Changes made to the accuracy-related penalty by the Omnibus Budget Reconciliation Act of 1993- Penalties: Accuracy-related.--Reg. §1.6662-7 and amendments of Reg. §§1.6662-0, 1.6662-1, 1.6662-2, 1.6662-3, 1.6662-4, are proposed. Federal Register Publication Date: March 17, 1994.

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: These proposed regulations amend the accuracy-related penalty regulations under chapter 1 of the Internal Revenue Code. These amendments are necessary to effect changes to the accuracy-related penalty made by the Omnibus Budget Reconciliation Act of 1993. This document also provides notice of a public hearing on the proposed amendments.


SUPPLEMENTARY INFORMATION:

Temporary Regulations and 26 U.S.C. 7805(e)(1)


In *** [page 18, this Bulletin], the IRS is issuing temporary regulations (Treasury Decision 8533) to implement certain changes made to the accuracy-related penalty in section 6662 of the Internal Revenue Code (Code) by section 13251 of the Omnibus Budget Reconciliation Act of 1993 (OBRA 1993). Section 7805(e)(1) of the Code (26 U.S.C. 7805(e)(1)) requires the publication of a notice of proposed rulemaking whenever the Secretary issues temporary regulations to allow an opportunity for public comment. The substance of T.D. 8533 is reflected in the proposed amendments to sections 1.6662-1 through 1.6662-4. The Internal Revenue Service presently intends to revise §§1.6662-1 through 1.6662-4 in response to taxpayers' comments on the proposed regulations and does not presently intend to finalize §1.6662-7T.


Background


These proposed regulations set forth certain changes made to the accuracy-related penalty in section 6662 of the Code by section 13251 of OBRA 1993. These changes eliminated the disclosure exception for the negligence penalty (section 6662(b)(1) of the Code) and raised the disclosure standard for purposes of the penalties for disregarding rules or regulations (section 6662(b)(1) of the Code) and a substantial understatement of income tax (section 6662(b)(2) of the Code) from "not frivolous" to "reasonable basis." See section 13251 of OBRA 1993 and H. Rep. No. 213, 103rd Cong., 1st Sess. 669 (1993) (the Conference Report).


The legislative history to OBRA 1993 indicates that this "reasonable basis" standard is a relatively high standard of tax reporting that is significantly higher than the "not frivolous" disclosure standard previously applicable to taxpayers under section 6662 of the Code and currently applicable to preparers under section 6694 of the Code. See Conference Report, at p. 669. A position is not frivolous if it is not "patently improper." See §1.6694-2(c)(2) of the Income Tax Regulations and current §1.6662-3(b)(3). The legislative history to OBRA 1993 also provides that the reasonable basis standard is not satisfied by a position that is merely arguable or merely a colorable claim. See Conference Report, at p. 669.


In addition to adopting the new reasonable basis standard as the standard that a disclosed return position must satisfy to avoid the disregard and substantial understatement penalties, Congress adopted the new reasonable basis standard as the standard that a return position must satisfy to avoid the negligence penalty. See Conference Report at p. 669.


Treasury requests comments on how the new reasonable basis standard should be defined for purposes of the negligence, disregard, and substantial understatement penalties.


Explanation of Changes


Section 1.6662-3(a) of the regulations generally provides that if any portion of an underpayment, as defined in section 6664(a) of the Code and §1.6664-2, of any income tax imposed under subtitle A of the Code that is required to be shown on a return is attributable to negligence or disregard of rules or regulations, there is added to the tax an amount equal to 20 percent of such portion. Section 1.6662-3(b)(1) defines "negligence" to include any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax return. Currently, §1.6662-3(c) generally provides that no penalty under section 6662(b)(1) may be imposed on any portion of any underpayment that is attributable to negligence or a position contrary to a rule or regulation if the position is adequately disclosed and is not frivolous, if the requirements of that section are met.


Section 1.6662-4(a) of the regulations generally provides that if any portion of an underpayment of any income tax imposed under subtitle A of the Code that is required to be shown on a return is attributable to a substantial understatement of such income tax, there is added to the tax an amount equal to 20 percent of such portion. Section 1.6662-4(a) further provides that, except in the case of any item attributable to a tax shelter, an understatement is reduced by the portion of the understatement that is attributable to positions for which there was substantial authority or adequate disclosure. Currently, under §1.6662-4(e)(2), this adequate disclosure exception will not apply if the position on the return is frivolous.


As a result of OBRA 1993, the minimum standard that a disclosed return position must satisfy to avoid either the penalty for disregarding rules or regulations or for a substantial understatement of income tax has been raised from "not frivolous" to "reasonable basis." In addition, there is no longer a disclosure exception for the negligence penalty and, to avoid that penalty, the return position generally must satisfy the new reasonable basis standard.


