The penalty rules have changed - again.
The Revenue Reconciliation Act of 1989 significantly changed the manner in which the substantial understatement of tax and negligence penalties is assessed. Prior to this law, separate Code sections imposed these penalties. There were also separate Code sectios that assessed penalties for valuation misstatements, substantial overstatements of pension liabilities and substantial gift or estate tax valuation understatements. These penalties could be applied cumulatively, so that a single act or transaction was sometimes subject to multiple penalties. Congress believed that this stacking of penalties was inappropriate. As a result, these penalties were consolidated into a single "accuracy-related" penalty, which is 20% for a substantial understatement of tax or negligence. In addition, this law made uniform several rules and definitions that previously varied according to the particular penalty.
At the same time, Congress also enacted legislation that allowed the abatement of a penalty if a taxpayer adequately disclosed the position taken on his return and the position was not frivolous. These terms are defined by regulation. A nonfrivolous position is defined by Regs. Sec. 1.6694-2(c)(2) as a position that is not patently improper. Regs. Sec. 1.6662-3(c)(2) states disclosure is adequate if made on a properly completed and filed Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, as appropriate. There are limited exceptions in Regs. Sec. 1.6662-4(a) and (b) that allow (in the case of substantial understatement of income tax) disclosure by attaching to the return a statement fully disclosing the position taken without attaching Form 8275 or Form 8275-R. It should be noted that disclosure on the return will not abate the penalty if the position taken on the return has no reasonable basis or is not properly substantiated, or when the taxpayer fails to keep adequate books and records with respect to the item.
The Revenue Reconciliation Act of 1993 significantly changed these standards. The "non-frivolous" standard was replaced by a "reasonable basis" standard. The Senate Report (which the Joint Conference adopted) stated: The committee intends that "reasonable basis" be a relatively high standard of tax reporting, that is, significantly higher than "not patently improper." This standard is not satisfied by a return position that is merely arguable or merely a colorable claim.
Under the bill, a taxpayer can avoid a substantial understatement penalty by adequately disclosing a return position only if the position has at least a reasonable basis.
The term "reasonable basis" has not been defined by the regulations. The disclosure exception is no longer relevant with respect to the penalty for negligence, because a taxpayer generally is not considered to have been negligent with respect to a return position, regardless of whether it was disclosed, if the position has a reasonable basis.
In conjunction with this change, the IRS has revised Forms 8275 and 8275-R to comply with these changes. Ann. 94-77 states that these forms (released in May 1994 and currently available) are to be used after June 7, 1994. It should also be noted that these penalties are applicable to the preparer's penalty. Regs. Sec. 1.6694-2(c)(3) states: "In the case of a signing preparer, disclosure of a position that does not satisfy the realistic possibility standard is adequate only if the disclosure is made in accordance with [Regs. Sec.] 1.6662-4(f) (which permits disclosure on a properly completed and filed Form 8275 or 8275-R, as appropriate, or on the return in accordance with an annual revenue procedure)." There are similar rules applying to nonsigning preparers and preparers simply giving advice to a taxpayer.
From Richard W. Preston, CPA, Ostrow Reisin Berk & Abrams, Ltd., Chicago, Ill.
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|Title Annotation:||substantial understatement and negligence tax penalties|
|Author:||Preston, Richard W.|
|Publication:||The Tax Adviser|
|Date:||Oct 1, 1994|
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