As we move into tax season, it is worth remembering that IRS has a significant arsenal of civil and criminal penalties to address misbehaving preparers. I recently came across a federal district court case, Bailey v. United States that discussed an exception to the Flora full payment rule for preparers subject to penalties for preparing tax returns or refund claims that have understatements stemming from unreasonable positions or willful/reckless conduct. For preparers, that penalty can be fairly sizeable, as under Section 6694 the amount of the penalty is the greater of $1,000 for each return or refund claim ($5,000 if the understatement is due to willful or reckless conduct) or 50% (75% for willful/reckless conduct) of the income derived by the tax return preparer with respect to the return or claim for refund.
These penalties are not subject to the deficiency procedures, meaning that if IRS examines a preparer and determines that the preparer’s conduct in preparing the return or refund claim warrants a penalty, the preparer will generally have to pursue a refund suit to guarantee judicial review of the penalty. (I’ll skip the CDP discussion on this, a topic we also have discussed, which turns on whether a preparer has previously had an opportunity to dispute the penalty through its rights to have Appeals consider the matter).
We have often discussed the Flora rule, which requires full payment to ensure jurisdiction for a refund suit. Flora presents a considerable barrier, especially for moderate income persons subject to the penalty but also stemming from the fact that some civil penalties, including the variety of penalties preparers are subject to, can be very significant; Keith has written about that before here, suggesting perhaps it is time to rethink Flora in light of the impact and potential unfairness of requiring full payment to get a court to review the Service’s penalty determination.
Bailey implicates an implicit statutory exception to Flora for the 6694 penalties. IRS asserted $70,000 in penalties due to what IRS felt was his willful or reckless conduct. As per Section 6694(c)(1), if a preparer pays at least 15% of the Section 6694 penalty within 30 days of IRS making notice and demand, the preparer can stay collection and file a refund claim. Section 6694(c)(2) also provides that if a preparer fails to file suit in district court within the earlier of (1) 30 days after the Service denies his claim for refund or 30 days of the expiration of 6 months after the day on which he filed the claim for refund, then paragraph (1) of Section 6694(c) no longer applies. That suggests that a preparer can avoid the full payment rule; to that end see note 1 of the 2016 Bailey opinion, discussing the logical Flora implication of Section 6694(c)(2).
In Bailey, the preparer paid $10,500, or 15 percent of the penalty within 30 days of the IRS notice. He filed a refund claim on March 28, 2014. At the time of the suit, IRS did not deny the claim. Thirty days after the expiration of 6 months (and a day) from the time he filed his claim was October 29, 2014. Bailey filed his refund suit in district court on November 12, 2014. That filing was two weeks late, and he no longer was eligible to take advantage of the exception to Flora.
Because the preparer missed the deadline, the district court granted the government’s motion to dismiss the suit. The failure to comply with the time requirements in Section 6694(c)(2) meant that absent the preparer’s full payment of the penalty, the district court did not have subject matter jurisdiction over the suit. Because the dismissal was without prejudice, the preparer could cure his error by fully paying the balance and refiling his complaint.
Instead of full paying, the preparer filed another action in federal court in 2017; this time, the suit alleged personal misconduct among IRS employees; in light of a motion to dismiss the preparer filed a motion to substitute the US as a party to the suit and restated his allegations that his conduct did not warrant a penalty. In November of last year the court dismissed that suit.