These rules generally apply to returns that are due (without regard to extensions for filing) after December 31, 1993. However, the rules relating to changes to the penalties for negligence or disregard of rules or regulations will not apply to returns, including qualified amended returns, filed on or before March 14, 1994.


Special Analyses


It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.


Comments and Public Hearing


Before the adoption of these proposed regulations, consideration will be given to any written comments that are submitted timely (a signed original and eight copies) to the Internal Revenue Service. All comments will be available for public inspection and copying in their entirety.


A public hearing is scheduled to be held on July 12, 1994, in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, N.W., Washington, D.C. Because of access restrictions, visitors will not be admitted beyond the building lobby more than 15 minutes before the hearing starts.


The rules of 26 CFR 601.601(a)(3) apply to the hearing.


Persons who wish to present oral comments at the hearing must submit written comments, an outline of the topics to be discussed, and the time to be devoted to each topic by June 21, 1994.


A period of 10 minutes will be allotted to each person for making comments.


An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.


Drafting Information


The principal author of these proposed regulations is David L. Meyer, Office of Assistant Chief Counsel, Income Tax and Accounting, Internal Revenue Service. However, other personnel from the IRS and Treasury Department participated in their development.


List of Subjects in 26 CFR Part 1


Income taxes, Reporting and recordkeeping requirements.


Proposed Amendments to the Regulations


Accordingly, 26 CFR part 1 is proposed to be amended as follows:


PART 1--INCOME TAXES


Paragraph 1. The authority citation for part 1 continues to read in part as follows:


Authority: 26 U.S.C. 7805 ***


Par. 2. Section 1.6662-0 is amended by:


1. Revising the introductory language,


2. Adding entries for §1.6662-2(d)(1) and (d)(2),


3. Revising the entry for paragraph (b)(3) under §1.6662-3, and


4. Adding an entry for §1.6662-6.


5. The revised and added provisions read as follows:


§1.6662-0 Table of contents.


This section lists the captions that appear in §§1.6662-1 through 1.6662-6.


* * * * *

§1.6662-2 Accuracy-related penalty.

* * * * *


(d) ***


(1) Returns due before January 1, 1994.


(2) Returns due after December 31, 1993.


§1.6662-3 Negligence or disregard of rules or regulations.

* * * * *


(b) ***


(3) Reasonable basis.


(i) In general [Reserved].


(ii) Relationship to other standards.


* * * * *

§1.6662-6 Omnibus Budget Reconciliation Act of 1993 changes to the accuracy-related penalty.


(a) In general.


(1) Scope.


(2) Effective date.


(b) No disclosure exception for negligence penalty.


(c) Disclosure standard for other penalties is reasonable basis.


(d) Definition of reasonable basis.


(1) In general [Reserved].


(2) Relationship to other standards.


Par. 3. In §1.6662-1, the second and third sentences of the concluding text are revised to read as follows:


§1.6662-1 Overview of the accuracy-related penalty.

* * * * *


*** The penalties for disregard of rules or regulations and for a substantial understatement of income tax may be avoided by adequately disclosing certain information as provided in §1.6662-3(c) and §1.6662-4(e) and (f), respectively. The penalties for negligence and for a substantial (or gross) valuation misstatement under chapter 1 may not be avoided by disclosure. ***


Par. 4. Section 1.6662-2 is amended by:


1. Redesignating the text of paragraph (d) as (d)(1) and adding a heading,


2. Revising the first and second sentences of newly designated paragraph (d)(1), and


3. Adding paragraph (d)(2).


4. The revised and added provisions read as follows:


§1.6662-2 Accuracy-related penalty.

* * * * *


(d) Effective date--(1) Returns due before January 1, 1994. Section 1.6662-3(c) and §1.6662-4(e) and (f) (relating to methods of making adequate disclosure) as codified in 26 CFR revised April 1, 1993, apply to returns the due date of which (determined without regard to extensions of time for filing) is after December 31, 1991, but before January 1, 1994. Except as provided in the preceding sentence, §§1.6662-1 through 1.6662-5 as codified in 26 CFR revised April 1, 1993, apply to returns the due date for which (determined without regard to extensions of time for filing) is after December 31, 1989, but before January 1, 1994. ***


(2) Returns due after December 31, 1993. Except as provided in the last sentence of this paragraph (d)(2), the provisions of §§1.6662-1 through 1.6662-4 as revised to reflect the changes made to the accuracy-related penalty by the Omnibus Budget Reconciliation Act of 1993 and of §1.6662-5 apply to returns the due date for which (determined without regard to extensions of time for filing) is after December 31, 1993. These changes include raising the disclosure standard for the penalties for disregarding rules or regulations and for a substantial understatement of income tax from not frivolous to reasonable basis, eliminating the disclosure exception for the negligence penalty, and providing guidance on the meaning of reasonable basis. The Omnibus Budget Reconciliation Act of 1993 changes relating to the penalties for negligence or disregard of rules or regulations will not apply to returns (including qualified amended returns) that are filed on or before March 14, 1994, but the provisions of §§1.6662-1 through 1.6662-3 as codified in 26 CFR part 1 revised April 1, 1993, relating to those penalties will apply to such returns.


