See IRM 20.1.5.6.of this manual.

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

See IRC section 6662(e)(1)(B) relating to substantial valuation misstatements under IRC section 482 transactions.

If the value or adjusted basis of any property claimed on a return is 200 percent or more of the amount determined to be the correct amount of such value or adjusted basis, the valuation misstatement constitutes a " gross valuation misstatement." See IRC section 6662(h)(2)(A). If there is a gross valuation misstatement, then the 20 percent penalty under IRC section 6662(a) is increased to 40 percent. See IRC section 6662(h)(1).

There is no disclosure exception to this penalty. See Treas. Reg. 1.6662-5(a). The only exception is reasonable cause and good faith under IRC section 6664.

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.

A substantial valuation misstatement exists if the value or adjusted basis of any property claimed on a return is 150 percent or more of the amount determined to be the correct amount of such value or adjusted basis. IRC section 6662(e)(1)(A).

IRC section 6662(e)(1)(B) 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.

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.

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.

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.

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 calculation examples see Treas. Reg. 1.6662-6(c)(7).

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).

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

A gross valuation misstatement exists:

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

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 200 percent ($46,000 divided by $10,000 = 460 percent). The gross valuation misstatement penalty would then apply at 40 percent of the applicable underpayment.

For calculation examples, involving carryovers and flow through entities, See IRM 20.1.5.2.3. and Treas. Regs. 1.6662-5(d) and (h).

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.

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).

See IRM 20.1.5.3.2 of this manual.

See IRM 20.1.5.6 of this manual.

The following example illustrates the penalty criteria and calculation:

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.

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.

See IRM 20.1.5.6. of this manual.

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 65 percent or less of the corrected amount (or 40 percent or less in the case of a gross valuation misstatement). See IRC section 6662(g)(1) and IRC section 6662(h)(2)(C) respectively.

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.

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

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

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).

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:

For calculation examples that relate to the above adjustments, see Exhibit 20.1.5-5.

See IRM 20.1.5.3.2 of this manual.

See IRM 20.1.5.6 of this manual.

IRC section 6663 does not define "fraud" Courts have long recognized that the essence of the fraud penalty is the taxpayer’s state of mind. The state of mind required has been described in various ways, but most definitions require "intent to evade tax." Intent is distinguished from inadvertence, reliance on incorrect professional advice, honest difference of opinion, negligence or carelessness.

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:

Some common "badges of fraud" include:

Recommendations for asserting the civil fraud penalty should be carefully reviewed to fully establish that the evidence supports the assertion. Fraud must be proven by clear and convincing evidence

All statutory notices of deficiency asserting the fraud penalty must be reviewed by Area Counsel.

Civil fraud penalty 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.

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 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.

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.

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.

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 6651(f) 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 penalties, see IRM 20.1.2.7 for additional information on the fraudulent failure to file penalty under IRC section 6651(f).

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. See IRC section 6663(c).

As a general rule, neither Collection employees nor Customer Service employees are 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. IRM 25.1.11.

In cases closing as unagreed with the civil fraud penalty, the report must include the alternative IRC section 6662 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.

The examiner’s report will reflect the civil fraud penalty by IRC section and identify the adjustments attributable to fraud. The examiner will attach Form 3198, Special Handling Notice for Examination Case Processing or Form 3198-A, TE/GE Special Handling Notice to the case file.

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

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 25.1.3, Criminal Referrals.

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

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.

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

Examiners and managers should be aware of collateral estoppel and the important distinction it can have in civil tax fraud penalty cases. Collateral estoppel is a legal doctrine that prevents a taxpayer, who has been previously convicted of criminal tax evasion under 7201, from asserting a defense to the civil fraud penalty. See IRM 25.1.6.3.

Examiners should coordinate closely with the group manager and local counsel on cases involving potential fraud.

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

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).

For a calculation example involving the accuracy-related penalty and the civil fraud penalty, see Exhibit 20.1.5-1 .

