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Part 20. Penalty and Interest

Chapter 1. Penalty Handbook

Section 5. Return Related Penalties (Cont. 1)

20.1.5  Return Related Penalties (Cont. 1)

20.1.5.9  (10-01-2005)
IRC Section 6662(e): Substantial Valuation Misstatement

  1. The amount of the penalty is 20 percent of the underpayment attributable to a substantial valuation misstatement and 40 percent in the case of a gross valuation misstatement.

20.1.5.9.1  (10-01-2005)
Penalty Assertion

  1. The examining officer is responsible for the assertion of the accuracy-related penalty attributable to a valuation misstatement.

  2. The valuation misstatement penalty is not imposed unless the underpayment attributable to the misstatement is greater than $5,000 ($10,000 for corporations, except S corporations and personal holding companies).

  3. The valuation misstatement penalty is limited to underpayments of taxes under Chapter 1 or transfer pricing transactions.

  4. The substantial valuation misstatement penalty does not apply to any understatement upon which a penalty under IRC section 6662A is imposed. IRC section 6662A does not apply to any understatement upon which the gross valuation misstatement penalty is imposed.

20.1.5.9.2  (10-01-2005)
IRC Section 6662(e)(1)(A): Substantial Valuation Misstatement

  1. A substantial valuation misstatement occurs when the value (or adjusted basis) of any property claimed on any return of tax under Chapter 1 is 200 percent or more of the corrected value or adjusted basis, as the case may be.

20.1.5.9.3  (10-01-2005)
IRC Section 6662(e)(1)(B): Valuation Misstatement Penalties for Transfer Pricing Transactions Under IRC Section 482

  1. IRC section 6662(e) imposes transfer pricing penalties on any underpayment attributable to a substantial valuation misstatement pertaining to transfer pricing under IRC section 482. These penalties are identified as the transactional penalty and the net adjustment penalty.

  2. The Transactional Penalty. This penalty applies when the price reported for any property or services is 200 percent or more (or 50 percent or less) of the amount determined under IRC section 482 to be the correct price.

  3. The Net Adjustment Penalty. This penalty applies when the net section 482 adjustment exceeds the lesser of $5 million or 10 percent of the taxpayer’s gross receipts.

  4. The term "price for any property or services" encompasses all kinds of adjustments under IRC section 482, including purchase prices, fees, services, rents, interest, and advances.

  5. For the net IRC section 482 adjustments that are excluded from the penalty, see IRC section 6662(e)(3)(B) and Treas. Reg. 1.6662-6(d). For example calculations see Treas. Reg. 1.6662-6(c)(7).

  6. In order to monitor and gather information on the application of the transfer pricing penalty, the Service formed the Transfer Pricing Penalty Oversight Committee to review these cases. See Announcement 96-16, 1996-13 I.R.B. 22 (March 25, 1996).

  7. Exhibit 20.1.5-4 contains a flow chart for the IRC section 6662(e) Transfer Pricing Penalty.

20.1.5.9.4  (10-01-2005)
IRC Section 6662(h): Gross Valuation Misstatement

  1. A gross valuation misstatement occurs:

    1. If the value (or adjusted basis) of any property on any return of tax under Chapter 1 is 400 percent or more of the corrected amount, or

    2. If the price for any property or service (or for the use of property) claimed on any return is 400 percent or more (or 25 percent or less) of the amount determined under IRC section 482 to be the correct price, or

    3. If the net section 482 adjustment exceeds the lesser of $20,000,000 or 20 percent of the taxpayer’s gross receipts.

20.1.5.9.5  (10-01-2005)
Penalty Calculation

  1. The substantial valuation penalty applies to the individual income tax return in the example below because both conditions for assertion are met (no exceptions to the penalty apply and the amount of the understatement and underpayment are equal):

  2. Example:

      a) Price of property (or adjusted basis) as reported on the return $46,000
      b) Price as adjusted by examination $20,000
      c) 200 percent times the amount in (b) $40,000
      d) Note: Condition #1 is met. The value reported on the return of $46,000 is more than 200 percent of the adjusted amount of $20,000 ($46,000 divided by $20,000 = 230 percent).
      e) Amount adjusted (line "a" less line " b" ) $26,000
      f) Underpayment on $26,000 $7,000
      g) Penalty (20 percent times $7,000) $1,400
      h) Note: Condition #2 is met. The underpayment of $7,000 attributable to the misstatement of $26,000 exceeds the required $5,000.

