The Accuracy-Related Penalty (Part II) 

    by John Cook, J.D., LL.M., and Alan J. Ocheltree, J.D., LL.M. 
    Published May 01, 2010

    EXECUTIVE
    SUMMARY

    • In general, Sec. 6664 provides that the Sec. 6662 accuracy-related penalty will not apply to any portion of an underpayment for which the taxpayer had a reasonable cause and acted in good faith.
    • The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Whether the taxpayer had reasonable cause is an objective determination, and whether the taxpayer acted in good faith is a subjective determination.
    • Depending on the specific facts and circumstances, reliance on an informational return or on professional advice may demonstrate reasonable cause and good faith by the taxpayer.
    • Special rules apply to underpayments related to reportable transactions, substantial underpayments attributable to corporate tax shelter items, and valuation misstatements of charitable deduction property.

    Sec. 6662 imposes an accuracy-related penalty equal to 20% of any underpayment of federal tax resulting from certain taxpayer conduct (e.g., negligence, disregard of rules or regulations, substantial understatement of income, and certain over- and undervaluations).1 This is part II of a two-part article addressing the Sec. 6662 accuracy-related penalty and the defense available to taxpayers. Part I, in the April issue, provided an overview of the various bases upon which the IRS can impose a Sec. 6662 penalty. Part II discusses the Sec. 6664 reasonable cause and good-faith defense to the Sec. 6662 penalty. Both parts describe key considerations for practitioners helping clients contest an asserted Sec. 6662 penalty.

    Overview

    Sec. 6664 provides broadly that “[n]o penalty shall be imposed under section 6662 . . . with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.”2 There are exceptions to the general rule, however, and more importantly there are extensive regulations detailing the circumstances under which taxpayers will be deemed to have acted with reasonable cause and good faith. The Sec. 6664 reasonable cause/good-faith exception applies to all Sec. 6662 triggers, not just the conduct-based triggers.

    As discussed in part I, there is considerable overlap between the Sec. 6662 negligence, careless disregard, and reckless disregard concepts on the one hand and the Sec. 6664 reasonable cause/good-faith concept on the other. This is because the definitions of negligence (no reasonable attempt to comply), careless disregard (no reasonable diligence), and reckless disregard (substantial deviation from the standard of conduct that a reasonable person would observe) all generally require a determination of the reasonableness of a taxpayer’s conduct. Similarly, the Sec. 6664 reasonable cause exception applies if the taxpayer “exercises ordinary business care and prudence in determining its tax obligations” but nonetheless fails to comply with the Code’s requirements.

    Given the overlap in terminology and standards, the Sec. 6664 exception should apply most often, if not exclusively, to the substantial understatement and valuation penalties. For example, if taxpayers act reasonably under the circumstances in preparing their return or in determining the treatment of an item on the return (either themselves or through reasonable reliance on an adviser), the Sec. 6662 penalty for negligence or careless or reckless disregard by its terms simply should not apply in the first instance, and taxpayers should have no need to resort to the Sec. 6664 reasonable cause/good-faith defense. If, in contrast, a taxpayer mistakenly deducts an item that is not properly deductible and that deduction causes a substantial understatement, the taxpayer would need to resort to Sec. 6664 in an effort to excuse the understatement (e.g., by demonstrating reliance on an information return or professional tax adviser).3

    However, notwithstanding the considerable overlap in statutory and regulatory standards, the provisions do perform different functions. Fundamentally, Sec. 6664 provides an exception to the Sec. 6662 penalty. In other words, it is appropriate to think of Sec. 6664 as providing a reasonable cause excuse for taxpayer conduct that would otherwise be subject to penalty under Sec. 6662. Thus, asking whether the taxpayer had reasonable cause is not necessarily the same as asking whether the taxpayer acted reasonably. That is, Sec. 6664 asks (1) whether the taxpayer has an excuse for his or her conduct (e.g., substantial understatement of tax subject to penalty under Sec. 6662) and (2) whether that excuse constitutes reasonable cause. The proper focus is on whether the taxpayer can demonstrate a reasonable excuse (i.e., reasonable cause) for deviating from the standards normally expected of taxpayers.

