Do you know that the IRS has at its disposal over 130 potentially applicable civil tax penalties in the Internal Revenue Code? This does not even include certain sanctions imposed administratively for correcting plan documents or operational errors involving tax qualified employee benefit plans, which in some cases can be enormous.
This expansion of governmental penalty powers seems to be accompanied by a growing tendency of the Courts to deny penalty relief, particularly in tax shelter cases. For example, last year, the Tax Court concluded that a taxpayer could not argue that they reasonably relied on the tax opinion of a large CPA firm who rendered that opinion for several hundred thousand dollars the payment of which was conditioned upon the closing of the underlying transaction, which closing was in turn also conditioned upon the rendering of that opinion. So, now, for purposes of potential penalty imposition, the taxpayer must assess any “conflict of interest” of its tax advisor before it can rely on his or her opinion if that advisor has too much at stake beyond mere hourly fees for the time involved. Obviously, other circumstances of self serving conduct by advisors could also be pointed to by the IRS for the same purpose.
Perhaps a high water mark in the aggregation of penalty powers by the IRS is the recently enacted “economic substance” penalty added almost surreptitiously as part of the 2010 Health Care Act. The most striking part of that provision is that it contains a strict 20% penalty that cannot be abated by disclosure and for which there is no abatement for reasonable cause. That penalty doubles if the underlying transaction is not disclosed properly on the pertinent tax return. Even the IRS National Taxpayer Advocate has expressed concern about the lack of transparency in the Treasury Regulations involving this new penalty as well as the lack of an administrative appeal process. Perhaps of greater concern is that while the economic substance doctrine has traditionally been applied in the mass marketed tax shelter context, the newly added statutes and regulations do not so limit its applicability.
In the experience of this author, the IRS seems to routinely add accuracy related penalties to every proposed deficiency, often times with little or no supporting factual information in its reports. The distressing aspect of this is that interest is likewise accrued on the penalties, so a small proposed deficiency can quickly turn to a large one as a result. Frankly, given the growing hostile environment against taxpayers in the courts regarding penalty abatements, this can become a misused “bargaining chip” in settlement negotiations, so beware of these risks when doing your tax planning or having your income tax returns prepared. Planning conservatism seems to be the pertinent watchword now more than ever.
Continue reading “Expanding Income Tax Penalties; A Disturbing Trend”
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