  3. If the adjusted value in (b) above were $10,000 the amount reported of $46,000 would then exceed the adjusted amount ($10,000) by more than 400 percent ($46,000 divided by $10,000 = 460 percent). The gross valuation misstatement penalty would then apply at 40 percent of the applicable underpayment.

  4. For example calculations involving carryovers and flow through entities, See IRM 20.1.5.3.3. and Treas. Regs. 1.6662-5(d) and (h).

  5. The penalty is considered separately for each property adjusted. To distinguish between a substantial and a gross valuation misstatement requires a property-by-property calculation.

  6. With regard to the transfer pricing penalty under IRC section 6662(e), please refer to the rules for coordinating between the transactional penalty and the net adjustment penalty illustrated by examples in Treas. Reg. 1.6662-6(f).

20.1.5.9.6  (10-01-2005)
Penalty Assessment

  1. See IRM 20.1.5.4.2 for assessment of the accuracy-related penalty attributable to a substantial valuation misstatement.

20.1.5.9.7  (10-01-2005)
Penalty Relief

  1. Refer to IRC section 6662(e)(3)(B) and Treas. Reg. 1.6662-6(b)(3) and (c)(6).

20.1.5.9.7.1  (10-01-2005)
Reasonable Cause

  1. IRC section 6664(c) provides an exception to the penalty if the taxpayer has reasonable cause and acted in good faith. See IRM 20.1.1 for a more detailed discussion of general reasonable cause exceptions.

  2. The reasonable cause exception applies to the transfer pricing penalties (IRC section 6662(e) and Treas. Reg. 1.6662-6) only under certain circumstances.

    1. For the Transactional Penalty (see IRM 20.1.5.9.3 and IRC section 6662(e)(1)(B)(i)), a taxpayer must meet the reasonable cause requirements of Treas. Reg. 1.6664-4 to avoid the penalty.

    2. For the Net Adjustment Penalty ( See IRM 20.1.5.9.3. the reasonable cause requirements under IRC section 6664(c) are met only if the taxpayer meets the requirements of Treas. Reg. 1.6662-6(d).

  3. In applying the provisions of Treas. Reg. 1.6664-4 where a taxpayer has relied on a professional analysis in determining its transfer pricing, whether the professional is an employee of, or related to, the taxpayer is not determinative in evaluating whether the taxpayer reasonably relied in good faith on advice.

20.1.5.9.7.2  (10-01-2005)
Charitable Deduction Property

  1. The taxpayer will not satisfy the good faith test by merely relying on an appraisal. The taxpayer will not be considered to have reasonably relied in good faith on advice unless the requirements of Treas. Reg. 1.6664-4(b) and (c) are met.

  2. In addition, the taxpayer must meet the specific requirements in Treas. Reg. 1.6664-4(h) where charitable deduction property is involved.

  3. When there is an underpayment due to overstated charitable deduction property, the reasonable cause exception under IRC section 6664(c)(2) applies only if the following two conditions are first met:

    1. The claimed value of the property was based on a "qualified appraisal" made by a "qualified appraiser," and

    2. The taxpayer made a good faith investigation of the value of the contributed property. See Treas. Reg. 1.6664-4(h).

20.1.5.10  (10-01-2005)
IRC Sections 6662(f): Substantial Overstatement of Pension Liabilities

  1. The amount of the penalty is 20 percent of the underpayment attributable to a substantial overstatement of pension liabilities and 40 percent of the underpayment attributable to a gross valuation misstatement.

  2. An overstatement of pension liabilities occurs when the actuarial determination of the liabilities taken into account for purposes of computing the employer contribution deduction under IRC section 404(a) is 200 percent or more of the correct amount (400 percent or more in the case of a gross valuation misstatement).

  3. The penalty does not apply unless the underpayment attributable to the substantial overstatement of pension liabilities (or gross valuation misstatement, if applicable) exceeds $1,000.

