, and grappling with penalties and compliance programs. With 2024 proving to be a year of intense litigation and precedent-setting decisions, let’s dive into the cases you should be aware of going into 2025.

Key Takeaways:

• Moore v. United States – The Supreme Court upholds the constitutionality of the Mandatory Repatriation Tax (MRT)
• Farhy v. Commissioner of Internal Revenue – The D.C. Circuit Court reaffirms the IRS’s authority to impose penalties for failing to file Form 5471.
• Mukhi v. Commissioner – The Tax Court rules that the IRS lacks statutory authority to impose penalties under Section 6038(b).
• Texas Top Cop Shop v. Garland – Challenges the constitutionality of the Corporate Transparency Act (CTA), focusing on issues of state sovereignty, privacy rights, and compelled disclosures.
• Bruyea v. United States – Establishes that foreign tax credits (FTCs) can offset Net Investment Income Tax (NIIT) liabilities under the Canada-U.S. Tax Treaty.
• United States v. Sagoo – Highlights the IRS’s intensified focus on pursuing willful penalties for FBAR violations.

1. Moore v. United States

Why This Case Is Important

The Moore case delves into the constitutionality of the Mandatory Repatriation Tax (MRT), a provision introduced by President Trump in the 2017 Tax Cuts and Jobs Act (TCJA). The MRT fundamentally changed how the U.S. taxes certain foreign earnings by imposing a one-time tax on the retained earnings of Controlled Foreign Corporations (CFCs) owned by U.S. shareholders. 

Before the TCJA, foreign earnings in a CFC were not subject to U.S. taxation until those earnings were distributed to the U.S. shareholders as dividends. This deferment allowed small business owners and individual taxpayers to reinvest their foreign company’s retained earnings without immediate tax consequences.

The MRT disrupted this long-standing precedent by retroactively taxing undistributed earnings accumulated over the years, regardless of whether U.S. shareholders had received any cash or other distributions. For many small business owners outside of the U.S., particularly those who owned 100% of a foreign company, the retained earnings often represented savings reinvested into the business rather than liquid cash available to cover taxes.

The sudden imposition of this tax created significant financial hardships, as taxpayers were forced to pay substantial tax bills without receiving corresponding income. Many tried to argue it was unconstitutional, but none got it as far as the Moores did.

When the Supreme Court decided to hear this case, it carried the potential for even broader implications that extended far beyond the scope of the Mandatory Repatriation Tax (MRT) and foreign corporate holdings.

At its core, the case raised questions about whether all earnings not yet distributed to end shareholders could be exempt from taxation. Such a ruling could have fundamentally altered the tax treatment of partnerships, S-corporations, and other pass-through entities, which rely on similar principles of taxing distributed income.

Had the Court ruled against the taxation of undistributed earnings, it would have represented a seismic shift in the U.S. tax code, potentially dismantling long-standing flow-through taxation principles.

Summary of the Case

Charles and Kathleen Moore, U.S. citizens, invested in KisanKraft, an Indian corporation. They did not receive any distributions or payments from their investment. Yet, they were taxed on their proportional share of KisanKraft’s retained and undistributed earnings under the MRT. The Moores argued that the tax violated the Direct Tax Clause of the U.S. Constitution, which stipulates that direct taxes must be apportioned among the states.

Their central argument was that taxing unrealized income—income not yet received by the taxpayer—is unconstitutional. The Supreme Court, however, ruled 7-2 in favor of upholding the MRT.

The Court’s opinion confirmed that Congress has the authority to attribute realized but undistributed income of foreign corporations to U.S. shareholders and levy taxes accordingly. It is important to note that the Court also took a very limited scope approach here and ended up not opining on the more significant questions of unrealized income, which could have been delved into. For now, while boring, it also means that the tax laws are safe and tax preparers have an easy life without major changes.

