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Understanding the IRC’s Excessive Refund Claim Penalty

Recently, the Internal Revenue Service (IRS) has been asserting the Internal Revenue Code Section 6676 penalty much more frequently in examinations and in court. For example, in 2023, a government counterclaim in the US District Court for the Middle District of Georgia sought to recover Section 6676 penalties in Townley v. United States. And, internal IRS guidance requires examiners to consider whether to assert the penalty in every case in which a refund is disallowed.

In light of these factors, and major questions being raised in high-profile tax cases like Moore v. United States, which is currently pending before the Supreme Court of the United States, taxpayers are wondering whether the penalty can be asserted as a protective refund claim.

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Can the IRS Assert IRC Section 6676’s Erroneous Refund Penalty on Protective Refund Claims?

We once again want to bring to your attention the Internal Revenue Service’s (IRS) new favorite penalty provision: Internal Revenue Code (IRC) Section 6676. We have reported on this provision several times before (See here, here and here), but this time we’re analyzing it in the context of protective refund claims.

As background, IRC Section 6676 was enacted in 2007 in response to the high number of presumed meritless refund claims being filed at the time. It imposes a 20% penalty to the extent that a claim for refund or credit with respect to income tax is made for an “excessive amount.” An “excessive amount” is defined as the difference between the amount of the claim for credit or refund sought and the amount that is actually allowable. For example, if a taxpayer claims a $2 million refund and the IRS allows only $1 million, the taxpayer can still be penalized $200,000 (e.g., 20% of the amount of the refund that was disallowed). Significantly, IRC Section 6676 does not require the IRS to show any fault or culpability on the part of the taxpayer (e.g., negligence or a disregard of rules or regulations). Neither the IRC nor the regulations provide for any defense to the Section 6676 penalty other than “reasonable cause.” Moreover, the penalty is immediately assessable, and generally taxpayers cannot fight the IRS on the penalty in a prepayment forum like it can the US Tax Court. Instead, the taxpayer must first pay the penalty and seek redress in a refund forum in either the relevant US federal district court or the US Court of Federal Claims.

Now that the IRS is asserting the IRC Section 6676 penalty more frequently, taxpayers are asking whether the penalty can apply to a protective refund claim. A protective refund claim is a judicial creation under which a taxpayer files a “protective” refund claim that is expressly contingent on a specified future event, like a taxpayer-friendly holding in a relevant court case. The Supreme Court of the United States has endorsed protective refund claims to toll the statute of limitations on the refund claim and thereby protect the taxpayer’s right to claim the refund if the favorable event should occur. (See, e.g., United States v. Kales, 314 US. 186 (1941), and CCA 201136021 (describing protective claims in detail).)

So, does the IRC Section 6676 penalty apply to a protective refund claim? Based on IRS internal guidance from 2022, the IRS believes that the IRC Section 6676 penalty applies to any filing that constitutes a “claim for credit or refund” of income tax, including a protective refund claim. To apply the penalty, the IRS would have to process the protective refund claim, deny the claim and then assert the IRC Section 6676 penalty.

Processing and denying a protective refund claim go against most tax practitioners’ experience and understanding of how the IRS treats protective refund claims. Typically, the refund claim is [...]

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Weekly IRS Roundup January 8 – January 12, 2024

Check out our summary of significant Internal Revenue Service (IRS) guidance and relevant tax matters for the week of January 8, 2024 – January 12, 2024.

January 8, 2024: The IRS released Internal Revenue Bulletin 2024-2, which includes the following:

