NEW JERSEY ASSOCIATION OF PUBLIC ACCOUNTANTS

    Lines from Lance - Newsletter                                     November 2009

    Business Owners, Accountants, and Others Fined
    $200,000 by IRS and Don’t Know Why

    By Lance Wallach

    If you are a small business owner, accountant or insurance professional you may be in big trouble
    and not know it.  IRS has been fining people like you $200,000.  Most people that have received
    the fines were not aware that they had done anything wrong.  What is even worse is that the fines
    are not appeal-able.  This is not an isolated situation.  This has been happening to a lot of people.

    Currently, the Internal Revenue Service (“IRS”) has the discretion to assess hundreds of
    thousands of dollars in penalties under §6707A of the Internal Revenue Code (“Code”) in an
    attempt to curb tax avoidance shelters. This discretion can be applied regardless of the innocence
    of the taxpayer and was granted by Congress.  It works so that if the IRS determines you have
    engaged in a listed transaction and failed to properly disclose it, you will be subject to a potentially
    draconian penalty regardless of any other facts and circumstances concerning the transaction. For
    some, this penalty has been assessed at almost a million dollars and for many it is the beginning of
    a long nightmare.

    The following is an example:  Pursuant to a settlement with the IRS, the 412(i) plan was
    converted into a traditional defined benefit plan.  All of the contributions to the 412(i) plan would
    have been allowable if they had initially adopted a traditional defined benefit plan.  Based on
    negotiations with the IRS agent, the audit of the plan resulted in no income and minimal excise
    taxes due.   This is because as a traditional defined benefit plan, the taxpayers could have
    contributed and deducted the same amount as a 412(i) plan.

    Towards the end of the audit the business owner received a notice from the IRS.  The IRS
    assessed the client penalties under the §6707A of the Code in the amount of $900,000.00.  This
    penalty was assessed because the client allegedly participated in a listed transaction and allegedly
    failed to file the form 8886 in a timely manner.        

    The IRS may call you a material advisor and fine you $200,000.00. The IRS may fine your clients
    over a million dollars for being in a retirement plan, 419 plan, etc. As you read this article,
    hundreds of unfortunate people are having their lives ruined by these fines. You may need to take
    action immediately. The Internal Revenue Service said it will extend until the end of 2009 a grace
    period granted to small business owners for collection of certain tax-shelter penalties.

    But with that deadline approaching, Congress has not yet acted on the tax shelter penalty
    legislation. IRS Commissioner Doug Shulman said in a letter to the chairmen and ranking members
    of tax-writing committees that the IRS will continue to suspend its collection efforts with regard
    to the penalties until Dec. 31, 2009.

    "Clearly, a number of taxpayers have been caught in a penalty regime that the legislation did not
    intend," wrote Shulman. "I understand that Congress is still considering this issue, and that a
    bipartisan, bicameral, bill may be in the works."  The issue relates to penalties for so-called listed
    transactions, the kinds of tax shelters the IRS has designated most egregious. A number of small
    business owners that bought employee retirement plans so called 419 and 412(i) plans and others,
    that were listed by the IRS, and who are now facing hundreds and thousands in penalties, contend
    that the penalty amounts are unfair.

    Leaders of tax-writing committees in the House and Senate have said they intend to pass
    legislation revising the penalty structure.

    The IRS has suspended collection efforts in cases where the tax benefit derived from the listed
    transaction was less than $100,000 for individuals, or less than $200,000 for firms.

    Senator Ben Nelson (D-Nebraska) has sponsored legislation (S.765) to curtail the IRS and its
    nearly unlimited authority and power under Code Section 6707A. The bill seeks to scale back the
    scope of the Section 6707A reportable/listed transaction nondisclosure penalty to a more
    reasonable level. The current law provides for penalties that are Draconian by nature and offer no
    flexibility to the IRS to reduce or abate the imposition of the 6707A penalty. This has served as a
    weapon of mass destruction for the IRS and has hit many small businesses and their owners with
    unconscionable results.