What This Means for Taxpayers

The Supreme Court’s ruling reaffirms Congress’s power to impose taxes on undistributed income held in foreign corporations. This outcome solidifies the MRT’s constitutionality and reinforces the legality of similar provisions like Global Intangible Low-Taxed Income (GILTI), which imposes taxes on annual foreign corporate earnings. U.S. citizens with ownership stakes in foreign corporations must plan for the possibility of being taxed on earnings they have not yet received. The case underscores the need for meticulous tax planning to anticipate obligations and minimize unexpected liabilities.

Although the Supreme Court’s decision resolves the constitutionality of the MRT, broader discussions around taxing unrealized income may lead to future legislative or judicial challenges. Congress or regulatory bodies may revisit aspects of foreign income taxation as taxpayers continue challenging the fairness and mechanics of such taxes. Given that legislation is now being lobbied against taxing U.S. citizens abroad, this area will grow in significance over the coming years.

2. Farhy v. Commissioner of Internal Revenue

Why This Case Is Important

The Farhy case examines whether the IRS has statutory authority to impose penalties for noncompliance with foreign information reporting requirements under Section 6038(b) of the Internal Revenue Code. Specifically, it focuses on penalties related to failure to file Form 5471, a crucial document that U.S. citizens with ownership in foreign corporations are required to file.

Form 5471 serves as a critical tool for the IRS to monitor and assess the activities of Controlled Foreign Corporations (CFCs) and their U.S. shareholders. It provides detailed information about the foreign entity’s income, shareholders, and financial activities, ensuring that all income connected to U.S. taxpayers is appropriately reported and taxed.

Form 5471 applies to many U.S. citizens living abroad who operate businesses there, as the structure of these companies often meets the definition of a CFC. It is common for U.S. expatriates to establish closely held corporations to manage their business operations. Under U.S. tax law, if a foreign corporation is more than 50% owned by U.S. shareholders, it qualifies as a CFC, triggering the requirement to file Form 5471 annually.

The reporting obligations are detailed and burdensome, requiring taxpayers to disclose extensive information about the company’s ownership, income, balance sheets, and transactions with related parties.

Failure to file Form 5471 can result in severe penalties, even if the taxpayer owes no U.S. tax. For example, the IRS imposes an initial $10,000 penalty per unfiled form, with additional penalties for continued noncompliance. For many Americans living abroad, these penalties can quickly escalate, especially for those unaware of their obligations.

The complexity of the form and its detailed requirements often lead to errors or omissions, making compliance challenging even for those attempting to fulfill their reporting duties.

Summary of the Case

Alon Farhy, a U.S. taxpayer, failed to file Form 5471 for several years, leading to the IRS imposing $60,000 in penalties for noncompliance. Farhy challenged the penalties, arguing that the IRS lacked statutory authority to assess and collect them administratively because Congress had not explicitly granted this power. In 2023, the U.S. Tax Court agreed with Farhy that the IRS could not impose penalties under Section 6038(b) through administrative action, as the statute lacked explicit language granting the agency such authority. This decision marked a significant win for taxpayers facing similar challenges, as it limited the scope of the IRS’s enforcement powers.

However, the D.C. Circuit Court revisited the case in 2024 and reversed the Tax Court’s decision. The appellate court concluded that the IRS had the authority to impose these penalties administratively, reasoning that enforcing foreign information reporting requirements was consistent with congressional intent. The decision emphasized the necessity of penalties to ensure compliance.

It upheld the broader powers of the IRS to administer and enforce international tax provisions. This reversal brought the outcome of the Farhy case in line with similar precedents, solidifying the IRS’s position and restoring its ability to impose significant penalties for noncompliance.

What This Means for Taxpayers

The Farhy ruling reaffirms the IRS’s ability to impose substantial penalties for failing to file foreign information returns like Form 5471. This decision underscores the severity of noncompliance, even in cases where no actual tax is owed.

Taxpayers must recognize that penalties for foreign reporting failures are significant and can accumulate rapidly. Individuals with foreign ownership interests should prioritize accurate and timely filing to avoid scrutiny and penalties. However, before throwing in the towel and paying IRS penalties, let’s look at the case of Mukhi v. Commissioner to see why there may still be hope for Farhy.

