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20.1.5.1
(07-01-2008)
Penalty Policy
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The office of Servicewide Penalties, part of Examination Policy, oversees
the implementation of Service-wide policies and strategies for all penalties.
This office also provides policy guidance in IRM 20.1
across all operating divisions to ensure consistent and accurate
treatment of all taxpayers.
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Consideration of penalties must be documented
in all taxpayer examinations, including those involving tax shelters. A penalty
must be developed as the audit progresses. Only after all facts and circumstances
surrounding a penalty have been developed can a determination be made as to
the application of appropriate penalties.
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The consideration and assertion of penalties in audits involving tax
shelters is vital to the Service’s efforts in addressing the proliferation
of tax shelters. Appropriate administration of penalties seeks to ensure fairness
and consistency in the administration of the tax law and seeks to effectively
discourage noncompliant behavior. Penalties should be considered and developed
simultaneously with the examination of the tax shelter transaction, and not
at the conclusion of the audit. Proper consideration and application of penalties
will:
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Encourage voluntary compliance;
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Conserve IRS resources due to early disposition of tax shelter issues;
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Provide clear guidance to taxpayers and practitioners;
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Ensure consistent and fair treatment of the issues; and
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Ensure that noncompliant behavior is penalized in appropriate circumstances.
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All penalties including the accuracy-related and fraud penalties are
important deterrents to non-compliance. Examiners and managers should not
use penalties as a bargaining point in the development or processing of cases.
The penalty Policy Statement 20-1, should be reviewed prior to the assertion
of penalties, see IRM 20.1.1, Exhibit 20.1.1-1.
See IRM 8.6.4.1.2(6), Office of Appeals guidance
on trading penalties. See http://www.irs.gov/pub/irs-ccdm/cc-2004-036.pdf
, Office of Chief Counsel, Penalty Administration.
20.1.5.1.1
(07-01-2008)
Background
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The return-related penalties covered in this IRM include, IRC section 6662, Imposition of Accuracy-Related Penalty
on Underpayments, IRC section 6663, Imposition
of Fraud Penalty, IRC section 6662A, Imposition
of Accuracy-Related Penalty on Understatements with Respect to Reportable
Transactions, IRC section 6707A, Penalty
for Failure to include Reportable Transaction Information with Return and
IRC section 6676, Erroneous Claim for Refund
or Credit penalty.
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IRC section 6662 imposes an accuracy-related penalty on any portion
of an underpayment attributable to any action or failure to act that results
in one or more of the following:
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Negligence or disregard of the rules or regulations.
See IRM 20.1.5.7 and IRC section 6662(c).
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Substantial understatement of income tax.
See IRM 20.1.5.8 and IRC section 6662(d).
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Substantial valuation misstatement. See
IRM 20.1.5.9 and IRC section 6662(e).
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Substantial overstatement of pension liability.
See IRM 20.1.5.10 and IRC section 6662(f).
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Substantial estate or gift tax valuation understatement.
See IRM 20.1.5.11 and IRC section 6662(g).
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Gross valuation misstatement. See IRM 20.1.5.9.4.
and IRC section 6662(h).
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IRC section 6663 imposes a penalty on any portion of an underpayment
attributable to fraud. See IRM 20.1.5.12.
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IRC section 6662A imposes an accuracy-related penalty on a reportable
transaction understatement. See IRM 20.1.5.13.
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IRC section 6707A imposes a penalty for failure to include reportable
transaction information with return. Information for this penalty is included
in IRM 20.1.5.13 of this manual as it relates to the IRC section 6662A penalty.
Functional procedures for IRC section 6707A will be forthcoming in IRM 4.32.4.
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IRC section 6676, imposes a penalty for erroneous claim for refund or
credit with respect to income tax. See IRM 20.1.5.14.
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See IRC section 6664, Definitions and
special rules for the accuracy-related penalties and
See IRM 20.1.5.6, of this manual on penalty relief.
20.1.5.1.2
(07-01-2008)
Large and Mid-Sized Business
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LMSB Commissioner issued a memorandum providing guidelines for the consideration
of the accuracy-related penalty in LMSB examinations. This memorandum requires
agents to consider, and then, if appropriate develop the accuracy-related
penalty in all cases in which there is an underpayment of tax attributable
to a listed transaction. For a tax shelter case involving a listed transaction,
the decision to impose or not impose an accuracy-related penalty must be approved
by the respective Director of Field Operations (DFO).
