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Tax Practice and Administration: Sanctions, Agreements, and Disclosures

Tax Practice and Administration: Sanctions, Agreements, and Disclosures. Penalties. (Civil). Taxpayer Conduct Penalties. Characterized by statute as “addition to tax;” as such, are not deductible Imposed when statutes are violated Without reasonable cause As a result of Negligence, or

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Tax Practice and Administration: Sanctions, Agreements, and Disclosures

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  1. Tax Practice and Administration:Sanctions, Agreements, and Disclosures

  2. Penalties (Civil)

  3. Taxpayer Conduct Penalties • Characterized by statute as “addition to tax;” as such, are not deductible • Imposed when statutes are violated • Without reasonable cause • As a result of • Negligence, or • Intentional disregard of rules or regulations, or • Willful disobedience, or • Fraud

  4. But, first …… Preparer Penalties

  5. Preparer Penalties (Civil)

  6. §6695 Disclosure Penalties ITRP’s Beware $50 each occurrence (return) • On employer and/or ITRP if TP is not given complete copy of return upon presentation for signature • On employee ITRP if he/she fails to sign return • On employer, if TIN of preparer or employer, or both, not on return

  7. §6695 Disclosure Penalties (cont’d) • On employer and/or ITRP if he/she does not retain a copy of each return prepared (or retain a list of taxpayer names and ID numbers) • On employer of ITRP for each failure to • Retain • and for each item omitted - for each ITRP employed for year beginning July 1 of each year: (1) Name, - (2) TIN – (3) Place of work

  8. §6695 Disclosure Penalties (cont’d) Maximum §6695 disclosure penalty - $25,000

  9. §6694 Conduct Penalties • Endorsing or negotiating a refund check - $500 [§6695(F)]

  10. §6694 Conduct Penalties (cont’d) • Understatement due to unrealistic position - $250 [§6694(a)] • No realistic possibility that position will be sustained on merits • Waived if position disclosed on return • Also applies if TP provided info appears incomplete or inadequate, and preparer fails to make adequate inquiry

  11. §6694 Conduct Penalties (cont’d) Realistic Possibility – reasonable and well-informed analysis by person knowledgeable in tax law would conclude there is a one-in-three likelihood the position would be upheld on its merits • No penalty if a nonfrivolous position is disclosed on Forms 8275 or 8275-R.

  12. §6694 Conduct Penalties (cont’d) • Willful understatement - $1,000 [§6694(b)] • Willfully understates, or • Recklessly or intentionally disregards IRS rules and regulations

  13. §6700 Conduct Penalties • Organizing abusive tax shelters • Organizing • Participates in a sale • Furnishes a statement regarding an expected tax benefit that the person knows or has reason to know is either false or fraudulent, or a gross valuation understatement

  14. §6701 Conduct Penalties • Aiding and Abetting Understatement - $1,000 ($10,000 for corporations) [§6701(a)] • Aids, assists, procures, advises, in the prep or presentation of any return or claim, knowing it will be used in any material matter and will result in understatement of another person’s tax liability.

  15. Preparer Penalty Procedures • Separate from the audit and no discussion of the preparer penalty is to occur in the presence of a taxpayer. • Generally not proposed until the examination is completed. • After manager review, if the examiner determines that a penalty should be asserted, the preparer is given an opportunity to agree to the assessment.

  16. Preparer Penalty Procedures • IRS is not bound by the deficiency procedures and can immediately assess the penalty (no 90 day letter and therefore no right to challenge in Tax Court). • IRS does allow the preparer an opportunity for appeal (30 day letter) IRS will assess the penalty (or not) after the appeal is finished. • Preparer who wants judicial review can pay 15% of penalty, file a claim for refund (which will be denied) and then file suit in District Court.

  17. Preparer Penalties (Criminal)

  18. Criminal Conduct Penalty • Aiding or Assisting in Prep of False Return, a felony– up to $100,000 ($500,000 for corporations) + up to 3 years imprisonment - §7206 • (Criminal equivalent to civil §6701 Aiding and Abetting penalty)

  19. Criminal Conduct Penalty (cont’d) • For willfully aiding or assisting in the prep of a return or other document that is false as to any material matter • Preparer may include any person that supplies false info used in the prep of a return

  20. Criminal and Civil Conduct Penalty • Disclosure or Use of Info by Return Preparer – civil - $250, $10,000 max per year - §6713 - for disclosure or use of tax return info for other than preparing the tax return • Criminal misdemeanor – up to $1,000 + imprisonment if knowingly or recklessly so uses - §7216