3. Mukhi v. Commissioner

Why This Case Is Important

The Mukhi case highlights a growing judicial conflict regarding the IRS’s authority to assess penalties for failing to file foreign information returns under Section 6038(b). This case bears striking similarities to the Farhy case, as both address whether the IRS has the statutory authority to impose penalties administratively without explicit congressional authorization. However, the outcomes of these cases diverge significantly, illustrating the nuanced and often unpredictable nature of tax litigation.

The Mukhi case represents a significant divergence in how courts view the IRS’s authority to impose penalties for failing to file foreign information returns under Section 6038(b). Unlike the Farhy case, which centered on similar issues but resulted in the D.C. Circuit upholding the IRS’s authority, Mukhi provides a different narrative and outcome.

Summary of the Case

The Tax Court, sitting en banc, refused to follow the D.C. Circuit’s reasoning in Farhy. In its ruling, the Tax Court held that Congress had not granted the IRS the explicit statutory authority to assess penalties under Section 6038(b). This decision applies to taxpayers outside the D.C. Circuit’s jurisdiction, creating a split among courts and leaving taxpayers in different regions subject to differing interpretations of the law.

In Mukhi, the Tax Court ruled in favor of the taxpayer, holding that the IRS lacks the statutory authority to assess penalties under Section 6038(b). The court found that Congress had not explicitly authorized the IRS to impose these penalties administratively. This ruling was celebrated as a significant victory for taxpayers who face reporting obligations for foreign entities, as it suggested a limitation on the IRS’s ability to enforce penalties in certain jurisdictions.

What This Means for Taxpayers

Unlike Farhy, which saw a reversal upon appeal, Mukhi remains a case that has not yet been overturned. This has left taxpayers in jurisdictions outside the D.C. Circuit with a potential pathway to challenge penalties, as the Tax Court’s decision provides a precedent limiting the IRS’s enforcement powers. For U.S. citizens living abroad with complex reporting requirements, such as filing Form 5471, this case offers hope that the penalties for noncompliance may be contestable in certain circumstances.

However, this judicial divide between cases like Mukhi and Farhy creates significant uncertainty for taxpayers. Without a uniform standard, the IRS’s authority is interpreted differently depending on jurisdiction, leaving taxpayers unsure about their obligations and risks. This inconsistency underscores the importance of legal clarity in tax administration. It highlights broader questions about fairness and due process in enforcement practices.

For taxpayers, particularly those dealing with foreign reporting requirements, the Mukhi decision serves as a reminder of the importance of seeking expert guidance. While it offers a potential avenue to contest penalties, taxpayers must remain cautious and informed, as future appeals or judicial decisions could further alter the landscape.

As the IRS continues to pursue aggressive enforcement, taxpayers and advisors must closely monitor developments to navigate this evolving legal environment effectively.

Taxpayers facing penalties for failing to file Forms 5471 or similar documents should consult their advisors to evaluate how the Mukhi decision might impact their cases. Hopefully, a Supreme Court hearing will help solve this court disparity.

4. Texas Top Cop Shop v. Garland

Why This Case Is Important

The Texas Top Cop Shop case challenges the constitutionality of the Corporate Transparency Act (CTA), a law mandating that businesses report Beneficial Ownership Information (BOI) to the Financial Crimes Enforcement Network (FinCEN). BOI includes details about individuals who own or control at least 25% of a business or significantly influence its operations. The CTA aims to combat money laundering, terrorism financing, and other financial crimes by increasing transparency around who owns and controls entities operating in the United States. While its goals are laudable, the CTA has faced significant criticism for its broad scope and the burdens it imposes on small businesses.

