Accountants, Business Owners and Others Face IRS Million Dollar Fines and Don't Know It

The IRS may call you a material advisor and fine youimpose the reportable transaction penalty by law, as
$200,000.00. The IRS may fine your clients over awell, but may remove the penalty when the IRS
million dollars for being in a retirement plan, 419 plan, etc.determines that removal of the penalty would promote
As you read this article, hundreds of unfortunatecompliance and support effective tax administration.
people are having their lives ruined by these fines. YouThe 6707A penalty is particularly harmful in the small
may need to take action immediately. The Internalbusiness context, where many business owners
Revenue Service said it will extend until the end ofoperate through an S corporation or limited liability
2009 a grace period granted to small business ownerscompany in order to provide liability protection to the
for collection of certain tax-shelter penalties.owner/operators. Numerous cases are coming to light
But with that deadline approaching, Congress has notwhere the IRS is imposing a $200,000 penalty at the
yet acted on the tax shelter penalty legislation. IRSentity level and them imposing a $100,000 penalty per
Commissioner Doug Shulman said in a Thursday letterindividual shareholder or member per year.
to the chairmen and ranking members of tax-writingThe individuals are generally left with one of two
committees that the IRS will continue to suspend itsoptions:
collection efforts with regard to the penalties until Dec.1. Declare Bankruptcy
31, 2009.2. Face a $300,000 penalty per year.
"Clearly, a number of taxpayers have been caught in aKeep in mind, taxes do not need to be due nor does
penalty regime that the legislation did not intend," wrotethe transaction have to be proven illegal or illegitimate
Shulman. "I understand that Congress is still consideringfor this penalty to apply. The only proof required by the
this issue, and that a bipartisan, bicameral, bill may be inIRS is that the person did not properly and timely
the works."disclose a transaction that the IRS believes the person
The issue relates to penalties for so-called listedshould have disclosed. It is important to note in this
transactions, the kinds of tax shelters the IRS hascontext that for non-disclosed listed transactions, the
designated most egregious. A number of smallStatue of Limitations does not begin until a proper
business owners that bought employee retirementdisclosure is filed with the IRS.
plans so called 419 and 412(i) plans and others, thatMany practitioners believe the scope and authority
were listed by the IRS, and who are now facinggiven to the IRS under 6707A, which allows the IRS to
hundreds and thousands in penalties, contend that theact as judge, jury and executioner, is unconstitutional.
penalty amounts are unfair.Numerous real life stories abound illustrating the punitive
Leaders of tax-writing committees in the House andnature of the 6707A penalty and its application to small
Senate have said they intend to pass legislationbusinesses and their owners. In one case, the IRS
revising the penalty structure.demanded that the business and its owner pay a
The IRS has suspended collection efforts in cases6707A total of $600,000 for his and his business'
where the tax benefit derived from the listedparticipation in a Code section 412(i) plan. The actual
transaction was less than $100,000 for individuals, ortaxes and interest on the transaction, assuming the
less than $200,000 for firms.IRS was correct in its determination that the tax
Senator Ben Nelson (D-Nebraska) has sponsoredbenefits were not allowable, was $60,000. Regardless
legislation (S.765) to curtail the IRS and its nearlyof the IRS's ultimate determination as to the legality of
unlimited authority and power under Code Sectionthe underlying 412(i) transaction, the $600,000 was due
6707A. The bill seeks to scale back the scope of theas the IRS's determination was final and absolute with
Section 6707A reportable/listed transactionrespect to the 6707A penalty. Another case involved
nondisclosure penalty to a more reasonable level. Thea taxpayer who was a dentist and his wife whom the
current law provides for penalties that are DraconianIRS determined had engaged in a listed transaction
by nature and offer no flexibility to the IRS to reducewith respect to a limited liability company. The IRS
or abate the imposition of the 6707A penalty. This hasdetermined that the couple owed taxes on the
served as a weapon of mass destruction for the IRStransaction of $6,812, since the tax benefits of the
and has hit many small businesses and their ownerstransactions were not allowable. In addition, the IRS
with unconscionable results.determined that the taxpayers owed a $1,200,000
Internal Revenue Code 6707A was enacted as partsection 6707A penalty for both their individual
of the American Jobs Creation Act on October 22,nondisclosure of the transaction along with the
2004. It imposes a strict liability penalty for any personnondisclosure by the limited liability company.
that failed to disclose either a listed transaction orEven the IRS personnel continue to question both the
reportable transaction per each occurrence.legality and the fairness of the IRS's imposition of
Reportable transactions usually fall within certain6707A penalties. An IRS appeals officer in an email to
general types of transactions (e.g. confidentiala senior attorney within the IRS wrote that "...I am both
transactions, transactions with tax protection, certainan attorney and CPA and in my 29 years with the IRS
loss generating transaction and transactions of interestI have never {before} worked a case or issue that left
arbitrarily so designated as by the IRS) that have theme questioning whether in good conscience I could
potential for tax avoidance. Listed transactions areuphold the Government's position even though it is
specified transactions which have been publiclysupported by the language of the law." The
designated by the IRS, including anything that isTaxpayers Advocate, an office within the IRS, even
substantially similar to such a transaction (a phrasewent so far as to publicly assert that the 6707A
which is given very liberal construction by the IRS).should be modified as it "raises significant Constitutional
There are currently 34 listed transactions, includingconcerns, including possible violations of the Eighth
certain retirement plans under Code section 412(i) andAmendment's prohibition against excessive
certain employee welfare benefit plans funded in partgovernment fines, and due process protection."
