March 2018 JD Supra
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IRS and Accuracy – JD Supra 3/21/18.

According to the IRS, accuracy related penalties remain the number one most litigated tax issue.  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”.  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. 

How is accuracy determined?

  • The IRS proposes the accuracy-related penalty as part of its examination process and through its Automated Under-Reporter (AUR) computer system

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

The IRS has experience in litigating accuracy related penalties.  Recent reports (including the National Taxpayer Advocate 2017 Report to Congress), 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.

Don’t be a victim of your own making.  Seek the help of a qualified tax professional in order to avoid accuracy related mistakes in a Tax Return or Understating your tax responsibility.