6694 and Information returns

Is a return preparer responsible for the failure of a client to file any on of the multitude of information returns, including (for example) Forms 1099 as required by section 6041?


The best argument that a return preparer is not responsible for the failure of a client to file any information return is that section 6694(a) is limited to apply to "understatements due to unreasonable positions." The failure of a client to file an information return does not result in an understatement of tax by the client - it results in an understatment (or possible understatement) in the return of the person receiving the payment from your client.

In addtion, information returns are not "returns" subject to penalty in Notice 2008-13 and Notice 2008-46

I personally believe that a return preparer has an obligation to ask a client for information that would surface the need for a reporting requirement. For example, a return preparer should ask a client for information on all payments made to contractors in the amount of $600 or more. In this regard, section 1.6694-3(a)(1)(ii) of the proposed regulations applies the $5,000 penaltyh for "any reckless or intentional disregard of rules or regulations by such person." How would you defend yourself against an assessment by an IRS examiner for being "reckless" in knowing that the Internal Revenue Code requires inormatin returns and you did not investigate whether your client was required to file any information return? I do not think you need that kind of aggrivation.

If your client did not file 10 Forms 1099, your penalty could be $50,000.

I believe the issue is resolved by the clear language of section 6694(b) and its use of the word "reckless." Although the proposed regulations and IRS Notices exempt you from information return responsibility, there is no doubt that the 6694(b) statute trumps the IRS proposed regulations and Notices. In short, I think the IRS proposed regulations and Notices are inconsistent with the "reckless" language of the 6694(b) because the Code requires information returns and also imposes a $5,000 for reckless and willful conduct. Why is it not "reckless" if you do not check out your clients statutory responsibility to file Forms 1099?

Consider the following FSA and its reference to the term "reckless" in connection with an information return. 6662(c) and 6694(b) each use the term "reckless." I believe that this FSA gives substance to my analysis.


FSA 0950
FSA 1992-1110-1

Internal Revenue Service

memorandum

date: November 10, 1992

to: Chief, Appeals Office, Miami SE:MIA:AP Attn: Jay L. Wein

from: Assistant Chief Counsel (Field Service) CC:FS

subject: Form 8300 Cases

This is in response to your request for field service advice dated August 19, 1992. You ask a number of questions concerning processing of Form 8300, Report of Cash Payments Received in a Trade or Business.

ISSUES

1. Under I.R.C. §6721(e), what is the level of proof and who has the burden of proof for intentional disregard of the reporting requirements of section 6050I?

2. What criteria should be used to distinguish between intentional disregard and willfulness?

3. How is reasonable cause defined under section 6724?

CONCLUSIONS

1. The assessed party has the burden of proving by a preponderance of the evidence that a section 6721(e) penalty assessment is incorrect. However, we do not recommend reliance on the plaintiff's burden as a primary method to prevail in such a refund case. Courts might be inclined to shift the burden of proof under a rationale similar to that espoused in Portillo v. Commissioner, 932 F.2d 1128 (5th Cir. 1991).

2. A failure is due to intentional disregard if it is a knowing or willful failure to comply with section 6050I. Whether a person knowingly or willfully fails to comply with section 6050I is determined on the basis of all the facts and circumstances in each particular case. Treas. Reg. §301.6721-1(f)(2). While some insight into the meaning of the terms "intentional disregard, knowing and willful" may be found in other sections of the Internal Revenue Code, we believe, as a practical matter, the government should develop a well documented case at the earliest stage of the proceeding which establishes (1) the person involved was under a legal duty to report under section 6050I, (2) that person knew of the duty, and (3) that person intentionally violated or recklessly disregarded the duty.

3. A section 6721(e) penalty assessment may be waived for reasonable cause only if the filer establishes that there are either significant mitigating factors for the failure to comply with section 6050I or the failure arose from events beyond the filer's control. In addition, the filer must establish that the filer acted in a responsible manner before and after the failure occurred. Treas. Reg. §301.6724-1(a)(2).

DISCUSSION

Section 6050I(a) requires that any person who is engaged in a trade or business, and who, in the course of such trade or business, receives more than $10,000 in cash in one transaction (or two or more related transactions), shall make a return with respect to such transaction (or related transactions) at such time as the Secretary may by regulations prescribe. I.R.C. §6050I(a); Treas. Reg. §1.6050I-1(a)(1). Generally, the information required to be provided is the name, address, and TIN of the person from whom the cash was received, the amount of cash received, and the date and nature of the transaction. I.R.C. §6050I(b). The return is made on Form 8300, Report of Cash Payments Received in a Trade or Business, and must be made within 15 days of receipt of the reportable amount. Treas. Reg. §1.6050I-1(e)(2). The penalty imposed for each failure which is in intentional disregard of the requirement to file an information return or provide all of the information required under section 6050I is the greater of $25,000 or the amount of cash received in the unreported transaction not to exceed $100,000. I.R.C. §6721(e).

