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By David I. Kempler and Elizabeth Minnigh
Buchanan Ingersoll & Rooney PC, Washington, DC
Section 6702 of the Internal Revenue Code was amended in 2006 to not only increase the penalty for frivolous returns but to apply it to all federal taxes not just income taxes. The penalty now applies to a "person" which includes individuals, trusts, estates, partnerships, associates, companies or corporations.
As amended, §6702 imposes a $5,000 penalty when a taxpayer files a frivolous return. A frivolous return is a return that (1) does not contain information "on which the substantial correctness of the self-assessment may be judged;" or (2) contains information that, on its face, indicates that the self-assessed tax is substantially incorrect.1 If the return meets the criteria for a frivolous return and the conduct of the taxpayer is (1) based on a position which the IRS has identified as frivolous or (2) reflects a desire to delay or impede the administration of federal tax laws, then the taxpayer is subject to the $5,000 penalty.2 The IRS currently imposes the frivolous tax submissions penalty under §6702 against the responsible individual when it determines that a business return is frivolous in nature and that individual is found to be responsible for the filing.
In a recent field attorney advice memorandum (FAA),3 the IRS addressed several hypothetical situations regarding the appropriate procedures for imposing the frivolous tax submissions penalty. The memorandum was issued in response to questions by field attorneys regarding whether the IRS can impose the §6702 penalties on different taxpayers with respect to a single tax return.
The IRS concluded that it is generally not appropriate to impose a penalty against both the business and a responsible individual in connection with the same return. The IRS noted that entities such as corporations, partnerships, limited liability companies and trusts must act through another party such as an officer, a general partner, a member or a trustee, and the return signor is acting on behalf of the entity not in an individual capacity.4 Accordingly, the IRS concluded that when the IRS receives a frivolous business return from an entity it will treat that return as filed by the entity taxpayer unless the taxpayer comes forward with strong evidence to establish that an unauthorized party signed and filed the return. Without such evidence, the IRS concluded that the frivolous return penalty should be asserted against the entity as the person filing the return.
The IRS concluded that this determination would remain largely the same no matter what type of entity the IRS was reviewing and no matter the type or number of members. However, for a sole proprietorship signed by someone other than the sole proprietor, the IRS noted that it must first make a determination regarding the role of the person signing the return in question. If the signing party was authorized to sign the business return, the sole proprietor would be responsible for any §6702 penalty. If the signing party was not authorized to sign the business return, the IRS impose the §6702 penalty on that signing party.
The IRS also noted that in the rare circumstances that more than one person was responsible for the filing of a frivolous return or submission, separate assessments against each person may be appropriate. In circumstances where an assessment against multiple individuals was possible, the IRS advised field attorneys to first consult with the IRS Small Business/Self-Employed Division counsel. Additionally, the IRS cautioned that the liability for the §6702 penalties is not joint and several.
Field attorneys also queried whether all liabilities for withholding taxes are assessed without the application of a statutory notice of deficiency procedure. The IRS concluded that where the withholding taxes are reported on a business master tax return the withholding taxes may be assessed without following a 90-day letter.5 However, the IRS noted that taxpayers liable for trust fund taxes must be given 60 days notice before being assessed the 100% penalty imposed on responsible persons who fail to collect, account for, and pay over such taxes.6 The IRS also noted that in certain cases where an exam involves worker classification issues, the notice of determinations procedures under §7436 apply, including sending taxpayers a "30-day" letter listing proposed adjustments.7
Pursuant to §3507, an employer must make payments of advanced earned income credit along with wages when an employee has an eligibility certificate in effect. An employer's payment of advanced earned income credit with the wage will not be treated as compensation,8 rather the employer will treat the advanced earned income credit paid to employees as a credit which reduces the employer's obligation to pay employment taxes.9
Field attorneys also queried whether an overstated advanced earned income credit claimed on Forms 941, 943, or 944 would be subject to statutory notice of deficiency procedures under §6211 and math error procedures under §6213(b) or §6201(a)(3). The IRS determined that those procedures would not apply in the employment tax context. However, the IRS noted that if it could identify a false credit before offsetting the taxpayers other liabilities or issuing a refund, the IRS could reverse the advanced earned income credit. Otherwise, the IRS stated that the procedures for determining and assessing liability as part of an employment tax audit would apply.
The FAA is a good guide to taxpayers as to the extent of their liability for a frivolous return in business return situations.
For more information, in the Tax Management Portfolios, see Tarr and Drucker, 634 T.M., Civil Tax Penalties, and in Tax Practice Series, see ¶3830, Penalties.
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