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Practitioners Fault Accelerated Assessable Penalty Collection

Posted on Mar. 18, 2020

The IRS’s collections practice for assessable penalties related to foreign information returns is increasingly placing taxpayers in a bind, and practitioners are eager to provide suggestions on how it can be improved.

Assessable penalties include foreign information return penalties, and under section 6671 are payable upon notice and demand. The penalties therefore generally can't be challenged in Tax Court.

Penalties for failure to file foreign information returns commonly include those for Form 5471 for U.S. persons with foreign corporations, Form 5472 for foreign corporations with a U.S. trade or business, and Form 3520 for foreign trusts and gifts. The penalties can be high: Failure to file Form 5471 is $10,000 initially, with added penalties for continued failure amounting to another $50,000; failure to file Form 5472 is $25,000 initially and an additional $25,000 for each 30-day period after 90 days that the failure continues; and failure to file Form 3520 is the greater of 35 percent of the gross reportable amount or $10,000 and is also subject to $10,000 continuation penalties. Section 6038, related to information reporting for foreign corporations and partnerships, also prescribes penalty rules for reducing foreign tax credits.

Given those amounts, it’s no wonder that practitioners are frustrated by what they view as problems with IRS enforcement and collections.

Rochelle Hodes of Crowe LLP said she has noticed an acceleration in collection actions on assessed penalties in the last six or eight months, and that even in cases in which the penalty is clearly erroneous, she has had difficulty halting the collections process. She said she believes that in some situations, the IRS reduced the number of notices requesting payment before beginning collection proceedings.

Megan Brackney of Kostelanetz & Fink LLP, who addressed the issue of foreign information return penalties and collections in a series of Procedurally Taxing blog posts in January, told Tax Notes that while enforcement has increased over the last two or three years, collection activity has sped up only within the last year. Now, not only are there fewer notices, but sometimes notices for demand and payment come in before a taxpayer’s time to appeal has expired, she said.

The IRS declined to comment.

It Can’t Be Reasoned With

In one case, Brackney represented a taxpayer who was the secondary beneficiary of a foreign trust and began receiving distributions after her mother died. The taxpayer’s CPA never filed a Form 3520 after getting the relevant information from the taxpayer, despite checking the box “yes” as to the taxpayer having an interest in a foreign trust on the return. The taxpayer later filed the forms with a reasonable cause statement and a letter from the CPA saying he did not advise her to file the form because he was unaware of the requirement. Her reasonable cause defense was denied in a form letter citing the non-delegable duty to file forms. The IRS imposed a 35 percent penalty on the transactions for each of the corrected years with her appeal still pending.

Brackney said she doubted that anyone at the IRS reviewed her submission.

“In the meantime, despite numerous phone calls and letters to collections, she got a notice of intent to levy,” Brackney said, adding that their request for a collection due process hearing also hasn’t been resolved. “It’s incredibly frustrating because this is a person who clearly should not be getting a half-million-dollar penalty. . . . If you had spent one second, you’d see she hadn’t set [the trust] up . . . and you’d see that it’s not a non-delegable duty situation.”

Brackney pointed out that despite the IRS’s reliance on United States v. Boyle, 469 U.S. 241 (1985), in the form letter denying her reasonable cause, that position didn't apply to her case because advice on whether a return is due is not a non-delegable situation. Nevertheless, the IRS has begun to take the taxpayer’s overpayments of her estimated tax.

“This is not a bad taxpayer,” Brackney said. “[The IRS] collected a significant amount of money without really any due process. . . . This is so typical. . . . Everybody has their crazy story, which isn’t so crazy anymore because it’s just a constant issue.”

In Boyle, the Supreme Court unanimously held that failing to timely file an estate tax return isn’t excused by an executor’s reliance on an agent, and that such reliance isn’t reasonable cause to avoid the late-filing penalty of section 6651(a)(1).