20.1.5.10.1  (10-01-2005)
Penalty Calculation

  1. The following example illustrates the penalty criteria and calculation:

  2. Example:

    a) The taxpayer’s 1990 return had taxable income of $300,000 and tax of $98,000.
    b) In determining the amount of taxable income, the taxpayer deducted $80,000 for contributions to a defined benefit pension plan maintained for its employees
    c) Upon examination of the taxpayer’s return, the Service adjusted the interest assumption in valuing the pension liabilities for calculating the deduction
    d) The taxpayer’s maximum deduction for contributions to its plan was accordingly adjusted from $80,000 to $35,000.

  3. Note: The 200 percent requirement is met when the amount deducted on the return ($80,000) exceeds the correct amount ($35,000) by more than 200 percent ($80,000 divided by $35,000 = 229 percent). The penalty is calculated as follows:

      a) Taxable income as adjusted ($300,000 + $45,000) $345,000
      b) Tax liability as adjusted $111,500
      c) Tax liability as filed $98,000
      d) Underpayment ("b" less "c" ) $13,500
      e) Penalty rate 20%
      f) Penalty ("d" times "e" ) $2,700

    Note:

    Since the deduction claimed exceeds the corrected amount by more than 200 percent, but is less than 400 percent, the penalty applies at the 20 percent rate. If the corrected deduction were $18,000, the percentage of the overstatement would be 444 percent ($80,000 divided by $18,000) and the penalty would apply at the 40 percent rate.

  4. See Notice 89-47, 1989-1 C.B. 687, for guidance on the calculation of the penalty. While this notice applies to IRC section 6659A, which is repealed, the examples contained in the notice still provide guidance on the mechanics of calculating the penalty.

20.1.5.10.2  (10-01-2005)
Penalty Relief

  1. The penalty will not apply if the taxpayer shows that there was a reasonable cause for the valuation or assumptions used in deriving the deduction on the return and that the taxpayer acted in good faith.

  2. See IRM 20.1.5.6.2 and Treas. Reg. 1.6664-4(c) for reliance on advice of an actuary or other professional as it relates to the reasonable cause exception in IRC section 6664(c).

20.1.5.11  (10-01-2005)
IRC Section 6662(g): Substantial Estate or Gift Tax Valuation Understatement

  1. The amount of the penalty is 20 percent of the underpayment attributable to a substantial estate or gift tax valuation understatement or 40 percent of the underpayment attributable to a gross valuation misstatement.

  2. The penalty applies only to returns of tax imposed under Subtitle B.

20.1.5.11.1  (10-01-2005)
Penalty Assertion

  1. There is a substantial estate or gift tax valuation understatement if the value of the property claimed on an estate or gift tax return is 50 percent or less of the corrected amount (or 25 percent or less in the case of a gross valuation misstatement).

  2. The penalty does not apply unless the underpayment attributable to the substantial estate or gift tax valuation understatement (or gross valuation misstatement, if applicable) exceeds $5,000.

20.1.5.11.2  (10-01-2005)
Penalty Calculation

  1. The determination of whether the percentage threshold for a substantial or gross valuation misstatement is reached is made on a property-by-property basis.

  2. To calculate the valuation understatement percentage, divide the value of the property reported on the return by the corrected value of the property.

  3. The following example illustrates the calculation of the understatement percentage for three adjustments (assuming the $5,000 requirement is met and no exceptions to the penalty apply).

  4. Example: The decedent’s estate tax return included stock in three closely held corporations, A, B and C. On the return the stock in each corporation was valued at $80,000. On examination the corrected stock values were determined to be $150,000 for A, $190,000 for B, and $330,000 for C. The following determinations were made:

    1. Stock A: The amount on the return ($80,000), divided by the corrected amount ($150,000) is 53 percent. The penalty does not apply to this adjustment because the value of the stock is not 50 percent or less of the corrected amount.

    2. Stock B: The amount on the return ($80,000), divided by the corrected amount ($190,000) is 42 percent. The accuracy-related penalty attributable to a substantial estate or gift tax valuation understatement applies to this adjustment because the value of Stock B is 50 percent or less (but more than 25 percent) of the corrected amount. The penalty amount is 20 percent of the underpayment attributable to the adjustment for Stock B.