  21. Civil / Criminal Penalties • Remember, if convicted of a criminal act and subjected to a criminal penalty, may and probably will also be subject to the civil equivalent

  22. Action to Enjoin • IRS may seek injunction against ITRP to prohibit him/her from practicing as ITRP (§7407) • Preparer must have: • Violated preparer penalty or criminal provision of IRC, or • Misrepresented his/her eligibility to practice before the IRS, or • Guaranteed payment of any tax refund or credit, or • Engaged in other fraudulent or deceptive conduct,

  23. Action to Enjoin (cont’d) • IRS may also obtain an injunctions against a person guilty of promoting abusive tax shelters, or of aiding and abetting an understatement of tax liability, to prohibit him/her from engaging in such conduct or activities (§7408)

  24. Taxpayer Penalties (Civil)

  25. Failure to File Penalty - §6651 • Civil– 5% per month or fraction, maximum 25%. • Reasonable cause exception applies • Burden of proof on TP • Criminal – 15% per mo. or fraction- max of 75%

  26. “Reasonable Cause” • No statutory definition • Courts – “whether an ordinary, intelligent person would act in the same manner as did the taxpayer in similar circumstances” • The following are not acceptable excuses: • Lack of funds to pay tax • TP incarcerated • Illness that was not incapacitating • Ignorance of the law

  27. Failure to Pay Penalty - §6651 • .5% per month until IRS Notice and Demand if paid w/in 10 days (21 days if tax >$100,000); if not paid, becomes 1% per month. Max – 25% • Reasonable cause applies • This penalty reduces the Failure to File penalty by the same amount, so that there is no more than a 5% penalty for any given month

  28. Accuracy Related Penalty - §6662 20% of the portion of a deficiency attributable to one or more of • Negligence or disregard of statute or regulations • Negligence = failure to make a reasonable attempt to comply with the provisions of the IRC • Disregard = careless, reckless, or intentional disregard of the elements of the tax law

  29. Accuracy Related Penalty - §6662 (cont’d) • Negligence defense • good faith effort to comply • Full disclosure on return of non-frivolous position – attach Form 8275 (or 8275-R, position contrary to regs) to return

  30. §6662 Penalty (cont’d) • Substantial understatement of income of greater of: • Deficiency of 10% or more of proper tax liability, or • $5000 ($10,000 for corp. other than S Corp or PHC) • Defense • Full disclosure – Form 8275 or 8275-R • Substantial authority (cont’d)

  31. §6662 Penalty (cont’d) • Substantial Authority includes (Regulation §1.6662-4(d)(3)(iii): • Code • Court decisions • Proposed Regulations • PLRs, TAMs, GCMs • Press releases, notices • Etc. – see Reg. • NOT professional opinions or legal periodicals, secondary authorities

  32. Substantial Authority Defense • The penalty does not apply if there was substantial authority for the taxpayer’s treatment of the item. • Note FSA 1999-145 • In determining substantial authority, consider: • Judicial decisions, revenue rulings and regulations. • Committee reports, PLRS, TAMS, GCMs, IRS press releases and other announcements published in the IRB. • Secondary sources are NOT authority. (Regulation §1.6662-4(d)(3)(iii):

  33. FSA 1999-145 • There is substantial authority for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of the authorities supporting a contrary position. Treas. Reg. section 1.6661-3(b); Antonides v. Commissioner, 91 T.C. 686, 702 (1988), aff'd, 893 F.2d 656 (4th Cir. 1990); Schirmer v. Commissioner, 89 T.C. 277, 283 (1987). The weight of the authorities for the tax treatment of an item is determined by the same analysis that a court would follow in evaluating the treatment of the item. Thus, if an authority is materially distinguishable on its facts from the facts of the case at issue, then the authority is of little relevance. Antonides, 91 T.C. at 702-703; see also Treas. Reg. section 1.6661-3(b)(2).

  34. FSA 1999-145 • The legislative history of the substantial understatement penalty explains the substantial authority exception as follows: Congress did not adopt an absolute standard that a taxpayer may take a position on a return only if, in fact, the position reflects the correct treatment of an item because, in some circumstances, tax advisors may be unable to reach so definitive a conclusion. Rather, Congress adopted a more flexible standard under which the courts may assure that taxpayers who take non-disclosed highly aggressive filing positions are subject to the penalty while those who endeavor in good faith to fairly self-assess are not penalized.