1. Burden of Proof

In a refund suit, the Commissioner's assessment is presumed to be correct, and the taxpayer must produce sufficient evidence to support a finding contrary to the Commissioner's determination. In addition to rebutting this presumption, the assessed party has the burden of proving by a preponderance of the evidence that the assessment is incorrect, and the correct amount of the assessment. See Welch v. Helvering, 290 U.S. 111, 115 (1933); Lewis v. Reynolds, 284 U.S. 281, 283 (1932); Rockwell v. Commissioner, 512 F.2d 882, 887 (9th Cir.), cert. denied, 423 U.S. 1015 (1975); National Weeklies v. Commissioner, 137 F.2d 39, 41 (8th Cir. 1943). See also M. Saltzman, I.R.S. Practice & Procedure ¶1.05[2][c] (2d ed. 1990); Mertens, Law of Federal Income Taxation §50.442 (1992). This applies with equal force in a refund action which involves a penalty assessment. Liddon v. United States, 448 F.2d 509, 514 (5th Cir. 1971), cert. denied, 406 U.S. 918 (1972) (involving a suit for the refund of the 100 percent penalty under section 6672). This allocation of the burden of proof in refund cases stems, in part, from historical judicial reliance on actions involving the common law count for money had and received. Lewis, 284 U.S. at 283.

The impetus for a party assessed under section 6721(e) to argue that "intentional disregard" is synonymous with "fraud", and thereby within the parameters of section 7454(a) is clear because the burden would shift. 1 However, we find no support for such a construction. If Congress had intended fraud to be the standard of conduct required to trigger a violation of section 6721(e), presumably such term would have been used in the statutory provision. The Treasury Regulations define the term as a "knowing or willful" failure to timely file or include correct information, not fraudulent failure to timely file or provide correct information. Treas. Reg. §301.6721-1(f)(2).

Further, except when specifically excepted by Congressional mandate, plaintiffs carry the burden of proof on other penalties which employ similar language. See, e.g., Sections 6653(a) and 6662 (underpayments due to negligence or disregard of the rules and regulations) (under I.R.C. §§6653(c) and 6662(c) the term disregard includes any careless, reckless or intentional disregard); Section 6672 (100 percent penalty) (plaintiff must prove lack of willfulness); Section 6694(b) (preparer penalty) (under Treas. Reg. §1.6694-3(h) plaintiff has burden on issues of whether he recklessly or intentionally disregarded the rule; however, government has the burden pursuant section 7427 to prove preparer willfully attempted to understate liability). We find no statutory exception to the general proposition that the plaintiff has the burden of proving by a preponderance of evidence that an assessment under section 6721(e) is incorrect.

However, reliance on the plaintiff's burden as a primary method to prevail in a refund case involving a section 6721(e) penalty assessment might present a significant litigation hazard. For example, without a reasonable basis in fact, the government's position in various 100 percent penalty cases was held to be unreasonable. Donelan Phelps & Co., Inc. v. United States, 681 F. Supp. 615, 621 (E.D. Mo. 1987), aff'd, 876 F.2d 1373 (8th Cir. 1989) (court awarded attorney's fees and ordered the abatement of a section 6672 penalty because the record revealed a total lack of evidence that Donelan's conduct was willful); see also, Hershey v. United States, 89-1 U.S.T.C. 9233 (D. Nev. 1988). Carson v. United States, 560 F.2d 693 (5th Cir. 1977), involved a refund case where the Court held that an excise tax assessment which was based on the taxpayer's alleged wagering activities could not, without a factual foundation, stand on the presumption of correctness alone. In so holding, the Fifth Circuit stated that the need for tax collection does not excuse the Service from providing some factual foundation for its assessments. Id. at 696.

While deficiency proceedings are not applicable in an action for the refund of a section 6721(e) penalty assessment, the difficulties encountered with the appellate opinion in Portillo v. Commissioner, 932 F.2d 1128 (5th Cir. 1991), by analogy, illustrate our concerns. The Fifth Circuit held that the Service's notice of deficiency, based on the taxpayer's receipt of unreported income, was arbitrary. Hence, the deficiency notice was not accorded the usual presumption of correctness, and the burden of going forward with evidence was shifted to the Service. The appellate court stated that the Service had some duty to investigate further why a Form 1099 showed more income than the taxpayer reported on his return before issuing the deficiency notice. Id. at 1134.