  • Notice 2024-7, which provides eligible taxpayers with automatic relief from additions to tax for failure to pay with respect to certain income tax returns for 2020 and 2021.
  • Announcement 2024-3, which explains Voluntary Disclosure Program eligibility criteria, terms and procedures for taxpayers to resolve refunds or credits for erroneous Employee Retention Credit (ERC) claims.
  • Notice 2024-2, which provides guidance on certain SECURE 2.0 Act of 2022 provisions.
  • Notice 2024-3, which sets forth the 2023 Cumulative List of Changes in Plan Qualification Requirements for Defined Contribution Qualified Pre-approved Plans.
  • Notice 2024-4, which updates the corporate bond monthly yield curve and corresponding spot segment rates for December 2023 used under Internal Revenue Code (Code) § 417(e)(3)(D), the 24-month average segment rates for December 2023 and the 30-year Treasury rates, as reflected by the application of § 430(h)(2)(C)(iv).
  • Revenue Ruling 2024-1, which provides covered compensation tables under § 401(1)(5)(E) for the 2024 plan year.
  • Notice 2024-1, which provides the percentage increase for calculating the qualifying payment amounts for items and services furnished in 2024 for purposes of Code §§ 9816 and 9817, §§ 716 and 717 of the Employee Retirement Income Security Act of 1974, and §§ 2799A-1 and 2799A-2 of the Public Health Service Act.
  • Notice 2024-6, which provides additional guidance on the sustainable aviation fuel (SAF) credit, including methods and Renewable Fuel Standard program safe harbors used to qualify for and calculate the SAF credit.
  • Announcement 2024-1, which revokes § 501(c)(3) determinations for certain organizations and stipulates that contributions made to the organizations by individual donors are no longer deductible under § 170(b)(1)(A).
  • Notice 2024-5, which provides a safe harbor for the incremental cost of certain qualified commercial clean vehicles placed in service in calendar year 2024 for purposes of the credit pursuant to § 45W.
  • Notice 2024-8, which provides the optional 2024 standard mileage rates that taxpayers can use when computing the deductible costs of operating an automobile for business, charitable, medical or moving expense purposes.
  • Notice 2024-9, which notes the IRS’s intent to propose regulations concerning statutorily required exceptions to the elective payment phaseout for entities that do not satisfy the domestic content requirements of §§ 45, 45Y, 48 and 48E. The notice also provides the transitional process for how applicable entities can claim the statutory exception for elective payment projects that begin construction during calendar year 2024 and fail to satisfy the domestic content requirement.
  • Notice 2024-11, which updates the list of treaties that meet the requirements of § 1(h)(11)(C)(i)(II) as it relates to [...]

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Employers Be Forewarned and Forearmed: Recent IRS Announcements Require Action on ERTC Claims

Promoters and tax advisors have extensively marketed the Employee Retention Tax Credit (ERTC) as a way for employers to reclaim Federal Insurance Contributions Act payroll taxes paid during the first two years of COVID-19. The rules governing ERTC claims are complex and nuanced, however, resulting in increased scrutiny by the Internal Revenue Service (IRS). Asserting that many employers have improperly claimed these heavily marketed ERTC refunds, the IRS released two announcements, one on September 14, 2023, and the other on October 19, 2023, that address ERTC claims. In conjunction with these announcements, the IRS has already named fraudulent ERTC claims as number one on its “Dirty Dozen” list for 2023.

Specifically, the IRS will now target erroneous ERTC claims with penalties and interest. If a case is deemed fraudulent, the IRS will investigate and may impose civil and criminal penalties. The IRS has also suspended ERTC refund claims and provided a new withdrawal process for potentially fraudulent claims.

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Weekly IRS Roundup October 30 – November 3, 2023

Check out our summary of significant Internal Revenue Service (IRS) guidance and relevant tax matters for the week of October 30, 2023 – November 3, 2023.

October 30, 2023: The IRS released Internal Revenue Bulletin 2023-44, which includes the following:

  • Proposed regulations that would update the rules governing the IRS’s sale of taxpayer property that was seized by levy.
  • Proposed regulations addressing so-called “Killer B” transactions. These transactions, at a high level, are structured to repatriate foreign subsidiary earnings through triangular reorganizations. The proposed regulations would formalize and modify guidance set forth in Notices 2014-32 and 2016-73.
  • Final regulations that provide rules for prohibitions on certain contributions to Type I and Type III supporting organizations, as well as rules for qualifying as functionally integrated and non-functionally integrated Type III supporting organizations.
  • Notice 2023-71, which extends all tax filing and payment deadlines from October 7, 2023, to October 7, 2024, for taxpayers affected by the recent terrorist attacks in Israel.

October 30, 2023: The IRS extended its policy for accepting digital signatures for certain tax forms until October 31, 2025. The IRS updated the Internal Revenue Manual to be consistent with this extension.

October 31, 2023: The IRS reminded taxpayers to remain vigilant against potential online threats and highlighted certain practices to help protect against cybersecurity attacks.

November 1, 2023: The IRS announced that clean vehicle sellers can now register for time-of-sale reporting and dealer advance payments for the clean vehicle credit using the new Energy Credits Online tool.

