Appeals of 6694 and District Court

1.6694-4 Extension of period of collection when tax return preparer pays 15 percent of a penalty for understatement of taxpayer's liability and certain other procedural matters.

(a) In general. (1) The Internal Revenue Service (IRS) will investigate the preparation by a tax return preparer of a return of tax under the Internal Revenue Code (Code) or claim for refund of tax under the Code as described in §301.7701-15(b)(4) of this chapter, and will send a report of the examination to the tax return preparer before the assessment of either --

(i) A penalty for understating tax liability due to a position for which either it was not reasonable to believe that the position would more likely than not be sustained on its merits under section 6694(a) or no substantial authority, as applicable (or not a reasonable basis for disclosed positions); or

(ii) A penalty for willful understatement of liability or reckless or intentional disregard of rules or regulations under section 6694(b).

(2) Unless the period of limitations (if any) under section 6696(d) may expire without adequate opportunity for assessment, the IRS will also send, before assessment of either penalty, a 30-day letter to the tax return preparer notifying him of the proposed penalty or penalties and offering an opportunity to the tax return preparer to request further administrative consideration and a final administrative determination by the IRS concerning the assessment. If the tax return preparer then makes a timely request, assessment may not be made until the IRS makes a final administrative determination adverse to the tax return preparer.

(3) If the IRS assesses either of the two penalties described in section 6694(a) and section 6694(b), it will send to the tax return preparer a statement of notice and demand, separate from any notice of a tax deficiency, for payment of the amount assessed.

(4) Within 30 days after the day on which notice and demand of either of the two penalties described in section 6694(a) and section 6694(b) is made against the tax return preparer, the tax return preparer must either --

(i) Pay the entire amount assessed (and may file a claim for refund of the amount paid at any time not later than 3 years after the date of payment); or

(ii) Pay an amount which is not less than 15 percent of the entire amount assessed with respect to each return or claim for refund and file a claim for refund of the amount paid.(5) If the tax return preparer pays an amount and files a claim for refund under paragraph (a)(4)(ii) of this section, the IRS may not make, begin, or prosecute a levy or proceeding in court for collection of the unpaid remainder of the amount assessed until the later of --

(i) A date which is more than 30 days after the earlier of --

(A) The day on which the tax return preparer's claim for refund is denied; or

(B) The expiration of 6 months after the day on which the tax return preparer filed the claim for refund; and

(ii) Final resolution of any proceeding begun as provided in paragraph (b) of this section.

(6) The IRS may counterclaim in any proceeding begun as provided in paragraph (b) of this section for the unpaid remainder of the amount assessed. Final resolution of a proceeding includes any settlement between the IRS and the tax return preparer, any final determination by a court (for which the period for appeal, if any, has expired) and, generally, the types of determinations provided under section 1313(a) (relating to taxpayer deficiencies). Notwithstanding section 7421(a) (relating to suits to restrain assessment or collection), the beginning of a levy or proceeding in court by the IRS in contravention of paragraph (a)(5) of this section may be enjoined by a proceeding in the proper court.

(b) Preparer must bring suit in district court to determine liability for penalty. The IRS may proceed with collection of the amount of the penalty not paid under paragraph (a)(4)(ii) of this section if the preparer fails to begin a proceeding for refund in the appropriate United States district court within 30 days after the earlier of --

(1) The day on which the preparer's claim for refund filed under paragraph (a)(4)(ii) of this section is denied; or

(2) The expiration of 6 months after the day on which the preparer filed the claim for refund.

(c) Suspension of running of period of limitations on collection. The running of the period of limitations provided in section 6502 on the collection by levy or by a proceeding in court of the unpaid amount of a penalty or penalties described in section 6694(a) or section 6694(b) is suspended for the period during which the IRS, under paragraph (a)(5) of this section, may not collect the unpaid amount of the penalty or penalties by levy or a proceeding in court.

(d) Effective/applicability date. This section is applicable to returns and claims for refund filed, and advice provided, after December 31, 2008.

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I have tried to understand the above language and have come to the conclusion that there is substantial ambiguity of these regulations.

The administrative appeal is probably to the IRS Office of Appeals, but that is strangely unclear.

There does not appear to be any right to judicial appeal if the appeal is denied.

Instead the trust of the section 6694(c), that the above regulations were supposed to clarify, is that you pay 15% or the full amount and then claim a refund which will likely get you to the local District Court.

Hiring an attorney for a $1,000 or a $5,000 penalty to go to the Disctrict Court creates a cost of appeals that is greater than the penalty. What is the cut-off point that would make one want to hire an attorney to go to the District Court? I would argue that anything under $50,000 in 6694 penalties would make it not worth the effort to undergo the time and money needed to litigate the penalties in the District Court because the cost of District Court litigation would probably be at least that amount if not more. Litigating attorney burn lots of time and lots of hours on their cases with multiple appearances, motions, a brief and replies to the answer. Regardles of whether you agree or disagree with the $50,000 number, my main point is that it is an expensive proposition. That is all the more reason to spend more time on tax return preparation checking compliance with the applicable statute, regulations, IRS puplished positions and the case law. If you do not have that skill-set, you need to find a new occupation.

The regulations do not break the penalty to divisible amounts. What if there are three penalties, do each require a 15% deposit?

The statute of limitations described in the above regulations appear to merely apply to the issue of when collection by the IRS can be tolled. That being the case, what is the statute of limitations to appeal a denial of the claim for refund to the District Court? That answer is not in the 6694 final regulations.

So if you think that the 6694 penalty is bad, you should also know that the appeal procedures are not return-preparer friendly.

Overall the size of the penalty, the standards for technical support, and the appeal procedures will likely force a lot of return preparers to seek a new occupation.

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