On October 15, 2021, the Internal Revenue Service (IRS) issued a news release and fact sheet for IRS Frequently Asked Questions (FAQs), which are typically posted on the IRS’s website. The purpose of the fact sheet is to confirm and explain the extent to which FAQs can be relied upon for purposes of avoiding civil tax penalties. (For a primer on penalties and defenses, see our prior article in the Tax Executive.)
The Internal Revenue Code and Treasury Regulations, along with relevant case law, provide rules on what can (and cannot) be relied upon for penalty protection purposes. The most common penalty defenses are reasonable basis (sometimes coupled with a disclosure requirement), substantial authority and reasonable cause. Substantial authority is an objective standard, and Treasury Regulation § 1.6662-4(d)(3)(i) contains a laundry list of such authorities. Absent from this list are IRS FAQs. Reasonable basis has generally been viewed as an objective standard as well (at least outside the US Court of Appeals for the Eighth Circuit), and satisfaction of the substantial authority standard suffices for reasonable basis purposes. Reasonable cause is a subjective standard based on consideration of all the facts and circumstances, with the most important factor being the extent to which the taxpayer took steps to determine their proper tax liability.
For many years, taxpayers and practitioners have debated the value of IRS FAQs. On the one hand, they provide much needed guidance that can be helpful to taxpayers. On the other hand, FAQs are not published in the Internal Revenue Bulletin, are not treated as precedential or binding on the IRS and may be removed or changed by the IRS at any time (without any repository available to find prior versions of FAQs). The IRS relies heavily on FAQs to provide immediate guidance to taxpayers—sometimes in the form of substantive guidance—but has historically disclaimed any ability for taxpayers to rely on its FAQs or for IRS personnel to follow its FAQs. This has led to uncertainty in the tax community as to whether (and to what extent) taxpayers can and should follow IRS FAQs for both substantive positions and penalty protection purposes.
Prior to his return to private practice earlier this year, former IRS Chief Counsel Michael Desmond noted the need for better transparency and permanency around certain IRS FAQs. That transparency and permanency has finally arrived, although the weight of its value still remains uncertain. In the new release and fact sheet, the IRS announced as follows:
FAQs are a valuable alternative to guidance published in the Bulletin because they allow the IRS to more quickly communicate information to the public on topics of frequent inquiry and general applicability. FAQs typically provide responses to general inquiries rather than applying the law to taxpayer-specific facts and may not reflect various special rules or exceptions that could apply in any particular case. FAQs that have not been published in the Bulletin will not be relied on, used, or cited as precedents by Service personnel in the disposition of cases. Similarly, if an FAQ turns out to be an inaccurate statement of the law as applied to a particular taxpayer’s case, the law will control the taxpayer’s tax liability. Only guidance that is published in the Bulletin has precedential value.
Notwithstanding the non-precedential nature of FAQs, a taxpayer’s reasonable reliance on an FAQ (even one that is subsequently updated or modified) is relevant and will be considered in determining whether certain penalties apply. Taxpayers who show that they relied in good faith on an FAQ and that their reliance was reasonable based on all the facts and circumstances will not be subject to a penalty that provides a reasonable cause standard for relief, including a negligence penalty or other accuracy-related penalty, to the extent that reliance results in an underpayment of tax. See Treas. Reg. § 1.6664-4(b) for more information. In addition, FAQs that are published in a Fact Sheet that is linked to an IRS news release are considered authority for purposes of the exception to accuracy-related penalties that applies when there is substantial authority for the treatment of an item on a return. See Treas. Reg. § 1.6662-4(d) for more information.
Thus, under the fact sheet, IRS personnel are instructed to consider reliance on IRS FAQs as part of the reasonable cause determination and to treat IRS FAQs as substantial authority so long as they are published in a fact sheet that is linked to an IRS news release. Additionally, prior versions of IRS FAQs will be maintained on the IRS’s website to ensure taxpayers can locate IRS FAQs that have been removed or changed.
Practice Point: The news release and fact sheet should be viewed as a positive development. The IRS has acknowledged the important role that IRS FAQs play, and that taxpayers should not be penalized for relying on IRS FAQs. However, IRS FAQs remain not binding authority and informal guidance and, unlike guidance published in the Internal Revenue Bulletin, cannot be relied upon as support for the correctness of a tax reporting position. Additionally, the news release and fact sheet are not authoritative guidance and can be revoked at any time. While this is a welcome development, the next logical step would be for the IRS to issue published guidance in the form of updated regulations or a revenue ruling or procedure setting forth this new position. An additional consideration is whether taxpayers can continue to rely on an IRS FAQ for a position if the IRS deletes it from its website after the taxpayer relies on the FAQ in planning its transactions but before the tax year ends or the tax return for the year is filed. Does the taxpayer lose its “reliance on IRS statements” defense in this situation? And, despite the IRS stating that it will retain prior versions, if you rely on an IRS FAQ for a position, we recommend printing out the IRS FAQ and filing it away, at least until the statute of limitations on assessment has expired.