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Part 20. Penalty and Interest

Chapter 1. Penalty Handbook

Section 5. Return Related Penalties

20.1.5  Return Related Penalties

20.1.5.1  (07-01-2008)
Penalty Policy

  1. 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.

  2. 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.

  3. 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:

    • Encourage voluntary compliance;

    • Conserve IRS resources due to early disposition of tax shelter issues;

    • Provide clear guidance to taxpayers and practitioners;

    • Ensure consistent and fair treatment of the issues; and

    • Ensure that noncompliant behavior is penalized in appropriate circumstances.

  4. 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

  1. 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.

  2. 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:

    1. Negligence or disregard of the rules or regulations. See IRM 20.1.5.7 and IRC section 6662(c).

    2. Substantial understatement of income tax. See IRM 20.1.5.8 and IRC section 6662(d).

    3. Substantial valuation misstatement. See IRM 20.1.5.9 and IRC section 6662(e).

    4. Substantial overstatement of pension liability. See IRM 20.1.5.10 and IRC section 6662(f).

    5. Substantial estate or gift tax valuation understatement. See IRM 20.1.5.11 and IRC section 6662(g).

    6. Gross valuation misstatement. See IRM 20.1.5.9.4. and IRC section 6662(h).

  3. IRC section 6663 imposes a penalty on any portion of an underpayment attributable to fraud. See IRM 20.1.5.12.

  4. IRC section 6662A imposes an accuracy-related penalty on a reportable transaction understatement. See IRM 20.1.5.13.

  5. 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.

  6. IRC section 6676, imposes a penalty for erroneous claim for refund or credit with respect to income tax. See IRM 20.1.5.14.

  7. 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

  1. 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).

  2. 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 .

  3. 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

  1. 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.

  2. 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

  1. 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.

  2. 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.

  3. 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.

  4. 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.

  5. 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).

  6. 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.

  7. 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.

  8. The AJCA also added IRC section 6707A, Penalty for Failure to Include Reportable Transaction Information with Return and IRC section 6664(d),

  9. The Pension Protection Action of 2006 added a penalty under IRC section 6695A, Substantial and Gross Valuation Misstatements Attributable to Incorrect Appraisals.

  10. 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

  1. 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.

    1. 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.

    2. 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

  1. 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.

  2. 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.

  3. 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).

  4. For SB/SE exam cases, written managerial approval should be documented on the Penalty Approval Form, workpaper 300.

  5. 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.

  6. For W&I and SB/SE campus cases, written managerial approval should be documented on Form 4700.

  7. TE/GE and miscellaneous functions that assert penalties should also obtain managerial approval as required by IRC section 6751(b).

  8. Any penalties automatically calculated through electronic means are excluded from this requirement.

    1. 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.

    2. 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

  1. 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.

20.1.5.2  (07-01-2008)
Common Features: Accuracy-Related and Civil Fraud Penalties

  1. The accuracy-related and fraud penalties apply only if a return is filed, except that the penalties do not apply in the case of a return prepared by the Secretary under IRC section 6020(b). See Treas. Reg. 1.6662–2(a). Penalty review, abatement and reconsideration follow guidelines established for the examination of the return. Penalty issues are developed separately from the tax law issues that gave rise to the tax understatement. Penalty issues are subject to higher level review prior to being asserted.

  2. Special abatement procedures for TE/GE apply for those accuracy-related penalties assessed on NMF. These penalties relate to:

    1. Form 4720, Return of Certain Excise Taxes on Charities and Other Persons, Under Chapters 41 and 42 of the Code and

    2. Form 5330, Return of Excise Taxes Related to Employee Benefit Plans assessments prior to January 1, 2001, are posted to NMF, and all assessments after January 2, 2001 are posted to BMF.

  3. Claims for refund on assessed accuracy-related and civil fraud penalties are handled like other claims.

  4. Return Filing Requirement: The accuracy-related penalties and the civil fraud penalty apply when a return is filed, either timely or late. These penalties cannot be asserted on a substitute-for-return (SFR) filed under IRC section 6020(b). See IRC section 6664(b). The accuracy-related and fraud penalties can be asserted on a secured delinquent return, i.e., an original return obtained after the taxpayer is contacted by the IRS; however, examiners cannot apply the accuracy-related penalties to a delinquent return after an assessment (TC 290/300) is made under SFR procedures. Examiners should review available IRS CFOL information when making penalty determinations to establish payment patterns and any history of non-compliance.

