Section 209 of the recent PATH legislation amended IRC section 6664 and reversed the Tax Court’s decision in Rand v. Commissioner. We have previously written about Rand, here, here, here, here and here. The legislation not only reversed the Rand decision going forward but also for years open for assessment on December 18, 2015. This reversal has caused Chief Counsel’s Office to issue interim guidance, in Notice CC-2016-004, copied below, to its attorneys concerning how to handle cases with this issue. Following the Rand decision, the Government decided not to appeal and Chief Counsel’s Office issued Notice CC-2014-007 that its attorneys should concede the penalty issue presented in Rand. The new notice advises them to reverse course based on the PATH legislation.
The notice is short so I am going to reproduce almost all of it here:
“In Rand v. Commissioner, 141 T.C. 376 (2013), the Tax Court held that disallowed refundable credits must be taken into account when determining the tax shown on the return, but cannot reduce the tax shown on a return below zero. Consistent with this holding, the Service issued Chief Counsel Notice 2014-007, instructing attorneys to calculate any accuracy-related or fraud penalty involving disallowed refundable credits in accordance with the Rand decision and to concede penalties in excess of the amount provided for by Rand.
Section 209(a) of the PATH Act amends section 6664(a) of the Code to provide that “a rule similar to the rule of section 6211(b)(4) shall apply for purposes of this subsection.” Under section 6664 as amended, disallowed refundable credits must be taken into account when determining the tax shown on the return and can reduce the tax shown on a return below zero for purposes of calculating the underpayment subject to penalty under sections 6662 and 6663. Section 209(d)(1) of the PATH Act provides that the amendment is effective for all returns filed after December 18, 2015, and all returns filed on or before December 18, 2015, for which the period of limitations specified in section 6501 had not expired as of that date.
Attorneys should not follow Rand and Chief Counsel Notice 2014-007 and should not concede section 6662 or section 6663 penalties based on disallowed refund claims for erroneous refundable credits when the statutory notice of deficiency asserted those penalties on such amount. Pending further guidance on procedures for handling pending and future Tax Court cases, attorneys should contact Procedure and Administration. For questions regarding this notice, contact Procedure and Administration Branch 1 Attorney Jon Black, at (202) 317-6845….”
Though some penalty assessments based on a treatment of the refundable credit as tax in the 6664 calculation had occurred for years, the IRS began making assessments wholesale after a pair of Service Center advisory opinions in 2009 and 2010. These advisory opinions which impacted hundreds of thousands of individuals involving hundreds of millions of dollars were not even reviewed at the Branch Chief level in the IRS Office of Chief Counsel before being unleashed on the public. After the initiation of the Rand litigation, the IRS partially changed course in asserting these penalties in a Service Center advisory opinion in 2012 because it concluded that it should not treat the refundable credits as part of the tax for calculating the penalty when it did not actually refund the money requested by the taxpayer through the refundable credit but rather froze the refund. This change in course led the IRS to embark on an abatement program for individuals hit with the penalty whose refunds were frozen. The Treasury Inspector General for Tax Administration (TIGTA) issued a report in August of 2015 that provides some details about this abatement program and criticizes the IRS for abating too much by not being sufficiently careful with its filters.
While the TIGTA report focuses on the over-breadth of the abatement program, the report provides some details concerning the number of cases caught up in the penalty program litigated in Rand. TIGTA redacted its report to a greater extent than it normally does; however, it states that its survey of penalty abatement cases was impacted because almost 30% of the cases in its sample came from “two large-scale penalty abatement projects that were necessitated by an IRS Chief Counsel Memorandum dated May 30, 2012.” The footnote to this statement makes clear that the abatement program resulted from the change in position described above regarding the penalties imposed on individuals with disallowed refundable credits whose refunds were frozen. The report further states that “because the IRS had incorrectly assessed hundreds of millions of dollars in penalties, it was required to correct taxpayers’ accounts that were improperly charged…. During FYs 2012 through 2014, the IRS systemically abated a total of $215.6 million in accuracy-related penalties on 168,635 returns based on the Chief Counsel Memorandum.”
The report gives some glimpse of the scale of cases impacted by the Rand decision. Even though refundable credits primarily relate to low income taxpayers, Congress felt the need to reverse this decision so that penalty assessments could be made or retained with respect to the most vulnerable elements of the population. The legislation came as a surprise to the low income taxpayer community. So, it is safe to say that no one was lobbying on the Hill on behalf of these individuals. It is unclear why Treasury or Congress chose to target this group of rather uncollectible individuals with this retroactive legislation but the legislation poses a few interesting questions that will be worked out in the coming years.
By limiting the scope of the retroactivity to open years for assessment and including elsewhere in this legislation a codification of the Taxpayer Bill of Rights which includes the right to pay no more than the correct amount, did Congress signal to the IRS that any periods for which the statute of limitations on assessment has closed the IRS should abate any penalties it assessed based on its misinterpretation of the penalty provisions? Based on the number of cases reported in the TIGTA report involving frozen refunds, it is logical to assume that hundreds of thousands of incorrect penalty assessments involving hundreds of millions of dollars exist for years prior to 2012 on which the assessment statue is no longer open. If you represent a taxpayer with a penalty assessment based on the incorrect interpretation of 6664 for a year prior to 2012, the legislation does not appear to appear to save the wrongful assessment and you should seek abatement of the penalties and other remedies as appropriate.
Aside from not impacting the hundreds of thousands of older assessments, the retroactive application of the statute in this situation raises issues that might result in litigation concerning the taxpayers (presumably also hundreds of thousands) assessed this penalty prior to the legislation for tax years 2012 and later. Unlike court decisions which have a retroactive impact because they interpret the statute in existence, this legislation seeks to change the law as interpreted by the Tax Court and conceded by the IRS. Litigation challenging this retroactive application is likely to occur and should be watched by those with clients in this group. Already, people are wondering whether the Fifth Amendment’s Due Process Clause has been violated by retroactively changing a civil penalty after the penalized conduct has already taken place.
Based on Notice 2014-007 the IRS has conceded some of the Rand cases petitioned to the Tax Court in the time between that notice and Notice 2016-004 issued last week. If your client obtained a concession in Tax Court, the year is closed and the legislation will not impact them. If you client has petitioned the Tax Court on this issue and not yet obtained a concession, expect to have to fight if you want to oppose the penalty.
It seems there should be better ways than picking on the most vulnerable part of the population retroactively to find sources of revenue. Shame on Treasury and Congress.