A Civil Penalty Potpourri Under Tefra
| Publication year | 1983 |
| Pages | 243 |
| Citation | Vol. 12 No. 2 Pg. 243 |
1983, February, Pg. 243. A Civil Penalty Potpourri Under TEFRA
The word "penalty" derives from the Latin poena, poenae, meaning "retribution," "punishment," "hardship" or "pain." There are few contexts in which this definition could be more aptly applied than that of the civil tax "punishments" and "pains" inflicted under Subtitle F. Chapter 68, of the Internal Revenue Code ("Code"). This follows, with a vengeance, in the wake of TEFRA.(fn1)
The civil penalties are the mine field in the battleground of the Code. With mind-boggling intricacy and scope, they touch upon myriad areas of the tax law. They operate directly upon tax liability itself, as well as on the plethora of the Code's information reporting and filing requirements.
This situation is only exacerbated by TEFRA, which also dramatically raises the stakes. Further, since TEFRA is effective relative to post-December 31, 1982, filings, it affects many 1982 transactions, particularly with regard to the filing and reporting penalties. Civil penalty provisions can no longer be ignored nor taken lightly.
The practitioner, whether a specialist or generalist, who undertakes to advise or otherwise represent a client without a firm grasp of the exposure to risk inherent in these measures truly acts at his peril. At a minimum, a basic awareness of these provisions is essential to competent tax, business, and other general representation of the client. Hopefully, this article will be of some assistance in the pursuit of that awareness.
Particularly after TEFRA, the interest and penalty provisions of the Code are inextricably connected. The "good" news is that, beginning January 1, 1983, the interest rate for tax and penalty purposes drops to only 16 percent, from 20 percent. Thereafter, the rate is to be adjusted semi-annually, based upon the average adjusted prime rate charged by commercial banks during the six-month period ending September 30 (effective January 1 of the following calendar year) and March 31 (effective July 1 of the same calendar year).(fn2) Remember when it was 6 percent? The bad news is that Congress has provided that all interest payable to or by the United States accruing after December 31, 1982, is to be compounded daily.(fn3)
The United States Supreme Court has observed that "Congress has imposed a variety of sanctions for the protection of the system and the revenue."(fn4) These range from small fines to substantial periods of incarceration. The thrust of these measures is to punish, deter and, in the case of monetary sanctions, to reimburse the Treasury for the drain thereon effected incident to the pursuit of errant taxpayers. Their raison d'etre is to bring about a high level of compliance in a "voluntary" system of assessment and collection.
The two broad categories of civil penalties are ad valorem, wherein the penalty is computed as a percentage of the tax liability itself, and assessable, wherein it is usually figured at a fixed dollar amount.(fn5)
Ad valorem penalties ("additions to tax") are assessed and collected in the same manner as are taxes and are paid upon notice and demand. The same is true for assessable penalties.(fn6) However, ad valorem penalties are also generally subject to the same deficiency procedures as are applicable to income, gift and estate taxes,(fn7) whereas assessable penalties are not.(fn8)
This distinction follows from the fact that ad valorem penalties are regarded as "additions to tax," thus partaking of the character of the tax itself. Moreover, their computation is directly based upon the amount of actual underpayment of tax liability. Assessable penalties, on the other hand, are arbitrarily established fixed-sum civil fines, not in the nature of true "additions to tax."
Notwithstanding the tax-like characterization of both kinds of penalties for purposes of assessment and collection, neither are deductible, nor are they generally dischargeable in bankruptcy.(fn9)
A discussion of specific penalties fitting within the two general categories follows.