Reasonable cause is a defense to foreign information return penalties. Under Internal Revenue Manual section 20.1.1.3.2, reasonable cause is based on facts and circumstances, with relief generally being available on exercise of “ordinary business care and prudence.”

Shamik Trivedi of Grant Thornton LLP said that presumably, reasonable cause statements for service-center penalties or those not arising during an exam aren't being read or, at most, are “always rubber-stamped as lacking.”

Nobody Is Looking

In some instances, taxpayers may request penalty relief, including under the first-time abatement procedures. Section 6404(a) allows the IRS to abate unpaid assessments that are erroneous, excessive, or assessed after expiration of the statute of limitations.

But practitioners sending letters to the IRS center in Ogden, Utah, seeking relief from international penalties may find lengthy communication delays, which can lead to more frustrations. 

“Nobody is looking at this stuff. I don’t know why,” Hodes said. “You get these letters saying, ‘Gee, we haven’t gotten to your [case]; we need 60 more days.’ But in the meantime, you’re getting the notice of the intent to levy or a notice of a federal tax lien.” Particularly problematic is that the law allows the IRS to send a notice of federal tax lien and then provide the taxpayer with an opportunity to ask for a CDP hearing, she added.

Hodes was quick to point out that a notice of federal tax lien will prevent borrowing by businesses.

“From a tax policy perspective, [the IRS] is fighting penalty abatement for things that eventually should go away. The taxpayer, the taxpayer’s reps, and the IRS are using all of these resources, ginning up all of this work . . . causing all of this effort for penalties they aren’t even going to be collecting,” Hodes said.   

Holds Not Sticking

Another problem, a lack of communication between the penalty notice process and the collection notice process, isn't new, according to Hodes, but the speed of collections actions is. Although taxpayers with reasonable cause for their failure to file may have previously been able to place a collection hold with a simple call to a priority hotline, that isn't the case now, she said.

“It seems like sometimes the collections holds aren’t sticking, or [the IRS] has other initiatives going on, and [taxpayers] can’t get a collection hold,” Hodes said. “You’ve always had this divergence . . . but it just got so much worse recently.”

Trivedi said he too has seen the IRS assess penalties and then quickly pass them along to collections, even after a call has been made to place a hold on collections. Wait times on the practitioner priority service hotline have also increased over the past year, he said, starting around the time the government reopened after its shutdown in January 2019.

A taxpayer with a denied reasonable cause claim will be able to go to IRS Appeals. IRM 8.11.5.1, pertaining to international penalties, states that a taxpayer is entitled to post-assessment prepayment review of the penalty by Appeals.

But Brackney said the IRS continued with collection in many cases despite that provision. She also pointed to a problem with a backlog at Appeals, a problem that is only compounded when taxpayers ask for a CDP hearing request, which also goes to Appeals.

In some cases, errors in coding are also responsible for the IRS improperly continuing collections even after the agency has told taxpayers that a hold would be placed, according to Brackney. Holds might be placed on the 1040 module but not on the civil penalty module, leading to automated notices continuing to go out to taxpayers, she said.

“It's hard to say what goes on on the other side, but we do see weird things and errors on the IRS side,” Brackney said. “The people who seem to be suffering from it, in addition to the taxpayers, are Appeals, who are now inundated with completely unnecessary appeals, both in the first place because the IRS is hitting people really hard for hypertechnical violations or minor noncompliance, and also because there is duplication because we are going to CDP since the IRS won’t stop collection.”

Brackney added that she has dealt with situations in which collection officers deliver notices of intent to levy while taxpayers’ appeals are pending. She said she has asked the officers directly why they are proceeding when they are aware of that and know she will file for a CDP hearing.

“[The collections officer] wasn’t able to explain why they don’t stop once they’ve been notified because . . . no one is telling her to stop,” Brackney said. “Why should she stop doing the thing that is her job? . . . This is her inventory. They don’t have any information or direction as to what they’re supposed to be doing.”