with life insurance under Code sections 419A(f)(5),Senate bill 765, the bill sponsored by Senator Nelson,
419(f)(6) and 419(e). Many of these plans wereseeks to alleviate some of above cited concerns.
implemented by small business seeking to provideSpecifically, the bill makes three major changes to the
retirement income or health benefits to theircurrent version of Code section 6707A. The bill would
employees.allow an IRS imposed 6707A penalty for nondisclosure
Strict liability requires the IRS to impose the 6707Aof a listed transaction to be rescinded if a taxpayer's
penalty regardless of innocence of a person (i.e.failure to file was due to reasonable cause and not
whether the person knew that the transaction neededwillful neglect. The bill would make a 6707A penalty
to be reported or not or whether the person made aproportional to an understatement of any tax due.
good faith effort to report) or the level of the person'sAccordingly, non-tax paying entities such as S
reliance on professional advisors. A Section 6707Acorporations and limited liability companies would not be
penalty is imposed when the transaction becomes asubject to a 6707A penalty (individuals, C corporations
reportable/listed transaction. Therefore, a person hasand certain trusts and estates would remain subject to
the burden to keep up to date on all transactionsthe 6707A penalty).
requiring disclosure by the IRS into perpetuity forThere are a number of interesting points to note about
transactions entered into the past.this action:
Additionally, the 6707A penalty strictly penalizes1. In the letter, the IRS acknowledges that, in certain
nondisclosure irrespective of taxes owed. Accordingly,cases, the penalty imposed by section 6707A for
the penalty will be assessed even in legitimate taxfailure to report participation in a "listed transaction" is
planning situations when no additional tax is due but andisproportionate to the tax benefits obtained by the
IRS required filing was not properly and timely filed. It istransaction.
worth noting that a failure to disclose in the view of the2. In the letter, the IRS says that it is taking this action
IRS encompasses both a failure to file the proper formbecause Congress has indicated its intention to amend
as well as a failure to include sufficient information asthe Code to modify the penalty provision, so that the
to the nature and facts concerning the transaction.penalty for failure to disclose will be more in line with
Hence, people may find themselves subject to thethe tax benefits resulting from a listed transaction.
6707A penalty if the IRS determines that a filing did not3. The IRS will not suspend audits or collection efforts
contain enough information on the transaction. Ain appropriate cases. It cannot suspend imposition of
penalty is also imposed when a person does not filethe penalty, because, at least with respect to listed
the required duplicate copy with a separate IRS officetransactions, it does not have the discretion to not
in addition to filing the required copy with the tax return.impose the penalty. It is simply suspending collection
In our numerous talks with IRS, we were also told thatefforts in cases where the tax benefits are below the
improperly filling out the forms could almost be as badpenalty threshold in order to give Congress time to
as not filing the forms. We have reviewed hundreds ofamend the penalty provision, as Congress has
forms for accountants, business owners and others.indicated to the IRS it intends to do.
We have not yet seen a form that was properly filledIt should also be noted that identical bills have been
in. We have been retained to correct many of theseintroduced in the Senate and the House to amend
forms.Section 6707A. Each bill has been referred to the
The imposition of a 6707A penalty is not subject toappropriate committee, where no action has taken
judicial review regardless of whether the penalty isplace. There are a couple of points about the
imposed for a listed or reportable transaction.proposed legislation:
Accordingly, the IRS's determination is conclusive,1. The legislation would reduce the penalty for failure to
binding and final. The next step from the IRS is sendingdisclose participation in a reportable transaction, other
your file to collection, where your assets may bethan a listed transaction, to the amount imposed by
forcibly taken, publicly recorded liens may be placedsection 6662A for an understatement of tax. For a
against your property, and/or garnishment of yourlisted transaction, the penalty would equal 200% of the
wages or business profits may occur, amongst otherpenalty imposed for an understatement of tax. The
measures.amount of the penalty imposed by section 6662A is
The 6707A penalty amount for each listed transaction20%.
is generally $200,000 per year per each person that is2. The proposed legislation is different than the position
not an individual and $100,000 per year per individualexpressed by the IRS. The IRS would like the penalty
who failed to properly disclose each listed transaction.to equal the tax benefits obtained from the transaction.
The 6707A penalty amount for each reportable3. The legislation does not change the penalty
transaction is generally $50,000 per year for eachprovisions for material advisors.
person that is not an individual and $10,000 per yearThe information provided herein is not intended as legal,
per each individual who failed to properly disclose eachaccounting, financial or any other type of advice for
reportable transaction. The IRS is obligated to imposeany specific individual or other entity. You should
the listed transaction penalty by law and cannotcontact an appropriate professional for any such
remove the penalty by law. The IRS is obligated toadvice.