63National Taxpayer Advocate 2024 Purple Book
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Legislative Recommendation #28
Convert the Estimated Tax Penalty Into an Interest Provision to
Properly Reflect Its Substance
SUMMARY
• Problem: If a self-employed individual or business fails to pay sucient estimated tax during the year,
the IRS will impose an addition to tax that is computed as an interest charge but classied as a penalty.
e term “penalty” implies that the individual or business has engaged in improper conduct, yet small
businesses often experience signicant uctuations in their incomes and expenses from year to year that
make it dicult for them to accurately estimate their tax liabilities.
• Solution: Reclassify the addition to tax for underpaying estimated tax as an interest charge (rather than
a penalty).
PRESENT LAW
rough the combination of wage withholding and estimated tax payments, the IRC aims to ensure that
federal income and payroll taxes are paid ratably throughout the year. IRC § 3402 generally requires
employers to withhold tax on wages paid to employees. For many employees, wage withholding covers
their tax liabilities in full. But taxpayers who are self-employed and taxpayers who have investment income
typically are not subject to withholding on this “non-wage” income and instead must make estimated
tax payments.
IRC § 6654 generally requires individual taxpayers to pay at least the lesser of (i) 90 percent of the tax shown
on a tax return for the current tax year or (ii) 100 percent of the tax shown on a tax return for the preceding
tax year (reduced by the amount of wage withholding) in four installment payments due on April 15,
June 15, September 15, and January 15 of the following tax year.
1
IRC § 6655 generally requires corporate
taxpayers to pay at least 100 percent of the tax shown on a tax return for the current tax year or, in some cases,
100 percent of the tax shown on a tax return for the preceding tax year in four installment payments due on
April 15, June 15, September 15, and December 15.
IRC §§ 6654(a) and 6655(a) provide that a taxpayer who fails to pay sucient estimated tax will be liable
for a penalty that is computed by applying (i) the underpayment rate established under IRC § 6621(ii) to the
amount of the underpayment (iii) for the period of the underpayment. IRC § 6621 is an interest provision.
erefore, the additional amount a taxpayer owes for failing to pay sucient estimated tax is computed as an
interest charge, even though it is denominated as a “penalty.”
1 If the adjusted gross income of a taxpayer for the preceding tax year exceeds $150,000, “110 percent” is substituted for
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64 Reform Penalty and Interest Provisions
REASONS FOR CHANGE
For a variety of reasons, taxpayers often have diculty predicting how much tax they will owe. Self-employed
taxpayers or taxpayers who own small businesses may experience signicant uctuations in their income
and expenses from year to year. Taxpayers with sizable investment incomes may experience signicant
uctuations. Substantial changes in tax laws, such as those that took eect in 2018, may aect tax liabilities
in ways that taxpayers do not fully anticipate. As a result, millions of taxpayers do not satisfy the requirements
of IRC § 6654 and are liable for penalties each year, even though many have attempted to comply. Corporate
taxpayers face similar challenges.
e term “penalty” carries negative connotations, and the National Taxpayer Advocate believes it should be
reserved for circumstances in which a taxpayer has failed to make reasonable eorts to comply with the law.
us, she agrees with the assessment of the House Committee on Ways and Means when it wrote during a
previous Congress: “Because the penalties for failure to pay estimated tax are calculated as interest charges,
the Committee believes that conforming their title to the substance of the provision will improve taxpayers’
perceptions of the fairness of the estimated tax payment system.”
2
e Oce of the Taxpayer Advocate has conducted research studies that have found “tax morale” has an
impact on tax compliance.
3
When the IRS imposes a “penalty” on a taxpayer, there is a strong implication that the taxpayer has engaged
in improper conduct. For that reason, penalties generally should be subject to waiver for reasonable cause.
Under current law, the estimated tax penalty cannot be waived. us, an individual who experiences a
re, ood, medical emergency, or other exigent circumstance that precludes payment by the estimated tax
deadline will still be “penalized.” is characterization is not good for “tax morale.” If the addition to tax
is recharacterized as an interest charge designed solely to compensate the government for the time value of
money, it would be easier to justify imposing it without waiver.
RECOMMENDATIONS
• Recharacterize the penalty for failure to pay sucient estimated tax as an interest charge– which is the
basis for the calculation of the addition to tax. Toward that end, relocate IRC §§ 6654 and 6655 from
part I of subchapter A of chapter 68 to the end of subchapter C of chapter 67 and make conforming
modications to the headings and text.
4
• If a failure to pay sucient estimated tax continues to be treated as a penalty, enact a reasonable cause
exception so that the penalty will not apply when a payment is late due to circumstances beyond the
taxpayer’s control, such as a re, ood, or medical condition that makes compliance impractical.
5
2 H.R. REP. NO
SeeDo Accuracy-Related
Penalties Improve Future Reporting Compliance by Schedule C Filers?),
.
5 For more detail on our recommendation to enact a reasonable cause exception if the additional charge for failure to pay
A Framework for Reforming the Penalty Regime),
vol2.pdf.
65National Taxpayer Advocate 2024 Purple Book
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Legislative Recommendation #29
Apply One Interest Rate Per Estimated Tax Underpayment Period
SUMMARY
• Problem: e due dates for estimated tax payments and the dates on which the interest rate for
estimated tax underpayments are adjusted do not align. As a result, more than one interest rate may
apply for a single estimated tax underpayment period, causing unnecessary complexity and burden
for taxpayers.
• Solution: Apply the interest rate established on the rst day of a calendar quarter to any underpayment
that begins during that calendar quarter.
PRESENT LAW
IRC § 6654(c) provides that taxpayers who make estimated tax payments must submit those payments on or
before April 15, June 15, September 15, and January 15 of the following tax year. Similarly, IRC § 6655(c)
provides that corporations required to make installment payments must submit those payments on or before
April 15, June 15, September 15, and December 15.
