Introduction: Section 6038 Penalties and the American Who Owns a British Company
Section 6038 penalties are the most expensive filing failure a wealthy American in Britain can make. Almost nobody sees them coming. You incorporated a UK limited company. You paid your corporation tax to HMRC on time. Your accountant filed spotless accounts every year. Nevertheless, you never attached Form 5471 to your US return. Consequently, the Internal Revenue Service can charge you $10,000 for every accounting period, for every company. It can do that even when you owed no American tax at all.
That last point deserves emphasis. Section 6038 penalties are information return penalties. Therefore they are not tax penalties, and they do not depend on a balance due. They apply on a nil balance. They apply to a loss-making company. Moreover, they apply to a dormant shelf company you forgot you owned.
Furthermore, the exposure compounds in three separate directions at once. One of those directions is largely unreported elsewhere. Specifically, it quietly reduces the foreign tax credit that shields your entire UK income from double taxation.
At TaxYork we see this pattern constantly. Founders, investment bankers and property investors move to London. Then they set up a British trading company. Accordingly, this guide sets out how the exposure is built. It also explains what the courts have said about the IRS power to charge it. Above all, it identifies which disclosure route actually caps the damage.
Section 6038 Penalties Begin at $10,000 and Reach $60,000 Per Form
The statute is short and brutal. Internal Revenue Code section 6038 requires a US person who controls a foreign business entity to furnish information about it. Fail, and subsection (b)(1) bites. It says you "shall pay a penalty of $10,000 for each annual accounting period with respect to which such failure exists".
Additionally, a continuation penalty then starts. It begins 90 days after the IRS mails notice of the failure. Thereafter subsection (b)(2) adds a further $10,000 for each 30-day period, or fraction of one. That increase caps at $50,000. Therefore Section 6038 penalties reach a maximum of $60,000 per company per year. Notably, the clock runs whether or not you understood the notice.
Why Section 6038 Penalties Hit High-Net-Worth Founders Hardest
Wealthy readers face a compounding problem that ordinary expats do not. Specifically, you probably own more than one entity. You probably owned each one for several years. In addition, you probably pay substantial personal UK tax. Each of those three facts multiplies the exposure independently.
The charge is levied per foreign corporation, per accounting period. Three companies held for six years produces eighteen separate failures. Consequently, the initial Section 6038 penalties alone total $180,000. No continuation charge is needed to reach that figure. In our experience reviewing catch-up cases for UK-resident Americans, that arithmetic converts an administrative oversight into a genuine wealth event.
The Three Layers You Must Quantify Before Acting
Every assessment we run separates the exposure into three layers. Firstly, there are the dollar charges under subsection (b). Secondly, there is the foreign tax credit reduction under subsection (c). Thirdly, there is the open assessment period under section 6501(c)(8).
Most guides address only the first layer. However, the second and third layers frequently cost our clients more. Section 6038 penalties are best measured across all three layers at once. Accordingly, we treat them as a single problem, and this article follows that order.
What Triggers Section 6038 Penalties on a UK Limited Company
Most people assume the duty attaches to control alone. In reality, Form 5471 has several filing categories. Several of them catch shareholders who own far less than half the company. Consequently, many Americans who consider themselves passive investors face Section 6038 penalties. They never managed anything at all.
Category 4: The Controlling Shareholder
A Category 4 filer controls the foreign corporation. Control means more than 50% of the voting power or value. Furthermore, that test is met over an uninterrupted period of at least 30 days in the accounting period. Therefore a solo founder owning 100% of a British company always files.
Additionally, control is tested using attribution rules. Shares held by your spouse or your children can count as yours. Hence you may hold control on paper at 40%. In that situation, Section 6038 penalties apply exactly as they would to a full owner.
Category 5: The Ten Per Cent Investor in a Controlled Foreign Corporation
Category 5 catches a US shareholder of a controlled foreign corporation. That means owning 10% or more of vote or value. It also requires that US persons collectively own more than half the company. Consequently, four American co-founders holding 25% each create a controlled foreign corporation. All four must then file.
In practice, this is the most commonly missed category we encounter. It generates Section 6038 penalties on people who assumed a minority stake carried no duty. The IRS instructions for Form 5471 set out each category in full. Nevertheless, the categories overlap, and one shareholder frequently files under two.
Category 2 and 3: The Officer and Director Trap
Here the exposure widens dramatically. A US citizen may be merely an officer or director of a foreign corporation. That person must still file when a US person acquires a 10% stake. The duty also arises when an existing holder increases a stake. Critically, the officer need own no shares whatsoever.
