Penalties and Interest

AuthorW. Patrick Cantrell
Penalties and Interest
Federal Penalty Structure
I. Introduction
A. Scope of Presentation
The intent of this presentation is to provide the reader with a bird’s-eye
view of the civil penalty structure of the Internal Revenue Code to see
how it all fits together. The process of securing a reduction or abatement
of any asserted penalty is discusse d later in this chapter under “Penalty
Abatement.” Additionally, the following specific penalties, because of
their relative importance, are discussed elsewhere in some depth:
1. Underestimate penalties (later in this chapter),
2. Civil fraud (chapter 8),
3. Trust fund liability (later in this chapter), and
4. Preparer penalty (chapter 9).
B. Background
There are over 150 penalties in the Internal Revenue Code. As it is pres-
ently configured, the existing system is a patchwork maze of incon-
sistent, overlapping, and often draconian levies. This subchapter will
attempt to explain and make some sense of this system and highlight
some of the more common penalties that the average practitioner is
likely to encounter.
C. IRS Policy and Procedure
The IRS’s stated policy is that a penalty i s to be imposed only to ensure
voluntary compliance with the tax law.1 However, the result of pen-
alty imposition is also to raise revenue, punish the taxpayer, and reim-
burse the IRS for the cost of enforcement. According to existing policy,
IRS agents may not use penalties as a bargaining ploy to extract an
agreement on other issues.2 In any “notice” that gives a taxpayer a
right of appeal, the IRS is required to provide an explanation for any
proposed penalty. However, failure to do so will not invalidate such a
D. Civil and Criminal Penalties Distinguished
Penalties couched in terms of a percentage of the tax owed are called
“ad valorem” civil penalties and are designed to encourage or coerce
compliance with the law. Nearly all civil penalties are ad valorem,
whereas criminal penalties, imposed on ly after conviction in court, do
not depend on the amount of the tax involved. Thus, there are two prin-
cipal penalty classifications: (1) specific penalties, consisting principally
of fines with maximum lim its and imprisonment; and (2) ad valorem
penalties, measured by a percentage of the tax liability. Note that
acquittal on a criminal c harge does not prevent the later imposition of
a civil fraud penalty.4 The ad valorem provisions of the I.R.C. are often
referred to in the statute as “additions” to tax, but the generic term is
“penalty.” Ad valorem penalties may be determined and assessed by
the IRS, but specific criminal penalties cannot be so assessed and are
enforceable only by a suit and prosecution.
E. Assessable versus Nonassessable
Chapter 68 of the I.R.C. refers to “assessable penalties” and “additions to
the tax,” as if there were some important distinction between the two cat-
egories. “Additions to the tax” are found in I.R.C. §§6651 through 6665.
Assessable penalties” are found in I.R.C. §§6671 through 6751. But, as
a practical matter, there are no distinctions between the two categories.
F. Constitutional Objections
Civil tax penalties have survived a number of constitutional chal-
lenges, most notably the double jeopardy clause, which forbids a sec-
ond “punishment” for the same offense.5
G. Penalty “Stacking”
There are some judicially imposed limits on the IRS’s attempts to
impose multiple penalties on the same deficiency. For example, the
IRS cannot stack penalty on top of penalty just because of an under-
statement of tax attributable to investment in a tax shelter, particularly
where the taxpayer is inexperienced and uneducated.6
II. Failure to File or Pay
A. Failure to File
1. General rule: In the case of a failure to file a return, or late filing of
a return, the I.R.C. imposes a penalty equal to 5 percent of the tax
Failure to File or Pay 217
due, per month of delinquency or fraction thereof, up to 25 percent
in the aggregate. As can be seen, this is a significant deterrent to
filing late. This penalty can be avoided or abated upon a showing
of reasonable cause.7 This penalty is also commonly referred to as
the “delinquency” penalty.
2. Extended returns: Merely paying the tax within an approved
extension period will not avoid the § 6651(a)(1) penalty if the
return is filed after the extension period expired, absent a showing
of reasonable cause. Thus, in the event of late filing, the penalty
is based on the total correct tax, unreduced by the payment made
after the due date.8
3. Accrual starting point: For purposes of the “per month” calculation,
the date of accrual is the first day after the final extension period
has expired.9
4. De minimis rule: The failure-to-file penalty will never be lower
than the lesser of (1) $135 or (2) 100 percent of the tax liability.
Thus, if the late-filed return reflects a refund or zero liability, the
delinquency penalty will likewise be zero.10
5. Mailbox rule: When there is a dispute as to when (or whether)
an extension was filed, a taxpayer’s own sworn statement when
coupled with other circumstantial evidence will be sufficient to
establish timely filing under the “mailbox” rule.11
6. Fraud: If a failure to file is fraudulent, the penalty rate is tripled.
Five percent per month becomes 15 percent per month, and the
25percent maximum becomes 75 percent.12
7. Exempt organization returns: In the case of failure to file an exempt
organization return (see Form 990), the penalty is $20 for each
day during which the failure continues. The maximum penalty
is the lesser of $10,000 or 5 percent of the gross receipts of the
tax-exempt organization.13 This penalty can also be abated upon a
showing of reasonable cause.14
8. Pension or profit-sharing returns: In the case of failure to file a return
(Form 5500 series) for a deferred compensation plan, the penalty is
$25 per day, not to exceed $15,000.15
B. Failure to Pay
1. General rule: Regardless of whether a return is filed in a timely
manner, or within an approved extension period, a failure-to-
pay penalty is imposed if 100 percent of the tax due is not paid
on or before the original due date of the return. This penalty is
calculated at a rate of 0.5 percent (of the unpaid tax), per month (or
fraction thereof), up to 25 percent in the aggregate. This penalty
may also be avoided by a showing of reasonable cause.16
2. Deficiency cases: The failure-to-pay penalty can also be imposed
with respect to a tax deficiency, but only after twenty-one days

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