    Probably the most common such excuse for a taxpayer’s noncompliant conduct is the taxpayer’s reliance on the advice of a tax professional. However, other excuses have been held to constitute reasonable cause. Indeed, the regulations state that the determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances.4 Given that the Sec. 6664 determination is fact intensive, the approach taken here is to discuss generally the concepts of reasonable cause and good faith and then to review some of the more common situations in which reasonable cause and good faith may be demonstrated.

    Reasonable Cause and Good Faith

    Sec. 6664 does not define the terms “reasonable cause” and “good faith.” The absence of definitions is not surprising, however, as both terms were familiar in the context of federal tax penalties for many years prior to the statutory consolidation of accuracy-related penalties in 1989. For example, former Sec. 6661 (the old substantial understatement penalty provision) allowed that the penalty could be waived “on a showing by the taxpayer that there was reasonable cause for the understatement . . . and that the taxpayer acted in good faith.” The legislative history to Sec. 6664 states that Congress intended “that the terms ‘reasonable cause’ and ‘good faith’ be interpreted under [Sec. 6664] as those terms are interpreted under [then-] present law.”5

    The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances.6 The most important fact in making this determination is the extent of the taxpayer’s effort to assess the proper tax liability.7 To avail themselves of the Sec. 6664 exception, taxpayers have the burden of demonstrating both objective reasonable cause and subjective good faith.8 It should be borne in mind that these are two distinct requirements, although the IRS and the courts often appear to treat the two concepts as one. In addition, whether the elements that constitute reasonable cause are present in a given situation is a question of fact, but which elements must be present to constitute reasonable cause is a question of law.9

    Reasonable Cause

    The regulations under Sec. 6651 define the term “reasonable cause” as the “exercise of ordinary business care and prudence.”10 As discussed above, Congress intended this definition to be used for Sec. 6664. This objective standard involves the type of analysis required in the context of the Sec. 6662 negligence determination. Reasonable cause exists if the taxpayer “exercises ordinary business care and prudence in determining its tax obligations” but is nonetheless unable to comply with the Code. In the context of Sec. 6651, facts or events that prevent a taxpayer from complying with Code requirements, notwithstanding the taxpayer’s exercise of ordinary business care and prudence, include, among other things, the taxpayer’s reliance on a tax adviser, the taxpayer’s reliance on the erroneous advice of an IRS officer or employee, the death or serious illness of the taxpayer or a member of his or her immediate family, the taxpayer’s unavoidable absence, and the destruction by casualty of the taxpayer’s records or place of business.11

    Good Faith

    As mentioned earlier, neither the Code nor the regulations define “good faith.” Black’s Law Dictionary defines the term as “honesty of purpose,” “observance of reasonable commercial standards,” and “absence of design to defraud or seek an unconscionable advantage.”12 While it is not clear from the Code or the regulations, the good-faith component of the Sec. 6664 exception generally is considered to be a subjective standard.13 As such, the question for this purpose is whether the taxpayer actually acted in good faith, not whether the taxpayer’s actions were objectively reasonable.

    Thus, the Sec. 6664 defense to the Sec. 6662 penalty has both subjective and objective aspects. The Sec. 6664 regulations do not define the terms but do provide examples of situations where both are found, or not, as the case may be. Because the reasonable cause and good-faith determinations both involve a facts-and-circumstances analysis, it is perhaps most instructive to review those examples in an effort to see the terms’ application in specific contexts.

    Specific Circumstances and Taxpayer Conduct

    Reliance on an Information Return

    The regulations provide, somewhat unhelpfully, that reliance on an information return demonstrates reasonable cause and good faith “if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith.”14 Warning that reliance on an information return “does not necessarily demonstrate reasonable cause and good faith,” the regulations explain that:

    A taxpayer’s reliance on erroneous information reported on a Form W-2, Form 1099 or other information return indicates reasonable cause and good faith, provided the taxpayer did not know or have reason to know that the information was incorrect. Generally, a taxpayer knows, or has reason to know, that the information on an information return is incorrect if such information is inconsistent with other information reported or otherwise furnished to the taxpayer, or with the taxpayer’s knowledge of the transaction. This knowledge includes, for example, the taxpayer’s knowledge of the terms of his employment relationship or of the rate of return on a payor’s obligation.15