November 1, 2023: The IRS announced that the amount individuals can contribute to their 401(k) plans in 2024 has increased to $23,000, up from $22,500 in 2023. Notice 2023-75, which was released the same day, provides adjusted 2024 limitations on benefits and contributions under qualified retirement plans as under § 415(d).

November 2, 2023: The IRS rescheduled the hearing on proposed regulations regarding digital asset transactions from November 7, 2023, to November 13, 2023.

November 2, 2023: The IRS published Tax Tip 2023-119, which notes that individuals may now review 18 new Nationwide Tax Forums Online seminars.

November 3, 2023: The IRS reminded taxpayers to review their tax withholding obligations ahead of the upcoming tax filing season to avoid having a large refund or balance due.

November 3, 2023: The IRS issued proposed regulations that would add new requirements relating to the disclosure of information that group health plans and health insurance issuers must include subject to the No Surprises Act. The proposed regulations consider requiring plans and issuers to register via the Federal IDR portal. Comments must be received by January 2, 2024.

November 3, 2023: The IRS released its weekly list [...]

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IRS Provides Tax Penalty Relief for Certain Late Filed Returns

In Notice 2022-36, the Internal Revenue Service (IRS) announced relief for taxpayers who failed to file certain tax and information returns with respect to tax years 2019 and 2020. The relief, which will be automatic, is provided if taxpayers file the missing forms by September 30, 2022. Once filed, the penalties will be waived or to the extent previously assessed, abated, refunded or credited to taxpayers.

The reason for this unprecedented relief is based upon the COVID-19 pandemic. In the Notice, the IRS explains that with a blanket abatement of penalties, IRS personnel can focus resources on processing the millions of returns backlogged by the pandemic and facilitate the IRS to get back to business as usual.

The IRS will abate any and all civil tax penalties related to failing to timely file the following returns:

  • The Form 1040 series
  • The Form 1041 series
  • The Form 1120 series
  • Form 1066
  • Form 990-PF
  • Form 1065.

The IRS will also abate the civil tax penalties asserted pursuant to Internal Revenue Code (IRC) Sections 6038, 6038A, 6038C, 6039F and 6677 for failing to timely file the following international information returns:

  • Forms 5471 and 5472
  • The Form 3520 series.

Additionally, the IRS will not impose penalties under IRC Section 6721(a)(2)(A) for failure to timely file any information return (as defined in IRC Section 6724(d)(1), e.g., certain Form 1099s) that meets the following criteria:

  • 2019 returns that were filed on or before August 1, 2020, with an original due date of January 31, 2020; February 28, 2020 (if filed on paper) or March 31, 2020 (if filed electronically); or March 15, 2020
  • 2020 returns that were filed on or before August 1, 2021, with an original due date of January 31, 2021; February 28, 2021 (if filed on paper) or March 31, 2021 (if filed electronically); or March 15, 2021.

Penalty relief, however, does not apply in situations where fraud was involved or if the tax penalty was settled under an Offer in Compromise or Closing Agreement.

Practice Point: Numerous civil tax penalties apply to taxpayers who fail to timely file certain tax and information returns—and those penalties can add up, accruing underpayment interest until paid. Notice 2022-36 is welcome relief to taxpayers who did not timely file as these penalties have been a bane to those who could not timely file their returns because of COVID-19 or did file timely but their returns have been sitting in an IRS center waiting to be processed. We have helped numerous taxpayers obtain abatement for these penalties over the last two years, and the process takes a lot of time and resources to complete. With this announcement, hopefully the IRS can redirect its limited resources to backlogged tax returns it has not been able to process since the pandemic began in early 2020.

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An Update on Section 6751 Penalties

Tax penalties are always a hot topic here. The Internal Revenue Service (IRS) has a large arsenal when it comes to grounds for asserting penalties on income tax deficiencies, ranging from the common 20% penalty under Internal Revenue Code (Code) Section 6662(a) to higher penalties ranging from 40% (gross valuation or basis misstatements and economic substance) to 75% (fraud).

However, before the IRS can assert most penalties against taxpayers, it must comply with the procedural requirement in Code Section 6751(b): That the “initial determination” to assert the penalty be “personally approved (in writing) by the immediate supervisor of the individual making such determination.” As the US Court of Appeals for the Second Circuit explained in Chai v. Commissioner, US Congress imposed this requirement because it “believes that penalties should only be imposed where appropriate and not as a bargaining chip” and “[t]he statute was meant to prevent IRS agents from threatening unjustified penalties to encourage taxpayers to settle.”

