Applicability of Sec. 6662 Accuracy-Related Penalties to Refund Claims

A taxpayer may be subject to an accuracy-related penalty under Sec. 6662 for a tax return position that either is not (1) supported by substantial authority or (2) adequately disclosed and lacks a reasonable basis. (Special rules apply for tax shelter items.) The question arises whether Sec. 6662 penalties apply to positions first taken on a refund claim or amended return (hereinafter collectively referred to as refund claim).

Under Sec. 6662, the amount of each accuracy-related penalty is determined by reference to the tax underpayment that results from the taxpayer's negligence, intentional disregard of rules or regulations, substantial understatement, etc. Unlike IRS-initiated adjustments to the amount of taxable income shown on a taxpayer's original return, complete or partial disallowance by the Service of a refund claim would not result in a tax underpayment. Disallowance of a refund claim would not constitute an IRS determination that the taxpayer owes additional tax; instead, it indicates that the Service does not agree with the taxpayer's contention that its tax liability has been overstated and overpaid on the original return.

Taxpayers and their advisers should be aware, however, that, under certain circumstances, a position taken on a refund claim might trigger Sec. 6662 accuracy-related penalties. Specifically, this could happen if the claimed refund is issued by the IRS, but it later determines that the taxpayer's correct income tax liability is greater than that shown on the refund claim.

Under this scenario, the refund would constitute a "rebate erroneous refund." Because a tax deficiency, within the meaning of Sec. 6211, generally is created by a rebate erroneous refund, the incorrectly refunded amount can be assessed through normal deficiency procedures (provided the limitation period for assessment under Sec. 6501 has not expired) and can be collected through the Service's administrative collection tools (e.g., lien, levy, seizure and offset under Sec. 6402). Alternatively, a rebate erroneous refund may be recovered from a taxpayer by civil action brought in the name of the U.S. under Sec. 7405(a); such a suit may be the IRS's only recourse if the limitation period for assessment under Sec. 6501 has expired.

Accordingly, if the Service issues a claimed refund but subsequently has a change of heart, the position taken by the taxpayer on the refund claim has resulted (albeit in a roundabout fashion) in a tax underpayment on which the IRS may base Sec. 6662 accuracy-related penalties. If the taxpayer filed its refund claim shortly before expiration of the limitation period on assessment under Sec. 6501, however, the Service cannot use a deficiency determination to recover an erroneously issued refund.

Note: The IRS practice of reviewing refund claims for examination potential before issuing the claimed refund should limit the number of such cases.

In a somewhat different context, issuance of a tentative refund under Sec. 6411 also can give rise to Sec. 6662 accuracy-related penalties if the IRS (1) determines that it is entitled to recapture the tentative refund, (2) determines that the recapture is attributable to a "tainted item" (within the meaning of Regs. Sec. 1.6662-4(c)(3)) and (3) chooses to employ the Sec. 6212 deficiency procedures to effectuate the recapture (as opposed to simply assessing the excess refund amount as a mathematical or clerical error, as permitted by Sec. 6213(b)(3)).

Finally, regardless of whether Sec. 6662 accuracy-related penalties apply, return preparer penalties under Sec. 6694 may be imposed on refund claims based on "unrealistic positions" (those defined as having less than a one-in-three chance of being sustained on the merits if challenged by the IRS). Adequate disclosure of such a position would protect the preparer from imposition of the Sec. 6694(a) penalty (as long as the position is not frivolous), and would not seem to place the taxpayer at any significant disadvantage in a refund claim context, as it generally would be difficult to "hide" a significant issue on an amended return.

From Michael A. Urban, J.D., MLT, Washington, DC