AIDING OR ABETTING UNDERSTATEMENT PENALTIES: Those who aid or assist taxpayers to understate their tax liability do so at their peril because there is no statute of limitations to the penalties under IRC [section]6701.

Author:Curatola, Anthony P.

WHEN THE TAX EQUITY and Fiscal Responsibility Act of 1982 (TEFRA) was passed, the Senate Finance Committee (Senate Rep No. 97-494, 272) held the belief that an increasing part of the compliance gap in revenue could be attributed to the "audit lottery," which is when taxpayers take questionable positions-though not amounting to fraud or negligence-hoping they won't be audited. So TEFRA added several tax penalty provisions to improve taxpayers' and tax advisors' reporting of taxable income. IRC [section]6701 was one of those provisions to deter promoters of abusive tax shelters and tax advisors from aiding or abetting taxpayers to substantially understate their tax liability.

Calling it a lottery was apt, as the potential outcomes of entering were that either the understatement would go undetected and the taxpayer saved taxes with "an absolute reduction in tax without cost or risk," or the understatement would be detected and the taxpayer paid the additional tax owed plus an amount of interest that was similar to the cost of borrowing.


Prior to IRC [section]6701, there was no penalty for this behavior. Taxpayers and their advisors weren't exposed to any downside risk in taking highly questionable positions on their tax return. The Senate Finance Committee realized that taxpayers and the government may reasonably differ with the tax laws, but it wanted to deter the use of undisclosed questionable reporting positions and hold taxpayers investing in substantial tax shelters to a higher standard.

In addition to penalizing taxpayers for the understatement of their tax liability, IRC [section]6701(a) imposes a penalty on the tax preparer, the tax consultant, or the tax advisor, to name a few, who provides the advice that creates wrongful tax savings for the taxpayer. The law specifically spells out that it includes any person who aids, assists in, procures, or advises a taxpayer (individuals or corporations) in the preparation or presentation of any portion of a tax return and knows (or has reason to believe) that such a position, if used, would result in an understatement of the taxpayer's tax liability. The term "procures" in [section]6701(a) includes ordering (or otherwise causing) a subordinate to commit and not attempting to prevent the individual's participation in an act. In other words, plausible deniability doesn't appear to be a defense for the boss. The amount of the penalty assessed to the tax advisor is...

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