This post was originally published on Forbes Jul 22, 2015
In something of a man bites dog story, the IRS is being criticized for being too easygoing in handing out penalties and is pushing back to defend its right to be forgiving of small errors. The argument is laid out in one of the latest Inspector General Reposts. Here is the story.
At any rate, the TIGTA report notes that the increased revenue from AUP is the result of doing a better job in picking the discrepancies worth investigating. There is also another change.
Historically, the AUR Program would match information returns to individual tax returns twice a year to select its inventory. The first match identifies discrepancies among individual tax returns filed on time (by April 15). The second match identifies discrepancies among individual tax returns filed after April 15 but on or before December 31. This generally includes taxpayers who received extensions to file or who filed their individual tax returns late. Starting in FY 2011, the AUR Program began testing a third match to identify additional discrepancies for tax returns filed significantly past the due date. Specifically, this third match identifies tax returns filed between January and March of the calendar year subsequent to that in which the tax return was due.
According to the IRS, AUR Program examiners should be allowed to determine whether to waive a penalty based on their experience and judgment of the facts and circumstances of each case and apart from the specific criteria in the IRM. While we agree that the examiner should evaluate all the facts and circumstances in each case when determining whether the taxpayer’s justification met one of the reasonable causes noted in the IRM, the development of additional guidance (e.g., lead sheet or desk guide) would help better ensure that existing IRM requirements are followed as well as ensure that penalties are waived appropriately and consistently.
The AUR Program analysts also stated that they considered the following when reviewing our exception cases: 1) whether the income omission was a new source of income, 2) whether the taxpayer was compliant in the previous three tax years, and 3) how quickly the taxpayer responded to the CP 2000 Notice. These additional factors were not listed in the IRM, or any other AUR Program guidance or training materials, as factors to consider when determining reasonable cause that would warrant penalty relief.
The IRS’s basis for this treatment of the negligence penalty comes from a long-standing AUR Program policy. Although this policy has been in existence for several decades, no rational basis has been provided for the policy, and there is no legal authority that prohibits the AUR Program from imposing the negligence penalty against taxpayers on their first offence. Furthermore, this policy allows a significant amount of noncompliance to go unaddressed. Specifically, we estimate that on an annual basis there are approximately 1.9 million taxpayers who have understatements of tax liabilities beneath the substantial understatement threshold that are not assessed an accuracy-related penalty for negligence. If the AUR Program addressed negligence as it occurred rather than waiting until a taxpayer becomes a “repeater,” approximately $657 million in accuracy-related penalties for negligence could have been assessed for Tax Year 2010 alone.
IRS management stated that they did not agree with our outcome measures. The use of penalties to raise revenue, as suggested by the outcome measures, is inconsistent with the position of many stakeholders.