When the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) was passed, the Senate Finance Committee (Senate Rep. No. 97-494, 272) held the belief that an increasing part of the compliance gap in revenue could be attributed to the “audit lottery,” which is when taxpayers take questionable positions—though not amounting to fraud or negligence—hoping they won’t be audited. So TEFRA added several tax penalty provisions to improve taxpayers’ and tax advisors’ reporting of taxable income. IRC §6701 was one of those provisions to deter promoters of abusive tax shelters and tax advisors from aiding or abetting taxpayers to substantially understate their tax liability.
Calling it a lottery was apt, as the potential outcomes of entering were that either the understatement would go undetected and the taxpayer saved taxes with “an absolute reduction in tax without cost or risk,” or the understatement would be detected and the taxpayer paid the additional tax owed plus an amount of interest that was similar to the cost of borrowing.
PENALIZING NOT ONLY TAXPAYERS
Prior to IRC §6701, there was no penalty for this behavior. Taxpayers and their advisors weren’t exposed to any downside risk in taking highly questionable positions on their tax return. The Senate Finance Committee realized that taxpayers and the government may reasonably differ with the tax laws, but it wanted to deter the use of undisclosed questionable reporting positions and hold taxpayers investing in substantial tax shelters to a higher standard.
In addition to penalizing taxpayers for the understatement of their tax liability, IRC §6701(a) imposes a penalty on the tax preparer, the tax consultant, or the tax advisor, to name a few, who provides the advice that creates wrongful tax savings for the taxpayer. The law specifically spells out that it includes any person who aids, assists in, procures, or advises a taxpayer (individuals or corporations) in the preparation or presentation of any portion of a tax return and knows (or has reason to believe) that such a position, if used, would result in an understatement of the taxpayer’s tax liability. The term “procures” in §6701(a) includes ordering (or otherwise causing) a subordinate to commit and not attempting to prevent the individual’s participation in an act. In other words, plausible deniability doesn’t appear to be a defense for the boss. The amount of the penalty assessed to the tax advisor is generally $1,000 and increased to $10,000 in the case of a tax liability for a corporation.
The Senate Finance Committee provided four reasons for the need to assess a civil penalty on tax advisors (Senate Rep. No. 97-494, 275). First, by discouraging those who would aid others in the fraudulent underpayment of their tax, it would permit more effective enforcement of the tax laws. Second, it’s inappropriate to impose sizeable civil fraud penalties on taxpayers but to allow the advisors who aid or assist those taxpayers to escape sanctions. Third, the committee recognized that certain types of conduct should be penalized even if they might not be severe enough to merit criminal prosecution. Fourth, the committee believed the penalty would help protect innocent taxpayers who are misled into fraudulent conduct by advisors looking to take advantage of them in order to make a profit.
In general, per IRC §6701, an individual who isn’t directly involved in aiding or assisting in the preparation of the understatement isn’t subject to the penalty. In other words, someone who helps by typing, reproducing, or entering the document’s information for the tax advisor wouldn’t be subject to this penalty.
NO STATUTE OF LIMITATIONS
The amount of the monetary penalty may not be huge, but it doesn’t appear to have a statute of limitations. That suggests that there’s no time limit for when the Internal Revenue Service (IRS) can assess a penalty—it could be years after the tax return was filed. A recent case actually addresses this issue. In Armstrong v. United States (123 AFTR 2d 2019-2282, June 20, 2019), a Certified Public Accountant (CPA) whose clients participated in two of her tax plans sought relief from the U.S. District Court in the Northern District of California by seeking a statute of limitations. The court didn’t agree with the taxpayer.
The Sixth Circuit concluded in Mullikin v. United States (69 AFTR 2d 92-376, December 30, 1991) that Congress intended that penalties can be assessed pursuant to IRC §6700 and §6701 at any time. Since IRC §6701 was part of the legislation intended as an anti-fraud provision, it seems reasonable that, like other anti-fraud provisions, the assessment should have an unlimited period. The Supreme Court denied certiorari (506 U.S. 827 (1992)) in this case, which suggests that it didn’t feel this issue merited its weigh-in.
The counterargument raised by Armstrong (and also referenced in Mullikin) is that 28 USC §2462, Time for Commencing Proceedings, is a catch-all limitations provision that should apply to IRC §6701. An interesting legal argument, to say the least, since this counterargument was relying on Title 28 (Judiciary and Judicial Procedure) and stepping outside where most federal tax law is contained in Title 26 (the Internal Revenue Code).
Section 2462 provides, in part, that “except as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued.” This position has been routinely rejected by the courts. As stated in Armstrong, the U.S. Supreme Court precedent is well settled that the U.S. isn’t subject to statutes of limitations in enforcing its rights unless Congress explicitly provides such limitations. The Fifth Circuit commented in Sage v. United States (66 AFTR 2d 90-5422 (1990)) that “[j]ust as with other provisions of the Code enacted to combat fraud no limitations period exists for assessment of an IRC §6700 penalty, and consequently no period of limitations is ‘properly applicable thereto.’ An assessment made at any time will trigger the Section 6502 period of limitations on collection.” That is, the statute of limitations doesn’t kick in until after the assessment is made.
Therefore, the aiding or abetting in the preparation of a tax return, affidavit, claim, or other document intended to use the audit lottery can result in an IRC §6701 penalty. Moreover, the courts have routinely sided with the IRS that this provision doesn’t have any statute of limitations.
© 2019 A.P. Curatola
December 2019