    3. Stock C: The amount on the return ($80,000), divided by the corrected amount ($330,000) is 24 percent. The accuracy-related penalty attributable to a gross valuation misstatement applies to this adjustment because the value of Stock C is 25 percent or less of the corrected amount. The penalty amount is 40 percent of the underpayment attributable to the adjustment for Stock C.

  5. For penalty calculations that relate to the above adjustments, See Exhibit 20.1.5-5.

20.1.5.11.3  (10-01-2005)
Penalty Assessment

  1. See IRM 20.1.5.4.2 for assessment of the accuracy-related penalty attributable to a substantial estate or gift tax valuation understatement.

20.1.5.11.4  (10-01-2005)
Penalty Relief

  1. IRC section 6664(c) provides an exception to the penalty if there is reasonable cause for the underpayment and the valuation was made in good faith.

  2. See IRM 20.1.5.6.2 and Treas. Reg. 1.6664-4 for reliance on advice of an appraiser or other professional as it relates to the reasonable cause exception in IRC section 6664(c).

20.1.5.12  (10-01-2005)
IRC Section 6663: Civil Fraud Penalty

  1. The amount of the penalty is 75 percent of the underpayment attributable to fraud.

  2. For common features of the civil fraud penalty and the accuracy-related penalties See IRM 20.1.5.3.

20.1.5.12.1  (10-01-2005)
Indications of Fraud

  1. Civil fraud is defined as an intentional wrongdoing designed to evade a tax that the taxpayer believed to be owing. Thus, mere negligence or ignorance of the law does not constitute fraud.

  2. Since direct proof of a taxpayer’s fraudulent intent is rarely available, fraud may be proven by circumstantial evidence and reasonable inferences. Fraud will generally involve one or more of the following elements:

    • Deception,

    • Misrepresentation of material facts,

    • False or altered documents,

    • Evasion (i.e., diversion or omission), or

    • Conspiracy.

  3. Some common "badges of fraud" include:

    1. Understatement of income (e.g., by omissions of specific items or entire sources of income, failure to report substantial amounts of income received);

    2. Fictitious or improper deductions (e.g., overstatement of deductions, personal items deducted as business expenses);

    3. Accounting irregularities (e.g., two sets of books, false entries on documents);

    4. Acts of the taxpayer evidencing an intention to evade tax (e.g., false statements, destruction of records, transfer of assets);

    5. A consistent pattern over several years of underreporting taxable income;

    6. Implausible or inconsistent explanations of behavior;

    7. Failure to cooperate with the examining agent;

    8. Concealment of assets;

    9. Engaging in illegal activities (e.g., drug dealing), or attempting to conceal illegal activities;

    10. Inadequate records; and

    11. Dealing in cash.

  4. Recommendations for asserting the civil fraud penalty should be carefully reviewed to fully establish that the evidence supports the assertion.

20.1.5.12.2  (10-01-2005)
Penalty Assertion

  1. Civil fraud penalties will be asserted when there is clear and convincing evidence to prove that some part of the underpayment of tax was due to civil fraud. Such evidence must show the taxpayer’s intent to evade tax which the taxpayer believed to be owing. Intent is distinguished from inadvertence, reliance on incorrect technical advice, honest difference of opinion, negligence, or carelessness.

  2. To assert the civil fraud penalty in a tax case, it is necessary to establish that a part of the deficiency is due to a knowingly false representation of facts by the taxpayer. The Service bears the burden of proving civil fraud by clear and convincing evidence in the Tax Court. See IRC section 7454(a). The Service must show that:

    • The taxpayer knew the content of the return was false; and

    • Made the return with the intent to evade tax.

  3. The civil fraud penalty should be asserted on a case-by-case basis giving consideration to all factors which have a bearing on the taxpayer’s fraudulent intent.

  4. If a taxpayer submits an amended return, it does not cure the defects on the previously filed fraudulent return and the fraud penalty would apply.

  5. The civil fraud penalty cannot be asserted on the same underpayment (or portion of an underpayment) on which accuracy-related penalties are asserted under IRC sections 6662 and 6662A (where the reportable transaction understatement is treated as an underpayment). Only one penalty can be applied to any portion of an underpayment of tax.