The law arose from long-standing concerns about using anonymous shell companies to obscure financial activity. By requiring the disclosure of BOI, the CTA seeks to provide law enforcement with the tools necessary to trace illicit activities and prevent the misuse of corporate structures. However, many argue that the law overreaches, violates privacy rights, and infringes on states’ authority to regulate corporate formation. Historically, regulating business entities has been a state matter, and opponents of the CTA see this federal mandate as an encroachment on state sovereignty.

The Texas Top Cop Shop case exemplifies these concerns, as the plaintiffs argued that the CTA violates the Tenth Amendment by undermining states’ rights and the Fourth Amendment by compelling the disclosure of private information. The U.S. District Court for the Eastern District of Texas issued a preliminary injunction against the enforcement of the CTA, finding that it likely exceeds Congress’s authority under the Commerce Clause. The court also emphasized the law’s expansive scope and potential to compel speech and infringe on privacy rights, further deepening the legislation’s controversy.

This case highlights the tension between federal efforts to combat financial crime and the rights of individuals and states to maintain control over business practices and private information. It has become a focal point in the ongoing debate over the balance between transparency, security, and individual freedoms.

Summary of the Case

The plaintiffs, including a small Texas business, argued that the CTA violates the Tenth Amendment by infringing on states’ rights to regulate corporate formation and governance. They also claimed the CTA compels private individuals to disclose sensitive information, violating the Fourth Amendment.

The U.S. District Court for the Eastern District of Texas initially agreed with the plaintiffs. It issued a preliminary injunction in early 2023, halting enforcement of the CTA. The court found that the law likely exceeded Congress’s authority under the Commerce Clause, emphasizing its expansive scope and the risks associated with compelled speech and private disclosures.

However, the legal battle did not end there. Toward the end of 2023, the injunction was lifted following a ruling that sided with the government, arguing that the CTA’s requirements were necessary to address systemic issues like money laundering and terrorist financing. Yet, one week later, on December 26, 2023, another court reinstated the injunction, citing unresolved constitutional concerns and reinforcing the plaintiffs’ claims of overreach and privacy violations.

This series of back-and-forth judicial decisions has left taxpayers and their advisors feeling like spectators at a tennis match, uncertain about the CTA’s enforceability and the ultimate legal resolution.

Currently, the CTA’s fate remains open to final decisions, leaving businesses in a state of limbo as they navigate evolving compliance requirements and await clarity from higher courts, potentially including the Supreme Court.

What This Means for Taxpayers

The court’s injunction* temporarily halts enforcement of the CTA, meaning businesses are not currently required to comply with its reporting requirements. However, this ruling leaves businesses in a state of uncertainty, as the legal status of the CTA remains unresolved.

Given the possibility of the injunction being overturned or modified in the future, small businesses, particularly, face challenges in determining how to proceed. Compliance with the CTA imposes new administrative burdens and the risk of penalties, making it essential for taxpayers to stay informed.

Taxpayers should consult their advisors to discuss the best next steps in light of the ongoing judicial back-and-forth. Advisors can provide guidance on how to prepare for potential reporting requirements and assess whether preemptive compliance efforts might mitigate future risks. With the legal landscape evolving, careful planning and professional advice are crucial to navigating this uncertain environment.

5. Foreign Tax Credit Under the Canada-U.S. Tax Treaty (Bruyea v. United States)

Why This Case Is Important

The Bruyea case addresses whether taxpayers can apply foreign tax credits (FTCs) to offset liabilities under the Net Investment Income Tax (NIIT). The NIIT, introduced in 2013 as part of the Affordable Care Act, is a 3.8% surtax applied to net investment income for individuals with modified adjusted gross income above certain thresholds ($200,000 for single filers and $250,000 for joint filers). Net investment income includes interest, dividends, capital gains, rental income, and certain other passive sources. Unlike regular income taxes, the NIIT is not considered a part of income taxes for which FTCs are typically applied. This distinction has made it a contentious issue for taxpayers seeking to reduce their overall tax liability using credits for foreign taxes paid.