Notably, these categories carry their own charge. It sits in section 6679, a companion provision. That section imposes $10,000, plus $10,000 for each 30-day period after 90 days notice, capped at $50,000. Therefore the two penalty regimes are separate. Accordingly, a founder who was both controlling shareholder and director can face Section 6038 penalties under 6038(b) and a further 6679 charge for the same year.
UK Partnerships, LLPs and Foreign Disregarded Entities
Section 6038 is not limited to corporations. It also covers controlled foreign partnerships. Therefore a US member of a UK limited liability partnership generally files Form 8865 instead. Furthermore, the penalty structure mirrors the corporate one exactly.
The $10,000 and $60,000 figures apply equally to LLP interests. Consequently, Section 6038 penalties reach partnership reporting exactly as they reach corporate reporting. American partners in London law firms, hedge funds and property partnerships therefore carry the same risk. In each case the underlying statutory text sits in the codified section 6038, not in the form instructions.
How Section 6038 Penalties Compound Across Years and Entities
Understanding the stacking is essential. The headline $10,000 figure badly understates the real risk. That is especially true for anyone resident in Britain for a decade. Section 6038 penalties do not aggregate into one charge. Instead, each accounting period of each entity is a separate failure with its own ceiling.
The Initial Charge Is Per Company, Per Period
Start with the base layer. One company and nine missed years produces nine failures. Therefore the initial Section 6038 penalties total $90,000. The IRS confirms the mechanic plainly. It states a $10,000 penalty applies "for each annual accounting period of each foreign corporation". Hence the arithmetic is multiplicative.
The Continuation Charge Multiplies the Base by Six
Then comes the second layer. The IRS mails a notice and 90 days pass. Thereafter each 30-day period adds another $10,000 per company per year. That escalation stops at the $50,000 cap. Until then, Section 6038 penalties grow every month you remain silent.
Consequently, our nine-year example grows from $90,000 to $540,000. Five months of silence achieves that alone. Additionally, the Taxpayer Advocate Service has flagged how quickly notices escalate for taxpayers overseas. International post delays routinely consume the response window.
Why Living Abroad Makes Section 6038 Penalties Worse
This point deserves separate treatment. The 90-day clock runs from the mailing date, not the date you read the letter. Therefore a founder in London receiving a CP15 six weeks late has already lost half the window.
Moreover, the IRS does not courier these notices to a UK address. A change of London flat may never reach the IRS record. In that case you may never see the letter at all. Meanwhile, Section 6038 penalties continue accruing on schedule.
Stacking Across an Entity Group
Now combine the two multipliers. A client with a UK trading company, a UK property company and an LLP interest holds three reportable entities. Assume eight missed years each. That produces twenty-four failures and $240,000 of initial exposure.
Furthermore, the continuation ceiling raises the theoretical maximum to $1.44 million. We rarely see the full figure assessed. Nonetheless, Section 6038 penalties in the low six figures are entirely routine on a three-entity group. Nevertheless, we routinely see six-figure notices, and they arrive without warning.
The Foreign Tax Credit Reduction Almost Nobody Explains
Here is the layer that other guides mention once and then drop. Beyond the dollar charges, subsection 6038(c) reduces your foreign taxes. Specifically, it cuts taxes "paid or deemed paid to any foreign country" by 10% for the year of the failure. For an American in Britain, that hits the credit protecting your UK income tax. In effect, Section 6038 penalties reach beyond the fine and into your relief from double taxation.
The Reduction Escalates Quarterly, Not Monthly
The escalation timetable differs from the dollar penalty. Suppose the failure continues 90 days or more after IRS notice. The reduction then becomes 10%, plus a further 5% for each three-month period. Fractions of a period count in full.
Notably, paragraph (1) states no ceiling of its own. Therefore Section 6038 penalties and the credit reduction run on two different timetables. Instead, the limits sit in the paragraphs that follow. Understanding those limits is where genuine planning value appears.
The Cap: The Greater of $10,000 or the Entity's Income
Subsection (c) caps the total reduction. It applies "whichever of the following amounts is the greater". The first amount is $10,000. The second is the income of the foreign business entity for the accounting period concerned.
Consequently, a dormant or loss-making UK company caps your credit exposure at $10,000 for that period. Your personal UK tax bill becomes irrelevant to that cap. Accordingly, Section 6038 penalties on a dormant company remain painful but bounded. That distinction matters greatly for our client base.
A property holding company with £4,000 of rental profit produces a small cap. Meanwhile, a trading company earning £900,000 produces no meaningful cap at all. In the second case, the 10% reduction runs unchecked against your whole Form 1116 claim.
