Small Business Jobs and Credit Act of 2010 presented to President
The bill containing relief for 6707A penalties has passed the Senate and the House and is awaiting the President’s signature. Following is the text of the relevant part of the bill:
PART IV–PROMOTING SMALL BUSINESS FAIRNESS
SEC. 2041. LIMITATION ON PENALTY FOR FAILURE TO DISCLOSE REPORTABLE TRANSACTIONS BASED ON RESULTING TAX BENEFITS.
(a) In General- Subsection (b) of section 6707A of the Internal Revenue Code of 1986 is amended to read as follows:
‘(b) Amount of Penalty-
‘(1) IN GENERAL- Except as otherwise provided in this subsection, the amount of the penalty under subsection (a) with respect to any reportable transaction shall be 75 percent of the decrease in tax shown on the return as a result of such transaction (or which would have resulted from such transaction if such transaction were respected for Federal tax purposes).
‘(2) MAXIMUM PENALTY- The amount of the penalty under subsection (a) with respect to any reportable transaction shall not exceed–
‘(A) in the case of a listed transaction, $200,000 ($100,000 in the case of a natural person), or
‘(B) in the case of any other reportable transaction, $50,000 ($10,000 in the case of a natural person).
‘(3) MINIMUM PENALTY- The amount of the penalty under subsection (a) with respect to any transaction shall not be less than $10,000 ($5,000 in the case of a natural person).’.
(b) Effective Date- The amendment made by this section shall apply to penalties assessed after December 31, 2006.
6707a
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IRS Fines for Business Owners Reduced! The 6707A penalties will be reduced for many taxpayers under the amended section, once it becomes law. Below is my opinion about the existing 6707A fines that have put business owners out of business and hurt accountants, insurance professionals and other so called material advisors.
Notwithstanding the underlying Congressional intent in enacting Section 6707A, the statute as it was written imposed unconscionable hardship on taxpayers. The statute allows penalties of up to $300,000 per year to be imposed on taxpayers with no underpayment of tax and no knowledge that they entered into transactions that the IRS has “listed.”
It is rare that a tax provision is found to violate the United States Constitution, but I think the imposition of such a large penalty on a taxpayer who entered into a transaction that produced little or even no tax savings and without regard to the taxpayer’s knowledge or intent raises significant Constitutional concerns with respect to the Eighth Amendment prohibition of excessive fines, etc. In practice, the requirement that this penalty be imposed without regard to culpability may have the effect of bankrupting middle class families who had no intention of entering into a tax shelter – an outcome that has dismayed even hardened IRS enforcement personnel.
The 6707A section imposes a penalty of $100,000 per individual and $200,000 per entity for each failure to make special disclosures with respect to a transaction that the Treasury Department characterizes as a “listed transaction” or “substantially similar” to a listed transaction. A listed transaction is one that is specifically identified as such by published IRS guidance. The question of what is “substantially similar” to such a transaction is increasingly troublesome, especially given the ever broadening IRS definition of the term, beginning with Treasury Decision 9,000 in 2002.
· The penalty applies without regard to whether the small business or the small business owners have knowledge that the transaction has been listed.
· The penalty applies even if the small business and/or the small business owners derived no tax benefit from the transaction. The penalty also applies even if on audit the IRS accepts the derived tax benefit, even if interest, penalties, etc., are not imposed.
· The penalty is applied at multiple levels, which is devastating to small businesses; the result is that small business and its owners are hit with multiple penalties. The two most common problems are that fines are imposed on both the business entity and the owners as individuals, and also that fines are imposed each year, and thus were sometimes imposed for five years or more. In the case of a small business, the penalties can easily exceed the total earnings of the business and cause bankruptcy – totally out of proportion to any tax advantage that may or may not have been realized.
· The penalty is final, must be imposed by the IRS (this is mandatory), and cannot be rescinded.
· There is no judicial review allowed, which raises another Constitutional issue, this time a separation of powers argument, as it amounts to one branch of government prohibiting another from functioning.
· The taxpayer’s disclosure must initially be made twice – once with the IRS Office of Tax Shelter Analysis and again with the tax return for the year in which the transaction is first required to be disclosed. Thereafter, for each year the taxpayer “benefits” from the transaction it must be reflected on the tax return. As a practical matter, the form should be filed with the tax return. The IRS directions assume a timely filing. There are no directions as to how to file late. A few experts have figured that out after months of study and numerous conversations with IRS personnel. Those conversations were with IRS people that drafted the regulations, those that receive the forms and others.
· A taxpayer that discloses a transaction is subject to the penalty if the IRS deems the disclosure to be incomplete. I have had numerous conversations with people who filed the disclosure forms and got fined. They did not properly prepare or file the forms.