Portillo is the latest in a line of cases which have carved out a limited exception from the general rule that the Service's determinations are presumptively correct. The underpinnings of this exception stem, in part, from the difficulties in proving a negative, i.e., that the taxpayer did not receive the income claimed. Portillo, 932 F.2d at 1133; Zuhone v. Commissioner, 883 F.2d 1317 (7th Cir. 1989); Churukian v. Commissioner, T.C. Memo. 1980-205. A filer who is assessed under section 6721(e), but contends that there was no obligation to report, is faced with the similar problem of proving a negative. Although we do not agree with the result reached in Portillo, and would distinguish its facts, as well as follow Portillo in the Fifth Circuit only, we, nonetheless, believe it would be prudent to remain sensitive to its message. See also, Scar v. Commissioner, 814 F.2d 1363 (9th Cir. 1987) (Service's deficiency notice was invalid because it failed to consider information directly relating to the taxpayer's return).

2. Intentional Disregard

As a preliminary matter, we would like to note that the term "willful" is used to define intentional disregard. Therefore, rather than address the issue as you have framed it, we will attempt to clarify the "intentional disregard" standard of section 6721(e). The basic definition is found in the regulations.

A failure is due to intentional disregard if it is a knowing or willful failure to timely file or to include correct information. Whether a person knowingly or willfully fails to timely file or include correct information is determined on the basis of all the facts and circumstances in each particular case. Treas. Reg. §301.6721-1(f)(2). The regulations also provide a nonexclusive list of the facts and circumstances that are considered in determining whether a failure is due to intentional disregard.

1. Whether the failure is part of a pattern of conduct by the filer of repeatedly failing to file or to include correct information;

2. Whether correction was promptly made upon discovery of the failure;

3. Whether the filer corrects a failure within thirty days after the date of any written request from the Service to file or to correct; and

4. Whether the general penalty under section 6721(a) is less than the cost of compliance with section 6050I.

Treas. Reg. §§301.6721-1(f)(3)(i)-(iv).

Without any section 6721(e) case law developed at present, a logical starting point in defining intentional disregard is found in other Internal Revenue Code provisions. For instance, now repealed section 6653(a) (negligence or disregard of the rules or regulations) employs the term "intentional disregard" and section 6672 (100 percent penalty) employs the term "willful".

While negligence cases may serve as analogs for the knowledge element contained in Treas. Reg. §301.6721-1(f)(2), we believe the "intentional disregard" standard of section 6721(e) is more rigorous than that of the civil negligence penalty. Thus, we emphasize the point that a negligence standard is an insufficient guide to measure conduct which comes within the parameters of section 6721(e).

Various section 6653(a) cases focus on the taxpayer's knowledge of their duty to comply with the rules and regulations. Generally, courts find that taxpayers negligently or intentionally disregarded the rules and regulations if they knew of their duty and disregarded it. See, e.g., Husher v. Commissioner, T.C. Memo. 1986-236 (petitioner's failure to provide sufficient information on his return was due to intentional disregard of the rules and regulations under section 6653(a) because he had properly filed in previous years and, thus, knew of his duty to file and correctly report income); Lee v. Commissioner, T.C. Memo. 1986-294 (petitioner's failure to file was due to "willful disregard" of the rules and regulations since his filing of protestor returns demonstrated his knowledge of the duty to file); Ludwig v. Commissioner, T.C. Memo. 1980-392 (petitioner's failure to file was due to intentional disregard of the rules and regulations because his filing in prior years demonstrated his knowledge of the duty).

These cases suggest that persons who know of the duty to report section 6050I transactions, yet fail to do so, might be in violation of section 6721(e). Perhaps the best evidence establishing section 6050I knowledge is prior compliance. Knowledge may also be shown by admissions of the parties to the transaction, which would require testimony. In addition, notification by the Service of required compliance may serve to establish knowledge; however, establishing proof of receipt of notification might be more difficult. In addition to proof of knowledge of the legal duty, section 6721(e) also might require actual knowledge that the duty was violated.