  35. FSA 1999-145 The standard of substantial authority was adopted, in part, because it is a new standard....It was intended that the courts be free to look at the purpose of this new provision in determining whether substantial authority existed for a position taken in a particular case. Congress believed such a standard should be less stringent than a “more likely than not” (i.e., more than 50 percent) standard and more stringent than a “reasonable basis” (i.e., non-negligent) standard. This new standard will require that a taxpayer have stronger support for his position than a mere “reasonable basis.” Thus, a taxpayer is required to have more support for his position than that it is arguable, but fairly unlikely to prevail in court upon a complete review of the facts and authorities.

  36. FSA 1999-145 • We think it unlikely that the Commissioner would prevail in arguing that the *** partners did not have substantial authority for the positions taken on their return. The partners do not have to show that they had a 50 percent or greater chance of prevailing on the merits to meet the substantial authority standard. Here, three courts have considered the exact items in question, and one of the courts has held that those items are deductible. Thus, petitioners' argument as to the deductibility of these items can no longer be classified as one that is “arguable, but fairly unlikely to prevail in court.” Id. The legal support for their argument exceeds this standard, though it may not rise to the level of “more likely than not.”

  37. FSA 1999-145 Furthermore, as mentioned previously, Congress designed the substantial authority exception so that taxpayers would not be penalized for their advisor's inability to reach a definitive conclusion based on the facts and the law as it existed at the time. What better evidence could there be of the advisor's inability to reach a definitive conclusion than to have two courts who are later faced with the same issue reach contradictory conclusions? The taxpayer could argue that, at the time he filed his return, he did his best to determine the proper tax treatment of the item in question given the lack of analogous cases. Certainly, he should not be penalized because he was no more well-versed in the complexities of the tax law than were the two circuit court judges who ruled in his favor. For these reasons, we think that the Commissioner is unlikely to prevail on the issue of substantial authority. (emphasis added)

  38. §6662 Penalty (cont’d) • Substantial valuation overstatement – • 200% or more, resulting in • deficiency of over $5,000 ($10,000 for C corporations) • Penalty is 40% if overstatement is 400% or more • Substantial overstatement of pension liability

  39. §6662 Penalty (cont’d) • Substantial understatement of E & G tax valuation • 50% or less than actual value • Penalty is 40% if stated value is 25% or less of actual value

  40. CivilFraud Penalty - §6663 Standard of proof – “Clear and convincing evidence” • Penalty is 75% of the portion of the underpayment attributable to fraud • Burden of proof is on government • Criminal tax case will be prosecuted first (if at all).

  41. §6663 Civil Fraud Penalty (cont’d) Fraud – not defined by statute Courts’ definition – Actual, intentional wrongdoingWith intent of specific purpose to evade a tax believed to be owingWillfulness is a crucial element Willfulness is present when TP’s actions “constitute a voluntary, intentional violation of a known legal duty.” SCt, 97 429 U.S. 10

  42. §6663 Civil Fraud Penalty (cont’d) Standard of Proof Required • Criminal – “beyond a reasonable doubt” • Civil – “clear and convincing evidence” If convicted of criminal fraud, cannot contest civil fraud – collateral estoppel

  43. §6663 Civil Fraud Penalty (cont’d) • Civil Fraud Penalty (CFP) negates/supercedes • Failure to file • Failure to pay • Accuracy related

  44. Failure to Make Estimated Tax Payments - §6654 • Is similar to interest, and rate varies • Individuals – computed on the difference between the actual payment and the least of: • 90% of the tax on the current year’s return • 100% of the tax on the prior year’s return • 90% of the tax on annualized income up to the month the installment is due

  45. Failure to Make Estimated Tax Payments - §6654 (cont’d) • Corporations – computed on the difference between the actual amount paid and • 100% of tax shown on return • 100% of nonzero amount on prior year return • Corp with a TI of $1 million or more in 3 prior years cannot use this exception. • 100% of the annualized amount.

  46. Estimated Tax Penalty - §6654 (cont’d) • Is not applicable if underpayment is under $1,000

  47. Failure to Make Employment Tax Deposits - §6656 • Rate varies from 2% to 15% depending on when failure is corrected. • Is a reasonable cause penalty • Assessed on employer • But remember the §6672 Trust Fund Recovery Penalty

  48. Filing a Frivolous Return Penalty - §6702 • $500 per return • Usually filed to assert • Fifth Amendment rights violated • TP objects to use for defense or other uses • Or other frivolous argument • Applies when • Return does not contain sufficient info for tax computation and assessment • Otherwise takes a frivolous position • Return indicates info insufficient for proper assessment

  49. Reliance on Advice of IRS - §6404(f) • Don’t –unless • In writing, • In response to specific request, and • Based on sufficient and accurate information

  50. Taxpayer Penalties (Criminal) Standard of proof – Beyond a any reasonable doubt

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