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On July 10, 2003, the LMSB Commissioner issued a memorandum providing
that examiners should not develop the accuracy-related penalty in cases where
the taxpayer filed and was considered qualified under the terms of Announcement
2002-2. This determination should be confirmed by the team manager, with no
other approval required. The memorandum also provides that, for cases not
qualifying for treatment under the Disclosure Initiative outlined in Announcement
2002-2, consideration of penalties remains mandatory.For
additional information see http://www.irs.gov/pub/irs-utl/penalty_policy_reiteration_7-10-03_debbie_nolan.pdf
.
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For discussion of Announcement 2002-2 as it relates to penalties, See IRM 20.1.5.5 of this manual. If an underpayment
of tax is attributable to a taxpayer’s participation in a listed transaction,
the examiner must develop the accuracy-related penalty issues and prepare
a written report supporting the recommendation to impose or not to impose
the penalty. When an LMSB examiner identifies a new potentially abusive tax
shelter transaction or promoter information, the examiner must contact LMSB
field counsel as well as the Office of Tax Shelter Analysis (OTSA).
20.1.5.1.3
(07-01-2008)
Small Business/Self Employed Examination
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SB/SE examiners should follow existing penalty provisions regarding
managerial approval for imposing penalties in a tax shelter case involving
a listed transaction. See IRM 20.1.5.1.6 of
this manual for existing penalty provisions on managerial approval of penalties.
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Examiners should send promoter information to the Lead Development Center
(LDC), and contact the appropriate Technical Advisor, responsible for coordinating
and assisting in the identification of abusive tax shelters.
20.1.5.1.4
(07-01-2008)
Statutory Changes
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This section reflects the current law unless otherwise stated. Below
is a list of the relevant statutory changes since the accuracy-related penalty
was created. Also listed are other penalty statutory changes that may have
an effect on the accuracy-related penalty. If the examiner has questions relating
to previous years or relating to the effect of these statutory changes, the
examiner should consult with the IRM applicable to that year or contact Area
Counsel.
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The Omnibus Budget Reconciliation Act of 1989 (OBRA 89) consolidated
and renumbered the accuracy-related penalties and the civil fraud penalty
and added definitions and special rules under IRC section 6664.
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The Omnibus Budget Reconciliation Act of 1990 (OBRA 90) provides that
a "substantial valuation misstatement"
under IRC section
6662(e) may exist under certain circumstances if IRC section 482 applies to
a transaction.
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The Omnibus Budget Reconciliation Act of 1993 (OBRA 93) amended the
definition of substantial valuation misstatement as it relates to a transaction
if IRC section 482 applies.
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The Uruguay Round Agreements Act of 1994 eliminated the exception to
the accuracy-related penalty attributable to a substantial understatement
for which the taxpayer had substantial authority and a reasonable belief that
it was more likely than not the proper treatment as it applied to tax shelter
items of corporations (other than S corporations and personal holding companies).
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The American Jobs Creation Act of 2004 (AJCA) added IRC section 6662A,
Imposition of Accuracy-Related Penalty on Understatements with Respect to
Reportable Transactions and Reasonable Cause Exception for Reportable Transaction
Understatements.
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AJCA amended IRC section 6662(d) by changing the definition of "substantial"
as it relates to corporations (other than S corporations
or personal holding companies) and eliminating the exception for tax shelter
items as it relates to all taxpayers.
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The AJCA also added IRC section 6707A, Penalty for Failure to Include
Reportable Transaction Information with Return and IRC section 6664(d),
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The Pension Protection Action of 2006 added a penalty under IRC section
6695A, Substantial and Gross Valuation Misstatements Attributable to Incorrect
Appraisals.
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The Small Business and Work Opportunity Tax Act of 2007 added IRC section
6676, Erroneous Claim for Refund or Credit.
20.1.5.1.5
(07-01-2008)
IRS Settlement Initiatives
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Described below are two IRS Initiatives which provided an excellent
opportunity to quickly bring more taxpayers into compliance in a cost effective
manner. It also strengthens the public’s view that the Internal Revenue
Service is applying the tax laws in a fair and equitable manner to all taxpayers.
The information below discuss the initiatives as they relate to the accuracy-related
penalty.
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On December 21, 2001, the Service announced a Disclosure Initiative under
which the IRS would waive accuracy-related penalties for transactions that
produce an underpayment of tax and that the taxpayer discloses to the IRS
during the period within which the initiative was in effect. For a limited
period, Announcement 2002-2 provided an administrative basis under which a
taxpayer could avoid the accuracy-related penalty for an underpayment of tax.