Slow Down, You’re Moving Too Fast

Hodes said that to fix the problem, the IRS should slow down its collection notices and properly identify if a taxpayer had timely responded. But she is skeptical that it will take such unilateral action and thinks legislation will be necessary.

Trivedi also recommended the IRS slow its collections process by allowing a service-center assessed penalty to be referred to collections only after at least 90 days have passed since the date of the initial Notice CP215, “Notice of Penalty Charge.” He recommended that if the taxpayer had communicated with the IRS during the period, another 45 days pass without communication before the penalty is referred to collections. Another solution would be for the IRS to institute a tracking system to track submissions across service centers, he said. And practitioner priority line employees should be allowed to stop collection actions once a taxpayer is in the IRS’s automated collection system, he said.

Trivedi hopes increased digital communication can be at least a partial solution to many of the problems practitioners are encountering.

“Practitioners have been vocal with the IRS during the Taxpayer First Act listening sessions that there should be some more interaction through online accounts,” Trivedi said. “Ideally, holds on collections, coupled with requests for [first-time abatement], along with submissions of requests for abatement, will be digitized in the future and allow for a more streamlined resolution without burdening scarce resources.”

More broadly, Trivedi said the IRS should stop systematically assessing penalties for late-filed forms 5471 and 5472, because it discourages voluntary compliance.

“It is baffling to me how a taxpayer can voluntarily come forward and file a delinquent information return, where no tax is due and there is no monetary prejudice to the government, and still be subject to substantial penalties,” Trivedi said.

A possibly more controversial measure he suggested would be to limit current collections policy to actual tax and interest delinquencies, and to provide a separate, less automated system for penalties, which “inevitably are being contested” for reasonable cause, first-time abatement, or doubt as to liability.

Brackney said collection enforcement needs to cease while appeals are still pending. She also suggested that the IRS start reviewing reasonable cause statements and do a better job training its employees to understand them.

“Reasonable cause is a tough standard to meet. Not every reasonable cause statement that is submitted is going to meet the standard . . . but they need to consider it as they would in any other requests for abatement,” Brackney said. She added that the IRS should consider formalizing and consistently applying a first-time abatement policy beyond where it is now applied.

Under IRM section 20.1.1.3.3.2.1, first-time abate relief from penalties is available for failure-to-file penalties under sections 6651(a)(1), 6698(a)(1), and 6699(a)(1). There is no reference to international information return penalties. But IRM sections 20.8.2.20.2 and 20.8.2.21.2 contain "if/then" statements for when forms 5471 and 5472 penalties should be abated based on first-time abatement.

“[The IRS] could create any kind of first-time abatement policies that they want — the first time the form was filed and that the person didn't owe any taxes — that would be great. That really sort of seems fair, and it would clear out the people who really don't belong in this situation,” Brackney said.

Relief in the Time of Coronavirus

The economic impact of the coronavirus on taxpayers should also cause the IRS to reconsider its current collection efforts, Hodes argued. Taxpayers may have difficulties reaching tax advisers with offices closing, and remote work could lead to delays in dealing with notices, she said. She added that taxpayers could also miss 30-day CDP hearing request deadlines, and that taxpayers and representatives not being permitted to digitally sign powers of attorney may cause “serious issues” for a more remote workforce.

“Many taxpayers just won’t have the money. . . . The very short time frames before the collection process escalates means that these delays could result in more severe collection consequences,” Hodes said. “If you can electronically sign a tax return with a PIN, and if you can fax an original signature on a power of attorney, it is difficult to understand why the taxpayer and the representative can't digitally sign the power of attorney.”

Trivedi said that IRS employees on the hotline take issue with powers of attorney “more often than you think,” even when they are properly executed, which can result in delays, even if the IRS is not at fault.

“Some taxpayers are not located in the U.S., and so the mail takes longer to reach them, and even then the mail from the IRS may be routed to the wrong department in the case of a business,” Trivedi said. “Those delays add up, and by the time a competent adviser has been informed of the notice, the collections machinery has already started, and once it has started, it won’t stop."

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