  5. Uniform Definition of Underpayment: IRC section 6664(a) provides a common definition of underpayment. The accuracy-related and civil fraud penalties are calculated only on the underpayment (or portion of the underpayment) of tax attributable to the misconduct or fraud, as applicable. See IRC sections 6662(a) and 6663(a).

  6. Coordination of Accuracy-Related and Civil Fraud Penalties: The accuracy-related and civil fraud penalties cannot be asserted on the same portion of the same underpayment, except as an alternative; however, the accuracy-related penalty and the civil fraud penalty may be asserted on the same return when civil fraud applies to one portion of the underpayment and the accuracy-related penalty applies to another portion of the underpayment. See IRC section 6662(b).

  7. Coordination of the Accuracy-Related Penalty Attributable to a Reportable Transaction Understatement and the Civil Fraud Penalty: The accuracy-related penalty attributable to a reportable transaction understatement and the civil fraud penalty cannot be asserted on the same portion of the same understatement (a reportable transaction understatement is treated as an underpayment for purposes of determining the fraud penalty). However, the accuracy-related penalty attributable to a reportable transaction understatement and the civil fraud penalty may be asserted on the same return when civil fraud applies to one portion of the underpayment and the accuracy-related penalty attributable to a reportable transaction understatement applies to another portion. See IRC section 6662A(e).

  8. Interest: Under IRC section 6601(e)(2)(B), interest on civil fraud and accuracy-related penalties is imposed from the due date of the return, including extensions, until the date of payment. IRC section 6601(e)(3) provides, however, that if payment is made within 21 calendar days after notice and demand (10 business days if the amount for which the notice and demand is made equals or exceeds $100,000), interest on the amount paid is not imposed for the period after the date of the notice and demand.

  9. Deficiency Procedures May Apply: If the underlying tax is subject to deficiency procedures, the penalty is as well; in such a case, the accuracy-related and fraud penalties follow the guidelines for 30-day letters and statutory notices of deficiency.

20.1.5.2.1  (07-01-2008)
Two and Ten Year Bans on Claiming the Earned Income Tax Credit (EITC)

  1. This section covers the two-year and ten-year bans placed on taxpayers whose EITC disallowance was due to reckless or intentional disregard of the EITC rules (two-year) or fraud (ten-year) for tax years beginning after December 31,1996.

  2. The two-year ban under IRC section 32(k)(1)(B)(ii) applies when it is determined that a taxpayer recklessly or intentionally disregarded the EITC rules when claiming the EITC.

  3. The ten-year ban under IRC section 32(k)(1)(B)(i) applies when it is determined that a taxpayer fraudulently claimed the EITC.

  4. The two and ten-year sanctions are in addition to any other penalty imposed under present law. The law does not require that an accuracy-related penalty under IRC section 6662(c) for negligence or disregard be asserted in order to impose the EITC two-year ban. The two-year ban is asserted under IRC section 32(k)(1)(B)(ii) for "reckless or intentional disregard of the EITC rules and regulations," while the accuracy-related penalty under IRC section 6662(c) is asserted for either negligence or disregard; "disregard" in this context is "any careless, reckless, or intentional disregard." As a result of these very fine distinctions, the two-year ban may sometimes (though seldom) apply when the accuracy-related penalty does not.

  5. Follow IRM 20.1.5.7 guidelines when asserting the accuracy-related penalty under IRC section 6662(c).

  6. The ten-year ban for fraudulently claiming the EITC essentially follows criteria for assertion of civil fraud under IRC section 6663. See IRM 20.1.5.12.2. However, the ten-year ban can be asserted even if the fraud penalty is not (or cannot be) applied.

20.1.5.2.2  (07-01-2008)
Allocation

  1. An allocation is necessary only when both the accuracy-related and the civil fraud penalties apply. When there are three return adjustments, for example, and one penalty applies to just one of the three, apply the penalty rate times the amount of that underpayment. This is the amount of the penalty.

