Ways and Means Committee penalty reform package - very good, but could be better.
Chairman J.J. Pickle of Texas and his colleagues on the Oversight Subcommittee have fashioned a penalty reform bill that will significantly improve our existing civil tax penalty structure. The bill, however, does contain some negatives for the corporate taxpaying community. For example, the bill does not deal with the problem faced by "large corporations" in making their estimated income tax payments. In addition, there is a need for the committee report on the bill to expressly address some situations to ensure that the legislation achieves its intended results. This article reviews the provisions that should be of most interest to business taxpayers.
Information Returns and Payee Statements
The bill would introduce a time sensitivity factor with respect to the penalties to be levied on most delinquent information returns filed with the government. If such returns are filed late, but within 30 days of the due date, the penalty is to be $15 per return -- up to a maximum of $75,000 for the year. (1) If the returns are filed more than 30 days after their due date but prior to August 1, the penalty will be $30 per return -- subject to an annual cap of $150,000. (2) Information returns filed after August 1 would be subject to the $50 per return penalty -- with a maximum payment of $250,000 in a given year. (3)
In addition, the bill includes a de minimis rule that would allow the correction or completion of previously filed incorrect or incomplete information returns by August 1. Such corrections or completions will not give rise to a penalty assertion to the extent the number of returns do not exceed the greater of (i) 10 or (ii) one-half of one percent of the total of such returns filed by the taxpayer. Since as an estimated 84 percent of payers file 10 or fewer returns, the de minimis exception offers substantial relief to small businesses.
As to certain specified information returns, the $50 per delinquent return (to a maximum of $100,000) remains in effect.
If non-filing is due to intentional disregard, the existing higher penalties will continue to apply.
The bill would substantially increase the penalty attributable to untimely filed payee statements -- those given to the recipients of payments -- from $5 to $50 per return and would impose a $100,000 (rather than $20,000) annual cap on such penalties.
Significantly, the bill contains a general waiver provision in respect of penalties relating to information returns and payee statements. These penalties will be waived if the failure is due to reasonable cause and not to willful neglect. Unfortunately, the explanation submitted to the Budget Committee by the Ways and Means Committee Report does not include a helpful, TEI-provided example of what constitutes "reasonable cause." TEI recommended that the legislative history provide that reasonable cause will exist where --
(i) a taxpayer establishes reasonable business procedures to assure compliance with its obligation, and
(ii) the taxpayer makes a good-faith effort to comply with those procedures.
If such example were to be included as establishing reasonable cause, many of the existing and anticipated problems with Internal Revenue Service auditors would be avoided.
Under the bill, neither the fraud nor the negligence penalties are to apply to a failure to file a tax return. If, however, the delinquency is due to a fraudulent or intentional failure to file a tax return, a penalty of 15 percent of the tax due will be levied on a per-month basis (increased from 5 percent a month) -- to a maximum of a 75-percent penalty after five months (increased from 25 percent). Absent fraudulent or intentional failure to file, the penalty remains at five percent per month -- up to a maximum of 25-percent.
Time sensitivity has also been introduced with respect to the failure-to-deposit penalty. If a deposit is delinquent but is made by the fifth day following the due date, a two-percent penalty is applied. If the tax is deposited between the sixth and fifteenth days following the due date, a five-percent penalty is applied. If the failure occurs after the fifteenth day following the due date, a 10-percent penalty applies. Finally, if the failure to deposit is not corrected within 10 days after the date the first delinquency notice has been sent to the taxpayer, a 15-percent penalty applies.
A waiver provision exists if a failure to file a return or make a deposit is due to reasonable cause and not willful neglect. Again, unfortunately, the Committee Report does not include the TEI-provided example of what constitutes "reasonable cause" with respect to a waiver of the delinquency penalties.
To avoid the problem of "stacking" -- applying more than one accuracy penalty to a single deficiency -- the bill provides for a single 20-percent accuracy penalty on underpayments attributable to negligence, substantial understatement, and substantial overvaluation.
With respect to the negligence penalty, while the rate has been increased from five percent to 20 percent, the negligence is now "targeted." In other words, the penalty will be levied only on the amount of a tax deficiency attributable to the taxpayer's negligent conduct. Furthermore, according to the committee report, disclosure of nonfrivolous positions (including a good-faith challenge to the regulations) will "generally" prevent the imposition of the penalty.
As to the substantial understatement penalty, the committee report provides that the definition of "authorities" -- for purposes of determining whether substantial authority exists -- is to be expanded to include private rulings, technical advice memoranda, GCMs, documents published in the Internal Revenue Bulletin, and the Joint Committee on Taxation's "bluebooks." Additionally, the report instructs the IRS not to automatically impose the substantial understatement penalty -- apparently responding to the levying of these penalties based only upon a mechanical calculation.
A concern remains, however, about how large corporate taxpayers (particularly those in the Coordinated Examination Program) can effectively avail themselves of the "disclosure" relief with respect to the multitude of unknown issues subsumed in their voluminous tax returns. Another issue relates to the propriety of the bill's imposing the same 20-percent penalty on nonnegligent substantial understatements as it does to negligent conduct.
The bill extends the reach of the substantial overvaluation penalty to corporations. Consequently, the allocation of purchase price on acquisitions could now give rise to such a penalty, as could excess valuations with respect to charitable contributions. The overvaluation penalty of 20 percent is to apply to the portion of the underpayment attributable to an overvaluation of 200 percent but less than 400 percent. Should such overvaluation amount to 400 percent or more, the standard 20-percent penalty is increased to a 40-percent penalty.