1
Failure to make required estimated tax payments results
in a penalty that is determined by the underpayment rate, the amount of the underpayment, and the period
of the underpayment.
Under IRC § 6621(a)(2), the underpayment rate is equal to the federal short-term interest rate, plus three
percentage points. Under IRC § 6621(b)(1), the federal short-term interest rate is determined quarterly by
the Secretary of the Treasury. If the Secretary determines a change in the federal short-term interest rate, the
change is eective on January 1, April 1, July 1, and October 1.
REASONS FOR CHANGE
Under current law, more than one interest rate may apply for a single estimated tax underpayment period.
Calculations are typically required to cover 15-day periods. For example, if a taxpayer fails to make an
estimated tax payment due June 15 and the Secretary determines a change in the federal short-term interest
rate eective July 1, one interest rate would apply for the period from June 16 through June 30, and the
rate would be subject to adjustment on July 1. A change in interest rate just 15 days after the estimated tax
underpayment period begins causes unnecessary complexity and burden for taxpayers. is complexity and
burden would be reduced if a single interest rate were applied for each period.
RECOMMENDATION
• Amend IRC §§ 6654 and 6655 to provide that the underpayment rate for any day during an estimated
tax underpayment period shall be the underpayment rate established by IRC § 6621 for the rst day of
the calendar quarter in which the underpayment period begins.
2
1 To make compliance easier, the National Taxpayer Advocate has recommended that Congress set the estimated tax
See
Adjust Individual Estimated Tax Payment Deadlines to Occur Quarterly,
.
See also
H.R. REP. NO
66 Reform Penalty and Interest Provisions
REFORM PENALTY AND INTEREST PROVISIONS
Legislative Recommendation #30
Pay Interest to Taxpayers on Excess Payments of Estimated
Tax to the Same Extent Taxpayers Must Pay a Penalty on
Underpayments of Estimated Tax
SUMMARY
• Problem: e government charges taxpayers interest for underpayments of estimated tax, but it does
not pay taxpayers interest for overpayments of estimated tax. In both perception and reality, this
incongruity is one-sided and unfair.
• Solution: Require the government pay interest on overpayments of estimated tax to the same extent as it
charges taxpayers interest for underpayments of estimated tax.
PRESENT LAW
rough wage withholding and estimated tax payments, Congress aims to ensure that taxes are prepaid ratably
throughout the year. IRC § 3402 generally requires employers to withhold tax on wages paid to employees.
IRC § 6654(g) provides that income taxes withheld from wages are deemed paid in equal amounts on the
estimated tax installment due dates throughout the year unless the taxpayer establishes the dates on which the
amounts were withheld.
IRC §§ 6654 and 6655 generally require individual and corporate taxpayers, respectively, to prepay their tax
in four installment payments. A taxpayer who fails to pay enough estimated tax will be liable for a “penalty”
determined at a rate that is roughly equal to the interest rate on an underpayment under IRC § 6621
beginning on the date the estimated tax payment was due. However, the government does not pay interest on
excess estimated tax payments made by taxpayers.
IRC § 6621(a) provides that the overpayment and underpayment rates are generally the federal short-term
rate, plus three percentage points (or two percentage points for overpayments by corporations).
1
IRC § 6611(b)(2) provides that the government is, in practice, generally entitled to a grace period of up to
30 days before it is required to pay interest. IRC § 6611(b)(3) provides that if a return is late, the government
does not pay interest for any day before it is led.
REASONS FOR CHANGE
ere are at least three good reasons for the government to pay interest on excess estimated tax payments.
First, it would be reciprocal and fair. e government eectively charges interest on estimated tax
underpayments.
2
It seems one-sided that it does not pay interest on estimated tax overpayments.
1 The overpayment rate for corporations is further reduced to the extent their overpayments exceed $10,000, and corporations are
that interest is payable on equivalent underpayments and overpayments made by the same taxpayer, the net rate of interest is zero.
IRC § 6621(d).
2 Technically, amounts the government charges for tax underpayments are denominated as penalties pursuant to IRC §§ 6654(a)
a recommendation to convert the estimated tax penalty into an interest provision, see Convert the Estimated Tax Penalty into an
Interest Provision to Properly Reflect Its Substance, supra.
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67National Taxpayer Advocate 2024 Purple Book
Second, paying interest could improve voluntary tax compliance. Tax professionals routinely advise
taxpayers that it is foolish to make excess tax payments because they are, in eect, giving the government an
interest-free loan.
3
But it is often dicult for taxpayers to estimate exactly how much they should pay.
4
Notably, taxpayers who owe a balance upon ling are more likely than others to understate their tax
liabilities.
5
In tax year 2021, moreover, nearly 33 percent of such taxpayers with a balance due failed to pay
it in full.
6
us, if encouraging excess estimated tax payments reduces underpayments, it should improve
both reporting and payment compliance.
ird, paying interest would provide an additional incentive for taxpayers to le timely to avoid forfeiting
the interest on a late-led return pursuant to IRC § 6611(b)(3). erefore, it might also serve to improve
ling compliance.
RECOMMENDATION
• Amend IRC § 6621 to pay interest on excess estimated tax payments at the applicable overpayment rate
beginning on the due date of the payments. If Congress wishes to minimize the budget impact of this
recommendation, it could cap the excess estimated tax payment amount that will bear interest for each
taxpayer on an annual basis.
See, e.gThe Great Tax Refund Debate: Is It Financially Wiser to Get a Big Refund — or Nothing?EWS
MONEYWATCH.
4 See, e.g
citing W&I Customer Research
Shortchanged: The Tax Compliance Challenges of Small Business Operators Driving the On-Demand Platform Economy
or (reporting on a survey that found
The Association Between Underwithholding and
Noncompliance
understated tax on other returns”).
