January 2019 JD Supra
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IRS Accuracy Related Penalties is the number one most litigated tax issue was published by JD Supra on 1/29/19.

The National Taxpayer Advocate 2017 Report to Congress states that the Accuracy-Related Penalty under Internal Revenue Code Section 6662 remains the number one most litigated tax issue and has been over the last four years.  In the cases where Taxpayers litigated the negligence or disregard of rules or regulations or the substantial understatement components of the accuracy-related penalty, the IRS prevailed in full in 80 percent of the cases.

IRS penalties exist to ensure consistent and accurate treatment of all Taxpayers

The U.S. tax system is based on a voluntary system of compliance.  This means that each Taxpayer reports their income freely and voluntarily. The tax liability is calculated, and the tax return is filed on a timely basis. The system is voluntary.  Taxpayers are free to arrange their financial affairs in a manner that allows them to best take advantage of tax incentives made available through legislation. Voluntary does not mean that citizens are voluntarily paying tax, nor does it mean that the tax laws don’t apply. Voluntary means that Taxpayers can minimize taxes by taking advantage of various exemptions, deductions and tax credits.  Voluntary also means that Taxpayers must disclose to the IRS their U.S. Tax liabilities and the only way to do that is to file a tax return.

The Internal Revenue Code authorizes the IRS to impose penalties if a Taxpayer is negligent or disregards tax rules and regulations that cause an underpayment of a required tax.  The amount of an accuracy-related penalty equals 20 percent of the portion of the underpayment that is attributable to the Taxpayer’s negligence or disregard of rules or regulations, or to a substantial “understatement”. The IRS proposes the accuracy-related penalty as part of its examination process and through its Automated Under-Reporter (AUR) computer system.  Taxpayers are not subject to accuracy-related penalties if the Taxpayer can establish that they acted in good faith and had reasonable cause for the underpayment

U.S. tax laws seek to “discourage” noncompliant behavior and:

  • Encourage voluntary compliance
  • Provide clear guidance to taxpayers and practitioners
  • Ensure consistent and fair treatment of the issues
  • Ensure that noncompliant behavior is penalized

Accuracy-related penalties are attributable to:  

  • Negligence or disregard of the rules or regulations.
  • Substantial understatement of income tax.
  • Substantial valuation misstatement.
  • Substantial overstatement of pension liability.
  • Substantial estate or gift tax valuation understatement.
  • Gross valuation misstatement.
  • Disallowance of claimed tax benefits by reason of a transaction lacking economic substance or failing to meet the requirements of any similar rule of law.  
  • Nondisclosed noneconomic substance transactions.
  • Undisclosed foreign financial asset understatement.
  • Inconsistent estate basis.

What happens if Non-Accuracy is determined?

  • The IRS must send a notice of deficiency with the proposed adjustments and inform the taxpayer that the Taxpayer has 90 days to petition the United States Tax Court to challenge the assessment.
  • A Taxpayer that receives a notice of deficiency has an opportunity to engage the IRS on the merits of the penalty where IRS concluded that an accuracy-related penalty was warranted.
  • Taxpayers may seek judicial review through refund litigation.
  • Taxpayers can request an administrative review of IRS collection procedures (and the underlying liability) through a Collection Due Process hearing

The Burden of Proof

  • In court proceedings, the IRS bears the initial burden of production regarding the accuracy-related penalty.
  • The IRS must first present sufficient evidence to establish that the penalty was warranted.
  • The burden of proof then shifts to the Taxpayer to establish any exception to the penalty, such as Reasonable Cause or Reasonable Basis.

Reasonable Cause and Good Faith

Did the Taxpayer made an effort to determine the proper tax liability?  If the Taxpayer relied on a Return Preparer, this may constitute reasonable cause and good faith if the reliance was reasonable and the taxpayer acted in good faith. There is three-part test for reasonable reliance on a tax professional in accuracy-related penalty cases:

(1) The adviser was a competent professional who had sufficient expertise to justify reliance;

(2) The taxpayer provided necessary and accurate information to the adviser; and

(3) The taxpayer actually relied in good faith on the adviser’s judgment.

Reasonable Basis

A Taxpayer could reasonably rely on one or more of the authorities listed in the Treasury Regulations such as:

  • sections of the Internal Revenue Code
  • proposed, temporary, or final regulations
  • revenue rulings and revenue procedures
  • tax treaties
  • Treasury Department and other official explanations of such treaties
  • Court cases
  • congressional intent as reflected in committee reports

What is a Negligent Taxpayer?

  • Negligence is defined by IRS to include “any failure to make a reasonable attempt to comply with the provisions of this title, and the term ‘disregard’ includes any careless, reckless, or intentional disregard.”
  • Negligence includes a failure to keep adequate books and records or to substantiate items that give rise to the underpayment.
  • Strong indicators of negligence include instances where a taxpayer failed to report income on a tax return that a Payor reported on an information return.
  • Taxpayer failed to make a reasonable attempt to ascertain the correctness of a deduction, credit, or exclusion.
  • Taxpayer had a Substantial Understatement.  An “Understatement” is the difference between (1) the correct amount of tax and (2) the tax reported on the return, reduced by any rebate.

Common arguments used by Taxpayers

  • Confused on how to report items on Tax Returns
  • Obtained guidance from the IRS on how to report items and received incorrect guidance from an IRS employee
  • Not able to find a qualified person to assist the Taxpayer
  • Tax understatements were the result of complex tax issues (living abroad or being employed abroad)
  • Complexity of the tax code
  • Inability to find answers to tax law questions

Don’t be a victim of your own making

IRS seeks to appropriately administrate penalties in order to seek and ensure fairness and consistency in the application and administration of tax laws. For the IRS, penalties are viewed as a means to enhance voluntary compliance.

Taxpayers ought to seek the help of a qualified tax professional in order to avoid accuracy related mistakes in a Tax Return or Understating their tax responsibility.   

Taxpayers should also keep in mind that good record keeping is the best way to prevent a problem.  Taxpayers have the responsibility keep adequate records and be able to support entries, deductions, and statements by having the information, receipts and records at hand to substantiate their own statements.  https://www.jdsupra.com/legalnews/irs-accuracy-related-penalties-is-the-17644/