  2. In computing the portions of an underpayment subject to penalties imposed under IRC sections 6662 and 6663, adjustments to a return are considered made in the following order. See Treas. Reg. 1.6664–3:

    1. Those for which no penalties are imposed.

    2. Those for which a penalty has been imposed at a 20 percent rate (i,e., a penalty for negligence or disregard of rules or regulations, substantial understatement valuation misstatement, under sections 6662(b)(1) through 6662(b)(3), respectively).

    3. Those for which a penalty is imposed at a 40 percent rate (i.e., a penalty for a gross valuation misstatement under sections 6662(b)(3) and (h).

    4. Those for which a penalty has been imposed at a 75 percent rate (i.e., a penalty for fraud under section 6663).

  3. See Exhibit 20.1.5-1 for an example calculation of the underpayment on a return with three adjustments—the first with no penalty, the second with the accuracy-related penalty attributable to a substantial understatement, and the third with the civil fraud penalty.

  4. See See IRM 20.1.5.13.3 of this manual for an example of a calculation involving IRC sections 6662, 6663 and 6662A.

  5. Only one penalty rate applies to any portion of an underpayment. When two penalties could apply, the penalty at the higher rate is asserted. If two penalties at the same rate would apply, assert the penalty that is more comprehensively applicable and, in unagreed cases, include the other penalty in the report as an alternative position.

  6. The following illustrates the "no stacking" provision in Treas. Reg. 1.6662–2(c):

    1. If a portion of the underpayment of tax required to be shown on a return is attributable to both negligence and a substantial understatement, the accuracy-related penalty would apply only once at the 20 percent rate to this portion of the underpayment. The examining agent should assert the penalty that is most strongly supported by the facts and circumstances and write up the other as an alternative position.

    2. The penalty is applied at the 40 percent rate on any portion of the underpayment attributable to a gross valuation misstatement. Any penalty at the 20 percent rate that could have applied to this portion is not asserted except as an alternative.

    3. A penalty is applied at the 75 percent rate on any portion of the underpayment attributable to civil fraud. Any penalty that could have applied to this portion at the 20 or 40 percent rate is not asserted except as an alternative.

  7. Any income tax withholding, estimated tax payments, or other payment made before a return was filed, that was not claimed on the return or previously allowed as a credit against the tax liability for the taxable year is allocated as follows:

    1. If the unclaimed prepayment credit is allocable to a particular adjustment, e.g., withholding on unreported W–2 income, the credit is used to reduce the amount of the underpayment resulting from the adjustment. See Treas. Reg. 1.6664–3(c)(1).

    2. If the unclaimed prepayment credit is not allocable to a particular adjustment, the credit is applied in accordance with the ordering rules set forth in Treas. Reg. 1.6664–3(b). See Treas. Reg. 1.6664–3(c)(2).

    3. See Treas. Reg. 1.6664–3(d) for examples illustrating the manner in which unclaimed prepayment credits are to be allocated.

20.1.5.2.3  (07-01-2008)
Carrybacks and Carryovers

  1. The amount of an underpayment subject to IRC sections 6662 or 6663 will not be reduced by any carryback of a net operating loss (NOL), deduction, or credit to that year. See Treas. Reg. 1.6664–2(f)

  2. Example:

    1. A Tax Year (TY) 2000 examination adjustment results in an underpayment of $3,000, which is subject to the accuracy-related penalty attributable to negligence.

    2. A $12,000 NOL carryback from TY 2001 to TY 2000 offsets the $3,000 underpayment for income tax purposes, but the $3,000 underpayment is subject to the penalty because the NOL is not taken into account in determining the underpayment for TY 2000. The amount of the penalty imposed for TY 2000 is $600 (20% x $3,000).

  3. If an underpayment in a loss year is subject to IRC section 6662 or 6663 and that loss is carried back to an earlier year, or carried forward to a later year, any underpayment resulting from the disallowance of the loss in the earlier or later year will be subject to IRC section 6662 or 6663. See Treas. Reg. 1.6662-3(d) and 1.6662-4(c).