    An example in the regulations illustrates the foregoing.16 In the example, the taxpayer did odd jobs and filled in for other employees when necessary. The taxpayer worked irregular hours and was paid by the hour. The amount of the taxpayer’s paycheck differed from week to week. The Form W-2, Wage and Tax Statement, furnished to the taxpayer reflected $29,729 of wages for the tax year. The W-2, however, did not include compensation of $1,467 paid for some hours the taxpayer worked. The taxpayer, relying on the Form W-2, filed a return reporting wages of $29,729. The taxpayer had no reason to know that the amount reported on the Form W-2 was incorrect. The regulations conclude that, under these circumstances, the taxpayer “is considered to have acted in good faith in relying on the Form W-2 and to have reasonable cause for the underpayment attributable to the unreported wages.”

    Practice tip: Notwithstanding the regulation’s ambivalence regarding reliance on an information return, in most cases a taxpayer should be able to rely on the information reported on forms such as the W-2, the 1099 series, and Form 1098, Mortgage Interest Statement. Obviously, if the information is on its face inconsistent with the taxpayer’s understanding of the relevant facts, the taxpayer has a duty to investigate the apparent discrepancy. But amounts that appear “in the ballpark” should not require further taxpayer investigation. Because a taxpayer is not generally required to obtain a second opinion with respect to professional advice, a taxpayer should similarly be able to assume that the information provided on such forms is accurate without auditing such amounts.

    Reliance on Advice

    The regulations contain a similarly unenlightening and circular rule with respect to reliance on professional tax advice: Reliance on professional advice demonstrates reasonable cause and good faith only if the taxpayer’s reliance was, under the circumstances, reasonable and in good faith. Again, the regulations warn that reliance on a tax professional’s advice or an appraiser does not necessarily demonstrate reasonable cause and good faith.

    Indeed, fairly elaborate rules are provided that establish the factual basis a taxpayer must demonstrate to support the Sec. 6664 “reliance-on-counsel” defense. As a general rule, the regulations provide that all facts and circumstances must be considered in determining whether a taxpayer has reasonably relied in good faith on professional tax advice. For example, the taxpayer’s education, sophistication, and business experience are relevant in determining whether his or her reliance on tax advice was reasonable and made in good faith.

    Reliance on professional advice—Minimum requirements: The regulations flatly state that “[i]n no event will a taxpayer be considered to have reasonably relied in good faith on advice” unless the requirements of Regs. Sec. 1.6664-4(c)(1) are satisfied.17 The term “advice” for this purpose means

    any communication, including the opinion of a professional tax adviser, setting forth the analysis or conclusion of a person, other than the taxpayer, provided to (or for the benefit of) the taxpayer and on which the taxpayer relies, directly or indirectly, with respect to the imposition of the section 6662 accuracy-related penalty.18

    Advice does not have to be in any particular form (i.e., it can be written or oral). It is important to bear in mind that these are truly minimum standards; more importantly, their satisfaction is a necessary but not sufficient condition for the exception to apply. For example, the taxpayer’s reliance may not be considered to be reasonable or in good faith if the taxpayer knew, or reasonably should have known, that the adviser lacked knowledge in the relevant aspects of federal tax law. The three specific “minimum requirements” are:

    • The advice must be based on all facts and circumstances;
    • The advice may not rely on unreasonable assumptions; and
    • If the advice is that a regulation is invalid, the position must be adequately disclosed.

    These specific minimum requirements are discussed in greater detail below.

    All facts and circumstances considered: The advice must be based on all pertinent facts and circumstances and the law as it relates to those facts and circumstances. This means, for example, that the advice “must take into account the taxpayer’s purposes (and the relative weight of such purposes) for entering into a transaction and for structuring a transaction in a particular manner.”19 In addition, this minimum requirement is not satisfied if the taxpayer fails to disclose to the adviser a fact that the taxpayer knows, or reasonably should know, is relevant to the proper tax treatment of an item that is the subject of the advice.20

    No unreasonable assumptions: The regulations also require that the advice must not be based on unreasonable factual or legal assumptions.21 In addition, the advice must not “unreasonably rely” on any representations, statements, findings, or agreements of the taxpayer or any other person. For example, the advice must not be based upon a representation or assumption that the taxpayer knows, or has reason to know, is unlikely to be true—e.g., an inaccurate representation or assumption as to the taxpayer’s purposes for entering into a transaction or for structuring a transaction in a particular manner.

