Penalties; Burdens of Proof

December 28, 2012

Penalties Overview

§ 6662:  Imposition of accuracy-related penalty on underpayments:  Underpayment penalty of 20% attributable to (a) negligence or disregard (careless, reckless or intentional disregard) of rules or regulations, (b) any substantial understatement of income tax (if amount of understatement exceeds greater of 10% of tax required to be shown or $5,000 – special rule for corporations), (c) any substantial valuation misstatement under chapter 1, (d) any substantial overstatement of pension liabilities, (e) any substantial estate or gift tax valuation understatement, (f) any disallowance of claimed tax benefits by reason of a transaction lacking economic substance (within the meaning of § 7701(o)) or failing to meet the requirements of any similar rule of law, and (g) any undisclosed foreign financial asset understatement.

§ 6662A:  Imposition of accuracy-related penalty on understatements with respect to reportable transactions: Underpayment penalty of 20% with respect to reportable transactions.

§ 6663:  Imposition of Fraud Penalty: Fraudulent underpayment penalty of 75%.

Penalties for Promoting Abusive Tax Shelters (I.R.C. 6700)

The Internal Revenue Service may pursue actions under I.R.C. § 6700 against firms and individuals that violate tax laws by participating in abusive transactions.  Section 6700 provides for the imposition of penalties on “any person who […] (1) organizes (or assists in the organization of) a partnership or other entity, any investment plan or arrangement or any other plan or arrangement or participates (directly or indirectly) in the sale of any interest in an entity or plan or arrangement referred to above, and (2) makes or furnishes or causes another person to make or furnish (in connection with such organization or sale) (A) a statement with respect to the allowability of any deduction or credit, the excludability of any income, or the securing of any other tax benefit by reason of holding an interest in the entity or participating in the plan or arrangement which the person knows or has reason to know is false or fraudulent as to any material matter, or (B) a gross valuation overstatement as to any material matter.”  The penalty imposed by I.R.C. § 6700 is in addition to any other penalty provided by law.  The burden of proof of whether or not a person is liable for the penalty in I.R.C. § 6700 is on the Secretary.

Penalties for Failure to Show or Furnish Original Issue Discount Information on Debt Instruments (I.R.C. 6706)

Information required to be set forth on the face of the debt instrument (Non-Publicly Offered Instruments):

In the case of failure to set forth on a debt instrument the information required to be set forth thereon under I.R.C. 1275(c)(1) (unless it is shown that the failure is due to reasonable cause and not willful neglect), the issuer must pay a penalty of $50 for each instrument with respect to which the failure exists.  For debt instruments not publicly offered, Treas. Reg. 1.1275-3(b) requires that the issuer:

  • legend the instrument by stating on the face of the instrument that the instrument was issued with OID; and
  • Either:
    • Set forth on the face of the instrument the issue price, the amount of OID, the issue date, the yield to maturity and, if the instrument is subject to the rules of Treas. Reg. 1.1275-4(b), the comparable yield and projected payment schedule; or
    • Provide the name or title and either the address or phone number of a representative of the issuer who will, beginning no later than 10 days after the issue date, promptly make available to holders upon request the information described in the prior paragraph.

The legending described above must occur when the bond issue first issued in physical form, but is not required before the first holder of the debt instrument disposes of the instrument.

The legend must survive reissuance.

Legending is not required for debt instruments described in I.R.C. 1272(a)(2) (tax-exempt obligations, United States savings bonds, short-term obligations, obligations issued by natural persons, loans between natural persons), debt instruments issued by natural persons, REMIC regular interests or other debt instruments subject to I.R.C. 1272(a)(6) (regular interest in a REMIC or qualified mortgage held by a REMIC, any other debt instrument if payments under such debt instrument may be accelerated by reason of prepayments of other obligations securing such debt instruments, or any pool of debt instruments the yield on which may be affected by reason of prepayments), or stripped bonds and coupons within the meaning of I.R.C. 1286.

Information required to be reported to the Secretary upon issuance (Publicly Offered Instruments):

Any issuer who fails to furnish information required under I.R.C. 1275(c)(2) with respect to any issue of debt instruments on the date required must pay a penalty equal to one percent of the aggregate issue price of the issue, unless it is shown that the failure is due to reasonable cause and not willful neglect.  The amount of the penalty imposed with respect to any issue of debt instruments may not exceed $50,000 for the issue.

The issuer of the instrument must make an information return prescribed by the Commissioner (IRS Form 8281) within 30 days after the issue date of the issue.  The information reporting requirement does not apply to substantially the same debt instruments referred to in the exceptions paragraph for non-publicly offered instruments (with some changes).

Burdens of Proof

“Preponderance of the evidence” = The degree of relevant evidence that a reasonable person, considering the record as a whole, would accept as sufficient to find that a contested fact is more likely to be true than untrue. 51%

“Clear and convencing evidence” = Standard required by the IRS to prove fraudulent understatement for purposes of the penalty under § 6663.