Prior to the enactment of TEFRA, § 6653(b) provided for the imposition of a penalty equal to 50 percent of any underpayment of tax required to be shown on the return, "[i]f any part of [the] underpayment . . . is due to fraud." With TEFRA, effective with respect to taxes due after the date of its enactment (September 3, 1982), the penalty is augmented by an interest factor equal to 50 percent of the interest payable on that portion of the underpayment attributable to fraud.(fn10)
Although this new interest factor of the penalty is circumscribed only by that portion of the underpayment attributable to fraud, the base portion is not. In other words, as before TEFRA, the base portion continues to apply to the entire underpayment, irrespective of whatever portion is attributable to fraud. Thus, in an extreme example, even if only $100 of a $100,000 underpayment is due to fraud, the base penalty is 50 percent of the entire $100,000 underpayment or $50,000, not $50.(fn11)
"Fraud" is not defined in either the Code or Treasury Regulations. However, it has been defined by court decision, notably Mitchell v. Commissioner, which has been generally followed by other jurisdictions:
The fraud meant is actual intentional wrongdoing, and the intent required is the specific purpose to evade a tax believed to be owing.(fn12)
Fraud is conduct (1) the likely effect of which is to mislead or conceal, and (2) in which the taxpayer voluntarily and intentionally engages in order to evade tax he knows he has an obligation to pay.(fn13)
The only real difference between civil and criminal fraud is the burden of proof which the Commissioner must sustain---"beyond a reasonable doubt" in criminal cases versus "clear and convincing" in civil.
An "underpayment" in tax is defined as correct tax, minus the amount of tax shown on the return, minus amounts paid as a deficiency or on prior assessments, plus rebates made.(fn14) For purposes of imposition of the fraud penalty, underpayment is defined in the same manner, except that only those taxes reflected on a return filed on or before the due date (including extensions) qualify as "shown on the return.(fn15) This exception is designed to prevent the taxpayer from avoiding the penalty by filing a late or amended return.
For example, if a taxpayer timely files a return showing $5,000 in liability and it is later determined that he owes $15,000, the underpayment for purposes of the fraud penalty is $10,000. However, where the taxpayer files the same return late, the underpayment for purposes of the penalty is $15,000. Moreover, unlike the normal deficiency computation, amounts previously collected as deficiencies do not reduce the amount of underpayment for penalty computation purposes:
[T]he addition to tax for fraud is 50 percent of the difference between the taxpayer's correct tax liability and the tax shown on his return, even though, before the assessment of the fraud penalty for a year, additional tax has been paid (1) after an audit of the taxpayer's return by the Service; (2) after an amended return has been filed reporting additional tax; or (3) after a taxpayer files a delinquent return having fraudulenty failed to file a timely return.(fn16)
The 50 percent fraud penalty is the exclusive civil penalty available to the Commissioner where he determines any part of a deficiency to be due to fraud. He may not assert along with it either the negligence (except in the alternative)(fn17) or delinquency (late file/late pay) penalties,(fn18) which are discussed further below. He may, however, assert the penalty for underpayments of estimated tax.(fn19)
The taxpayer is afforded the full complement of administrative and judicial prepayment review of the Commissioner's proposal to impose the civil fraud penalty. In the Tax Court,(fn20) the burden of proof to establish that the taxpayer has been guilty of fraud with intent to evade tax is on the Commissioner and he must sustain it by "clear and convincing" evidence.(fn21)
Where the taxpayer has been convicted of evasion as to any given taxable period,(fn22) he is collaterally estopped, in the civil penalty context, to deny fraud as to the same taxable period. The rationale for this rule is that the criminal conviction necessarily carries with it the ultimate factual finding that the deficiency was due to fraud.
Conversely, a taxpayer's prior acquittal of attempted evasion does not bar the Commissioner from proving fraud at a later civil trial. The fact that the Commissioner did not sustain his burden "beyond a reasonable doubt" in the criminal proceeding does not preclude his doing so by "clear and convincing" evidence in the civil.
When any part of an underpayment is determined by the Commissioner to have been attributable to the taxpayer's negligence or intentional disregard of rules and regulations, a 5 percent negligence penalty is imposed.(fn23) As with the civil fraud penalty, the negligence penalty is computed on the entire amount of the underpayment, irrespective of whatever portion thereof is actually "tainted." Moreover, as was effected relative to the fraud penalty through TEFRA, the negligence penalty is augmented under ERTA(fn24) by the same kind of 50 percent interest factor, for taxes due after December 31, 1981. Thus, 50 percent of the interest accrued on that portion of the underpayment attributable to negligence, from the underpayment's due date (without regard to any extension) until the earlier of the date of assessment or payment, is added to the penalty base. Nonetheless, no portion of the...
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