68 Reform Penalty and Interest Provisions
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Legislative Recommendation #31
Extend the Reasonable Cause Defense for the Failure-to-File
Their Returns
SUMMARY
• Problem: A taxpayer who fails to le a tax return by the deadline is subject to a late-ling penalty unless
the taxpayer can demonstrate “reasonable cause” for the failure. In 1985, the Supreme Court held
that reliance on a tax return preparer to le a return did not alone constitute “reasonable cause” for
a late-ling penalty because the taxpayer had a responsibility to ensure the deadline was met. While
that conclusion may be appropriate in the context of paper-led returns, where a taxpayer can mail
the return himself, it is not appropriate in the context of e-led returns, where the preparer typically
submits the return and the taxpayer cannot easily verify whether a return has been led and accepted.
• Solution: Allow taxpayers who rely on tax return preparers to e-le their returns to receive “reasonable
cause” relief from the failure-to-le penalty.
PRESENT LAW
IRC § 6651 imposes an addition to tax when a taxpayer fails to le a return by the due date, unless the
taxpayer can show the failure was due to reasonable cause and not due to willful neglect (the “failure-to-le
penalty”).
1
Reasonable cause exists when a taxpayer has exercised ordinary business care and prudence but was
unable to le the return within the prescribed time.
2
In United States v. Boyle, the Supreme Court held that a taxpayer’s reliance on an agent to le a return did not
constitute “reasonable cause” for late ling.
3
In Boyle, the tax return at issue was led on paper. In 2023, the
U.S. Court of Appeals for the Eleventh Circuit ruled that the Boyle holding applies in the context of e-led
returns.
4
is was the rst time a federal appeals court had decided the issue. Several U.S. district courts have
similarly held that Boyle applies to e-ling.
5
In the IRS Restructuring and Reform Act of 1998, Congress adopted a policy that “paperless ling should be
the preferred method and most convenient means of ling Federal tax and information returns” and gave the
Secretary broad authority to incentivize taxpayers to le returns electronically.
6
IRC § 6011(e)(3) authorizes
the Secretary to require tax return preparers to le returns electronically unless they reasonably expect to le
ten or fewer individual income tax returns during a calendar year. Treas. Reg. § 301.6011-7 implements
this requirement.
1
maximum of 25 percent. The penalty increases to 15 percent per month up to a maximum of 75 percent if the failure to file is
fraudulent. IRC § 6651(f).
2
See also
.
Boyle
4
Lee v. United States
5
See, e.g., Haynes v. United Statesvacated and remanded
Intress v. United StatesOosterwijk v. United States
6
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REASONS FOR CHANGE
At the time Boyle was decided, all tax returns were led on paper. Taxpayers generally could fulll the basic
responsibility of mailing returns to the IRS themselves, even when they engaged tax professionals to prepare
them. In ruling that the taxpayer in Boyle was not entitled to “reasonable cause” abatement as a matter of law,
the Supreme Court stated that “[i]t requires no special training or eort to ascertain a deadline and make sure
that it is met.”
7
In eect, the Boyle decision concluded that the duty to le a return is non-delegable. While that rule might
make sense in a paper-ling context, it is not reasonable to apply it in the e-ling context. Today, most
taxpayers eectively delegate the electronic ling of their returns to preparers or use software providers.
Particularly when a taxpayer uses a preparer, the taxpayer is generally several steps removed from the ling
process. When a preparer e-les a tax return, he or she must transmit it through an electronic return
originator (typically, a software company) to the IRS. us, there are four parties sequentially involved in
this chain: (i) the taxpayer; (ii) the preparer; (iii) the software company; and (iv) the IRS. If the IRS rejects an
e-led tax return, it generally sends a notication back through the software company to the preparer, but it
will not notify the taxpayer directly.
8
In these circumstances, a taxpayer cannot easily ensure his or her return
has been properly submitted by the preparer and accepted by the IRS. In addition, the IRS rejects e-led
returns before processing for a wide variety of reasons, and unlike with paper ling, a return that is e-led
with the IRS but rejected before processing is not treated as timely led.
While Treasury regulations generally require tax return preparers to e-le client returns, the regulations exempt
preparers from the e-ling requirement if a taxpayer provides the preparer with “a hand-signed and dated
statement” that says the taxpayer chooses to le a paper return.
9
is “opt-out” may reduce a taxpayer’s risk
of incurring a failure-to-le penalty. In light of the congressional directive to incentivize e-ling, it makes
little sense for the government, in eect, to tell taxpayers they can reduce their risk of incurring a failure-to-le
penalty by ling their returns on paper.
10
e Eleventh Circuit’s decision, Lee v. United States, highlights the unfairness of applying the Boyle rule in
the context of e-ling. In many ways, the taxpayer in Lee was a model taxpayer. A surgeon with signicant
earnings, he hired a certied public accountant (CPA) to prepare and le his complicated returns for
2014-2016. During each of those years, he ensured the returns were timely prepared and veried, and he sent
a signed Form 8879, IRS e-le Signature Authorization, to the CPA before the ling deadline. Additionally,
he made signicant overpayments of tax each year to avoid an underpayment penalty, choosing to apply the
overpayments to the following year’s liability. However, his CPA never led the returns, apparently because
they were too complex for the ling software, and he did not tell the taxpayer. e CPA also did not provide
the IRS with the taxpayer’s correct mailing address, so the taxpayer did not receive any notices. e taxpayer
was completely unaware that his returns had not been led until the IRS visited his oce in2018. Because
the CPA had not led the returns, the IRS did not apply the 2014 overpayment to subsequent years, leaving
the taxpayer with tax liabilities for 2015 and 2016 and approximately $70,000 in penalties.
11
7
Boyle
8
.
10
than 84 million returns). See
.