  6. The criteria for proving fraudulent failure to file under IRC section 6651(f) and civil fraud under IRC section 6663 are the same. Generally, if a fraudulent return is filed, but filed late, the civil fraud penalty under IRC section 6663 is the appropriate penalty to assert. Although there is no specific prohibition against asserting penalties under both IRC sections 6651(f) and 6663, the examiner should exercise caution. The court is not likely to sustain the assertion of both penalties unless compelling facts support the Service’s position. Area Counsel should be consulted before asserting both these penalties on the same return. For more information regarding restrictions on the assertion of the civil fraud penalty with respect to the failure to file and fraudulent failure to file, see IRM 20.1.2.

  7. On a joint return, the civil fraud penalty does not apply to a spouse unless some part of the underpayment is due to civil fraud on the part of that spouse. IRC section 6663(c).

    1. For taxpayers filing a joint return after having filed separate returns, see IRC section 6013(b)(5).

    2. The civil fraud penalty follows the Code provision that allows a married couple to file a joint return after separate returns have been filed.

    3. If the sum of the amounts shown as tax on the two separate returns (for example, $150 plus $100 = $250) is less than the amount shown as tax on the joint return (for example, $300), then for the purpose of computing the civil fraud penalty, the sum of the amounts shown on the separate returns is treated as the amount shown on the joint return.

    4. Any fraud on either separate return will be deemed to be fraud on the joint return.

  8. As a general rule, neither Collection nor Customer Service is authorized to assess the civil fraud penalty. When fraud is identified by one of these functions, the case must be discussed with the group manager and the Fraud Technical Advisor (FTA) for referral consideration.

  9. In cases closing unagreed with the civil fraud penalty, the report must include the alternative penalty positions that are most applicable. Closing an unagreed case without including an explanation of the alternative penalty positions in the report may hamper the government’s litigating position because the basis for the alternative penalty positions may be unclear to either Appeals or Area Counsel.

  10. The examiner’s report will reflect the civil fraud penalty by Code section on a separate attachment, identifying the adjustments attributable to the penalty. Form 3198, Special Handling Notice for Examination Case Processing or Form 3198-A, TE/GE Special Handling Notice, will be attached to the case.

  11. For additional information on the Civil Fraud Process, see IRM 25.1, Fraud Handbook.

20.1.5.12.3  (10-01-2005)
Penalty Referral

  1. When an examiner determines that only the civil fraud penalty would apply, a referral to Criminal Investigation (CI) is not required. Determination of the civil fraud penalty is a shared responsibility of the examiner, the examiner’s group manager and the Fraud Technical Advisor. Referral guidelines to CI are contained in IRM 20.1.3, Criminal Referrals.

20.1.5.12.4  (10-01-2005)
Civil and Criminal Fraud

  1. The major difference between civil and criminal fraud is the degree of proof required to establish fraud on the part of the taxpayer.

    1. Criminal fraud requires sufficient evidence to prove guilt beyond a reasonable doubt.

    2. Civil fraud requires clear and convincing evidence of fraud with intent to evade tax.

  2. Due to the lower standard of proof in civil cases, the civil fraud penalty may be imposed upon a taxpayer who was not convicted of criminal tax evasion. If the taxpayer is convicted of criminal tax evasion under IRC section 7201, the civil fraud penalty should be asserted for the same tax year.

  3. However, criminal conviction does not mean the civil penalty will be automatically sustained.

20.1.5.12.5  (10-01-2005)
Penalty Calculation

  1. The civil fraud penalty is derived by multiplying the 75 percent penalty rate times the underpayment attributable to civil fraud.

  2. If any part of an underpayment is due to civil fraud, then the entire underpayment shall be treated as attributable to civil fraud unless the taxpayer establishes otherwise. The examiner will make a good faith effort to objectively weigh the evidence provided and eliminate those items that are inaccurate, but not fraudulent from the penalty calculation, see IRC section 6663(b).