  4. Example:

    1. The taxpayer filed a TY 2002 return with an NOL of $45,000. The taxpayer carried forward $20,000 of the NOL to TY 2003.

    2. An examination of the TY 2002 return results in an adjustment of $60,000 due to the negligent omission of income. The $45,000 NOL is disallowed in full and there is an underpayment of $3,000 for TY 2002.

    3. The $20,000 amount carried over from TY 2002 to TY 2003 is disallowed. This produces a TY 2003 underpayment of $2,000. Because this is the result of an adjustment for which negligence applied in TY 2002, the penalty also applies to the TY 2003 underpayment.

      Note:

      If the NOL disallowance for TY 2002 did not result in an underpayment, but did create an underpayment for TY 2003 (due to the disallowed carryover from TY 2002), then the penalty would still apply to the underpayment in TY 2003.

  5. When the penalty assertion requires a dollar threshold (e.g., $5,000 for substantial understatements and valuation misstatements), this threshold must be met for each year in which the penalty will be asserted (including a carryback or carryover year).

  6. For special rules regarding carrybacks and carryovers in the area of transfer pricing, see Treas. Reg. 1.6662–6(e).

  7. In the case of carrybacks and carryovers, adequate disclosure is made only with the return for the taxable year in which the carryback or carryover originates. See IRM 20.1.5.7.2.1 of this manual for more information relating to adequate disclosure.

20.1.5.2.4  (07-01-2008)
Definitions

  1. Amount of tax imposed: The term "amount of tax imposed" is the corrected tax imposed by Internal Revenue Service Title 26, including any statutory adjustments based on adjusted gross income (AGI). For example:

    1. Medical, casualty loss, and miscellaneous deductions,

    2. Changes to the tax as a result of the examination, or

    3. Changes to any credit, prepayment credit, or refundable credit as a result of the examination (this includes any prepayment credits that were paid for the year under examination but were not credited).

  2. Listed Transaction: Means a reportable transaction, which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of IRC section 6011. See IRC section 6707A(c)(2) and Treas. Reg. 1.6011-4(b)(2).

  3. Qualified amended return: Treas. Reg. 1.6664-2(c)(3). A qualified amended return is an amended return or a timely request for administrative adjustment under IRC section 6227 filed after the due date of the return (determined with regard to extensions), but before:

    1. The receipt of an audit notification letter,

    2. Contact concerning an activity described in IRC section 6700,

    3. The date a pass-through entity is first contacted by the Service,

    4. The date the Service serves a John Doe summons relating to the tax liability of a person, group or class that includes that taxpayer or pass-through entity in which the taxpayer may have an interest,

    5. The date on which the Commissioner announces a settlement initiative to compromise or waive penalties with respect to a listed transaction, or

    6. With respect to an undisclosed listed transaction, contact concerning activity described in IRC section 6707(a) or contact concerning a list described in IRC section 6112.

  4. Rebate: A rebate is the amount of an abatement, credit, refund, or other repayment, as was made on the basis that the tax imposed was less than the excess of the sum of:

    1. The amount shown as a tax by the taxpayer on the return, plus

    2. Amounts not shown previously assessed, (or collected without assessment) over rebates previously made.

  5. Reportable Transaction: Any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under IRC section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion. See IRC section 6707A(c)(1) and Treas. Reg. 1.6011-4(b)(1).

  6. Reportable Transaction Understatement: The reportable transaction understatement is the sum of:

    1. The increase in taxable income that results from a difference between the proper tax treatment of the item related to the transaction and the taxpayer’s treatment of the item multiplied by the highest tax rate imposed by IRC section 1 for individuals or IRC section 11 for corporations, and

    2. The decrease in the aggregate amount of credits which results from the difference between the credits the taxpayer claimed and the proper amount. See IRM 20.1.5.13.2 of this manual for a calculation example.

  7. Tax per return: Tax per the return includes:

    • IRS campus math error corrections,

    • Changes made by a qualified amended return posted to the account as a credit or debit, and

    • Any amounts not shown on the return, but previously assessed or collected without assessment (e.g., jeopardy assessments). See Treas. Reg. 1.6664–2(d).