The Coordination Offset and the Real $100,000 Threshold
Now the provision that changes the analysis completely. Subsection (c) also offsets the two charges. The reduction "shall be reduced by the amount of the penalty imposed by subsection (b)". Therefore the dollar penalty and the credit haircut do not simply stack.
Work the arithmetic through and a clean threshold appears. Ten per cent of your foreign taxes only exceeds the $10,000 offset once those taxes pass $100,000. Accordingly, Section 6038 penalties impose a real second hit on the credit only above that level. Below it, the offset absorbs the reduction entirely.
For a London banker, partner or founder, that threshold is easily crossed. Our tax treaty and foreign tax credit work models the effect year by year. Furthermore, one rule helps you. No taxes may be reduced more than once for the same failure.
The Statute of Limitations Problem Under Section 6501(c)(8)
Money is only half the exposure. Arguably the graver consequence of Section 6038 penalties is procedural. The failure holds your assessment period open, potentially for ever.
Your Whole Return Stays Open, Not Just the Company
Section 6501(c)(8) sets the rule. Where information is required under section 6038, assessment of "any tax imposed by this title" stays open. That extension covers "any tax return, event, or period to which such information relates". It expires three years after the IRS receives the information.
Read that wording carefully. The extension applies to the return, not merely to the omitted schedule. Therefore a missed Form 5471 for 2016 keeps your entire 2016 Form 1040 assessable today. That includes your employment income, your investment gains and your pension reporting. Consequently, Section 6038 penalties expose far more than the company itself.
Reasonable Cause Narrows the Extension to Related Items
There is a meaningful limitation, and it is widely overlooked. Subparagraph (B) addresses failures due to reasonable cause and not wilful neglect. In those cases the extension applies "only to the item or items related to such failure".
Therefore reasonable cause does more than defeat a penalty. Additionally, it re-closes the rest of the return. That protects unrelated years of investment income from reassessment. Consequently, we document reasonable cause even where Section 6038 penalties are already waived by a disclosure programme.
What This Means for a Company You Formed in 2014
Consider the practical consequence. You incorporated a British company in 2014 and never filed. The IRS may therefore still assess 2014 through 2025 today. Moreover, the clock only starts once the information is furnished. It then runs a further three years.
Hence silence achieves nothing. Rather, a properly documented filing is the only way to start the three-year period running. That is the single strongest argument for acting this year.
Can the IRS Even Assess Section 6038 Penalties? Farhy and Mukhi in 2026
A genuine legal fight has run since 2023. The question is whether the IRS may assess these penalties administratively. Alternatively, it may have to sue in federal court to collect them. The position in August 2026 remains unresolved.
The DC Circuit Restored Assessment Authority in 2024
The Tax Court originally held in Farhy that no statute authorises assessment of a 6038(b) penalty. However, the Court of Appeals for the District of Columbia Circuit reversed on 3 May 2024. It concluded that the text, structure and function of section 6038 show congressional intent to allow assessment. Consequently, the IRS power to assess Section 6038 penalties stands in that circuit.
The Tax Court Refused to Follow It in Mukhi
Then the Tax Court held its ground. It decided Mukhi v. Commissioner, 163 T.C. No. 8 on 18 November 2024. Sitting en banc, the court ruled 15 to 1 against assessment authority. Notably, it reasoned that the appeal route lay to the Eighth Circuit. Therefore the DC Circuit decision did not bind it. Published opinions for both courts remain available through the federal judiciary records system. For now, therefore, the assessability of Section 6038 penalties depends on where your appeal would be heard.
Why the Split Should Not Change Your Filing Behaviour
The Eighth Circuit has not ruled as at August 2026. A genuine conflict therefore persists, and Supreme Court review remains possible. Nevertheless, three practical points matter far more than the doctrine.
Firstly, the IRS continues assessing Section 6038 penalties systemically on late-filed forms. The litigation has not changed its processing. Secondly, litigating your way out costs more than filing correctly ever would. Thirdly, and decisively, the cases touch only subsection (b). They do not touch the credit reduction in subsection (c). Equally, they do not touch the open assessment period.
Therefore treating the case law as a reason for silence is a serious error. In our experience, clients who waited for the courts simply accumulated more open years. Meanwhile, any legislative fix would appear through Treasury and IRS rulemaking, and none has arrived.
Fixing Missed Filings: Streamlined, DIIRSP and Reasonable Cause
Three routes exist. Choosing correctly is worth more than any argument you will make about the penalty itself. Furthermore, the routes are not interchangeable. Picking the wrong one can forfeit protection you were entitled to.