  3. For an example calculation involving the accuracy-related penalty and the civil fraud penalty. See Exhibit 20.1.5-1.

  4. For an example calculation involving civil fraud when Schedule C gross receipts cause an adjustment to self-employment tax under IRC section 1401, with a related change in the income tax deduction allowed under IRC section 164(f), See Exhibit 20.1.5-6.

20.1.5.12.6  (10-01-2005)
Civil Fraud Development

  1. If it is determined that a fraud case has firm indications of fraud, but does not meet criminal criteria, Form 11661, Request for Fraud Development, must be prepared.

  2. The examiner should contact the local FTA when the initial indicators of fraud are uncovered and for assistance in completing Form 11661.

  3. See IRM 25.1.2, Recognizing and Developing Fraud for procedures on developing and processing a civil fraud case. Also see SB/SE Director, Examination, memorandum date December 28, 2004, Fraud Awareness and Case Development.

  4. Technical Services, the National Fraud Program Office, and Criminal Investigation published a special edition of the Technical Digest devoted to the National Fraud Program. This special edition contains fraud program highlights and other valuable information and guidance to help the Compliance employees identify and develop quality fraud referrals. See the Technical Digest, Special issue, Combating Tax Fraud, February 2005.

20.1.5.12.7  (08-20-1998)
Penalty Assessment

  1. The total civil fraud penalty will be assessed using:

    • Form 5344, Examination Closing Record,

    • Form 5403, Appeals Closing Record,

    • Form 5599, TE/GE Examined Closing Record, or

  2. The penalty is assessed to the Master File using Transaction Code 320.

  3. The penalty is assessed to the Non-Master File using:

    • Form 4720, Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the IRC,

    • Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, or

    • Form 5734, Non-Master File Assessment Voucher.

  4. The Form 5734 will be processed with the tax return using established functional guidelines.

20.1.5.13  (10-01-2005)
IRC Section 6662A: Accuracy-Related Penalty on Understatements with Respect to Reportable Transactions

  1. The amount of the penalty is 20 percent of the reportable transaction understatement.

  2. The amount of the penalty is increased to 30 percent for any portion of any reportable transaction understatement attributable to an item that the taxpayer has not adequately disclosed under IRC section 6011. See IRC section 6664(d)(2)(A).

  3. This penalty applies only to an item that is attributable to a listed transaction or an item that is attributable to a reportable transaction with a significant Federal tax avoidance purpose (also referred to as a " reportable avoidance transaction" ).

  4. IRC section 6662A applies to any taxable year ending after October 22, 2004.

20.1.5.13.1  (10-01-2005)
Reportable Transaction Understatement

  1. A reportable transaction understatement is the sum of:

    1. The product of the amount of increase in taxable income (which resulted from a difference between the proper tax treatment of an item and the taxpayer’s treatment of such item (as shown on the return)), and the highest rate of tax imposed under IRC section 1 (IRC section 11 in the case of a corporation), and

    2. The amount of the decrease in the aggregate amount of credits which results from a difference between the taxpayer’s treatment of an item (as shown on the return) and the proper treatment of such item.

    Note:

    Any reduction of the excess of deductions allowed for the taxable year over gross income, and any reduction in the amount of capital losses which would be allowed, shall be treated as an increase in taxable income. See IRC section 6662A(b).

  2. An amended return or supplement to a return will not be taken into consideration in determining the amount of a reportable transaction understatement if filed after the earlier of:

    1. The date the taxpayer is first contacted by the Service regarding the examination or

    2. Any other date specified by the Secretary. (Notice 2005-12, 2005-7 I.R.B. 494 (February 14, 2005), provides that the Service will not take into account an amendment or supplement to a return filed after the dates specified in Treas. Reg. 1.6664-2(c)(3) and Notice 2004-38, 2004-21 I.R.B. 949 (May 24, 2004), or any amendments thereto, which are the dates after which a taxpayer may not file a qualified amended return.)

  3. RESERVED - Example Calculation that defines a Reportable Transaction Understatement.

20.1.5.13.2  (10-01-2005)
Coordination with Other Penalties

  1. IRC section 6662A does not apply to any portion of an understatement on which a penalty is imposed under IRC section 6663.

  2. IRC section 6662(e) does not apply to any portion of an understatement on which a penalty is imposed under IRC section 6662A.

