How to Avoid the 6707A Abusive Tax Shelter Penalty
You were in an abusive 412i retirement plan or 419 welfare benefit plan and either did not file
, filed improperly, or did not file with your state. Accountants or other advisors will probably be fined as material advisors. Once you get the large fine, the IRS claims it is not subject to an appeal, and the Tax Court acknowledges that it lacks jurisdiction to do anything about these fines.
You should have filed protectively for every year your business participated in the plan. For every year after 2003, the penalty for not properly filing is $200,000 a year for business entities and $100,000 a year for individuals. It is possible an employer in the plan since 2004 could be subject to over one million dollars in penalties solely as a result of the failure to file. For all years in the plan, the Statute of Limitations will not begin to run until after the form is properly filed. In addition, certain individual plan participants should also file for every year of plan participation. None of this has anything to do with any audit that you may currently be involved in or may previously have experienced.
Accountants may be fined up to $200,000 as material advisors.
Section 6707A of the Internal Revenue Code ("section 6707A") was enacted in the American Jobs Creation Act of 2004 to shut down abusive tax shelter transactions by imposing a strict liability penalty on taxpayers unless they disclosed the transactions to the IRS. Section 6707A imposes a penalty of $100,000 per individual and $200,000 per other entity for each failure to make special annual disclosure with their tax returns by filing Form 8886 (Reportable Transaction Disclosure Statement) with respect to a transaction that the Treasury Department characterizes as a "listed transaction" or "substantially similar" to a listed transaction.
The IRS determined that certain retirement and welfare benefit plans that had been adopted by small businesses for their employees were abusive and deemed them "listed transactions" subject to taxpayer disclosure to avoid the penalty. The alleged tax benefits received from many of those retirement and welfare benefit plans were relatively small. Accordingly, the imposition of Section 6707A penalties on small businesses and their owners were disproportionate to the tax benefit received when compared to the tax benefit realized by major corporations in more elaborate, sophisticated tax shelters. Indeed, the failure to disclose penalties of 6707A apply even if the tax benefit is allowed upon audit or the taxpayer can demonstrate "reasonable cause" for the failure to make timely disclosure.
The Section 6707A penalty is in addition to a 30% accuracy related penalty imposed on the tax understatement relating to listed transactions under Section 6662A. Accordingly, the combination of the Sections 6662A and 6707A penalties can substantially exceed 100% of the understatement of tax resulting from a listed transaction.
The 6707A penalty applies regardless of the amount of understatement of tax, even if there are no additional taxes due after IRS examination, and even though the taxpayer can demonstrate "reasonable cause" for the failure to make timely disclosure. In other words, a transaction is reportable even though it is compliant with the tax law.
Existing Section 6707A denies the Commissioner of Internal Revenue any discretion to abate the listed transaction penalty even though the taxpayer can demonstrate that disclosure was intended, that the failure to disclose was in inadvertent, or that the taxpayer did not know that the taxpayer had entered into a listed transaction, and the taxpayer's advisors did not advise the taxpayer of the need to disclose the listed transaction or the taxpayer can demonstrate "reasonable cause" for the failure to make timely disclosure. Furthermore, unlike all other adverse determinations made by the Internal Revenue Service, existing Section 6707A does not grant a taxpayer due process of law because judicial review in the Tax Court is not allowed.
The National Taxpayer Advocate 2008 Annual Report to Congress, at page 421, states:
"Notwithstanding the underlying congressional intent in enacting Section 6707A, the statute as written can impose unconscionable hardship on taxpayers. Even the penalty for proven cases of civil fraud is capped at 75 percent of the tax underpayment. Yet this statute allows penalties of up to $300,000 per year to be imposed on taxpayers with no underpayment of tax and no knowledge that they entered into transactions that the IRS has "listed". It is rare that a tax provision is found to violate the United States Constitution, but we believe that the imposition of such a large penalty on a taxpayer who entered into a transaction that produced little or even no tax savings and without regard to the taxpayer's knowledge or intent raises significant constitutional concerns, including possible violation of the Eight Amendment's prohibition against excessive government fines and due process protections."
"In practice, the requirement that this penalty be imposed without regard to culpability may have the effect of bankrupting middle class families who had no intention of entering into a tax shelter an outcome that has dismayed even hardened IRS enforcement personnel."
Pass-though entities, including S Corporations, partnerships, LLCs, and LLPs (taxed as partnerships) do not derive any tax benefit from an alleged listed transaction because they do not incur a tax liability. Only the shareholders or partners or members can have a tax understatement due to the denial of tax benefits by the IRS for a listed transaction. Existing Section 6707A provisions impose a penalty of $200,000 at the entity level and $100,000 at the individual level. The IRS has applied this provision to impose a $200,000 penalty on pass-through entities in addition to the $100,000 penalty on each shareholder or partner.
The U. S. voluntary tax system is unique and admired throughout the world. One of its most important tenets is the right of each taxpayer to judicial review of an adverse determination of tax issues by the Internal Revenue Service. Taxpayers have the right to file a lawsuit with the United States Tax Court and to receive an impartial adjudication of the tax controversy without first having to pay the assessed tax.
This basic right is not available to taxpayers who are deemed to have engaged in an alleged listed transaction unless they pay the penalty and sue for refund. However, when the listed transaction penalty ranges from $200,000 to in excess of one million dollars on small businesses and their owners, the requirement of a taxpayer to pay the penalty and sue for at best a refund places a "chilling effect" on the taxpayer's Constitutional right of due process of law under the Fourteenth Amendment. It could also be argued that the sheer size of the penalties may run afoul of the Eighth Amendment prohibition on excessive fines, etc.
In many cases, the penalty has been imposed where the disclosure Form 8886 (Reportable Transaction Disclosure Statement) (1) was filed but was incomplete; (2) was filed with the taxpayer's return, but not with the Office of Tax Shelter Analysis for the first year of the transaction; (3) was filed with the entity return, but not with the shareholder or partner return or vice versa; (4) was completely prepared but inadvertently was not attached to the taxpayer's return. In such cases, the taxpayer had demonstrated intent to disclose, but failed to fully comply with all technical requirements.
There are cases in which the 6707A penalty has been imposed after taxpayers voluntarily entered with the IRS Global Settlement Initiative (Announcement 2005-80) on the published promise that all tax, interest and penalty liability would be settled by treating the alleged transaction as if it had never occurred and paying all taxes and interest and a 5% understatement accuracy penalty. In such cases, the taxpayer came forward in reliance on IRS representations that subsequently turned out to be misrepresentations.
With respect to pass-through entities with several shareholders, partners or members, each shareholder, partner or member has had the Section 6707A penalty imposed on him or her. This has occurred even if the shareholder, partner or member was not active in the business and was not an active participant in (or even aware of) the transaction. It has even been imposed on minor children!
Learn more about how to determine if you are in an abusive tax shelter and what help there is available to you by visiting
www.taxaudit419.com or
www.taxadvisorexperts.org How to Avoid the 6707A Abusive Tax Shelter Penalty
By: Lance Wallach
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