Congress Enhances IRS Tax Penalty & Creates a New Penalty In the Process

The tax penalty for filing a frivolous income tax return has been set so low and its reach so limited that the penalty has not been of much concern to taxpayers. Unfortunately those days are now gone. The Tax Relief and Health Care Act of 2006 has made sweeping changes to the Section 6702 frivolous “tax submissions” penalty.

Prior to the recent change, Section 6702 provided for a $500 penalty for filing a frivolous “tax return.” It was a very short tax code section. The new Section 6702 is much longer. Section 6702 now provides a $5,000 penalty for filing a frivolous “tax return” and a $5,000 penalty for filing a frivolous “tax submission.”

New Section 6702(b)(2)(A) defines a “frivolous submission” as any request for a collection due process hearing or application for an installment agreement, offer in compromise, or taxpayer assistance order that the IRS deems to be frivolous and that the IRS sets out in a published list (the new Section 6702 does not take effect until the IRS publishes this magical list).

The new Section 6702 also provides that the “frivolous submission” penalty will not apply to taxpayers if they withdrawal their submission within 30 days after the IRS notifies the taxpayer that their submission was frivolous.

This gives the IRS the authority to determine what is and what is not “frivolous.” Unfortunately there are going to be instances where the IRS deems a collection due process, installment agreement or offer in compromise frivolous – even though it was submitted by the taxpayer in good faith. The question is how taxpayers are going to be able to convince the IRS of their good faith intent. This is particularly problematic since there is a wide range for many “submissions” that could easily be acceptable. I suppose we will have to wait for the IRS frivolous list to see how the IRS addresses this issue.

Luckily (?), the new Section 6702 gives the IRS the authority to reduce the amount of the penalty if the IRS determines that such a reduction would “promote compliance with and administration of the Federal tax laws.” This is a much different and pro-IRS standard than the “ordinary care” standard that is employed with other IRS tax penalties and it does not include the hardship provisions that are associated with other penalties.

The IRS has taken and continues to take very questionable positions with regard to what constitutes “ordinary care” for other penalties (as evidenced by the court cases where the taxpayers prevailed), so this standard basically gives the IRS the green light to never reduce a penalty. Having worked with the IRS to abate other penalties, I have to say that this provision is a real disappointment.

Along that line, taxpayers should note that there is no corresponding penalty imposed on the IRS for it sending out frivolous documents to taxpayers, which, if you have worked with the IRS on even a few cases, you know happens much more frequently than taxpayers sending frivolous documents to the IRS. As I have said on this blog before, the IRS should be held to the same standard that it holds taxpayers to. If taxpayers are subject to a frivolous submission penalty, the IRS should too.

I would also add that this new “frivolous submission” penalty ignores the fact that many unsuspecting taxpayers hire “tax resolution firms” and those firms submit these “submissions” on behalf of taxpayers. If these firms submit “frivolous submissions” to the IRS, they very well may not get around to withdrawing the submission within the 30 day period (primarily because they handle thousands of cases at one time – it is a volume business). I don’t understand how taxpayers are expected to know whether their “tax resolution firm” is submitting “frivolous submissions” and, even if the taxpayer knows that the submission is “frivolous,” how is the taxpayer to know what to do about it?

I guess this enhanced penalty makes it even more imperative that taxpayers choose wisely before hiring someone to help resolve their IRS tax troubles….