Section 6701 (aiding or abetting the understatement of tax liability) illustrates the importance of "knowledge". Prior to revision by the Omnibus Reconciliation Act of 1989, P.L. 101-239, section 6701 imposed a penalty on any person who aided in the preparation or presentation of any document, if such person knew the document would be used in connection with any matter arising under the internal revenue laws and who knew that such portion would result in an understatement of the liability for tax of another person. I.R.C. §6701(a). Section 6701 requires actual knowledge. Mattingly v. United States, 924 F.2d 785, 791 (8th Cir. 1991). Since one of the terms the regulations uses to define intentional disregard is "knowing failure", section 6721(e) might require proof that the filer had actual knowledge of such failure.

Treas. Reg. §1.6721-1(f)(3) (iii) is important in this regard because a failure to file within 30 days after the date of any request to do so from the Service is a consideration in determining whether a failure is due to intentional disregard. Thus, in the event a party fails to comply with such a request, and as long as there is a strong factual basis which supports the Service's position that reporting is required, notification with proof of receipt would be strong evidence in support of a section 6721(e) assessment. The legislative history of section 6721 also indicates Congressional willingness to consider as intentional disregard a "[f]ailure to correct information returns within a reasonable time after being requested to do so by the IRS." H.R. Rep. No. 101-247, 101st Cong., 1st Sess. at 1384.

A pattern of conduct has also been a factor courts may consider under section 6653. See Judge v. Commissioner, 88 T.C. 1175 (1987) (Tax Court found it significant that petitioners missed filing deadline in six of the years prior to the tax years at issue). The section 6721 regulations also indicate that a pattern of failing to comply with section 6050I is a circumstance considered in determining whether a failure is due to intentional disregard. Treas. Reg. §1.6721-1(f)(3)(i). The regulations do not specify how many failures are required; however, the greater the number of failures documented, the greater the likelihood the intentional disregard standard will be met. On the other hand, a court may overlook a certain number of failures if a business is relatively new and the failures occurred in the early stages of business activity.

The willfulness standard found in section 6672 cases may be used as a gauge to determine the meaning of willful as used in Treas. Reg. §301.6721-1(f)(2). It should be noted, however, that the factual circumstances under which the section 6672 and 6721(e) penalties arise are entirely different. Nevertheless, the language used in defining section 6672 willfulness is useful in describing section 6721(e) willfulness. Similarly, the willful standard found in section 7203, section 6721's criminal counterpart, may also lend some insight into section 6721(e) willfulness. However, we rely on section 7203 with caution, since that section imposes criminal sanctions and, thus, requires proof beyond a reasonable doubt with the burden on the government. Section 6721(e) imposes a civil fine, and as we have stated above, the burden is on the assessed party by a preponderance of the evidence.

Under section 6672, willfulness is a "voluntary, conscious and intentional act." Mazo v. United States, 591 F.2d 1151, 1154 (5th Cir. 1979), cert. denied, 444 U.S. 842 (1979). In order to be "willful" under section 6672, there need not be a showing of an intent to deprive or defraud the government of the taxes to be paid over; similarly, an "evil" or "bad" motive is not required. See, e.g., Dillard v. Patterson, 326 F.2d 302 (5th Cir. 1963); Bloom v. United States, 272 F.2d 215 (9th Cir. 1959), cert. denied, 363 U.S. 803 (1960). In the criminal tax arena, the Supreme Court defined the willfulness standard as the "voluntary, intentional violation of a known legal duty." Cheek v. United States, 111 S. Ct. 604, 610 (1991). Cheek also held that a good faith misunderstanding of law or a good faith misunderstanding that one is not violating the law negates willfulness. Cheek, 111 S. Ct. at 611.

Based on these criteria, the government should develop a well documented case at the earliest stage of the proceeding which establishes (1) the person involved was under a legal duty to report under section 6050I, (2) that person knew of the duty, and (3) that person intentionally violated or recklessly disregarded the duty. The case file should strive to establish that such person knew what they were doing. While we believe the burden of proof is on the filer under section 6721(e), we are not prepared to recommend the assessment of that penalty relying primarily on the filer's burden to prove the assessment was incorrect. Our concerns are two fold: The first are the considerations mentioned in the above burden of proof analysis. Second, without a reasonable basis for the assessment of the section 6721(e) penalty, the courts might be unwilling to affirm the Service's determination that such penalty was properly assessed.