  8. Underpayment: See Treas. Reg. 1.6664–2. An underpayment is defined as the amount by which any tax imposed, exceeds the excess of:

    1. The sum of the amount shown on the return, plus

    2. Amounts not shown that were previously assessed (or collected without assessment), over

    3. The amount of rebates made.

      Note:

      In calculating the amount of the underpayment, adjustments to refundable credits or prepayment credits for withholding or estimated tax are included.

    4. See Exhibit 20.1.5-1 for an example calculation of an underpayment.

20.1.5.2.5  (07-01-2008)
Notice of Inconsistent Treatment

  1. A partner, S corporation shareholder, beneficiary of an estate or trust, owner of a foreign trust, or residual interest holder in a real estate mortgage investment conduit (REMIC) generally must report items consistent with the way they were reported on Schedule K-1, Schedule Q, or a foreign trust statement.

  2. Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), is used to notify the Service of any inconsistency between the tax treatment of an item by a person listed above and the way the pass-through entity treated and reported such item.

  3. Form 8082 is also used to notify the Service if a person listed above did not receive a Schedule K-1, Schedule Q, or foreign trust statement.

  4. If the Form 8082 is not filed as required, the taxpayer may be subject to the accuracy-related penalty under IRC section 6662 or the fraud penalty under IRC section 6663.

  5. See IRC section 6227 and IRM 4.31.4 IRM for additional information on AARs.

20.1.5.3  (07-01-2008)
Examination Penalty Assertion

  1. The examiner is responsible for the assertion of the accuracy-related penalties and the fraud penalty. The term "examiner" includes revenue agents, tax compliance officers, examiners and other officers who are auditing income tax returns, excise tax returns, employment tax returns, estate and gift tax returns or tax exempt and government entities related tax returns.

  2. The accuracy-related penalties and the fraud penalty are to be addressed in all examinations and the workpapers should be prepared under the following guidelines:

    1. For examination adjustments that clearly do not involve penalties, a brief statement to that effect is sufficient.

    2. Examiners are required to document the procedures used, information obtained, and conclusions reached in deciding to recommend or not recommend applicable penalties during examinations. Penalties should not be asserted without an explanation. Standard statements such as "negligence penalty deemed not to be applicable" are not sufficient. Alternative penalty positions should be documented in the workpapers when applicable (e.g., fraud versus negligence penalties, and various components of the accuracy-related penalty). Documentation for TE/GE cases should be made on appropriate Forms 5772.

    3. The Service is now requiring a managerial review on the non-assertion of penalties when there is a substantial understatement of tax. See IRM 20.1.5.8 for substantial understatement criteria.

    4. As part of the examiner's workload review, managers should review the non-assertion of penalties when there is a substantial understatement of tax under IRC section 6662(d).

    5. SB/SE exam should document managerial involvement on workpaper 300-1.1. The substantial understatement penalty leadsheet may also be used for the development of the 6662(d) Penalty.

    6. LMSB team members should use the leadsheets available in the Information Management System 3.0. Managerial approval can be documented on the penalty leadsheet.

    7. For W&I and SB/SE campus cases, written managerial approval should be documented on Form 4700.

    8. TE/GE and miscellaneous functions that assert penalties should also obtain managerial approval as required by IRC section 6751(b).

    9. When adjustments would appear to warrant the penalty, but it is not asserted, the applicable exceptions to the penalty will be documented in the workpapers.

    10. Taxpayer claims for penalty relief under IRC section 6664 must be evaluated and, if a taxpayer cannot meet the standards for penalty relief, the penalty should be applied.

    11. Area Counsel should be utilized to assist in penalty development and evaluating a taxpayer's reasonable cause and substantial authority defenses. See http://www.irs.gov/pub/irs-ccdm/cc-2004-036.pdf.

  3. The Form 3198, Special Handling Notice for Examination Case Processing or Form 3198-A for TE/GE Special Handling Notice, should be attached to all penalty cases. The examiner will identify the applicable IRC section on the special handling notice for the Centralized Case Processing (CCP) function.