11
Circuit noted that it and other courts have held that BoyleLee v. United States,
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70 Reform Penalty and Interest Provisions
After ling a refund claim with the IRS, which was denied, the taxpayer brought suit in U.S. district court,
arguing there was reasonable cause for the failure to le due to his reliance on the CPA. e district court
held that the Boyle rule applied to e-led returns,
12
and the Eleventh Circuit agreed. e taxpayer made
several arguments as to why the penalties should be abated, including that once he had sent the Form 8879
to the CPA, the burden was on the CPA to le the returns and the failure to do so was beyond the taxpayer’s
control. However, the Eleventh Circuit rejected the taxpayer’s arguments, concluding there was no basis to
treat e-led returns dierently from paper-led returns under the Supreme Court’s Boyle decision. One judge
wrote a concurring opinion “to highlight the risks facing taxpayers” due to Boyle’s application in the e-ling
context, noting the fact that the taxpayer owed taxes and penalties to the IRS despite his otherwise prudent
actions “is reective of the current e-ling system and the precarious situation in which it places taxpayers
who rely on” preparers.
13
Prior to the Eleventh Circuit’s decision in Lee, several U.S. district courts had similarly held that Boyle applied
in the e-ling context.
14
As in Lee, the facts of these cases illustrate the unfairness of Boyle’s application. In
Haynes v. United States, a married couple employed a CPA to prepare and le their joint tax return.
15
e
preparer timely e-led the return, but the IRS did not accept it for processing because a taxpayer identication
number was listed on the wrong line. e preparer did not receive a rejection notice from the IRS. e
preparer notied the taxpayers that their return had been timely led. Ten months later, the IRS notied
the taxpayers that their return had not been received and asserted the failure-to-le penalty. e taxpayers
requested penalty abatement for reasonable cause, asserting they had sought to le their return timely, their
preparer had transmitted the return timely, and both the preparer and the taxpayers believed the return had
been received. e taxpayers led suit in district court, arguing that Boyle should not apply in the context of
electronic ling because the complexities of e-ling vastly exceed the comparatively simple and veriable task
of mailing a return. e district court concluded that the holding in Boyle applies to e-led returns to the
same extent as paper-led returns and ruled in the government’s favor as a matter of law.
16
e issue in these cases is not whether the failure-to-le penalty is applicable in the rst instance. Based on
the wording of the statute, there is no doubt the penalty is applicable if the return is led late. Rather, the
issue is whether taxpayers are entitled to request abatement of the penalty on “reasonable cause” grounds.
Because the Boyle decision used relatively sweeping language, lower courts have seemingly felt bound to apply
its holding in the context of e-led returns, notwithstanding the signicant dierences between paper ling
and electronic ling.
While the bright-line rule embodied in Boyle is convenient for the IRS to administer, the nearly automatic
assessment of the failure-to-le penalty for e-led returns deemed late (often where the return was submitted
timely by the taxpayer or preparer but rejected by the IRS before processing) is grossly unfair and undermines
12
Lee v. United States
Lee v. United States
noted that under Boyle
See id
14
See, e.g., Haynes v. United Statesvacated and remanded
Intress v. United StatesOosterwijk v. United States
15
16
and did not take a position on the Boyle issue. Haynes v. United StatesSee also Keith Fogg,
ROCEDURALLY TAXINGLOG, TAX NOTES FED
.
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the congressional policy that e-ling be encouraged. e American College of Tax Counsel shares this view
and submitted a compelling amicus curiae brief in the appeal of the Haynes decision.
17
RECOMMENDATION
• Amend IRC § 6651 to specify that reasonable cause relief may be available to taxpayers that use return
preparers to submit their returns electronically and direct the Secretary to issue regulations specifying
what constitutes ordinary business care and prudence for e-led returns.
17
See
.
72 Reform Penalty and Interest Provisions
REFORM PENALTY AND INTEREST PROVISIONS
Legislative Recommendation #32
Authorize a Penalty for Tax Return Preparers Who Engage in
Fraud or Misconduct by Altering a Taxpayer’s Tax Return
SUMMARY
• Problem: When a corrupt tax return preparer steals from a client or from the public sc, the
government’s enforcement options are limited. e Department of Justice (DOJ) may bring criminal
charges, but it lacks the resources to do so except in cases of widespread, high-dollar schemes. e
alternative is civil penalties, but the law currently does not authorize meaningful amounts.
• Solution: Authorize the IRS to impose larger civil penalties in a wider range of cases.
PRESENT LAW
IRC § 6694(b) authorizes the IRS to impose a penalty when a tax return preparer has understated a tax
liability on a “return or claim for refund” and the understatement is due to willful or reckless conduct.
1
IRC § 6695(f ) imposes a $500 penalty (adjusted for ination) on a preparer who negotiates a taxpayer’s
refund check.
2
REASONS FOR CHANGE
TAS has handled hundreds of cases involving return preparer fraud or misconduct. In the most common
scenario, a taxpayer visits a preparer to get his tax return prepared, the preparer completes the return while
the taxpayer is present, and the preparer alters the return after the taxpayer leaves before submitting it to
the IRS. In some cases, the items of income, deduction, and credit are accurate, but the preparer alters the
direct deposit routing information so that the entire refund is directed to the preparer’s account instead of the
taxpayer’s account. In other cases, the preparer increases the refund amount and elects a “split refund,”
3
so the
taxpayer receives the refund amount he expects, and the additional amount goes to the preparer.
e DOJ may bring criminal charges against preparers who alter tax returns, but resource constraints generally
preclude criminal charges except in cases of widespread schemes. In addition, the dollar amount of a refund
obtained by a preparer in these cases often will determine whether DOJ pursues an erroneous refund suit
under IRC § 7405, also due to resource constraints.