IRS Streamlined Filing Caps the Look-Back at Three Years
For most UK-resident Americans, the IRS Streamlined Foreign Offshore Procedures are decisively the strongest option. You file amended returns for the three most recent years whose due date has passed. You also file six years of FBARs. Then you certify non-wilfulness on Form 14653. Critically, the IRS waives information return penalties on those returns. That waiver includes Section 6038 penalties on the Forms 5471 you attach.
The structural advantage is the look-back period. Streamlined puts three Forms 5471 on the table. Meanwhile, a full delinquent filing of nine years puts nine forms and $90,000 of exposure on the table. No automatic waiver accompanies that route. Consequently, our IRS Streamlined Filing service usually cuts the exposure by an order of magnitude.
Eligibility does require care. You must be non-wilful. You must also satisfy the non-residency test. For a US citizen, that means 330 full days outside the United States in one of the three years. Additionally, the 5% miscellaneous offshore penalty applies only to domestic filers. Therefore a genuine UK resident pays nothing.
The DIIRSP Route and Its Pre-Assessment Asymmetry
Sometimes all income was reported correctly and only the forms were omitted. In that case the delinquent international information return submission procedures apply instead. You must not be under examination. You must not already have been contacted about the returns. Furthermore, you must have identified the failure yourself.
However, one line on that IRS page changes everything. The IRS states that "during the processing of the delinquent information return, penalties may be assessed without considering the attached reasonable cause statement". Then it adds a carve-out. It confirms that for "Form 3520 and Form 3520-A reasonable cause statements will be considered prior to a penalty being assessed".
Read those two sentences together. Form 5471 sits outside the carve-out. Therefore Section 6038 penalties are typically assessed first and argued afterwards. Accordingly, anyone filing delinquent Forms 5471 should expect a notice. You should budget for the abatement fight. Above all, never treat a reasonable cause statement as a shield against assessment.
Why the New Automatic Penalty Exemption Will Not Help You
Several 2026 guides still list first-time penalty abatement as a remedy here. That advice is outdated in two directions at once. Firstly, the IRS replaced first-time abate with an Automatic Exemption from Penalty announced in July 2026. It applies to original returns due on or after 1 January 2027.
Secondly, and decisively, the programme covers only three penalties. Those are failure to file, failure to pay and failure to deposit. Information return penalties sit expressly outside it. Consequently, Section 6038 penalties receive nothing from the new automatic relief. Neither do the FBAR charges that usually accompany them.
In short, only two things genuinely help a missed Form 5471. The first is reasonable cause. The second is a formal disclosure programme. Nothing else applies.
The Three Mistakes That Forfeit Relief Entirely
Certain errors recur constantly in our catch-up work. The first is the quiet disclosure. A taxpayer simply attaches the missing forms to a current-year return and hopes. That forfeits Streamlined protection permanently, because the programme requires amended returns filed under it. Furthermore, it invites Section 6038 penalties on every form submitted.
The second is a thin reasonable cause narrative. It is the most common reason Section 6038 penalties survive an abatement request. Generic statements fail, because the test is one of facts and circumstances. Specifically, "my accountant did not tell me" carries weight only in narrow conditions. You must have disclosed the foreign company to a qualified adviser. You must also have relied on specific advice. Therefore the narrative should name the adviser and evidence the reliance. Additionally, note that HMRC takes the opposite approach domestically. It expressly rejects reliance on an agent as a reasonable excuse, so British instincts mislead here.
The third is filing the form without the income analysis behind it. A technically complete Form 5471 drives your controlled foreign corporation inclusions. Those inclusions changed materially for 2026. Global intangible low-taxed income became net CFC tested income. The deduction reset to 40%, producing an effective rate near 12.6%. However, an individual shareholder claims no deduction without a section 962 election. That election must be modelled before filing, never afterwards.
Worked Case Study: A London Founder With Nine Missed Accounting Periods
Consider Daniel, an American citizen living in Kensington since 2016. He incorporated a UK trading company in April 2017. His shareholding is 100%. Additionally, he sits as sole director.
Furthermore, his accountant filed every set of statutory accounts at Companies House on time. The company paid corporation tax at the prevailing UK rates without fail. It kept adequate accounting records as the Companies Act 2006 demands. Nevertheless, Daniel's American returns never carried a single Form 5471.