    Reliance on the invalidity of a regulation: A taxpayer may not rely on an adviser’s opinion or advice that a regulation is invalid to establish that the taxpayer had reasonable cause and acted in good faith unless the taxpayer adequately discloses the position.22 The taxpayer must make the disclosure required here in accordance with Regs. Sec. 1.6662-3(c)(2). As discussed in part I of this article, this generally requires disclosure on a completed Form 8275, Disclosure Statement, or 8275-R, Regulation Disclosure Statement.23

    Practice tip: The regulations state that in order for the taxpayer’s reliance on advice to constitute reasonable cause and good faith, the reliance itself must be reasonable. In this regard, the regulations state that the taxpayer’s education, sophistication, and business experience are relevant factors in determining whether the taxpayer’s reliance on tax advice was reasonable. Because reasonableness is always determined “under the circumstances,” this adds little to the required analysis.

    Moreover, the minimum requirements themselves seem to create a standard that the courts, including the Supreme Court, have rejected. For example, the regulations require that the advice must consider all facts and circumstances and must contain no unreasonable assumptions. But how is a normal taxpayer (i.e., one who is not an expert in federal tax law) to judge whether his or her adviser has considered all pertinent facts or has made any unreasonable assumptions (especially legal assumptions)? The answer is that they most likely cannot. More importantly, they need not make this judgment:

    When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice. Most taxpayers are not competent to discern error in the substantive advice of an accountant or attorney. To require the taxpayer to challenge the attorney, to seek a “second opinion,” or to try to monitor counsel on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place. . . . “Ordinary business care and prudence” does not demand such actions.24 [Internal citations omitted.]

    Even with respect to the requirement that taxpayers disclose “invalid regulations” positions, the regulations seem to exceed what has been required of taxpayers by courts. The pertinent question for purposes of Sec. 6664 is not the reasonableness of the advice but the reasonableness of the taxpayer’s reliance on the advice. If the advice is facially so defective that even one unversed in the nuances of federal tax law could readily discern its invalidity, it would of course be unreasonable for the taxpayer to rely on it. This, however, in practice should prove to be the rare exception rather than the rule. In most cases, it should be reasonable for the taxpayer to rely on the advice of a qualified tax professional to whom the taxpayer has provided all pertinent information.

    Tax Shelter Items of Corporations

    With respect to a tax shelter item that creates a substantial understatement of income tax, the regulations provide special rules for determining whether a corporation demonstrates reasonable cause and good faith. A tax shelter item for this purpose means any item “directly or indirectly attributable to the principal purpose of a tax shelter to avoid or evade Federal income tax.”25 A tax shelter is any partnership or other entity (such as a corporation or trust), any investment plan or arrangement, or any other plan or arrangement whose principal purpose is to avoid or evade federal income tax.26

    Practice tip: The regulations acknowledge that a transaction’s principal purpose is not to avoid or evade federal income tax if its purpose is to claim exclusions from income, accelerated deductions, or other tax benefits in a manner consistent with the statute and congressional purpose.27 The regulations identify several common activities that are not tax shelter activities, such as holding tax-exempt bonds, taking cost recovery deductions, deferring income in tax sheltered retirement vehicles, and electing foreign sales corporation status.28 Thus, the regulations acknowledge that certain statutory provisions are inherently taxpayer favorable, and taxpayers may avail themselves of the benefits thereof without their actions being characterized as improperly “tax motivated.”

    As is generally the case, the determination of whether a corporation acted with reasonable cause and in good faith in its treatment of a tax shelter item is based on all pertinent facts and circumstances. However, the regulations identify specific ways in which a corporation can establish reasonable cause and good faith with respect to such items. Specifically, under the regulations a corporation may establish reasonable cause and good faith with respect to a tax shelter item by either legal justification or other factors.