  4. Examiners will identify the adjustments related to each penalty in the report, and identify each one separately by name, IRC section and penalty computation.

  5. In proposing the penalty to the taxpayer or taxpayer’s representative, the examiner will:

    1. Fully explain the proposed penalty,

    2. Document all the reasons why the penalty assertion is appropriate, and

    3. Consider and document any possible exceptions to the penalty provided by the taxpayer or the taxpayer’s representative whether or not they are accepted. The level of taxpayer cooperation is not grounds for asserting or not asserting a penalty.

  6. When more than one component of the accuracy-related penalty may apply to the same portion of an underpayment (e.g., negligence and substantial understatement):

    1. On agreed cases: the Service will assert the penalty with the strongest position.

    2. On unagreed cases: the Service will assert the penalty with the strongest position, but the examiner also will calculate and explain any alternative position(s) on Form 886–A, Explanation of Items, attached to the report. Alternative positions will also be included in the 30-day letter and statutory notice of deficiency.

20.1.5.3.1  (07-01-2008)
Underreporter Penalty Assertion

  1. The Automated Underreported Program/Project (AUR) is for computer-generated notices. If the accuracy-related penalty is applicable, the AUR system generates the appropriate paragraph for CP-2501, Initial Inquiry Letter, or the CP-2000, Notice of Proposed Adjustment. In the absence of a response, the determination will be made on the basis of return information and the significance of the amounts omitted.

  2. On AUR cases involving taxpayer contacts the assertion of the accuracy-related penalty requires managerial approval. See IRM 20.1.5.1.6 of this manual.

  3. Notices and reports will fully identify the names, IRC sections and the computation of the penalty amounts being asserted.

  4. All penalty determinations involving a reasonable cause exception will be documented in the workpapers. This will be done by identification on the AUR system and will remain with the casefile.

  5. In unagreed cases, the Service will provide the taxpayer or representative with a complete explanation of the penalty.

  6. See IRM 4.19.3.16.5 for additional information on AUR.

20.1.5.3.2  (07-01-2008)
Penalty Assessment

  1. The examiner will compute the penalty for Centralized Case Processing (CCP). The examiner will complete and attach the appropriate special handling notice: Form 3198, Special Handling Notice for Examination Case Processing, or Form 3198-A for TE/GE Special Handling Notice to identify the penalty IRC section and to provide any additional closing instructions.

  2. The amount of the 6662 penalty is 20 percent of the portion of the underpayment resulting from the misconduct. The penalty rate is increased to 40 percent in certain circumstances involving gross valuation misstatements.

  3. The amount of the 6663 penalty is 75 percent of the underpayment due to fraud. See IRM 20.1.5.12 of this manual.

  4. The amount of the 6662A penalty is 20 percent of the reportable transaction understatement, and 30 percent of the reportable transaction understatement where the transaction wasnot properly disclosed. See IRM 20.1.5.13.4 of this manual.

  5. The amount of the 6676 penalty is 20 percent of the " excessive amount" See IRM 20.1.5.14 of this manual.

  6. Stacking of the 6662, 6663, 6662A, and 6676 penalties are not permitted. The maximum amount of the 6662 penalty imposed on a portion of an underpayment of tax is 20 percent (or 40 percent in the case of a gross valuation misstatement) of that portion of the underpayment, even if that portion of the underpayment is attributable to more than one type of misconduct proscribed under IRC section 6662. See IRM 20.1.5.13.3 of this manual.

  7. The computed penalty amount and Penalty Reference Number (PRN) should be entered on Form 5344, Examination Closing Record, Form 5403, Appeals Closing Record or Form 5599, TE/GE Examined Closing Record.

  8. Using the appropriate closing record enter the PRN 680 with a positive dollar amount to assess the following components of the accuracy-related penalty:

    • 6662(c), negligence or disregard of the rules and regulations

    • 6662(d), substantial understatement

    • 6662(e), substantial valuation misstatement

    • 6662(f), substantial overstatement of pension liabilities

    • 6662(g) substantial estate or gift tax valuation understatement

    • 6662(h), gross valuation misstatement

  9. Enter PRN 681 to assess a reportable transaction understatement penalty under IRC section 6662A. See IRM 20.1.5.13.4 of this manual.