Par. 5. Section 1.6662-3 is amended by:


1. Revising the second sentence of paragraph (a),


2. Revising paragraph (b)(3), and


3. Revising paragraphs (c)(1) and (2).


4. The revisions read as follows:


§1.6662-3 Negligence or disregard of rules or regulations.


(a) *** The penalty for disregarding rules or regulations does not apply, however, if the requirements of §1.6662-3(c)(1) are satisfied and the position in question is adequately disclosed as provided in §1.6662-3(c)(2), or to the extent that the reasonable cause and good faith exception to this penalty set forth in §1.6664-4 applies. ***


(b) ***


(3) Reasonable basis--(i) In general. [Reserved].


(ii) Relationship to other standards. The reasonable basis standard is significantly higher than the not frivolous standard applicable to preparers under section 6694 and defined in §1.6694-2(c)(2).


* * * * *


(c) ***


(1) In general. No penalty under section 6662(b)(1) may be imposed on any portion of an underpayment that is attributable to a position contrary to a rule or regulation if the position is disclosed in accordance with the rules of paragraph (c)(2) of this section and, in case of a position contrary to a regulation, the position represents a good faith challenge to the validity of the regulation. This disclosure exception does not apply, however, in the case of a position that does not have a reasonable basis or where the taxpayer fails to keep adequate books and records or to substantiate items properly.


(2) Method of disclosure. Disclosure is adequate for purposes of the penalty for disregarding rules or regulations if made in accordance with the provisions of §§1.6662-4(f)(1), (3), (4), and (5), which permit disclosure on a properly completed and filed Form 8275 or 8275-R, as appropriate. In addition, the statutory or regulatory provision or ruling in question must be adequately identified on the Form 8275 or 8275-R, as appropriate. The provisions of §1.6662-4(f)(2), which permit disclosure in accordance with an annual revenue procedure for purposes of the substantial understatement penalty, do not apply for purposes of this section.


Par. 6. Section 1.6662-4 is amended by:


1. Removing the third sentence in paragraph (d)(2), and


2. Revising paragraph (e)(2) to read as follows:


§1.6662-4 Substantial understatement of income tax.

* * * * *


(e) ***


(2) Circumstances where disclosure will not have an effect. The rules of paragraph (e)(1) of this section do not apply where the item or position on the return--


(i) Does not have a reasonable basis (as defined in §1.6662-3(b)(3));


(ii) Is attributable to a tax shelter (as defined in section 6662(d)(2)(C)(ii) and paragraph (g)(2) of this section); or


(iii) Is not properly substantiated, or the taxpayer failed to keep adequate books and records with respect to the item or position.


Par. 7. Section 1.6662-7 is added to read as follows:


§1.6662-7 Omnibus Budget Reconciliation Act of 1993 changes to the accuracy-related penalty.


(a) In general--(1) Scope. The Omnibus Budget Reconciliation Act of 1993 made certain changes to the accuracy-related penalty in section 6662. This section provides rules reflecting those changes.


(2) Effective date. This section applies to returns that are due (without regard to extensions of time for filing) after December 31, 1993. However, the provisions of this section relating to the penalties for negligence or disregard of rules or regulations will not apply to returns (including qualified amended returns) that are filed on or before March 14, 1994


(b) No disclosure exception for negligence penalty. The penalty for negligence in section 6662(b)(1) may not be avoided by disclosure of a return position.


(c) Disclosure standard for other penalties is reasonable basis. The penalties for disregarding rules or regulations in section 6662(b)(1) and for a substantial understatement of income tax in section 6662(b)(2) may be avoided by adequate disclosure of a return position only if the position has at least a reasonable basis. See §§1.6662-3(c) and 1.6662-4(e) and (f) for other applicable disclosure rules.


(d) Definition of reasonable basis--(1) In general. [Reserved].


(2) Relationship to other standards. The reasonable basis standard is significantly higher than the not frivolous standard applicable to preparers under section 6694 and defined in §1.6694-2(c)(2).