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Tax Practice and Administration: Sanctions, Agreements, and Disclosures. Chapter 13. Tax Penalties. Voluntary Compliance vs. Revenue Production. Penalties. (Civil). Penalties. Characterized by statute as “addition to tax;” as such, are not deductible Imposed when statutes are violated

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Tax Practice and Administration:Sanctions, Agreements, and Disclosures

Chapter 13

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Tax Penalties

Voluntary Compliance


Revenue Production

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  • 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, or

  • Willful disobedience, or

  • Fraud

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But, first ……

Preparer Penalties

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Preparer Penalties

  • An Income Tax Return Preparer (affectionately - ITRP) is defined in IRC §7701:

    • > Any person who prepares,

      • Or employs one or more people to prepare,

  • > All or a substantial part of a return,

    • Or claim for income tax refund,

  • > for compensation

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    Return Preparer Definition (cont’d)

    • “Substantial portion of return” – obviously a relative term, but

    • Regulations help to define:

      • If entry on return > $2,000, or

      • > $100,000, and

        • > 20 % of

      • gross income (AGI of individual) shown on return, then

      • the item is not substantial

        Reg. §301.7701-15(b)(2)

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    Preparer Penalties (cont’d)

    • IRTP includes

      • Tax advisers

      • Planners

      • Software designers

      • Consultants

        even though they may only review the return, or give TP sufficient advice to complete return or claim for refund

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    Preparer Penalties (cont’d)

    • Definition includes – anyone who provides a taxpayer with “sufficient information and advice so that the completion of the return or claim for refund is largely a mechanical matter.”

      • §301.7701-15(a)(1)

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    §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

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    §6695 Disclosure Penalties (cont’d)

    • On employer and/or ITRP if he/she does not retain a copy of each return prepared

    • 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

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    §6695 Disclosure Penalties (cont’d)

    Maximum §6695 disclosure penalty - $25,000

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    §6694 Conduct Penalties

    • Endorsing or negotiating a refund check - $500 [§6695(F)]

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    §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

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    §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

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    §6694 Conduct Penalties (cont’d)

    • Willful understatement - $1,000 [§6694(b)]

      • Willfully understates, or

      • Recklessly or intentionally disregards IRS rules and regulations

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    §6694 Conduct Penalties (cont’d)

    • 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

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    §6694 Conduct Penalties (cont’d)

    • 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.

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    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)

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    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

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    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

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    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

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    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

      • Misrepresented his/her eligibility to practice before the IRS

      • Guaranteed payment of any tax refund or credit

      • Engaged in other fraudulent or deceptive conduct

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    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)

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    Failure to File Penalty - §6651

    • Civil– 5% per month or fraction, maximum 25%.

    • Reasonable cause applies

    • Burden of proof on TP

    • Criminal – 15% per mo. or fraction- max of 75%

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    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 “need not apply”

      • Lack of funds to pay tax

      • Records lost or destroyed

      • TP incarcerated

      • Etc.

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    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

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    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

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    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

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    §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)

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    §6662 Penalty (cont’d)

    • Substantial Authority includes (Regulation §1.6662-4(d)(3)(iii):

      • Code

      • Court decisions

      • Press releases, notices

      • Etc. – see Reg.

      • NOT professional opinions or legal periodicals, secondary authorities

    • Regs§1.6662-4(d)(3)(iii)

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    §6662 Penalty (cont’d)

    • Substantial valuation overstatement –

      • 200% or more, resulting in

      • deficiency of over $5000 ($10,000 for C corporations)

      • Penalty is 40% if overstatement is 400% or more

    • Substantial overstatement of pension liability

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    §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

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    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 fraud penalty may also apply

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    §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

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    §6663 Civil Fraud Penalty (cont’d)

    Standard of Proof Required

    • Criminal – “beyond a shadow of any reasonable doubt”

    • Civil – “clear and convincing evidence”

      If convicted of criminal fraud, cannot contest civil fraud – collateral estoppel

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    §6663 Civil Fraud Penalty (cont’d)

    • Civil Fraud Penalty (CFP) negates/supercedes

      • Failure to file

      • Failure to pay

      • Accuracy related

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    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

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    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

      • Or if no return filed, amount due

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    Estimated Tax Penalty - §6654 (cont’d)

    • Is not applicable if underwithheld < $1000

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    Failure to Make Deposits and Overstatement of 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