For a calculation example 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.

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.

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

See IRM 25.1.2, Recognizing and Developing Fraud for procedures on developing and processing a civil fraud case.

The examiner will compute the penalty and provide any special closing instructions for CCP on the appropriate special handling notice, Form 3198 or Form 3l98A.

The total civil fraud penalty will be assessed to the Master File with TC 320using:

The fraud penalty is assessed to the Non-Master File with TC 320 using:

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

See IRM 20.1.2.7 for assessments relating to fraudulent failure to file penalty under IRC section 6651(f).

A taxpayer uses Form 8886, Reportable Transaction Disclosure Statement, to make the disclosure required under IRC section 6011 and the regulations. Under Treas. Reg. 1.6011-4(e), the Form 8886 must be attached to the taxpayer's tax return (or amended return) for each taxable year for which a taxpayer participates in a reportable transaction. In addition, when the taxpayer files its first Form 8886, a duplicate form must be sent to the Office of Tax Shelter Analysis (OTSA).

Generally, a taxpayer should first file a Form 8886 beginning with the first year that it has participated in the reportable transaction. Thus, the requirement to file a duplicate Form 8886 should arise during the first year of participation in the reportable transaction.

If, however, the taxpayer fails to file any Form 8886 in its first year of participation, the requirement to send a duplicate Form 8886 to OTSA will arise whenever the taxpayer first submits a Form 8886, regardless of how many years it has been engaged in the reportable transaction at issue.

A failure to submit either filing is a failure to satisfy the disclosure requirements. If a taxpayer has entered into more than one reportable transaction, the taxpayer is required to meet the disclosure requirements with respect to each transaction.

A taxpayer is treated as meeting the disclosure requirements of IRC section 6011 and the associated regulations if the Commissioner (or the Commissioner’s delegate) rescinds the penalty under IRC section 6707A.

IRC section 6707A provides a monetary penalty for the failure to include on any return or statement any information required to be disclosed under IRC §6011 with respect to a reportable transaction.

IRC section 6707A authorizes the Commissioner to rescind the imposition of the penalty with respect to reportable non-listed transactions if it would promote compliance with the tax laws and effective tax administration. The penalty cannot be rescinded with respect to a listed transaction.

The Commissioner’s refusal to rescind the penalty may not be reviewed by Appeals or in any court proceeding.

The examiner should question the taxpayer or otherwise determine whether the taxpayer successfully sought rescission of an IRC section 6707A penalty with respect to the reportable transaction at issue, because such rescission could directly impact the application of IRC section 6662A.

If the transaction at issue is a listed transaction, however, IRC section 6707A does not permit rescission and, therefore, the potential rescission of an IRC section 6707A penalty and its impact on IRC section 6662A is not an issue.

The reportable transaction understatement is the sum of:

Example:

If the taxpayer files an amended return after the IRS first contacts the taxpayer regarding an examination of the return, or any other dates specified by the Secretary, the tax treatment of an item on the amended return is not taken into account in determining the reportable transaction understatement, see IRC section 6662A(e)(3), and Treas. Reg. 1.6664-2(c)(3).

In the case of a reportable transaction other than a listed transaction, the IRC section 6662A penalty will not be imposed if the taxpayer:

Generally, the IRC section 6662A penalty is in addition to any other penalty that may be imposed. The following penalties, however, may not be assessed if the IRC section 6662A penalty is assessed: IRC section 6662 penalty, Accuracy-Related Penalty on Underpayments; IRC section 6663 penalty, Fraud Penalty; and IRC section 6676 penalty, Erroneous Claim for Refund or Credit. Also, the IRC section 6662A penalty does not apply to any portion of an understatement on which the IRC section 6662(h), accuracy-related penalty for a gross valuation misstatement or IRC section 6663, fraud penalty, is assessed.

