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Penalty Administration Handbook.

On September 3, 1992, Tax Executives Institute filed the following preliminary comments with the Internal Revenue Service on its Consolidated Penalty Administration Handbook. The handbook is intended to ensure consistency in the administration of penalties; it includes guidelines for asserting, not asserting, and abating penalties. The comments were filed following a meeting between representatives of TEI's IRS Administrative Affairs Committee and two IRS officials with responsibility over the IRS's administration of the Internal Revenue Code's penalty provisions: Marshall V. Washburn, the IRS's Compliance 2000 Executive, and Damon O. Holmes, Taxpayer Ombudsman. The Institute's comments, which were signed by Timothy J. McCormally, the Institute's General Counsel and Director of Tax Affairs, were prepared under the aegis of its IRS Administrative Affairs Committee, whose chair is W. Remi Taylor of the Duke Power Company.

During our meeting, I referred briefly to an inference that I believe could regrettably be drawn from the Penalty Handbook.(1) Specifically, section (2)123(1)(d), which is captioned "Impartiality," states -

While each Service employee appropriately approaches his or her job from a government perspective and with the objective of protecting the government's interest, the true interest of the government in the area of penalties is the unbiased enforcement of the tax law.

Obviously, TEI does not disagree with the statement that "the true interest of the government in the area of penalties is the unbiased enforcement of the tax law." The inference, however, is that outside of the penalty area, Service employees should not worry about the unbiased enforcement of the tax law. That is to say, that the objective of protecting the government's interest (read: revenues?) should be considered paramount.

TEI recognizes that the inference is not intended. Indeed, the IRS's "Statement of Principles of Internal Revenue Tax Administration" (which is reprinted in every issue of the Internal Revenue Bulletin) clearly provides:

[I]t is the duty of the Service to carry out that [congressionally prescribed tax] policy by correctly applying the laws enacted by Congress; ... and to perform this work in a fair and impartial manner, with neither a government nor a taxpayer point of view.

It is the responsibility of each person in the Service, charged with the duty of interpreting the law, to try to find the true meaning of the statutory provision and not to adopt a strained construction in the belief that he or she is "protecting the revenue." The revenue is properly protected only when we ascertain and apply the true meaning of the statute.

Perhaps the best way to eliminate the unfortunate inference in the Penalty Handbook is to quote the Statement of Principles and stress its application in the penalty area. Alternatively, the offending sentence could be modified to read, as follows:

While each Service employee appropriately approaches his or her job with the objective of achieving a correct and equitable result under the law, it is especially critical that possible penalty assertions be approached with this objective in mind.

While each Service employee appropriately approaches his or her job from a government perspective and with the objective of protecting the government's interest, the true interest of the government is the unbiased enforcement of the tax law, including penalties.

As you know, TEI has long been interested in the proper administration of the Internal Revenue Code's penalty provisions. Although we believe the 1989 statutory changes represent a positive step, we continue to believe that the proof of the penalty reform "pudding" will be in the application. Thus, we are generally pleased with the tenor of the Penalty Policy Statement and Philosophy and with the Penalty Handbook as a whole. We remain concerned, however, that field agents will hold taxpayers to too exacting a standard, even when applying the reasonable cause exception (which Congress clearly intended to be interpreted with a view toward punishing only volitional noncompliance).

Consider the following example dealing with the payroll tax deposit rules, which one of our members recently reported. Twenty-six companies comprise the corporate group. In 1990, the companies made 2 errors out of 500 deposits, and in 1991, they made a single error. That error gave rise to a whopping penalty. Specifically, the taxpayer was one day late in making a $500,000 deposit. The cost to the government (in terms of lost interest) was, say, $50. But the taxpayer was hit with a penalty of $10,000! The tax manager who reported the situation to TEI said he was "not proud the Government lost $50 of interest," but added that "it is impossible to expect a group of human beings never to make an inadvertent error." Here, however, is how an IRS agent responded to the taxpayer's request for an abatement:

Carelessness or forgetfulness are the same as willful neglect and do not meet the criteria for practicing ordinary business care and prudence.

With due respect, the agent has confused "ordinary business care and prudence" with perfection. After all, in 1991, the taxpayer has a 99.8 percent perfect deposit record. Nevertheless, the IRS agent concluded that it had not demonstrated "due diligence."

No business can operate without an occasional error. Sometimes they just occur. This is why TEI has long advocated that the reasonable cause inquiry focus on whether the taxpayer has (1) established reasonable business procedures (i.e., acceptable internal controls) to ensure compliance with its obligations and (2) made a good faith effort to ensure that those procedures are followed.(2) If the taxpayer has done these things, it should not be penalized. As the old Bureau of Tax Appeals held in Bouvelt Realty, Inc., 46 B.T.A. 45 (1942), there should be no sanction where "responsible officers of corporations had taken every safeguard for filing their returns and yet something went wrong." Stated colloquially, we have urged the IRS to revise the various penalty regulations to distinguish, as Oliver Wendell Holmes said even dogs do, between someone who kicks them and someone who simply stumbles over them. Taxpayers should not be penalized for stumbling.

We recognize that the regulations generally define reasonable cause to encompass situations where the taxpayer exercises "ordinary business care and prudence." There is no explanation of the phrase, however, in the Penalty Handbook - nothing to prevent agents from interpreting it harshly and, in our opinion, vitiating the IRS's Statement of Principle and its Penalty Policy Statement and Philosophy.

As the IRS moves ahead with a revision of the Penalty Handbook, we urge you to consider these comments. If you should have any questions, please do not hesitate to call either Remi Taylor at (704) 382-8174 or me at (202) 638-5601.

(1) Our IRS Administrative Affairs Committee is currently reviewing the entire Penalty Handbook, and I hope that their comments will be completed, cleared by TEI's Executive Committee, and forwarded to you before our San Diego meeting. (2) In the information reporting area, the IRS has acknowledged the propriety of this approach (at least to a limited extent) by providing that a filer's "established history of complying with the information reporting requirement" constitutes a significant mitigating factor establishing reasonable cause. See Prop. Reg. [section] 301.6724-1T(b)(2).
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Publication:Tax Executive
Date:Sep 1, 1992
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