    Internal Revenue Code 6707A was enacted as part of the American Jobs Creation Act on October
    22, 2004. It imposes a strict liability penalty for any person that failed to disclose either a listed
    transaction or reportable transaction per each occurrence. Reportable transactions usually fall
    within certain general types of transactions (e.g. confidential transactions, transactions with tax
    protection, certain loss generating transaction and transactions of interest arbitrarily so designated
    as by the IRS) that have the potential for tax avoidance. Listed transactions are specified
    transactions which have been publicly designated by the IRS, including anything that is
    substantially similar to such a transaction (a phrase which is given very liberal construction by the
    IRS). There are currently 34 listed transactions, including certain retirement plans under Code
    section 412(i) and certain employee welfare benefit plans funded in part with life insurance under
    Code sections 419A(f)(5), 419(f)(6) and 419(e). Many of these plans were implemented by small
    business seeking to provide retirement income or health benefits to their employees.

    Strict liability requires the IRS to impose the 6707A penalty regardless of innocence of a person (i.
    e. whether the person knew that the transaction needed to be reported or not or whether the
    person made a good faith effort to report) or the level of the person’s reliance on professional
    advisors. A Section 6707A penalty is imposed when the transaction becomes a reportable/listed
    transaction. Therefore, a person has the burden to keep up to date on all transactions requiring
    disclosure by the IRS into perpetuity for transactions entered into the past.

    Additionally, the 6707A penalty strictly penalizes nondisclosure irrespective of taxes owed.
    Accordingly, the penalty will be assessed even in legitimate tax planning situations when no
    additional tax is due but an IRS required filing was not properly and timely filed. It is worth noting
    that a failure to disclose in the view of the IRS encompasses both a failure to file the proper form
    as well as a failure to include sufficient information as to the nature and facts concerning the
    transaction. Hence, people may find themselves subject to the 6707A penalty if the IRS determines
    that a filing did not contain enough information on the transaction. A penalty is also imposed when
    a person does not file the required duplicate copy with a separate IRS office in addition to filing
    the required copy with the tax return. Lance Wallach Commentary. In our numerous talks with
    IRS, we were also told that improperly filling out the forms could almost be as bad as not filing
    the forms. We have reviewed hundreds of forms for accountants, business owners and others.
    We have not yet seen a form that was properly filled in. We have been retained to correct many of
    these forms.

    For more information see www.taxaudit419.com, www.lawyer4audits.com, www.irs.gov or e-
    mail us at wallachinc@gmail.com

    The imposition of a 6707A penalty is not subject to judicial review regardless of whether the
    penalty is imposed for a listed or reportable transaction. Accordingly, the IRS’s determination is
    conclusive, binding and final. The next step from the IRS is sending your file to collection, where
    your assets may be forcibly taken, publicly recorded liens may be placed against your property,
    and/or garnishment of your wages or business profits may occur, amongst other measures.

    The 6707A penalty amount for each listed transaction is generally $200,000 per year per each
    person that is not an individual and $100,000 per year per individual who failed to properly
    disclose each listed transaction. The 6707A penalty amount for each reportable transaction is
    generally $50,000 per year for each person that is not an individual and $10,000 per year per each
    individual who failed to properly disclose each reportable transaction. The IRS is obligated to
    impose the listed transaction penalty by law and cannot remove the penalty by law. The IRS is
    obligated to impose the reportable transaction penalty by law, as well, but may remove the penalty
    when the IRS determines that removal of the penalty would promote compliance and support
    effective tax administration.

    The 6707A penalty is particularly harmful in the small business context, where many business
    owners operate through an S corporation or limited liability company in order to provide liability
    protection to the owner/operators. Numerous cases are coming to light where the IRS is imposing
    a $200,000 penalty at the entity level and them imposing a $100,000 penalty per individual
    shareholder or member per year.

    The individuals are generally left with one of two options:

    •        Declare Bankruptcy

    •        Face a $300,000 penalty per year.

    Keep in mind, taxes do not need to be due nor does the transaction have to be proven illegal or
    illegitimate for this penalty to apply. The only proof required by the IRS is that the person did not
    properly and timely disclose a transaction that the IRS believes the person should have disclosed.
    It is important to note in this context that for non-disclosed listed transactions, the Statue of
    Limitations does not begin until a proper disclosure is filed with the IRS.

