Penalty Assessments and Challenging Penalty Assessments

Question 1

What are the rules for challenging delinquency penalties?

What happens if the IRS assessed the penalties systemically (i.e., automatically) and the IRS does not issue a notice of deficiency after receipt of late return or late payment?

Answer 1

• If the IRS assessed the penalties during an audit and issued a statutory notice of deficiency, the taxpayer can challenge the penalties along with the tax
  1. in the Tax Court or
  2. by filing a refund claim
• If the IRS assessed the penalties systemically (i.e., automatically) and the IRS does not issue a notice of deficiency, after receipt of late return or late payment:
  Step 1: the taxpayer can request abatement of the penalties and appeal the denial, and
  Step 2: if not successful, pay the penalties and sue for a refund

Question 2

What are the rules for challenging accuracy and fraud penalties?

Answer 2

Penalties will be stated in the statutory notice of deficiency, and the taxpayer can challenge the penalties along with the tax deficiency:

1. in the Tax Court or
2. by filing a refund claim

Question 3

What are assessable penalties?

How do you challenge assessable penalties?

Can these be contested in Tax Court?

Answer 3

• Assessable penalties are those that come after IRC 6671. These are not subject to the deficiency procedures, and therefore the IRS may assess the penalties and proceed almost immediately to collection. (includes form 3520 and 5471 forms)
• IRC 6671(a): The penalties and liabilities provided by this subchapter shall be paid upon notice and demand by the Secretary, and shall be assessed and collected in the same manner as taxes.”
• For all penalties that come after IRC 6671 in the Code, NO statutory notice of deficiency is issued – JUST notice and demand for payment.
• Since there is no statutory notice of deficiency, the taxpayer cannot contest these penalties in Tax Court (with one narrow exception of review of Collection Due Process determination).
• There may or may not be pre-assessment review by Appeals, depending on the penalty.
• For judicial review, taxpayer must pay in full (some exceptions)

Question 4

What are Trust Fund Recovery Penalties that are Divisible Penalties?

Answer 4

• A taxpayer is generally required to pay the full amount of tax assessed for the period before filing a refund claim or initiating a refund suit.
• HOWEVER, employment taxes and the trust fund recovery penalty are “divisible” taxes and therefore, not subject to the full payment rule. See IRC § 6331(i)(2).
• A refund claim can be made after payment of the portion of a trust fund recovery penalty that equals the amount due for a single employee for the period at issue

Question 5

What are the procedural requirements for penalties under IRC 6751(b)?

What does the rule not apply to?

Answer 5

• Requires written supervisory approval of the initial determination of a penalty by the immediate manager or higher-level official of the employee initially proposing the penalty.
• Does not apply to any addition to tax under section section 6651 (failure to pay/file), 6654 (failure for estimated tax), or 6655; or any other penalty automatically calculated through electronic means.

Question 6

What happened in Chai v. Commissioner (about approval)?

Answer 6

• Basically about getting approval = have to show part of their burden that they got the proper approval in time
• “[W]e hold that § 6751(b)(1) requires written approval of the initial penalty determination no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty.”
• “[W]e further hold that compliance with § 6751(b) is part of the Commissioner’s burden of production and proof in a deficiency case in which a penalty is asserted.”
• “Read in conjunction with § 7491(c), the written approval requirement of § 6751(b)(1) is appropriately viewed as an element of a penalty claim, and therefore part of the IRS’s prima facie penalty case.”

Question 7

1. What are assessable penalties? They’re not subject to what procedures?
2. Assessable penalties are required to be paid upon?
3. Are there notice requirements prior to assessment?
4. How and where can you challenge assessable penalties?
5. Can they be contested in Tax Court? What is the one exception?
6. Are there pre-assessment review by appeals?
7. For judicial review, taxpayer must do what?

Answer 7

1. As a general rule, penalties are assessable without deficiency procedures when they are not dependent upon the determination of a deficiency. If a penalty is not dependent upon the determination of a deficiency, then the penalty may not be subject to deficiency procedures set forth in IRC 6211 through IRC 6215.
2. Assessable penalties are required to be paid upon notice and demand.
3. No notice requirement prior to assessment.
4. Taxpayers must generally challenge the IRC Section 6676 penalty in a tax refund court. This requires paying the penalty amount, filing a claim for refund with the IRS, and — assuming the claim is denied or the requisite six-month period has elapsed — filing a complaint in the appropriate U.S. District Court or the U.S. Court of Federal Claims seeking a refund of the penalty amount.
5. Since there is no statutory notice of deficiency, the taxpayer cannot contest these penalties in Tax Court (with one narrow exception of review of Collection Due Process determination).
6. There may or may not be pre-assessment review by Appeals, depending on the penalty.
7. For judicial review, taxpayer must pay in full (some exceptions).