A waiver for reasonable cause and good faith -- reviewable by the courts -- is provided for in the bill. In the context of CEP audits, however, how does one convince a revenue agent, or even an appeals conferee, that a simple error or the propounding of a new tax law theory by a revenue agent merits waiver under "reasonable cause"? Similarly, in the context of a CEP audit, whose "good faith" is to be scrutinized?
In its testimony on the bill, TEI recommended that the committee report clarify that the reasonable cause and good faith standard can be established without requiring a taxpayer to discover all tax law issues that may exist in respect of its return. Additionally, TEI suggested that the good faith of the tax responsible employees (or tax consultants) of the corporation be considered for purposes of the waiver. This suggestion was prompted by statements of certain IRS personnel that the bad faith of a single nontax employee whose action affects the financial books -- and thereby the tax return -- could result in the corporate taxpayer's failing the "good faith" test. Unfortunately, the Institute's suggestion was not adopted by the Ways and Means Committee.
Under the bill, a $250 penalty will be levied on preparers where (i) the understatement is due to a position for which there is "not a realistic possibility of being sustained on its merits"; (ii) the preparer knew or reasonably should have known of such position; and (iii) the position was not disclosed or was frivolous. The penalty would be waived, however, if the preparer could establish both reasonable cause for the understatement and the preparer's good faith. The preparer penalty provision is consistent with ABA Formal Opinion No. 85-352 (1985), which states:
[A] lawyer may advise reporting a position on a return even where the lawyer believes the position probably will not prevail, there is no "substantial authority" in support of the position, and there will be no disclosure of the position in the return. However, the position to be asserted must be one which the lawyer in good faith believes is warranted in existing law or can be supported by a good faith argument for an extension, modification or reversal of existing law. This requires that there is some realistic possibility of success if the matter is litigated. (Emphasis added.)
TEI has continued to question why a lower standard of conduct should apply to preparers/advisers than applies to taxpayers. Why shouldn't this standard also apply to taxpayers?
If a payer fails to withhold tax on a non-U.S. recipient, the bill would make the payer liable for applicable penalties and additions to tax even where the non-U.S. recipient discharges the tax liability. Furthermore, a failure to file withholding statements -- either the information return filed with the government or the payee statement sent to the recipient -- will result in appropriate penalties. Finally, a U.S. shareholder of a controlled foreign corporation (including a noncontrolling shareholder) may find itself subject to a $1,000 penalty for failing to provide such information "which the Secretary [of the Treasury] determines to be appropriate." This penalty is in addition to reductions in the amount of allowable foreign tax credits.
On to the Senate
Penalty reform legislation is assured of passage by the House of Representatives. The focus now shifts to the Senate and, ultimately, to the House-Senate Conference Committee.
The Senate Finance Subcommittee on Private Retirement Plans and Oversight of the Internal Revenue Service is chaired by Senator David Pryor of Arkansas. Additional members of the Oversight Subcommittee are Senators Daniel Patrick Moynihan of New York and John Heinz of Pennsylvania. Taxpayers and tax executives who are pleased -- or displeased -- with the provisions of the Improved Penalty Administration and Compliance Tax Act would be well advised to make their views immediately known not only to the members of the Oversight Subcommittee, but also to other members of the Senate.
Many people who have been involved in the penalty reform process -- including Administration officials and congressional staffers -- predict that "the window of opportunity" will close with the enactment of the 1989 legislation. In other words, the subject is unlikely to be revisited for a number of years and, consequently, issues not resolved or resolved unsatisfactorily may be left to fester for some time.
One such issue relates to the Code's current provisions relating to the estimated tax payment requirements of "large corporations." (4) In its testimony on penalty reform, TEI argued that current law effectively compels large corporations to overpay their estimated taxes (without receiving the benefit of interest) in order to avoid a substantial penalty under section 6655. TEI recommended that Congress enact a relief provision that would permit such large corporations to base their estimated tax payments on the prior year's (or years') taxes paid -- thereby placing this class of taxpayers in the same position as all other classes of taxpayers. Regrettably, the recommendation was not adopted by the Ways and Means Committee. Unless members of the Senate take up the call, no action can be anticipated. Now is the time to let your Senators know precisely what you and your companies want included in penalty reform legislation.
(1) A special maximum of $25,000 will apply to businesses whose annual gross receipts are less than $5 million.
(2) Again, small businesses will benefit from a reduced $50,000 annual cap.
(3) For small business, the cap would be $100,000.
(4) The Internal Revenue Code defines "large corporation" as one whose taxable income exceeded $1 million in any of the preceding three years.
Charles W. Rau is Vice President-Taxes for MCI Communications Corporation. He is currently a member of Tax Executives Institute's Board of Directors and of its IRS Administrative Affairs Committee. As chair of the Institute's 1988-1989 Penalties Task Force, Mr. Rau presented TEI's testimony on the reform of the civil penalty provisions of the Internal Revenue Code and has generally coordinated the development of the Institute's position on that legislation. Mr. Rau wishes to express his appreciation to Timothy McCormally, TEI's Tax Counsel and the Editor of The Tax Executive, for his assistance in preparing this article for publication.
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|Author:||Rau, Charles W.|
|Date:||Sep 1, 1989|
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