The IRS waived the accuracy-related penalty if the taxpayer disclosed an item
before the earlier of April 23, 2002, or the date the item was an issue raised
during an examination. If a taxpayer was not eligible under Announcement 2002-2
but disclosed regardless, there was no formal or informal administrative policy
of waiving the accuracy-related penalty in the case of a taxpayer solely because
the taxpayer disclosed to the examination team the existence of the item.
Accordingly, if there was an underpayment of tax attributable to a listed
transaction and the taxpayer did not (including because he/she was unable
to) disclose the transaction under Announcement 2002-2, then the penalty issue
should have been developed. The fact that the taxpayer did disclose may, however,
be a mitigating factor in some circumstances. This position was consistent
with the penalty consideration memorandum from the Commissioner of LMSB. See
Announcement 2002-2, for additional information.
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On October 27, 2005, the Service issued Announcement 2005-80 (commonly
referred to as Global Settlement Initiative, or GSI). Taxpayers who undertook
these arrangements had until January 23, 2006, to submit their settlement
papers with the IRS. In general, the initiative requires the taxpayer to concede
all of the claimed tax benefits associated with the transaction. Transaction
costs were allowed as an ordinary loss and an accuracy-related penalty under
IRC section 6662 ranging from 5 percent to 20 percent would be asserted based
upon the specific information. Since this was purely an administrative offer
(limited time) there were no provisions for penalty relief for reasonable
cause. In very limited circumstances, as set forth in Announcement 2005-80,
the taxpayer may have qualified for penalty relief. If the taxpayer asserted
reliance upon an independent written tax opinion, special service-wide procedures
were developed for reviewing penalty relief claims. To ensure consistent treatment,
a penalty panel subcommittee reviewed all cases where relief was proposed.
The Technical Advisors assigned the specific issues were available for assistance
on the settlement terms and penalty relief provision. See Announcement 2005-80,
for additional information.
20.1.5.1.6
(07-01-2008)
Managerial Approval of Penalties
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The Internal Revenue Service Restructuring and Reform Act of 1998 (RRA
98) added IRC section 6751(b), which requires managerial approval of all penalties
assessed after June 30, 2001, that are not automatically calculated through
electronic means. For additional information. Under
IRC 6751(b) written supervisory approval of the initial determination
of the penalty is required by the immediate manager or higher level official
of the employee initially proposing the penalty. Managerial approval is mandatory.
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The employee initially proposing the penalty should indicate the name
of the penalty, the Code section and the amount of the penalty on Form 4700,
Examination Workpapers, Form 4318, Examination Workpapers Index or Form 5772,
EP/EO Workpaper Summary for TE/GE cases. The penalty computation should also
be documented in the casefile.
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The Service is now requiring a managerial review on the non-assertion
of penalties when there is a substantial understatement of tax under IRS section
6662(d).
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For SB/SE exam cases, written managerial approval should be documented
on the Penalty Approval Form, workpaper 300.
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For LMSB cases, managerial approval can be documented on the penalty
leadsheets. The LMSB Information Management System provides leadsheets based
on the Standard Audit Index Number (SAIN) entry for the penalty issue.
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For W&I and SB/SE campus cases, written managerial approval should
be documented on Form 4700.
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TE/GE and miscellaneous functions that assert penalties should also
obtain managerial approval as required by IRC section 6751(b).
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Any penalties automatically calculated through electronic means are
excluded from this requirement.
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When IRC section 6662 accuracy-related penalties for negligence and substantial
understatement are assessed under the Automated Underreporter program (AUR)
without an employee independently determining the appropriateness of the penalty,
then the penalty is one that is automatically calculated through electronic
means and may be assessed without written supervisory approval.
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However, if a taxpayer responds either to the initial letter proposing
a penalty or to the notice of deficiency that the program automatically issues,
an IRS employee will have to consider the taxpayer’s response. Therefore,
the IRS employee will have to make an independent determination as to whether
the response provides a basis upon which the taxpayer may avoid the penalty.
The employee’s independent determination of whether the penalty is appropriate
means the penalty is not automatically calculated through electronic means.
Accordingly, IRC section 6751(b)(1) requires
managerial written approval of an employee’s determination to assert
the penalty.
20.1.5.1.7
(07-01-2008)
IRS Commissioner
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On December 29, 2003, the Commissioner issued a memorandum outlining
the Service’s penalty policy concerning reliance on certain tax shelter
opinions. The memorandum provides that the Service will question the reasonableness
and good faith of taxpayers who know or have reason to know that the tax advisor
has a financial arrangement or a referral agreement with a tax shelter promoter.
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