For purposes of determining whether the taxpayer has a substantial understatement of income tax under IRC section 6662(d), e.g., determining whether an individual has an understatement in excess of the lesser of:

The understatement attributable to the IRC section 6662A reportable transaction is included in the IRC section 6662(d) understatement calculation. However, the reportable transaction understatement upon which the IRC section 6662A penalty is asserted, is not included in the amount of the understatement used to determine the underpayment upon which the 20 percent under IRC section 6662(d) penalty is asserted. These calculations are illustrated in the following example.

Example:

Because IRC section 6662A penalty is computed on the reportable transaction understatement with respect to certain reportable transactions, the penalty cannot be asserted until the completion of the examination of the underlying tax liability.

Because there is no expedited or stand-alone assessment, there are generally no special procedures for case development or penalty approval for the IRC section 6662A penalty. Instead, the existing procedures for developing and approving an IRC section 6662 penalty can be used for the 6662A penalty. See IRM 20.1.5.3. See IRM 20.1.5.3.2. See IRM 20.1.5.1.6 . Also, when closing the case from the group, the examiner will:

The PRN 681 and assessment amount will post to the Master File account with Transaction Code 240.

The examiner should also check to determine whether the taxpayer successfully sought rescission of an IRC section 6707A penalty with respect to the same transaction, as rescission may impact the application of the IRC section 6662A penalty. See IRM 20.1.5.13.1 of this manual. (Because rescission is not available for a listed transaction, this consideration does not apply to those transactions).

Taxpayers are entitled to pre-assessment Appeals consideration and statutory notice of deficiency procedures for the IRC section 6662A penalty. When forwarding a case to Appeals, the examiner should ensure that the IRC section 6662A case file transmitted to Appeals through Technical Services includes information on any prior Appeals action, including the Appeals Officer’s name.

The accuracy-related penalty under IRC section 6662A does not apply with respect to any portion of a reportable transaction understatement if, pursuant to IRC section 6664(d), it is shown that there was reasonable cause and the taxpayer acted in good faith with respect to that portion of the understatement. A taxpayer does not have reasonable cause and did not act in good faith unless:

A taxpayer has reasonable belief with respect to the tax treatment of an item if the belief is based on the law and the facts that exist at the time the return is filed, and the belief relates solely to the taxpayer’s chances of success on the merits and does not take into account the possibility of audit.

An opinion of a tax advisor may not be relied upon to establish the reasonable belief of the taxpayer if the advisor or the opinion is disqualified. A tax advisor is disqualified if the tax advisor:

An opinion is disqualified if the opinion:

For more detailed information regarding reasonable cause see IRC sections 6662A and 6664(d).

The penalty is equal to 20 percent of the disallowed portion of the claim for refund or credit for which there is no reasonable basis for the claimed tax treatment. See IRC section 6676.

The penalty may be asserted on any person where the amount of the claim for refund or credit for any taxable year exceeds the claim allowable amount.

The penalty for filing an erroneous refund claim for refund or credit is asserted on the "excessive amount" of the claim for refund or credit.

Example of "excessive amount" :

The IRC section 6676 penalty shall not apply to any portion of the disallowed portion of the claim for refund or credit that is subject to:

Notwithstanding IRC section 6676(c), the Service has the sole discretion and authority to impose the penalty in the context of other penalties and to impose the penalty multiple times on multiple claims that lack reasonable basis. The Service shall apply a rule of equity and good conscience in determining whether to impose the penalty in the context of other penalties or multiple times.

IRC section 6676 shall not apply if there is reasonable basis for the claimed tax treatment.

Additional information on reasonable basis and reasonable cause will be provided in the Federal Tax Regulations.

IRC section 6676 will be assessed using Form 8278, Computation and Assessment of Miscellaneous Penalties. Form 8278 is an adjustment document used to assert penalties not subject to deficiency procedures.

The penalty is assessed using Penalty Reference Number 565 for: