IRS Addresses Penalties When Individuals Aren't Entitled to Requested First-Time Home Buyer Credit

UILC: 6662.00-00, 6664.01-00, 6676.00-00

If the taxpayer's filing position on his return includes a claim for refund or credit but does not result in an underpayment, the section 6676 penalty applies to the excessive amount of the claim.

Below, this memorandum determines the appropriate penalty for the examples submitted in your request. We have also included brief discussions of the examples included in the memorandum dated November 20, 2009, which deals with the first-time homebuyer credit and the accuracy-related penalty.

If the Service determines that the taxpayer's reporting on his return results in an underpayment, as defined under section 6664, the section 6662 accuracy-related or section 6663 fraud penalty applies. If either of these penalties applies to the particular tax year at issue, the section 6676 penalty for making a claim for an excessive refund or credit does not apply. I.R.C.§ 6676(c)(coordination provision).²

The following is a discussion of the appropriate penalty, if any, applicable to the examples submitted with this request.

Example 1 -- The taxpayer reported the following amounts on his Form 1040 for the 2008 taxable year:

 Line 43   Taxable Income                       $ (4,500)

Application of this regulatory formula to the facts presented results in the following:

 W    amount of income tax imposed                      $13,600⁷

 X    amount of the tax required to

Even if this taxpayer's underpayment were not attributable to a substantial understatement of tax, there is still a possibility that the Service could determine the 6662 penalty applies on the alternative grounds that taxpayer was negligent or disregarded rules or regulations.

The facts do not indicate whether the taxpayer filed his return timely. If this were true, the Service can consider applying the late filing penalty under section 6651(a)(1). Because the failure to pay penalty in section 6651(a)(2) applies only to tax shown on a return not paid, this will not apply to this example. The facts do not show that fraud was involved in the taxpayer's reporting, which would be necessary to impose the 75% penalty under section 6663. If this penalty were applicable, then the Service would be precluded from also asserting the 6662 accuracy-related penalty. I.R.C. § 6662(b)(". . . This section shall not apply to any portion of an underpayment on which a penalty is imposed under section 6663."). No other penalties are implicated by the facts presented.

Example 2 -- The taxpayer reported the following amounts on his Form 1040 for the 2008 taxable year:

 Line 43   Taxable Income                       $ 1,300

The Service should first apply the underpayment regulation to these facts.

The discussion under example 1 respecting other possible penalties applies to this example.

Example 3 -- The taxpayer filed a Form 1040X for the 2008 taxable year in which he reported:

 Line 61   Total Tax Liability                    $ 2,700

 W    amount of income tax imposed

Based on the limited facts presented, no other penalties or additions apply. See the discussion under example 1 in regard to other penalties that could apply if the factual situation supported such penalties.

The November 20, 2009 memorandum provided by our office includes seven examples. Examples 1-5 and example 7 illustrate taxpayers whose reporting produced underpayments. For each of these examples, imposition of the section 6662 accuracy-related penalty, rather than the penalty for erroneous refunds or credits, was correct.

Under the facts in Example 6 in the November 20, 2009 memorandum, the taxpayer is subject to the section 6676 penalty for making an excessive refund claim. In that example the taxpayer's correct tax liability was $2,400¹¹ and he claimed a refund of $1,200. Because taxpayer's reporting did not result in an underpayment, the section 6662 accuracy-related penalty did not apply.

Calculation of the penalty in Example 6 is as follows. Taxpayer's liability was $2,400 and there were allowable credits of $3,000 for estimated tax payments made during the tax year. The Service ultimately determined that the taxpayer was not eligible for the $600 additional child credit listed on line 68 of the tax return. Thus, the taxpayer was entitled to $600 as a refund or credit, rather the full $1,200 claimed on line 74a. In this situation, the "excessive amount," under I.R.C. § 6676(b) is $600 and is subject to a 20% penalty.

Finally, you requested our assistance in placing the results of our analysis into a chart or table, which could help the Service best apply the appropriate penalty for the circumstances at hand. You provided an illustrative example that includes columns with the headings "if" and "then." The illustration suggests that selection of the correct penalty between the accuracy-related penalty of section 6662 and the section 6676 penalty for erroneous refund or credit claims hinges on whether "tax imposed" is a positive or negative number.

One suggested format of a spreadsheet or chart for use by the Service's income tax return examiners is to make it flow from the concept of underpayment.

Step 1

Does the taxpayer's reporting result in an underpayment, as defined the regulation implementing section 6664?

If yes, proceed to step 2.

If no, skip steps, 2 and 3. Proceed to step 4.

Step 2 -- Determine if the underpayment resulted from fraud by the taxpayer

If yes, analyze the case under I.R.C. § 6663 to determine if the 75% penalty applies. IRM 20.1.5.12.

If no, analyze the facts presented by the taxpayer's filing under the section 6662 accuracy-related penalty. IRM 20.1.5.7. Proceed to step 3.

Step 3 -- Determine the cause of the underpayment

The accuracy-related penalty will apply to a taxpayer filing an income tax return if any of the following is satisfied:

• The taxpayer made an underpayment because of negligence or disregard of rules or regulations.

• The underpayment was attributable to the taxpayer's substantial understatement of tax (two questions must be answered: (i) was there an understatement of tax per Treas. Reg. § 1.6662-4(b)(2); and (ii) if so, was it substantial?)

• The taxpayer made a substantial valuation misstatement of property or basis on his return

Step 4 -- Does the penalty for an erroneous claim for refund or credit apply? IRM 20.1.5.14.

Has the taxpayer made a claim for refund or credit?

If no, the section 6676 penalty does not apply.

If yes, was the claim for an excessive amount, which means the disallowable portion of the claim?

If yes, the section 6676 could apply, unless the taxpayer can show that he had a reasonable basis as a defense to the penalty.

Was there a reasonable basis for the taxpayer making a claim for such excessive amount?

If yes, the section 6676 penalty does not apply

If no, the penalty applies and is equal to 20 percent of the excessive amount of the refund or credit claim.

Additional considerations

Did the taxpayer make a reportable transaction understatement?

Analyze the case under I.R.C. § 6662A. IRM 20.1.5.13 Because of the significant number of variables in each of the components of the regulatory definitions underpayment and understatement, it will be difficult to create a chart or table containing only 2 or 3 columns that will adequately reflect when each of the penalties apply. The correct figure corresponding to each of the components will depend on the taxpayer's particular situation. For example, the number representing "amounts not so shown previously assessed (or collected without assessment)," within the underpayment regulation can include:

• amounts not so shown previously assessed -- An amount assessed before the return was filed, such as a section 6851 termination assessment or a jeopardy assessment under section 6861

• amounts collected without assessment -- the amount by which the total of the credits allowable with withholding of tax on wages, withheld tax at the source on nonresident aliens or foreign corporations, estimated tax and other payments made to satisfy the tax before the return is filed exceed the "tax shown on the return." Such amount collected without assessment, however, exists only if the excess has not been refunded to the taxpayer. Treas. Reg. § 1.6664-2(d).

Please call (202) 622-4910 if you have any further questions.

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²See footnote 1 above (coordination provision in I.R.C. § 6676(c)) and IRM 20.1.5.3.2(6)("Stacking of the 6662, 6663, 6662A and 6676 penalties is not permitted.").

³ Under the regulation, the amount of income tax imposed is the correct tax, determined without regard to: (A) the credits for tax withheld on wages at the source under section 31 and tax withheld at the sourceon amounts payable to nonresident aliens and foreign corporations under section 33, (B) payments of estimated tax by the taxpayer; (C) any credit resulting from amounts collected as a consequence of a termination or jeopardy assessment, and (D) any tax the taxpayer is not required to assess on the return (e.g. the tax imposed by section 531 on the accumulated taxable income of a corporation). Treas. Reg. § 1.6664-2(b).

The Service interprets this regulation to mean that "amount of income tax imposed" is determined with regard to allowable credits, other than those noted in (A)-(D) in the prior paragraph.

⁴ Under Treas. Reg. § 1.6664-2(c), amount shown as tax by the taxpayer on his return is the tax reported by the taxpayer on his return (determined without regard to any credits for withholding tax, estimated tax payments or collected sums resulting from a termination or jeopardy assessment), less the amount of any overstated credit for withholding tax on wages or overstated withholding of tax at source on a nonresident alien or foreign corporation.

In calculating the amount shown as the tax by the taxpayer on his return, the Service also reduces the sum the taxpayer reported as tax by the credits he claimed, including the full amount of incorrectly claimed credits, but not including credits for withholding tax, estimated tax payments or collected sums resulting from a termination or jeopardy assessment.

⁵ The term amount not so shown previously assessed (or collected without assessment consists of two parts: (1) the amounts not so shown but which were previously assessed and (2) the amounts not so shown as previously assessed collected without assessment. The amounts not so shown but previously assessed means the amounts assessed before the return was filed that were not shown on the return (e.g. termination or jeopardy assessments) . The amounts so shown as previously collected without assessment is the amount by which: 1) the sum of (credits allowable for tax withheld on wages + credits allowable for tax withheld at the source + estimated tax payments + other payments made in satisfaction of the liability before the return was filed) exceeds 2) the tax shown on the return (provided the excess has not been refunded or allowed as a credit to the taxpayer) Treas. Reg. § 1.6664-2(d).

⁶ The term Amount of Rebates Made for purposes of I.R.C. § 6664 means so much of an abatement, credit, refund or other payment, as was made on the ground that the tax imposed was less than the excess of (1) the sum of (the amount shown as the tax by the taxpayer on his return + the amounts not so shown previously assessed [or collected without assessment), over (2) the rebates previously made. Treas. Reg. § 1.6664-2(e).

⁷ This memorandum assumes that this number reflects the correct tax imposed, including reductions for the allowable amount of the first-time homebuyer credit and recovery rebate credit.

Thus, the proper method for calculating this is:

 correct total tax (line 44)                  $17,650

There is no need to further reduce the taxpayer's self-reported tax liability by an amount corresponding to the number of exemptions claimed ($3,500 per exemption in tax year 2008) because this is already factored into the taxpayer's taxable income and tax, reported on lines 43 and 44 respectively.

⁹ In this case there is no rebate because no part of the refund paid to the taxpayer was made on the basis that the tax imposed by subtitle A is less than the tax shown on the return. Treas. Reg. § 301.6211-1(f). The tax imposed in this example is $13,600, which is more than the tax shown on the return by the taxpayer.

¹⁰ This example does not state the amount taxpayer claimed as a refund. We assume that no other credits are involved and that the Service first applied the FTHBC to the tax liability, refunding only the excess.

¹¹ In applying the underpayment regulation's definition of "amount of income tax imposed," (variable W), the Service did not reduce the tax liability by the $600 claimed as an additional child tax credit because the Service's audit revealed the taxpayer was ineligible for it.