  3. IRC section 6662A does not apply to any portion of an understatement on which a gross valuation misstatement penalty under IRC section 6662(h) is imposed.

  4. If the penalty under IRC section 6707A for failure to disclose a reportable transaction is rescinded by the Commissioner, the taxpayer is treated as having adequately disclosed in accordance with IRC section 6011 for purposes of IRC section 6664(d)(2)(A).

20.1.5.13.3  (10-01-2005)
Penalty Calculation

  1. RESERVED - Example of calculation of IRC sections 6662, 6662A and 6663 penalties.

20.1.5.13.4  (10-01-2005)
Penalty Assessment

  1. The examining officer will compute the accuracy-related penalty attributable to the understatement with respect to reportable transactions for the Case Processing Areas.

  2. Form 3198, Special Handling Notice for Examination Case Processing or Form 3198-A, TE/GE Special Handling Notice, will be completed by the examiner to indicate the penalty assertion under IRC section 6662A.

  3. Reference Number 681 (positive amount) must be used for assessment of the penalty under IRC section 6662A.

  4. The assessment will post to the taxpayer’s account with Transaction Code 240.

20.1.5.13.5  (10-01-2005)
Penalty Relief Under IRC Section 6664(d)

  1. In general, no penalty is imposed under IRC section 6662A with respect to any portion of a reportable transaction understatement if it is shown that there was a reasonable cause and the taxpayer acted in good faith.

  2. A taxpayer does not have reasonable cause and did not act in good faith unless:

    1. The relevant facts affecting the tax treatment of the item are adequately disclosed in accordance with the regulations prescribed under IRC section 6011,

    2. There is or was substantial authority for the treatment of the item, and

    3. The taxpayer reasonably believed that the treatment of the item was more likely than not the proper treatment.

  3. A taxpayer shall be treated as having a reasonable belief with respect to the tax treatment of an item only if such belief:

    1. Is based on the facts and law that exist at the time the return was filed, and

    2. Relates solely to the taxpayer's chances of success on the merits of such treatment and does not take into account the possibility that a return will not be audited, such treatment will not be raised during the audit, or such treatment will be resolved through settlement if it is raised.

20.1.5.13.5.1  (10-01-2005)
Reliance on Advice

  1. In general, a taxpayer may not rely upon a disqualified tax advisor or a disqualified opinion to establish the taxpayer’s reasonable belief.

  2. A tax advisor is disqualified under IRC section 6664(d)(3)(B)(ii), if the advisor;

    1. Is a material advisor and participates in the organization, management, promotion, or sale of the transaction or

    2. Is related to any person who so participates,

    3. Is compensated directly or indirectly by a material advisor with respect to the transaction,

    4. Has a contingent fee arrangement with respect to the transaction, or

    5. Has any other disqualifying interest with respect to the transaction as prescribed by the Secretary.

  3. A tax advisor’s opinion is disqualified under IRC section 6664(d)(3)(B)(iii) if the opinion is:

    1. Based on unreasonable factual or legal assumptions (including future events assumption),

    2. Unreasonably relies on representations, statements, findings, or agreements of the taxpayer or any other person,

    3. Does not identify and consider all relevant facts, or

    4. Fail to meet any other requirement as the Secretary may prescribe.

Exhibit 20.1.5-1  (10-01-2005)
Calculation of an Underpayment

Reference: Section 20.1.5.2.2.(3), Section 20.1.5.2.4(8) and Section 20.1.5.12.6(2)
         
The following example illustrates how an underpayment is computed:
    (a) Corrected tax $10,000
    (b) Less: Tax per return -7,000
    (c) plus any amounts not previously
 
       assessed or collected without assessment 0
    (d) plus any amount of rebates made   0
    (e) Underpayment ($10,000 less $7,000) $3,000
         
         
Calculation of the Underpayment with Multiple Adjustments
         
Adjustment A (no penalty imposed) $  1,000
Adjustment B (accuracy-related)  40,000
Adjustment C (Civil fraud penalty)  45,000
Total adjustments (A + B + C)  86,000
Plus: Taxable income shown on the return  15,800
Taxable income as corrected