    Reasonable Cause Based on Legal Justification

    The term “legal justification” includes any justification relating to the treatment or characterization under the federal tax law of the item or transaction in question.29 Thus, a taxpayer’s belief (whether independently formed or based on the advice of others) as to the merits of the taxpayer’s underlying position is a legal justification. Here too the regulations identify two so-called minimum requirements—the authority requirement and the belief requirement. Failure to meet these requirements will preclude a finding of reasonable cause and good faith based on legal justification. However, meeting the requirements is not necessarily sufficient to prove reasonable cause and good faith.

    Authority requirement—substantial authority: The authority requirement is satisfied only if there is substantial authority (within the meaning of Regs. Sec. 1.6662-4(d)) for the tax treatment of the item.

    Belief requirement—more likely than not: The belief requirement is satisfied only if, based on all facts and circumstances, the taxpayer reasonably believed, at the time the return was filed, that the tax treatment of the item was more likely than not the proper treatment. The taxpayer can either make this determination or rely on a professional tax adviser. In either case, such determination must be made in the manner prescribed in the regulations (essentially, a careful weighing of the relevant authorities). In making the more-likely-than-not determination, the taxpayer may not take into account the possibility that a return will not be audited, that an issue will not be raised on audit, or that an issue will be settled.30

    Practice tip: As noted above, meeting the minimum requirements may not be enough to prove reasonable cause and good faith. The regulations state that satisfaction of the minimum requirements would not be dispositive if, for example, the tax shelter lacked significant business purpose, if the taxpayer claimed tax benefits that were unreasonable compared with his or her investment in the tax shelter, or if the taxpayer agreed with the tax shelter’s organizer or promoter that the taxpayer would protect the confidentiality of the tax aspects of the tax shelter’s structure.31

    It is not readily apparent what this regulatory statement adds to the analysis. For example, it is difficult to imagine the existence of substantial authority for a transaction that lacks business purpose. Similarly, it is likely that a transaction the tax benefits of which are unreasonable compared with the taxpayer’s investment would lack economic substance. Nonetheless, the minimum requirements must be met, although meeting them will not necessarily be sufficient to establish reasonable cause and good faith in this context.

    Reasonable Cause Based on Other Factors

    If a corporate taxpayer with a substantial understatement attributable to a tax shelter item is unable to satisfy the minimum requirements, all is not lost. The regulations generously provide that the corporate taxpayer in this situation can nonetheless demonstrate reasonable cause and good faith by introducing other facts and circumstances.

    Valuation Misstatements of Charitable Deduction Property

    With respect to property valuations, the mere fact that a taxpayer obtains an appraisal is insufficient in itself to demonstrate reasonable cause and good faith.32 Other factors must be considered, including the methodology and assumptions underlying the appraisal, the appraised value, the relationship between appraised value and purchase price, the circumstances under which the appraisal was obtained, and the appraiser’s relationship to the taxpayer or to the activity in which the property is used.33

    With respect to charitable deduction property, the reasonable cause/good-faith exception does not apply unless the taxpayer (1) based the claimed value of the property on a qualified appraisal made by a qualified appraiser and (2) made a good-faith investigation of the value of the contributed property.34 For this purpose the term “charitable deduction property” means any property (other than money or publicly traded securities) contributed by the taxpayer where a deduction was claimed under Sec. 170 (the charitable contribution deduction).35

    Qualified appraisal: The term “qualified appraisal” means, for any property, an appraisal of such property that is (1) treated as a qualified appraisal under regulations or other guidance prescribed by the IRS and (2) conducted by a qualified appraiser in accordance with generally accepted appraisal standards and any regulations or other guidance.36

    Qualified appraiser: The term “qualified appraiser” means an individual who:

    • Has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in the regulations;
    • Regularly performs appraisals for which he or she receives compensation; and
    • Meets such other requirements as may be prescribed by the IRS in regulations or other guidance.37

    Practice tip: In this context, the Code and regulations seem to require more of taxpayers than courts have required in other contexts (e.g., reliance on other advisers). Again, the question for purposes of Sec. 6664 is whether the taxpayer can demonstrate reasonable cause and good faith. In answering this question, the focus is properly on the reasonableness of the taxpayer’s reliance on the appraiser’s advice, not the reasonableness of the appraisal itself. Nonetheless, the Code and the regulations in this context put the taxpayer in the position of having to judge or audit the work of his or her adviser (in this case an appraiser) or the adviser’s work product, something the Supreme Court has said is not necessary to demonstrate reasonable cause in other contexts.