4
It is therefore important that the IRS has the authority
to impose sizeable civil penalties against preparers who alter tax returns without the knowledge or consent
of taxpayers.
1
The amount of the penalty is per return or claim for refund and is equal to the greater of $5,000 or 75 percent of the income derived
2
Taxpayers can split their refunds among up to three accounts at a bank or other financial institution. See Form 8888, Allocation of
refunds into their tax return preparer’s account.
4
See
5r (“The erroneous refund suit is limited to amounts that exceed the litigating
threshold established by the Department of Justice.”).
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Under current law, the IRS has very limited authority to impose civil penalties in instances of preparer fraud
or misconduct. e IRC § 6694 penalty generally will not apply to either of the scenarios described above for
the following reasons:
• When a preparer has altered items of income, deduction, or credit in an attempt to increase a
taxpayer’s refund after the taxpayer has reviewed and approved the return for ling, the IRS Oce of
Chief Counsel has concluded that the resulting document is not a valid “return.”
5
As a consequence,
the IRC § 6694 penalty does not apply.
• When a preparer has altered only the direct deposit information on the return and has not changed
the tax liability, there is no understatement of tax.
In addition, it is unclear whether the IRC § 6695(f) penalty applies. Treasury regulations have interpreted
the IRC § 6695(f ) penalty as applicable to a preparer who negotiates “a check (including an electronic
version of a check).”
6
Although the IRS’s internal procedures currently treat direct deposits as subject to
the IRC § 6695(f ) penalty, the tax code and regulations do not make clear whether a “direct deposit” is
legally identical to an “electronic version of a check.”
7
Moreover, even if the penalty is applicable, the penalty
amount for 2023 of $600
8
is typically small in relation to the size of refunds that some preparers have
misappropriated and does not serve as a deterrent.
e National Taxpayer Advocate recommends the IRS be given the authority to impose civil penalties on
tax return preparers who engage in fraud or misconduct by altering the return of a taxpayer for personal
nancial gain.
RECOMMENDATIONS
• Amend IRC § 6694(b) so the penalty the IRS may assess against a tax return preparer for understating
a taxpayer’s liability is broadened beyond tax returns and claims for refund by adding the words “and
other submissions purporting to be returns.”
• Amend IRC § 6695 to (i) explicitly cover a preparer who misappropriates a taxpayer’s refund by
changing the direct deposit information and (ii) increase the dollar amount of the penalty to deter
preparers from engaging in this type of fraud or misconduct. To make the public sc whole, the penalty
should be equal to 100 percent of the amount a preparer has improperly converted to his own use by
altering a taxpayer’s tax return.
5
6
7
See.
8
74 Reform Penalty and Interest Provisions
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Legislative Recommendation #33
Clarify That Supervisory Approval Is Required Under
IRC § 6751(b) Before Proposing Penalties
SUMMARY
• Problem: By law, some penalties require supervisory approval. However, the law leaves the timing of
this approval unclear. is ambiguity has generated conicting decisions among the courts, which
leaves taxpayers lacking certainty about how they should be treated by the IRS.
• Solution: Clarify that supervisory approval is required before a proposed penalty is communicated in
written form to a taxpayer.
PRESENT LAW
IRC § 6751(b)(1) provides: “No penalty under this title shall be assessed unless the initial determination of
such assessment is personally approved (in writing) by the immediate supervisor of the individual making such
determination or such higher level ocial as the Secretary may designate.”
IRC § 6751(b)(2) carves out two categories of exceptions from this supervisory approval requirement:
(i) the additions to tax for failure to le a tax return or pay the tax due (IRC § 6651) and the additions to
tax for failure to pay sucient estimated tax (IRC §§ 6654 and 6655) and (ii) any other penalty that is
“automatically calculated through electronic means.”
REASONS FOR CHANGE
IRC § 6751(b) protects taxpayers’ right to a fair and just tax system
1
by ensuring that penalties are only
imposed in appropriate circumstances and are not used as a bargaining chip to encourage settlement.
2
However, the phrase “initial determination of [an] assessment” is unclear. A “determination” is made based
on the IRS’s investigation of the taxpayer’s liability and an application of the penalty statutes. An “assessment”
is merely the entry of a decision on IRS records. erefore, while a penalty can be determined and a penalty
can be assessed, “one cannot ‘determine’ an ‘assessment.’”
3
Due to this apparent drafting error and consequent
ambiguity in the statute, an increasing number of courts have had to grapple with the question of when
written supervisory approval must be provided.
4
In recent years, courts have come to various conclusions
about when the supervisory approval must occur:
• In 2016, the Tax Court held in Graev v. Commissioner (which was later vacated) that supervisory
approval for penalties subject to deciency procedures could take place at any point before the
assessment was made.
5
1 See.
2 SeeEP. NO
Chai v. Comm’rGraev v. Comm’r
4 SeeAccuracy-Related Penalty
U),
Accuracy.pdfAccuracy-Related Penalty
),
.
5 147 T.C. at 460, superseded by, in part, modified by, in part
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75National Taxpayer Advocate 2024 Purple Book
• In 2017, the U.S. Court of Appeals for the Second Circuit held in Chai v. Commissioner that
supervisory approval was required for penalties subject to deciency procedures no later than the date
on which the IRS issued the notice of deciency or, if the penalty was asserted through an answer or
amended answer, the time of that ling.
6
• In 2019, the Tax Court held in Clay v. Commissioner that supervisory approval for penalties subject to
deciency procedures was required prior to sending the taxpayer a formal communication that included
the right to go to the IRS Independent Oce of Appeals.
7
• In 2020, the Tax Court followed Clay and held in Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner
that the same timing rule applied to assessable penalties. at decision was overruled by the U.S.
Court of Appeals for the Ninth Circuit in 2022.