Calculating the Raw Exposure
Nine accounting periods from 2017 to 2025 produce nine failures. Therefore the initial Section 6038 penalties total $90,000. Daniel was also a director when he acquired his stake on incorporation. Consequently a further $10,000 arises under section 6679 for 2017. That takes the base exposure to $100,000.
Next, consider the continuation risk. Suppose Daniel had received a notice and ignored it for five months. Each of the nine periods would then have reached the $60,000 ceiling. His theoretical maximum therefore sat at $540,000 under section 6038. A further $60,000 was possible under section 6679, giving $600,000 in total.
The Foreign Tax Credit Layer
Daniel paid UK income tax of roughly $148,000 in the 2024 calendar year. That covered salary and dividends. Applying subsection (c), a 10% reduction removes $14,800 of creditable foreign tax. Section 6038 penalties had therefore already begun eroding his treaty relief.
Then the coordination rule applies. It reduces that figure by the $10,000 penalty already imposed for the period. Accordingly, the net credit loss was $4,800 for that year alone. Additionally, his company earned £780,000, so the income cap gave him no protection whatsoever.
The Route We Took and the Actual Outcome
Daniel qualified for the Streamlined Foreign Offshore Procedures. He had spent each of the past three years in Britain. Moreover, his failure was plainly non-wilful. Accordingly, we filed amended returns for 2022, 2023 and 2024. Each carried a Form 5471. We also filed six years of FBARs and a detailed Form 14653 narrative.
One further issue surfaced during the review. Daniel had drawn £62,000 from the company as a director's loan. HMRC taxes such loans under the section 455 regime, at the rate set out in the Company Taxation Manual. Consequently the loan was also United States property under section 956. That produced a deemed dividend on his US return. It generated $8,400 of additional American tax, which we paid with interest.
The final position was decisive. Total penalties charged came to nil. Total additional tax and interest stayed under $10,000. By contrast, a nine-year delinquent submission would have exposed $100,000 of Section 6038 penalties. That route carries no guaranteed waiver. Doing nothing, meanwhile, would have kept nine American tax years open indefinitely.
How TaxYork Can Help With Section 6038 Penalties
We prepare US and UK tax returns for exactly this client profile. Our clients are founders, investment professionals and company owners with real assets on both sides of the Atlantic. Therefore our work on Section 6038 penalties begins with an entity map, not a form.
We identify every foreign company, partnership and disregarded entity you hold. Then we establish the correct filing category for each. Finally, we quantify the exposure before recommending a route. Furthermore, we prepare the whole submission as one integrated package.
That package includes the amended US tax returns and the Forms 5471 with complete schedules. It also includes the FBARs, the Form 14653 certification and a reasonable cause narrative where the facts support one. A UK company almost always means UK business accounts. Consequently, those accounts frequently trigger obligations covered by our FBAR and FATCA compliance work.
Additionally, we handle the resulting IRS correspondence. A CP15 notice arriving at a London address needs a response drafted the week it lands. Our team also coordinates the British side throughout. Specifically, we reconcile the section 455 position, the director's loan account, the corporation tax computation and your Self Assessment against the American filing. That reconciliation is where the cross-border planning value genuinely sits.
Conclusion
Section 6038 penalties represent an unusually asymmetric risk. Doing nothing costs $10,000 per company per year, escalating to $60,000. It also holds every American tax year open indefinitely. Furthermore, it shaves your foreign tax credit once your UK taxes pass roughly $100,000. Meanwhile, a correct disclosure under the Streamlined Foreign Offshore Procedures frequently costs nothing in penalties at all.
The litigation over administrative assessment remains unresolved in 2026. Nevertheless, it should change nothing about your behaviour. Ultimately, the IRS keeps assessing. The credit reduction is untouched by the case law. Equally, the open assessment period is untouched.
Therefore the correct response to a missed Form 5471 is a properly structured disclosure. Prepare it quickly. Complete the income analysis before anything is filed. If you own a British company and your returns have never carried a Form 5471, your problem is defined and solvable. Act while the choice of route still belongs to you.
Contact Us
Speak to a specialist before the IRS writes to you. You can book a consultation with our cross-border team. Alternatively, email hello@taxyork.com or telephone 020 3488 8606. We will map your entities and quantify the Section 6038 penalties at stake. Then we will set out the disclosure route that closes the exposure at the lowest cost.
Disclaimer
This article provides general information about Section 6038 penalties and US-UK tax compliance. It does not constitute tax advice for any particular person or situation. You should not act on it without professional guidance. Tax law, rates and thresholds change frequently, and the litigation described here remains live. Figures cited are current as at August 2026. Always obtain specific professional advice on your own circumstances before making a disclosure or filing decision.