    Many practitioners believe the scope and authority given to the IRS under 6707A, which allows
    the IRS to act as judge, jury and executioner, is unconstitutional. Numerous real life stories
    abound illustrating the punitive nature of the 6707A penalty and its application to small businesses
    and their owners. In one case, the IRS demanded that the business and its owner pay a 6707A
    total of $600,000 for his and his business’ participation in a Code section 412(i) plan. The actual
    taxes and interest on the transaction, assuming the IRS was correct in its determination that the
    tax benefits were not allowable, was $60,000. Regardless of the IRS’s ultimate determination as to
    the legality of the underlying 412(i) transaction, the $600,000 was due as the IRS’s determination
    was final and absolute with respect to the 6707A penalty. Another case involved a taxpayer who
    was a dentist and his wife whom the IRS determined had engaged in a listed transaction with
    respect to a limited liability company. The IRS determined that the couple owed taxes on the
    transaction of $6,812, since the tax benefits of the transactions were not allowable. In addition,
    the IRS determined that the taxpayers owed a $1,200,000 section 6707A penalty for both their
    individual nondisclosure of the transaction along with the nondisclosure by the limited liability
    company.

    Even the IRS personnel continue to question both the legality and the fairness of the IRS’s
    imposition of 6707A penalties. An IRS appeals officer in an email to a senior attorney within the
    IRS wrote that “…I am both an attorney and CPA and in my 29 years with the IRS I have never
    {before} worked a case or issue that left me questioning whether in good conscience I could
    uphold the Government’s position even though it is supported by the language of the law.” The
    Taxpayers Advocate, an office within the IRS, even went so far as to publicly assert that the
    6707A should be modified as it “raises significant Constitutional concerns, including possible
    violations of the Eighth Amendment’s prohibition against excessive government fines, and due
    process protection.”

    Senate bill 765, the bill sponsored by Senator Nelson, seeks to alleviate some of above cited
    concerns. Specifically, the bill makes three major changes to the current version of Code section
    6707A. The bill would allow an IRS imposed 6707A penalty for nondisclosure of a listed
    transaction to be rescinded if a taxpayer’s failure to file was due to reasonable cause and not
    willful neglect. The bill would make a 6707A penalty proportional to an understatement of any tax
    due.

    Accordingly, non-tax paying entities such as S corporations and limited liability companies would
    not be subject to a 6707A penalty (individuals, C corporations and certain trusts and estates would
    remain subject to the 6707A penalty).

    There are a number of interesting points to note about this action:

    1.  In the letter, the IRS acknowledges that, in certain cases, the penalty imposed by section
    6707A for failure to report participation in a “listed transaction” is disproportionate to the tax
    benefits obtained by the transaction.

    2.  In the letter, the IRS says that it is taking this action because Congress has indicated its
    intention to amend the Code to modify the penalty provision, so that the penalty for failure to
    disclose will be more in line with the tax benefits resulting from a listed transaction.

    3.  The IRS will not suspend audits or collection efforts in appropriate cases.  It cannot suspend
    imposition of the penalty, because, at least with respect to listed transactions, it does not have the
    discretion to not impose the penalty.  It is simply suspending collection efforts in cases where the
    tax benefits are below the penalty threshold in order to give Congress time to amend the penalty
    provision, as Congress has indicated to the IRS it intends to do.  

    4.  The legislation does not change the penalty provisions for material advisors.

    “Congress has enacted a series of income tax laws designed to halt the growth of abusive tax
    avoidance transactions. These provisions include the disclosure of reportable transactions. Each
    taxpayer that has participated in a reportable transaction and that is required to file a tax return
    must disclose information for each reportable transaction in which the taxpayer participates. Use
    Form 8886 to disclose information for each reportable transaction in which participation has
    occurred. Generally, Form 8886 must be attached to the tax return for each tax year in which
    participation in a reportable transaction has occurred. If a transaction is identified as a listed
    transaction or transaction of interest after the filing of a tax return (including amended returns),
    the transaction must be disclosed either within 90 days of the transaction being identified as a
    listed transaction or a transaction of interest or with the next filed return, depending on which
    version of the regulations is applicable.”

    Lance Wallach, CLU, ChFC, CIMC, speaks and writes about benefit plans, tax reductions
    strategies, and financial plans. He has authored numerous books for the AICPA, Bisk Total tape,
    and others. He can be reached at (516) 938-5007 or wallachinc@gmail.com. For more articles on
    this or other subjects, feel free to visit his website at www.taxlibrary.us
           
    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.
Business Owners, Accountants, and Others
Fined $200,000 by IRS
and Don’t Know Why