The Internal Revenue Service needs to improve its procedures for processing cases involving taxpayers who fail to properly disclose reportable transactions, according to a new government report.
Taxpayers must report certain transactions to the IRS under Section 6707A of the Tax Code, which was enacted in 2004 to help detect, deter, and shut down abusive tax shelter activities. For example, reportable transactions may include transfers of stock options, lease arrangements and trust distributions. Taxpayers must disclose their participation in these and other transactions by filing a Reportable Transactions Disclosure Statement (Form 8886) with their income tax returns. Failure to report the transactions could result in monetary penalties ranging from $10,000 to $200,000.
The report, by the Treasury Inspector General for Tax Administration found that the procedures for documenting and assessing the Section 6707A penalty were not sufficient or formalized, and cases often are not fully developed.
TIGTA evaluated the IRS’s effectiveness in identifying, developing, and applying the Section 6707A penalty. Based on its review of 114 assessed Section 6707A penalties, TIGTA determined that many of these files were incomplete or did not contain sufficient audit evidence. TIGTA also found a need for better coordination between the IRS’s Office of Tax Shelter Analysis and other functions.
“As penalties are meant to encourage voluntary taxpayer compliance, it is important that IRS procedures for documenting and assessing them be well developed and fully documented,” said TIGTA Inspector General J. Russell George in a statement. “Any failure to do so raises the risk that taxpayers will not receive consistent and fair treatment under the law, and could further reduce their willingness to comply voluntarily.”
The Section 6707A penalty is a stand-alone penalty and does not require an associated income tax examination; therefore, it applies regardless of whether the reportable transaction results in an understatement of tax. TIGTA determined that, in most cases, the Section 6707A penalty was substantially higher than additional tax assessments taxpayers received from the audit of underlying tax returns.
On July 7, 2009, at the request of Congress, the IRS agreed to suspend collection enforcement actions because of complaints about the disproportionate size of the penalties for employers who had set up arrangements such as employee benefit plans that ran afoul of the reportable transaction requirements (see IRS Extends Moratorium on Tax Shelter Penalties). However, this did not preclude the issuance of notices of assessment that are required by law and adjustment notices which inform the taxpayer of any account activity. In addition, taxpayers continued to receive balance due and final notices of intent to levy and pay Section 6707A penalties.
Congress revised the size of the penalties last year in the Small Business Jobs Act to make the penalty for failing to disclose a reportable transaction proportionate to the underlying tax savings (see Small Business Bill Offers Tax Shelter Penalty Relief).
TIGTA recommended that the IRS fully develop, document, and properly process Section 6707A penalties. The IRS agreed with TIGTA’s recommendation and plans to take appropriate corrective actions.
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