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    Filing a Frivolous Return Penalty - §6702 §6656

    • $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

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    Reliance on Advice of IRS - §6404(f) §6656

    • Don’t –unless

      • In writing,

      • In response to specific request, and

      • Based on sufficient and accurate information

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    Taxpayer §6656



    Standard of proof – Beyond a shadow of any reasonable doubt

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    §§7201 and 7202 §6656Criminal Taxpayer Penalties

    • Willful attempt to evade or defeat tax (tax evasion) (§7201) – felony, fine up to $100,000 ($500,000 corporations), up to 5 years imprisonment

    • Willful failure to collect, account for, and remit (§7202)– felony, up to $10,000, 5 years

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    Criminal §6656 Taxpayer Penalty

    • Willful failure to file, supply info, or pay tax or estimated tax (§7203) – misdemeanor, up to $25,000 ($100,000 for corps), 1 year (5 years felony for returns relative to cash received by a business

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    §7206 §6656Criminal Taxpayer Penalty

    • Willful making, subscribing to, or aiding or assisting in making a return or document, verified by declaration under penalty of perjury, but not believed to be true and correct in every material matter (§7206) – felony, up to $100,000 ($500,000 for corps), three years

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    §7207 §6656Criminal Taxpayer Penalty

    • Willful filing of any known-to-be-false or fraudulent document (§7207 – misdemeanor, up to $10,000 ($50,000 for corps), up to one year

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    §7216 §6656Criminal Taxpayer Penalty

    • Disclosure or use of any info furnished to tax return preparer, or provided services connected with return preparation, for purposes other than return prep (§7216) – misdemeanor, up to $1000, one year.

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    Criminal §6656 Taxpayer Penalties (cont’d)

    There are others

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    Interest §6601 §6656

    • §6601 – is statutory

    • No matter which way it is going, simply for the payment for use of funds.

    • Also, as disincentive for TPs that would postpone payment of tax.

      • Under old rules, interest was always 6%. Under those rules postponement was a problem.

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    Interest §6656(cont’d)

    • Interest rate on tax owed is variable, may be adjusted quarterly

      • Large corporations add 2% to general rate

    • Compounded daily

    • Rate for refunds due individual TPs generally the same (after 1998) as on amounts due IRS

      • Corporations deduct 1%

      • For corporate > $10,000, deduct 2½%

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    Interest (cont’d) §6656

    • Computation of interest starts with the latter of the date of payment or the due date of the return. Due date of the return is the basis.

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    Interest Abatement - §6404 §6656

    • Interest is statutory and generally cannot be waived

    • However, interest may be waived where IRS commits a “ministerial” act (§6064)

      • Unintentional, non-discretionary, managerial, administrative

      • Must file claim for abatement

      • For obvious reasons, very rare

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    Statute of Limitations (SOL) - §6501 §6656

    • Collection – ten years, may be extended

    • Assessments – generally three years from latter of due date of return or date return filed

    • Exceptions

      • 25% omission of §61 gross income – 6 years

      • Fraudulent return - civil – 6 years

      • Fraudulent return - criminal – no limitation

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    SOL – Deficiency Procedure §6656

    • SOL suspended 150 days (210 days if TP out of country)

      • 90 SND period

      • Additional 50 days to allow for assessment if no petition is filed

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    SOL – Tax Court Jurisdiction §6656

    • SOL is suspended during the period TC has jurisdiction and for 60 days thereafter.

    • If judgment favors the government

      • Government must asses w/in 60 days after TC’s decision becomes final

      • Petitioner must pay tax

        • Or post bond

      • Even if planning an appeal

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    SOL - Refunds §6656

    • Generally latter of 3 years from date return filed or due date of return (same as Assessments)

    • Exception – latter of date established above, or two years from date of payment

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    SOL - Extensions §6656

    • Generally at IRS request during administrative proceeding

      • Form 872 – period specific

      • Form 872-A – period indefinite; TP may terminate by giving 90 days notice – Form 872-T

      • Practitioners generally prefer former; IRS prefers latter

    • TP not required to extend

      • Failure to do so may result in IRS initiating deficiency proceedings. Practitioner/client must weigh the consequences

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    §§1311-1314 Mitigation of Statute Provisions §6656

    • Very complex, generally an equity provision, works both ways

    • Allows for correction of error even if statute expired

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