· If a transaction is not “listed” at the time the taxpayer files a return but it later becomes listed, the taxpayer becomes responsible for filing a disclosure statement and will be liable for this penalty for failing to do so. This is true even if the taxpayer has no knowledge that the transaction has been listed.
· The penalty is imposed on transactions that the IRS in its sole discretion determines are “substantially similar” to a listed transaction. Accordingly, taxpayers may never know or realize that they are involved in a listed transaction, and accordingly the penalties compound because they never made any disclosure. At least, if a transaction is specifically identified, people can find out that it is a listed transaction. But how can anyone be sure that something is “substantially similar”, or not?
· The taxpayer must disclose each year, which can result in compounding of the already large penalties.
· The usual three-year Statute of Limitations does not apply. IRC 6501(c)(10) tolls the statute until proper disclosure is made.
Because the penalty is required to be imposed without regard to culpability, it may have the effect of bankrupting small business and/or their owners, even if they had no knowledge or intention of entering into a listed transaction.
The Treasury Department announces on an ad hoc basis what is a listed transaction. There is no regulatory process or public comment period involved in determining what should be a listed transaction. Once a transaction is deemed to be a listed transaction, the Draconian Section 6707A penalties are triggered. Section 6707A penalties not only apply to listed transactions but also to transactions that are deemed by Treasury to be “substantially similar” to any of the listed transactions. Some have said that under Section 6707A, IRS and Treasury are the judge, jury and executioner. Be that as it may, once again Constitutional concerns need to be addressed, this time possible due process violations pursuant to the Fourteenth Amendment.
While the penalties were aimed at transactions that the IRS considers abusive, the penalty is tied to disclosure so that, even if a court finds that the IRS is incorrect in its determination that a transaction is abusive, the penalty still applies.
Below are some examples.
I was an expert witness for the plaintiff who was sold a 401k with a springing cash value policy. In court, the Judge called the defendant insurance agent a crook (off the record), after I had explained the facts, and advised him to settle.
Another example is a business owner. He bought a type of life insurance policy known as a “springing cash value” plan as an alternative to a pension plan for his employees. Two years later, the IRS added this type of plan to its list of abusive tax shelters, and the business owner should have disclosed his purchase to the IRS. But he says the financial advisor who sold him the insurance plan at no point told him he needed to make such a disclosure.
Now, the IRS is demanding taxes and interest totaling $60,000. On top of that, the IRS has set penalties in the amount of $600,000, but has so far granted him several extensions, he says.
“I trusted people, my advisor, to take care of this. Then the IRS came and said, ‘Here’s $600,000 you’re going to have to pay.’ If I have to pay these fees, I will actually have to declare bankruptcy,” he said. And even that could be problematical, because government obligations generally cannot be discharged in bankruptcy.
Another example is a taxpayer who filed his Form 8886 with his tax returns, but failed to submit the Form 8886 also to the Office of Tax Shelter Analysis, as is required in the first year. The IRS assessed the Section 6707A penalty because the taxpayer had not disclosed “perfectly.”
A doctor thought he had settled his 419 welfare benefit plan issues with the IRS through the Global Settlement Initiative (IRS Announcement 2005-80). He entered into a closing agreement and paid his tax. After the closing agreement was executed, in full, the doctor received a letter from the IRS telling him he was subject to an additional assessment of penalty, for failing to file a Form 8886, in the amount of $300,000. The IRS publications on the Global Settlement Initiative did not disclose to the dentist that he might be assessed Code Section 6707A penalties even though he settled his tax issues through the IRS’ national settlement program.
I can go on and on with examples of taxpayers fined hundreds of thousands for something that they knew nothing about. I have been urging business owners to properly file 8886 forms protectively for years. When I speak at national accounting conventions, most accountants have no knowledge of these large fines. The few that do don’t speak up, possibly because the Office of Professional Responsibility is now investigating them as material advisors. If you get paid a certain amount, and give tax advice about a listed, etc., transaction, you are subject to a $100,000 fine and a referral to that office. If you are incorporated, the fine is $200,000.00.
The new tax law will reduce the fines for some taxpayers. They still have to properly file. The fines are still large and unfair.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, financial and estate planning, and abusive tax shelters. He writes about 412(i), 419, and captive insurance plans. He speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in the press and has been featured on television and radio financial talk shows including NBC, National Public Radio’s All Things Considered, and others. Lance has written numerous books including Protecting Clients from Fraud, Incompetence and Scams published by John Wiley and Sons, Bisk Education’s CPA’s Guide to Life Insurance and Federal Estate and Gift Taxation, as well as AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots. He does expert witness testimony and his side has never lost a case. Contact him at 516.938.5007, wallachinc@gmail.com or visit http://www.taxadvisorexperts.org or http://www.taxaudit419.com.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.