Historically, the IRS has maintained that the NIIT falls outside the scope of tax treaties, such as the Canada-U.S. Tax Treaty, because it is categorized as a separate surtax rather than a traditional income tax. This has left U.S. citizens living abroad, particularly in high foreign tax jurisdictions, unable to offset their NIIT liability using FTCs. Consequently, the NIIT has often led to double taxation, where taxpayers pay taxes on the same income to the foreign country and the U.S. without relief.

Summary of the Case

In the Bruyea case, Paul Bruyea, a U.S. citizen residing in Canada, challenged the IRS’s denial of FTCs to offset his NIIT liability. The court ruled in Bruyea’s favor, holding that the Canada-U.S. Tax Treaty allows FTCs to apply against the NIIT. The decision recognized the economic burden imposed on taxpayers subject to overlapping tax regimes and highlighted the importance of treaties in providing relief from double taxation.

This ruling significantly affects U.S. citizens abroad, particularly in high-tax jurisdictions like Canada. It establishes a precedent for interpreting tax treaties more broadly to include surtaxes like the NIIT, offering a potential avenue for relief to taxpayers facing similar challenges. By affirming that FTCs can offset the NIIT, the court’s decision reduces the risk of double taxation and provides greater equity for expatriate taxpayers. The IRS will undoubtedly appeal the decision, leaving the issue unresolved for taxpayers in other jurisdictions.

The outcome of the Bruyea case underscores the evolving interpretation of tax treaties and the ongoing tension between domestic tax policy and international tax obligations. This ruling allows taxpayers to revisit prior tax filings and amend returns to claim FTCs against the NIIT. Taxpayers should consult with advisors to determine their eligibility and prepare for potential challenges as the IRS continues to address this complex issue.

What This Means for Taxpayers

This ruling significantly reduces the tax burden for U.S. citizens in Canada by allowing them to offset NIIT liabilities with foreign tax credits. It sets an important precedent for taxpayers in similar circumstances and signals a broader interpretation of tax treaty provisions.

However, while the Bruyea case is a significant development, it is not sufficient to establish a universal precedent allowing all taxpayers to offset NIIT with FTCs. The ruling must be considered alongside similar cases, such as Christensen v. United States, which originated in France. In the Christensen case, the court also addressed whether FTCs could be used to offset NIIT, further solidifying the argument that these credits should apply to surtaxes like the NIIT.

The Bruyea and Christensen cases create a stronger foundation for taxpayers to challenge the IRS’s long-standing position that FTCs do not apply to the NIIT. These rulings provide a framework for further litigation. They may pave the way for a broader interpretation of tax treaties, particularly regarding surtaxes. If similar cases emerge in other jurisdictions, the cumulative effect could significantly shift the IRS’s stance, potentially reducing the overall tax burden for U.S. expatriates living in high-tax countries.

The ongoing developments highlight the importance of staying informed, as this area of tax law is far from settled. As more cases are decided, the legal framework surrounding FTCs and the NIIT could become more taxpayer-friendly, offering more significant opportunities for relief and reducing the risks of double taxation. Taxpayers should remain proactive, working with experienced advisors to assess their eligibility and maximize their benefits under these emerging interpretations.

6. United States v. Sagoo

Why This Case Is Important

The Sagoo case demonstrates the IRS’s increasingly aggressive stance toward taxpayers it deems non-compliant with FBAR requirements, even those who have attempted to rectify past issues through voluntary disclosure programs. The case signals the IRS’s renewed focus on pursuing willful penalties, particularly following a series of losses in other key tax enforcement cases.

In this case, Sharnjeet Sagoo was penalized for failing to disclose foreign accounts despite participating in the Streamlined Domestic Offshore Procedures program. This program is specifically designed for taxpayers who failed to meet their reporting obligations but were considered non-willful in their neglect. However, the IRS argued that Sagoo’s conduct amounted to willful neglect, asserting that she concealed the accounts from her accountants and the U.S. government for years. These accounts, with balances exceeding $1.7 million, became the focal point of the IRS’s case.