    What makes this situation worse is that there are elaborate regulatory requirements defining “qualified” appraisers and appraisals, and they require factual and legal conclusions that are beyond the knowledge of all but the most sophisticated and knowledgeable taxpayers. Similarly, in order to support the taxpayer’s claim of reasonable cause and good faith, the regulations also require that the taxpayer make “a good faith investigation of the value of the contributed property.” But is that not exactly why the taxpayer is consulting an appraiser in the first place?

    As a policy matter, the proper question ought to be simply whether the taxpayer’s reliance on the appraiser was, under the circumstances, reasonable and in good faith. Minimum requirements or mandatory requirements simply confuse the matter. For example, suppose a taxpayer reasonably and in good faith relies on an appraiser who presents himself as qualified, but it turns out that, unbeknownst to the taxpayer, the appraiser does not in fact possess the required qualifications under the regulations. It makes no sense—indeed it would be factually incorrect—under these circumstances to assert that the taxpayer did not act in good faith and did not have reasonable cause for his or her valuation position. Nonetheless, this would be the result under the Code and regulations. This situation, however, is largely mitigated by the fact that the Sec. 6662 valuation triggers are substantial over-/undervaluation triggers, and they do not apply unless the taxpayer’s valuation misses the mark by a substantial amount.

    Underpayments Attributable to Reportable Transactions

    Sec. 6664 establishes special rules regarding the reasonable cause and good-faith determination for any reportable transaction understatement.38 A reportable transaction understatement is generally any understatement attributable to a listed transaction or any other reportable transaction a significant purpose of which is the avoidance or evasion of federal income tax.39 Reportable transactions are those transactions that taxpayers are required to disclose under Regs. Sec. 1.6011-4 (including, among other things, confidential transactions, transactions with contractual protection, certain loss transactions, and “transactions of interest”).40

    For a reportable transaction understatement, the Sec. 6664 reasonable cause/good-faith exception does not apply unless the taxpayer meets certain statutory requirements. Specifically, the transaction must be adequately disclosed per the Sec. 1.6011-4 regulations, there must be substantial authority for the taxpayer’s treatment of the transaction, and the taxpayer must reasonably believe that his or her treatment of the transaction was more likely than not the proper treatment.41 Moreover, to be reasonable for this purpose, the taxpayer’s belief must be based on the facts and law that existed at the time the return was filed and must further be based solely on the substantive merits of the position (and not the chances that the transaction might not be reviewed on audit).42 In addition, the taxpayer’s reasonable belief may not be based upon certain disqualified advisers or disqualified opinions.43

    Sec. 482 Valuations

    Detailed regulations govern the Sec. 482 valuation penalty under Sec. 6662(b)(3).44 A discussion of these regulations is beyond the scope of this article. Nonetheless, as a general rule, the Sec. 6664 reasonable cause/good-faith exception applies to any such valuation penalty.45 However, Sec. 6662 itself states that a taxpayer is deemed not to have reasonable cause for any portion of an underpayment attributable to a net Sec. 482 transfer price adjustment unless the taxpayer meets certain Sec. 6662(e)(3)(B) requirements (i.e., the transfer pricing methodology used by the taxpayer and the taxpayer’s production of Sec. 482 contemporaneous documentation). Thus, these can be considered to be minimum requirements for purposes of demonstrating reasonable cause/good faith with respect to Sec. 482 valuations.

    Conclusion

    The Sec. 6662 accuracy-related penalty rules are numerous and complicated. Fortunately for taxpayers, Congress has recognized that generally only unreasonable taxpayer conduct should be penalized. Thus, Sec. 6664 provides a reasonable cause/good-faith exception to the imposition of the Sec. 6662 penalty. However, because it requires a facts-and-circumstances determination, the Sec. 6664 exception is itself complicated and often difficult to apply. In an environment where the Sec. 6662 accuracy-related penalty is being routinely asserted by IRS agents, it is imperative that tax advisers be familiar with both the Sec. 6662 rules and the Sec. 6664 reasonable cause/good-faith exception rules.