Over the past several years, there has been substantial litigation over the proper interpretation and application of Code Section 6751(b). The US Tax Court’s recent opinion in Oxbow Bend, LLC v. Commissioner is the latest development. In Oxbow Bend, the Tax Court rejected the taxpayer’s position that the “initial determination” was made on the date that the examining agent prepared a penalty lead sheet reflecting her recommendation to assert penalties and stated in a telephone conference with the taxpayer’s representative on that same day that penalties were being considered. Approximately three months later, the examining agent’s supervisor approved the penalty lead sheet, and the IRS issued a Notice of Final Partnership Administrative Adjustment asserting the penalties. The Tax Court, relying on its prior precedent, held that the word “determination”:

  1. “has an established meaning in the tax context and denotes a communication with a high degree of concreteness and formality”
  2. “signifies a consequential moment of IRS action”
  3. is not a “mere suggestion, proposal, or initial informal mention of penalties”
  4. “will be embodied in a formal written communication that notifies the taxpayer of the decision to assert penalties.”

Thus, under the Tax Court’s analysis, an “initial determination” can only be made in a “written” document that is provided to the taxpayer.

Oxbow Bend is a memorandum opinion of the Tax Court and, therefore, is limited to its facts and technically not precedential, as we have discussed in the past. However, memorandum opinions are often cited by litigants, and the Tax Court does not disregard these types of opinions lightly. One has to wonder whether, under different facts where an examining agent makes an explicit oral statement to a taxpayer that penalties “will” be asserted, courts might reach a different result given Congress’s express intent that examining agents should not threaten penalties and use them as a bargaining chip for settlement purposes. Further, Code Section 6751(b) expressly requires that the supervisory approval be “in writing” but contains a written requirement for purposes of the [...]

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Weekly IRS Roundup October 11 – October 15, 2021

Presented below is our summary of significant Internal Revenue Service (IRS) guidance and relevant tax matters for the week of October 11, 2021 – October 15, 2021. Additionally, for continuing updates on the tax impact of COVID-19, please visit our resource page here.

October 12, 2021: The IRS released a notice, announcing that the US Department of the Treasury (Treasury) and the IRS intend to amend the regulations under Section 987 to defer the applicability date of certain final regulations by one additional year. The deferred regulations will apply to tax years beginning after December 7, 2022. For calendar year taxpayers, the 2016 final regulations and the related 2019 final regulations will apply to the tax year beginning on January 1, 2023. The IRS and Treasury do not intend to amend the applicability date of Treasury Regulation § 1.987-12.

October 13, 2021: The IRS published an updated Form W-8BEN-E (Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)) and related instructions.

October 14, 2021: The IRS and Treasury published a notice and request for comments concerning assumption of partner liabilities. The rules relate to a partnership’s assumption of certain fixed and contingent obligations in connection with the issuance of a partnership interest, as well as to Section 358(h) for assumptions of liabilities by corporations from partners and partnerships and temporary regulations concerning the assumption of certain liabilities under Section 358(h). Written comments are due on or before December 13, 2021.

October 14, 2021: The IRS and Treasury published a notice and request for comments concerning Form 1127 (Application for Extension of Time for Payment of Tax Due to Undue Hardship). Written comments are due on or before December 13, 2021.

October 14, 2021: The IRS and Treasury published a notice and request for comments concerning Revenue Procedure 99-50, which permits combined information reporting by a successor business entity (i.e., a corporation, partnership or sole proprietorship) in certain situations following a merger or an acquisition. Written comments are due on or before December 13, 2021.

October 15, 2021: The IRS published draft instructions for Form 8949 (Sales and Other Dispositions of Capital Assets). The updated form reflects reporting for Section 1061, which concerns recharacterizing certain long-term capital gains of a partner who holds one or more applicable partnership interests as short-term capital gains.

October 15, 2021: The IRS published a news release, updating its process for certain frequently asked questions (FAQs) on newly-enacted tax legislation. The IRS is updating this process to address concerns regarding transparency and the potential impact on taxpayers when the FAQs are updated or revised. The IRS is also addressing concerns regarding the potential application of penalties to taxpayers who rely on FAQs by providing clarity as to their ability to rely on FAQs for penalty protection. The IRS stated that significant FAQs on newly-enacted [...]

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IRS Provides Guidance on Reliance of FAQs for Penalty Protection Purposes

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 [...]

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