8
ere, the Ninth Circuit held that approval must be
obtained before assessment of the penalty or, if earlier, before the relevant supervisor loses discretion to
approve the penalty assessment.
In Belair Woods, LLC v. Commissioner, the Tax Court found the IRS did not have to obtain supervisory
approval before sending the taxpayer a Letter 1807, TEFRA Partnership Cover Letter for Summary Report,
which invited the taxpayer to a closing conference to discuss proposed adjustments.
9
Instead, the court found
that Letter 1807 only advised the taxpayer of the possibility that penalties could be proposed, and the pivotal
moment requiring supervisory approval was when the IRS sent the 60-day letter formally communicating its
denite decision to assert the penalties.
In September 2020, the IRS issued interim guidance that instructs employees to obtain written supervisory
approval before sending a written communication that oers the taxpayer an opportunity to sign an
agreement or consent to assessment or proposal of a penalty.
10
e interim guidance species that prior to
obtaining written supervisory approval, employees can share written communications with the taxpayer that
reect proposed adjustments as long as they do not oer the opportunity to sign an agreement or consent to
assessment or proposal of the penalty.
In 2023, the Treasury Department issued proposed regulations under IRC § 6751.
11
For pre-assessment
penalties subject to Tax Court review, the proposed regulations would allow supervisory approval to
be obtained any time before issuance of the statutory notice of deciency. Penalties not subject to
pre-assessment Tax Court review could be approved up until the time of the assessment itself. Also in 2023,
the Treasury Department asked Congress to amend IRC § 6751 to achieve the same result.
12
us, the
proposed regulations and legislation would establish the broadest possible window and allow the requisite
supervisory approval to occur at the latest possible moment. In this way, the proposed regulations and
legislative proposal would bring relative certainty to this area, but they would do so by seriously eroding
8 Laidlaw’s Harley Davidson, Inc. v. Comm’rrev’gSee also Kroner v. Comm’r,
rev’gLaidlaw’s
decision. In Carter v. Comm’rrev’g
decision in Kroner.
10
reissued by
.
11
12 Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals
legislative change in case the courts invalidate the regulation.
REFORM PENALTY AND INTEREST PROVISIONS
76 Reform Penalty and Interest Provisions
the taxpayer protections provided by IRC § 6751 and in opposition to the views expressed by a range of
stakeholders and commentators, including the National Taxpayer Advocate.
13
Both Belair Woods and the Treasury Department’s position leave open the possibility that IRS employees could
use penalties as a bargaining chip – precisely what Congress sought to prevent by enacting IRC § 6751(b).
Under Belair Woods, IRS employees can propose penalties to induce a resolution without rst obtaining
written supervisory approval, so long as the communication is deemed a proposal and not a denite decision.
is approach undermines the statutory intent because, as explained in the dissent in Belair Woods, “[e]very
communication from the Commissioner proposing a deciency and a related penalty – whether it is a
preliminary report, a 30- or 60-day letter, or a notice of deciency – sets forth proposed adjustments, which
do not become nal until a decision is entered, or an assessment is properly recorded.”
14
e IRS’s interim guidance, the proposed regulations, and the Treasury Department’s legislative proposal
seek to resolve the question of what is merely a proposal as opposed to a denite decision by drawing the
line at written communications that oer a chance to agree to assessment or consent to proposal of a penalty.
However, employees could still use penalties as a bargaining chip because some taxpayers may feel pressured to
resolve their cases when penalties are rst put on the table as proposed adjustments.
In addition to the timing issue, the statutory language of IRC § 6751(b)(1) is also problematic because of
its focus on “assessment(s).” In Wells Fargo & Company v. Commissioner, the U.S. Court of Appeals for the
Eighth Circuit found that supervisory approval under IRC § 6751(b) was not required because there was
no assessment.
15
ere, the IRS asserted the accuracy-related penalty in a refund suit to oset any refund
granted to the taxpayer. Because the penalty, if upheld by the court, would only lead to a reduced refund
and not a balance to be assessed, the court found there would be no assessment and thus no requirement for
supervisory approval.
In practice, the overwhelming majority of penalties imposed by the IRS are excluded from the supervisory
approval requirement through one of the exceptions in IRC § 6751(b)(1).
16
But where written supervisory
approval is required, the National Taxpayer Advocate believes it should be required early enough in the process
to ensure it is meaningful and is not merely an after-the-fact rubber stamp applied in the cases in which a
taxpayer challenges a proposed penalty.
RECOMMENDATION
• Amend IRC § 6751(b)(1) to clarify that no penalty under Title 26 shall be assessed or entered in a nal
judicial decision unless the penalty is personally approved (in writing) by the immediate supervisor of
the individual making such determination or such higher level ocial as the Secretary may designate
prior to the rst time the IRS sends a written communication to the taxpayer proposing the penalty as
an adjustment.
Reconsidering the IRS’s Approach to Supervisory Review, NATIONAL TAXPAYER ADVOCATELOG
.
14 Belair Woods, LLC v. Comm’r
15 aff’g
16
.
77National Taxpayer Advocate 2024 Purple Book
REFORM PENALTY AND INTEREST PROVISIONS
Legislative Recommendation #34
Require an Employee to Determine and a Supervisor to Approve
SUMMARY
• Problem: e tax law generally requires supervisory approval before the IRS may assess a penalty, but
it provides exceptions for certain penalties that may be automatically calculated and do not require
employee judgment. e IRS currently takes the position that the negligence penalty can sometimes be
automatically calculated and applied, but whether a taxpayer acted negligently requires an assessment
of the taxpayer’s conduct and state of mind, which a computer cannot make. As a result, the IRS is
imposing the negligence penalty in some cases where the taxpayer was not negligent.
• Solution: Do not allow the IRS to impose the negligence penalty by automation, without employee
review and supervisory approval.