In our opinion, the section 6721(e) penalty should be reserved for particularly egregious factual situations. The legislative history of the intentional disregard penalty supports the argument that the standard used to measure conduct which comes within section 6721(e) must be more rigorous than negligence. Section 6721(e) originated in the Internal Revenue Code as part of section 6652 under the Tax Equity and Fiscal Responsibility Act of 1982 to prevent situations where "parties knowingly attempt to subvert the reporting requirements that are crucial to the functioning of our tax system." H.R. 6300, Tax Compliance Act of 1982 and H.R. 5829, Taxpayer Compliance Improvement Act of 1982: Hearings Before the House Ways and Means Committee, May 18, 1982, 97th Cong., 2d Sess. 53 (Comm. Print 1982) (Statement of John E. Chapoton, Assistant Treasury Secretary for Tax Policy). Second, the existence of section 7203, the criminal counterpart to section 6721(e), suggests that the intentional disregard standard should be more stringent than negligence. Third, a key element of the "intentional disregard" standard as used in the admittedly different section 6694 penalty, imposed upon tax return preparers for the understatement of a taxpayer's income tax, requires "knowledge or recklessness in not knowing of the rule or regulation in question". Finally, the regulations suggest that the penalty should be imposed in circumstances where there has been a knowing, voluntary or intentional act to circumvent the filing requirements. The appropriate sanction for conduct which is merely negligent is found under section 6721(a).

3. Reasonable Cause

The section 6721(e) penalty may be waived for failures to comply with section 6050I which are shown to be due to reasonable cause and not due to willful neglect. I.R.C. §6724(a). Reasonable cause is defined under the regulations. Under Treas. Reg. §301.6724-1(a)(2), a penalty is waived for reasonable cause only if the filer establishes that there are either significant mitigating factors for the failure or the failure arose from events beyond the filer's control. In addition, the filer must establish that the filer acted in a responsible manner before and after the failure occurred. Id.

One mitigating factor is that, prior to the subject failure, the filer was never required to file a Form 8300. Another mitigating factor is whether the filer has an established history of complying with the information reporting requirements of section 6050I. In determining whether the filer has such an established history, significant consideration is given to whether the filer has incurred similar penalties in prior years and, if such penalties were incurred in prior years, the extent of the filer's success in lessening its error rate from year to year. This is not an exclusive list of mitigating factors. Treas. Reg. §301.6724-1(b).

The regulations also provide a nonexclusive list of events which are considered to be beyond the filer's control:

1. The unavailability of relevant business records;

2. An undue economic hardship relating to filing on magnetic media;

3. Certain actions of the Service;

4. Certain actions of an agent; and

5. Certain actions of the payee or other persons providing necessary information with respect to the return or payee statement.

Treas. Reg. §301.6724-1(c)(1). Treas. Reg. §§301.6724-1(c)(2)-(6) further define each of the above five categories.

As mentioned above, to qualify for a reasonable cause waiver under section 6724, in addition to establishing that there were either significant mitigating factors or events beyond the filer's control, the filer must also establish that he acted in a responsible manner before and after the failure occurred. Treas. Reg. §301.6724-1(a)(2). Acting in a responsible manner means that a filer exercised reasonable care, which is that standard of care that a reasonably prudent person would use under the circumstances in the course of its business in determining its filing obligations. Treas. Reg. §301.6724-1(d)(1)(i). Further, the filer should show that he undertook significant steps to avoid or mitigate the failure. Treas. Reg. §301.6724-1(d)(1)(ii). For instance, requesting extensions of time to file, attempts to prevent a failure, acting to remove an impediment or the cause of the failure once it occurred, and rectifying a failure to file promptly, if possible, once the failure is discovered are steps a filer can take to mitigate a failure. Id. Other special rules to determine whether a filer acted in a responsible manner before and after a failure are provided for cases involving missing and incorrect taxpayer identification numbers under Treas. Reg. §§301.6724-1(e) and (f).

In seeking an administrative determination that the failure was due to reasonable cause and not willful neglect, the filer must submit a written statement to the district director or the director of the Service Center where the returns are required to be filed. The statement must contain the specific provision under which the waiver is requested, set forth all the facts alleged as the basis for reasonable cause, be signed by the person required to file the return, and contain a declaration that it is made under penalties of perjury. Treas. Reg. §301.6724-1(m).

This document may include confidential information subject to the attorney-client and deliberative process privileges, and may also have been prepared in anticipation of litigation. This document should not be disclosed to anyone outside the IRS, including the taxpayer(s) involved, and its use within the IRS should be limited to those with a need to review the document in relation to the subject matter or case discussed herein.

Please direct your inquires to Tom Oswald at 202-622-7910.

DANIEL J. WILES

By:

LEWIS J. FERNANDEZ

Acting Senior Technician Reviewer

Income Tax & Accounting Branch

Field Service Division

1 Section 7454(a) states that "In any proceeding involving the issue of whether the petitioner has been guilty of fraud with the intent to evade tax, the burden of proof in respect of such issue shall be on the Secretary."