  10. A Transaction Code (TC) 240 will post to the Master File (MF) account that relates to the assessment of a penalty.

  11. Master File will systemically compute interest on the penalty from the due date or extended due date of the return (whichever is later) to the earlier of:

    1. The date of payment,

    2. Waiver date plus 30 days, or

    3. 23C date of assessment.

  12. When abating an assessed 6662 penalty, enter PRN 680 with a negative dollar amount. Enter PRN 681 with a negative dollar amount to abate the 6662A penalty. A TC 241 will post to the MF account that relates to the abatement of the penalty. A penalty abatement amount can be in part or in full.

  13. See additional penalty assessment procedures for the 6662 penalty, 6663 penalty, 6662A penalty and the 6676 penalty in their respective sections of this IRM.

20.1.5.4  (07-01-2008)
Post-Assessment Abatement Consideration of the Accuracy-Related Penalties

  1. Whenever a taxpayer has the benefit of Service contact with respect to an examination and is afforded the opportunity to provide documentation to explain unreported income, but does not contact the Service, we issue the statutory notice showing additional tax and applicable penalties.

  2. When the notice defaults and no taxpayer contact was made, the tax, penalties and interest are assessed.

  3. If a taxpayer receives notice and demand for payment and then makes his/her first response to the Service requesting abatement of the accuracy-related penalties (while not disputing the tax liability and not requesting or not being eligible for audit reconsideration procedures), abatement should be considered based on the evidence provided.

  4. The function responsible for the penalty assessment should decide whether the penalty should be abated.

  5. If the evidence is not sufficient to support a reasonable cause claim for the penalty abatement, the taxpayer should be issued the appropriate letter to indicate that the abatement request is denied and the remaining recourse is to pay the tax, penalties and interest and file a claim for refund on Form 843, Claim for Refund and Request for Abatement.

  6. Post-assessment consideration of IRC section 6662 and 6662A accuracy related penalty abatement requests are not forwarded to Appeals.

20.1.5.5  (07-01-2008)
Statute of Limitations

  1. Examiners are responsible for protecting the statute of limitations on assessment. Consent forms to extend the statute of limitations are available for this purpose, along with Cover Letter 907. See IRM 25.6, Statute of Limitations.

    Note:

    LMSB team members must follow the steps detailed in PQA Director Kelly L. Cables’ July 13, 2007 memorandum, Statute Control Responsibilities.

  2. IRC section 6501(c)(1) extends the statute of limitations for assessment on false or fraudulent returns indefinitely.

  3. Under IRC section 6501(c)(10), the period of limitations for assessment of tax related to an undisclosed listed transaction will not expire before one year after the earlier of:

    1. The date the taxpayer satisfies the requirements of section 4 of Rev. Proc. 2005-26, 2005-17 I.R.B. 965 (April 25, 2005) or

    2. The date a material advisor makes available for inspection by the IRS a list under IRC section 6112 relating to the transaction with respect to the taxpayer.

      Note:

      See Rev. Proc. 2005-26 for further guidance on the statute of limitations on assessment of tax related to an undisclosed listed transaction.

  4. A six-year statute of limitations applies when the taxpayer omits more than 25 percent of the:

    1. Gross income reported on the return (IRC section 6501(e)(1)),

    2. Gross estate or total amount of gifts stated on the return (IRC section 6501(e)(2)), or

    3. Excise tax reported on the return (IRC section 6501(e)(3)).

  5. When the three-year period of limitations under section 6501(a) is about to expire, the examiner should try to secure an extension whenever possible, even if the examiner believes an exception may apply. See IRM 25.6, Form 895 and 180 day time-line. In litigation, a court may disagree with the Service as to whether an exception applies and determine that the three year statue has expired. Securing an extension, whenever possible, is therefore recommended.

  6. Criminal Investigation (CI) must give approval to solicit a consent to extend the statute of limitations for assessment where the return is being investigated jointly by Examination and CI.

20.1.5.6  (07-01-2008)
Penalty Relief