PRESENT LAW
IRC § 6662(b)(1) imposes a penalty equal to 20 percent of any underpayment of tax required to be shown
on a tax return that is attributable to negligence or disregard of rules or regulations. IRC § 6662(c) denes
“negligence” to include “any failure to make a reasonable attempt to comply with the provisions of this title”
and “disregard” to include “any careless, reckless, or intentional disregard.”
IRC § 6751(b)(1) provides: “No penalty under this title shall be assessed unless the initial determination of
such assessment is personally approved (in writing) by the immediate supervisor of the individual making
such determination or such higher level ocial as the Secretary may designate.”
1
IRC § 6751(b)(2) carves out
two categories of exception from this supervisory approval requirement: (i) the penalties for failure to le a tax
return (IRC § 6651(a)(1)), failure to pay the tax due (IRC § 6651(a)(2)), failure to pay sucient estimated
tax (IRC §§ 6654 and 6655), and understatements described in IRC § 6662(b)(9), and (ii) any other penalty
that is “automatically calculated through electronic means.”
REASONS FOR CHANGE
IRC § 6751 states that the initial determination of penalties must be personally approved (in writing) by the
immediate supervisor of the individual making the initial determination, subject to the exceptions described
above. In the signicant majority of cases, the IRS imposes penalties by electronic means because it is easier
and cheaper to do so.
2
Where the imposition of a penalty is mechanical, such as the penalties for failure to
le, failure to pay, or failure to pay estimated tax, that approach is justiable.
However, imposition of a penalty for “negligence or disregard of rules or regulations” is dierent. To
determine whether a taxpayer made a “reasonable attempt to comply” with the law, an employee must analyze
the taxpayer’s state of mind, the actions the taxpayer took to comply, and the taxpayer’s motivations for taking
those actions. A computer cannot perform this analysis.
1 The meaning of “initial determination of such assessment” and the timing required for approval have been the subject of litigation.
See, e.g., Belair Woods v. Comm’rClarify That Supervisory
Approval Is Required Under IRC § 6751(b) Before Proposing Penalties, supra.
2
.
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78 Reform Penalty and Interest Provisions
Nevertheless, Treas. Reg. § 1.6662-3(b)(1)(i) states that negligence is strongly indicated when a taxpayer omits
income from an information return on his or her income tax return. In reliance on this regulation, the IRS
has programmed its computers to calculate certain negligence penalties automatically as part of its Automated
Underreporter (AUR) program. For example, the AUR system proposes the negligence penalty where IRS
data suggests the taxpayer failed to report income reected on a third-party information return for a second
tax year in a row.
3
Legal advice from the Oce of Chief Counsel goes further, concluding that “in the absence of any other
evidence suggesting the failure was not negligent, it is appropriate to propose and subsequently assess an
accuracy-related penalty for negligence when a taxpayer does not include on an income tax return an amount
of income shown on an information return.”
4
However, the AUR system in this scenario solely checks for the presence of information returns and
unreported income. It cannot determine there is no other evidence that would rebut the negligence
nding, such as whether the information return was mailed to a dierent address than the one used by the
taxpayer when ling the return or whether the information return contained an error. Before the IRS can
reasonably conclude that a taxpayer acted negligently, an employee must review the case to consider facts and
circumstances that may suggest the taxpayer did not act negligently.
Although the AUR program and the applicable proposed regulations do require supervisory approval for the
negligence penalty if the taxpayer submits a response,
5
there are many reasons a taxpayer may not respond.
A taxpayer may have moved and not received the notice. A taxpayer may have put the notice aside and not
replied before the response deadline. Or a taxpayer may have accepted the proposed tax adjustment without
realizing that he or she must respond to avoid the penalty assessment.
In these and other circumstances, taxpayers may face a penalty for negligence without any analysis into their
reasonable attempts to comply with tax laws. Allowing a computer to determine negligence without employee
involvement harms taxpayers and undermines the protections aorded by IRC § 6751(b). e Treasury
Department has also made a legislative proposal that would perpetuate this harm by denitively removing all
IRC § 6662 penalties, including negligence penalties, from the supervisory review requirement.
6
RECOMMENDATION
• Amend IRC § 6751(b)(2)(B) to clarify that the exception for “other penalties automatically calculated
through electronic means” does not apply to the penalty for “negligence or disregard of rules or
regulations” under IRC § 6662(b)(1).
.
4
5
.
6 General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals
.
79National Taxpayer Advocate 2024 Purple Book
REFORM PENALTY AND INTEREST PROVISIONS
Legislative Recommendation #35
Modify the Definition of “Willful” for Purposes of Determining
Report of Foreign Bank and Financial Accounts Violations and
Reduce the Maximum Penalty Amounts
SUMMARY
• Problem: Penalties for failure to le international information returns or to disclose foreign assets are
steep and grow even steeper when the IRS determines a taxpayer’s failure was “willful.” e IRS has
become increasingly aggressive in asserting that taxpayers’ failures to le are willful, which can lead to
draconian penalties for good-faith errors.
• Solution: Increase the burden of proof on the IRS for declaring a failure “willful” and reduce the
maximum penalty for willful violations.
PRESENT LAW
U.S. citizens, residents, or entities (collectively, U.S. taxpayers) with specied interests in foreign
accounts exceeding $10,000 in total during the year generally are required by 31 U.S.C. § 5314 and
31 C.F.R. § 1010.350 to report the accounts to the Financial Criminal Enforcement Network (FinCEN) in
the Treasury Department. ey must do so on FinCEN Form 114, Report of Foreign Bank and Financial
Accounts (FBAR). 31 U.S.C. § 5321(a)(5) imposes civil penalties for failing to report accounts.
e amount of the civil penalty depends on whether the failure was “willful” or “non-willful.” e maximum
penalty for a non-willful violation is $10,000 (adjusted for ination).
