Taxation & Estate Planning

Section 6676 and Section 6694 penalties on refund claims but what is the applicable standard?

By Fox Rothschild

A slow week in tax litigation caused my eye to wander back to the 2007 Small Business Act, (the “Act”) and the imposition of penalties on refund claims.

As we are all aware prior to the Act, there was no applicable addition to tax on a refund claim because there was no deficiency to impose a penalty on. In the Committee Reports, the Act set forth the reasons why penalties needed to be sought but the applicable standard is not what it appears to be.

As can be gleamed from the standard to be applied the penalty is yet another front on the tax shelter wars. The interesting question becomes - are the sections with its new standard a barrier to a taxpayer’s right to either Federal District Court or the Court of Claims?

6676. Erroneous claim for refund or credit

(a) Civil penalty.--If a claim for refund or credit with respect to income tax (other than a claim for a refund or credit relating to the earned income credit under section 32) is made for an excessive amount, unless it is shown that the claim for such excessive amount has a reasonable basis, the person making such claim shall be liable for a penalty in an amount equal to 20 percent of the excessive amount.
(b) Excessive amount.--For purposes of this section, the term "excessive amount" means in the case of any person the amount by which the amount of the claim for refund or credit for any taxable year exceeds the amount of such claim allowable under this title for such taxable year.
(c) Coordination with other penalties.--This section shall not apply to any portion of the excessive amount of a claim for refund or credit which is subject to a penalty imposed under part II of subchapter A of chapter 68.

The Joint Committee report explains the provision as follows:

“The provision imposes a penalty on any taxpayer filing an erroneous claim for refund or credit. The penalty is equal to 20% of the disallowed portion for refund or credit foe which there is no reasonable basis for the claimed tax treatment. . . .”

Reasonable basis – we have seen that standard before. Nine times out ten it means reliance on an advisor and his/her opinion. Thus, the reasonable standard brings in the new standard of section 6694

6694. Understatement of taxpayer's liability by tax return preparer

(a) Understatement due to unreasonable positions.--
(1) In general.--Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to a position described in paragraph (2) shall pay a penalty with respect to each such return or claim in an amount equal to the greater of--
(A) $1,000, or
(B) 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim.
(2) Unreasonable position.--A position is described in this paragraph if--
(A) the tax return preparer knew (or reasonably should have known) of the position,
(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and
(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or
(ii) there was no reasonable basis for the position.
(2) Reasonable cause exception.--No penalty shall be imposed under this subsection if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.

Consequently, section 6694 adds to the definition of reasonable basis under 6676, a more likely than not component. Thus, according to the IRS, it appears that the cost of filing a refund claim has gone up as the standard is one of a tax opinion letter. A tax opinion letter that the IRS will probably want to see otherwise it will seek to impose its 20% penalty on the taxpayer and seek penalties on the return preparer or tax advisor behind the position set forth on the return.

Full post as published by Tax Litigation Blog on June 24, 2007 (boomark / email).