What makes the Sagoo case particularly noteworthy is its timing and context. Coming on the heels of the IRS’s defeats in cases like Farhy v. Commissioner, the case represents a shift toward more assertive enforcement, with the IRS aiming to reclaim its authority and expand the scope of what it considers willful neglect.

The Sagoo case has only begun, but it reflects a broader enforcement strategy that may lead to more cases of alleged willful neglect being pursued by the IRS. The judicial system’s response to these claims will play a critical role in shaping the future of voluntary disclosure programs and taxpayer protections.

Summary of the Case

The IRS imposed substantial penalties on Sharnjeet Sagoo for willfully failing to disclose foreign accounts despite her participation in the Streamlined Domestic Offshore Procedures program. The IRS has argued that Sagoo’s failure to disclose these accounts, which reportedly held balances exceeding $1.7 million, constituted deliberate and willful neglect. The crux of the IRS’s claim is that Sagoo intentionally concealed the accounts from her accountants and failed to provide accurate information to the U.S. government, demonstrating a noncompliance pattern beyond mere negligence.

The IRS contends that retroactive penalties are warranted in cases like Sagoo’s to deter other taxpayers from exploiting voluntary disclosure programs as a shield against accountability. By focusing on Sagoo’s alleged willfulness, the IRS seeks to establish a precedent that even participation in streamlined procedures does not grant immunity if willful intent can be proven.

What This Means for Taxpayers

Taxpayers must exercise extreme caution in disclosure programs, as willful penalties remain risky. For those who have not yet utilized the Streamlined Filing Compliance Procedures but are eligible to do so, time may be of the essence. The IRS’s increasingly aggressive stance in cases like Sagoo suggests that the window for voluntary compliance under lenient terms may close in the near future. This makes it imperative for taxpayers to act quickly to regularize their compliance while the program remains accessible.

However, taxpayers considering these programs must also ensure they meet the non-willful criteria. The IRS has shown a willingness to scrutinize cases and reclassify what was initially presented as non-willful neglect into willful noncompliance, carrying significantly harsher penalties. Taxpayers should carefully document their circumstances and seek professional advice to substantiate their claims of non-willfulness. This preparation not only strengthens their filing but also minimizes the risk of future disputes with the IRS.

The importance of proactive and accurate compliance cannot be overstated, as the consequences of missteps in these programs can be severe. With the IRS signaling a tougher approach, now is the time for eligible taxpayers to act decisively and responsibly, ensuring they meet all program criteria while mitigating the risks of increased scrutiny.

2024 In Summary

The 2024 rulings illustrate a pivotal year in the ongoing battle between taxpayers and the IRS, as numerous cases challenged the status quo with varied outcomes.

While some cases resulted in taxpayer victories, others reaffirmed the IRS’s authority, creating a dynamic legal landscape that continues to evolve. This year demonstrated that taxpayers, particularly those living abroad, are increasingly willing to push back against perceived overreach and penalties they consider unjust or unnecessary.

Cases like Farhy and Mukhi highlight the willingness of courts to question long-standing IRS enforcement practices, particularly around foreign reporting penalties. However, these victories have been tempered by reversals, such as in Mukhi, and by the IRS’s continued aggressive stance in cases like Sagoo, which signals a renewed effort to claim willful penalties and expand its authority. These decisions show the resilience of taxpayers who are determined not to pay penalties they believe to be arbitrary or excessive, as well as the risks they face as judicial interpretations vary across jurisdictions.

The ongoing legal battles have left taxpayers and their advisors navigating what feels like a tennis match of rulings, with each decision reshaping expectations for compliance and enforcement. While these cases underscore the importance of vigilance and expert guidance, they also reveal the potential for significant shifts in tax policy and enforcement in the near future. Taxpayers must remain proactive, informed, and prepared to adapt to new developments.

*https://www.uschamber.com/co/start/strategy/small-business-corporate-transparency-act