1
Under 31 U.S.C. § 5321(a)(5)(C)(i)(I)
and (II), the maximum civil penalty for a willful violation is the greater of $100,000 (adjusted for ination) or
50 percent of “the balance in the account at the time of the violation.”
2
As currently interpreted by the IRS in
non-binding policy guidance, 31 U.S.C. § 5321(a)(5)(B)(ii) will not allow for a penalty to be imposed for a
non-willful violation if the account holder led accurate or amended FBAR(s) rectifying prior violations and
had reasonable cause for failing to le the FBAR(s).
3
e IRS has created procedures that allow some account holders to correct non-willful noncompliance if
they learn about the problem early. Under its Delinquent FBAR Submission Procedures and Streamlined
Filing Compliance Procedures, the IRS will not impose a penalty (or will impose a penalty of ve percent) for
non-willful violations if an account holder reports his or her accounts on an FBAR and reports and pays tax
on the income from the foreign nancial accounts before being contacted by the IRS about an examination or
FBAR violation.
4
Account holders who rst learn of their FBAR violations when the IRS initiates an exam or
contacts them about a violation are ineligible for these procedures.
. See also United States v. Schwarzbaum
.
See
es
penalty if no underreporting and fixed before contact). See also
REFORM PENALTY AND INTEREST PROVISIONS
80 Reform Penalty and Interest Provisions
REASONS FOR CHANGE
e maximum FBAR penalty is among the harshest civil penalties the government may impose. For example,
if an account holder maintains a balance of $25,000 in a foreign account that he willfully fails to report,
the IRS may impose a penalty of over $100,000 per year and may go back six years, producing an aggregate
statutory maximum penalty of over $600,000.
5
Some commentators have suggested the penalty is so severe
that it may violate the U.S. Constitution’s prohibition against excessive nes.
6
Individuals who have lived
in foreign countries or have immigrated to the United States often maintain foreign bank accounts and may
overlook this requirement for benign reasons.
Although the Internal Revenue Manual (IRM) limits the total amount of the penalties for non-willful
violations to 50 percent of the highest aggregate balance (HAB) of all unreported foreign nancial accounts
for all years under examination, examiners are still free to propose a penalty of up to 100 percent of the HAB
for willful violations if a manager approves.
7
Even half the HAB can be more than the current balance if the
account value has declined. Account holders have reasonably argued in many cases that the harshness of the
maximum penalty, particularly the “willful” penalty, is disproportionate to the reporting failure.
While the distinction between willful and non-willful violations makes sense in concept, its application
can lead to unduly harsh results. If the IRS chooses to assert a violation was willful, it is very dicult for a
taxpayer to prevail. Schedule B of Form 1040, U.S. Individual Income Tax Return, asks if the taxpayer has a
foreign account and references the FBAR ling requirement. Taxpayers are presumed to know the contents
of their return when they sign it under penalties of perjury; the jurat they must sign states: “Under penalties
of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the
best of my knowledge and belief, they are true, correct and complete.”
It may be considered reckless or “willful blindness” for a taxpayer not to learn about the FBAR ling
requirement after having been directed to the FBAR form by Schedule B and having signed the jurat.
8
For
this reason, the government might reasonably argue (and a court might reasonably nd) that any failure to
le an FBAR form is willful where a taxpayer led a federal tax return that included Schedule B.
9
Courts
have arrived at dierent determinations when presented with this argument.
10
In practice, tax forms and
See
See also
(“In no event
6 SeeNew FBAR Penalty Limits Seen Reflecting IRS Concern on Eighth Amendment LitigationAX MGMT WEEKLY
REPT
See United States v. Toth,
United States v. BussellUnited States v. Kerr
United States v. Schwarzbaumvacated and remanded on other
grounds
7 See
.
See
.
See, e.g., Alison
New FBAR Penalty Limits Seen Reflecting IRS Concern on Eighth Amendment LitigationAX MGMT WEEKLY REPT
.
8 See, e.g., Norman v. United States
See, e.g., United States v. Bohanec
foreign accounts).
10 Compare United States v. Bohanec, id.United States v. Schwarzbaum
vacated and remanded on other grounds
REFORM PENALTY AND INTEREST PROVISIONS
81National Taxpayer Advocate 2024 Purple Book
instructions contain a lot of verbiage, and few if any taxpayers have a complete understanding of all lines,
questions, and instructions on a return.
Account holders who do not le required FBAR forms due to negligence, inadvertence, or similar causes may
be subject to penalties for non-willful violations (which have a reasonable cause exception). But they should
not face uncertainty regarding possible application of the harsh penalties for “willful” violations. e National
Taxpayer Advocate recommends Congress clarify that the IRS must prove a violation was “willful” without
relying on the instructions to Schedule B or the failure to check the box on Schedule B before imposing a
willful FBAR penalty and must do so by clear and convincing evidence – the standard typically required in
fraud cases.
11
RECOMMENDATIONS
• Clarify that the government has the burden to establish willfulness by clear and convincing evidence
before asserting a civil willful FBAR penalty and that the government cannot meet this burden by
relying on the Schedule B attached to a return.
• Remove subsection (I) in 31 U.S.C. § 5321(a)(5)(C)(i), which would have the eect of narrowing
the statutory maximum civil penalty for a willful FBAR violation to no greater than 50 percent of the
balance in the account at the time of the violation so that a $100,000 penalty cannot be imposed with
respect to low-balance accounts.
12
11 See Tax Ct. R. 142(b) (“In any case
clear and convincing evidence that some part of the
See, e.g., United States v. Garrity,
United States v. BohanecUnited States v. McBride,
United States v. Williamsrev’d on other
grounds
12 For more detail, see
Foreign Account Reporting: Legislative Recommendations to Reduce the Burden of Filing a Report of Foreign Bank and
),
.