    Footnotes

    1 The term “tax” for this purpose means any tax imposed by the Internal Revenue Code (Sec. 6664(a)). Thus, the Sec. 6662 penalty can apply to, among others, underpayments of income tax, gift tax, estate tax, or employment tax.

    2 Sec. 6664(c)(1).

    3 In practice, IRS agents seem to prefer to treat taxpayers as availing themselves of an exception to the Sec. 6662 penalty rather than recognizing that the penalty does not apply ab initio.

    4 Regs. Sec. 1.6664-4(b)(1).

    5 H.R. Conf. Rep’t No. 386, 101st Cong., 1st Sess. (1989), to accompany the Omnibus Budget Reconciliation Act of 1989, P.L. 101-239.

    6 Regs. Sec. 1.6664-4(b)(1).

    7 Id.

    8 This is the taxpayer’s burden because the IRS’s assertion of the Sec. 6662 penalty is presumptively correct and Sec. 6664 is essentially an affirmative defense thereto.

    9 Boyle, 469 U.S. 241 (1985).

    10 Regs. Sec. 301.6651-1(c)(1).

    11 IRM §20.1.1.3.2.

    12 Black’s Law Dictionary 477 (6th ed. 1991).

    13 Barrett, 561 F.3d 1140 (10th Cir. 2009). In the criminal context, see Cheek, 498 U.S. 192 (1991) (a good-faith misunderstanding of the law or a good-faith belief that one is not violating the law need not be “objectively reasonable if it is to be considered as possibly negating the Government’s evidence purporting to show a defendant’s awareness of the legal duty at issue”).

    14 Regs. Sec. 1.6664-4(b)(1).

    15 Id.

    16 Regs. Sec. 1.6664-4(b)(2), Example (3).

    17 Regs. Sec. 1.6664-4(c)(1).

    18 Regs. Sec. 1.6664-4(c)(2).

    19 Regs. Sec. 1.6664-4(c)(1)(i).

    20 Id.

    21 Regs. Sec. 1.6664-4(c)(1)(ii).

    22 Regs. Sec. 1.6664-4(c)(1)(iii).

    23 See the discussion at p. 253 in the April issue.

    24 Boyle, 469 U.S. at 251.

    25 Regs. Sec. 1.6662-4(g)(3).

    26 Sec. 6662(d)(2)(C); Regs. Sec. 1.6662-4(g)(2).

    27 Regs. Sec. 1.6662-4(g)(2)(ii).

    28 Id.

    29 Regs. Sec. 1.6664-4(f)(2)(ii).

    30 Regs. Sec. 1.6664-4(f)(2)(i)(B).

    31 Regs. Sec. 1.6664-4(f)(3).

    32 Regs. Sec. 1.6664-4(b)(1). The absence of an appraisal itself would likely demonstrate negligence in most cases, however.

    33 Id.

    34 Sec. 6664(c)(2).

    35 Regs. Secs. 1.6664-4(h)(1) and 1.6664-4(h)(2).

    36 Sec. 170(f)(11)(E)(i).

    37 There are extensive regulations under Sec. 170 that provide further definitions and requirements for appraisals and appraisers for this purpose. A full discussion of those rules is outside the scope of this article.

    38 Sec. 6664(d).

    39 Sec. 6662A(b)(2).

    40 Regs. Sec. 1.6011-4(b).

    41 Sec. 6664(d)(2).

    42 Sec. 6664(d)(3)(A).

    43 Sec. 6664(d)(3)(B).

    44 See generally Regs. Sec. 1.6662-6.

    45 Regs. Sec. 1.6662-6(b)(3).

    EditorNotes

    John Cook is an assistant professor of accountancy in the Raj Soin College of Business at Wright State University in Dayton, OH. Alan Ocheltree is director, Tax Controversy, at Cardinal Health, Inc., in Dublin, OH. For more about this article, contact Prof. Cook at john.cook@wright.edu.




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