Tax Fraud

Trust Fund Handbook page1
Trust Fund Handbook page2
Trust Fund Handbook page3
Tax Fraud
Willfulness - knowledge of non-payment
Statute of Limitations
Assessment p1
Assessment p2
Assessment p3
GCM 33653

Part 4. Examining Process

Chapter 23. Employment Tax Handbook

Section 9. Employment Tax Penalty and Fraud Procedures

4.23.9  Employment Tax Penalty and Fraud Procedures

• 4.23.9.1   Overview
• 4.23.9.2   Introduction
• 4.23.9.3   Reasonable Cause
• 4.23.9.4   Managerial Approval
• 4.23.9.5   Appeal Procedures
• 4.23.9.6   Fraud Penalty
• 4.23.9.7   Negligence Penalty
• 4.23.9.8   Assertion of Penalties Involving IRC 3509
• 4.23.9.9   Assertion of Failure to File Penalty
• 4.23.9.10   Assertion of Failure to Pay Penalty
• 4.23.9.11   Penalty for Failure to Make Timely Deposits
• 4.23.9.12   Penalties for Failure to File Certain Information Returns or Furnish Certain Statements
• 4.23.9.13   Trust Fund Recovery Penalty
• Exhibit 4.23.9-1   Instructions for Determining Civil Penalty Statute of Limitations

4.23.9.1  (03-01-2003)
Overview

1.       This section explains the employment tax penalty procedures.

2.       It is important that taxpayers be treated equitably and that decisions regarding liability for penalties be based on sound analyses of the reasons advanced by the taxpayer for failing to act.

3.       In 1989, the Omnibus Budget Reconciliation Act (OBRA) consolidated and restructured many penalty code sections to address legislative inconsistencies.

4.       Penalty Policy Statement P–1–18—ln accordance with this Policy Statement, the IRS administers a penalty system that is designed to:

·         Ensure consistency.

·         Ensure accuracy of results in light of the facts and the law.

·         Provide methods for the taxpayer to have his or her interests heard and considered.

·         Require impartiality and a commitment to achieving the correct decision.

·         Allow for prompt reversal of initial determinations when sufficient information has been presented to indicate that the penalty is not appropriate.

·         Ensure that penalties are used for their proper purpose and not as bargaining points in developing or processing cases.

5.       To ensure consistency, the Service prescribes and uses a single set of guidelines set out within the Penalty Handbook, IRM 20.1, which will be followed by all operational and processing functions

6.       Specific guidance on fraud indicators and the development of fraud may be found in IRM 25.1.1 and 25.1.2.

4.23.9.2  (03-01-2003)
Introduction

1.       This section discusses the penalties most frequently asserted in employment tax examinations. The penalties covered in this section should not be considered as all inclusive, and research should be done on a case by case basis to ensure correct penalty assessment. Examiners should refer to the Penalty Handbook, IRM 20.1, for complete information on penalties. Specific guidance on fraud indicators and the development of fraud may be found in IRM 25.1.1 and 25.1.2. Exhibit 4.23.9.1 contains instructions for determining civil penalty statute of limitations.

2.       Penalties are asserted in the same manner as the taxes to which they are applied. Although income taxes are subject to the deficiency procedure in IRC Subchapter B of Chapter 63, many penalties applying to income taxes have been specifically exempted from the deficiency procedure. For an example, see IRC section 6696(b).

3.       A Civil Penalties Master file has been developed to accommodate most penalties previously assessed on the Non-Master File (NMF) and the W–4 penalty previously assessed as MFT 30. These penalties are listed on Form 8278, Computation and Assessment of Miscellaneous Penalties which is used to forward the assessment/abatement action for input.

4.       When using the Civil Penalties Master File, the first assessment made on an entity will establish the module since there is no return filing to create the module prior to the first assessment. These MFTs will be single entity modules. No joint assessments can be made. Any joint penalty liabilities, such as a jointly filed frivolous return, must continue to be made on NMF utilizing existing instructions.

4.23.9.3  (03-01-2003)
Reasonable Cause

1.       If it is determined that the failure to act was due to reasonable cause, a written statement setting forth the reason should be obtained from the taxpayer. Form 4571, Explanation for Filing Return Late or Paying Tax Late, is available for this purpose with respect to failure to file or pay.

4.23.9.4  (03-01-2003)
Managerial Approval

1.       IRC section 6751(b) requires that penalty assessments be approved in writing by the examiner's immediate supervisor. The examiner is not required to provide a copy of the written approval to the taxpayer.

2.       Penalties under IRC section 6651, failure to file tax return or to pay tax and penalties automatically calculated through electronic means are excepted from the approval requirement. This means that the penalty must be free of any independent determination by a Service employee as to whether or not the penalty should be imposed against a taxpayer. Despite the fact that section 6651 penalties are exempted by statute from the managerial approval requirement, examiners should seek management approval of the fraudulent failure to file penalty in section 6651(f) because that penalty is not automatically calculated through electronic means.

4.23.9.4.1  (03-01-2003)
Computation of Penalty Included in Notice

1.       In accordance with RRA 98, sections 3306 and 3308 (notice requirements relating to computation of Penalty and Imposed Interest, respectively), IRC section 6751(a) requires that each penalty notice include the name of the penalty, the code section imposing the penalty, and a computation of the penalty. The requirement became effective July 1, 2001 .

A.      The computation must include:

                                                         I.            the formula for computing the penalty,

                                                       II.            the amount of each of the variables in that formula,

                                                      III.            the change in each of these variables since the date of the of the last notice, and

                                                    IV.            the bottom line amount of the penalty imposed.

B.      The penalties shown on the separate explanation sheet must agree with the penalty amounts shown on any employment tax reports, 2504(WC), 466(x), etc., issued to the taxpayer.

C.      A notice of penalty for purposes of IRC section 6751(a) is any notice on which the Service asserts a penalty. Thus, a revenue agents report, a thirty-day letter, a statutory notice of deficiency, a notice and demand, or a billing notice mailed subsequent to the notice and demand are all notices of penalty.

D.      Notices issued after June 30, 2001 and before July 1, 2003 may satisfy the computational requirement if the notice contains a telephone number at which the taxpayer can request a copy of the taxpayer's assessment and payment history with respect to such penalty. After June 30, 2003 , the computation of the penalty, described above, must be included with the notice.

4.23.9.5  (03-01-2003)
Appeal Procedures

1.       The appeals procedures provided with respect to employment taxes are applicable to unagreed delinquency and other ad valorem penalties proposed by an examiner, whether such penalties are in connection with unagreed adjustments to tax , or whether such penalties are the only items in issue. The appropriate standard preliminary 30-day letters, identified in IRM 4.23.10.8 will also be used in all unagreed penalty cases.

4.23.9.6  (03-01-2003)
Fraud Penalty

1.       In imposing fraud penalties, it is necessary to differentiate between tax avoidance and tax evasion. To successfully maintain a charge of fraud in a tax case, it is necessary to establish that a part of the deficiency is due to a false material representation of facts by the taxpayer and that the taxpayer had knowledge of its falsity and intended that it be acted upon or accepted as the truth.

2.       As stated in Policy Statement P–9–5, the civil fraud penalty will be recommended only where there is clear and convincing evidence to prove that some part of the underpayment of tax was due to fraud. Such evidence must show intent to evade payment of tax, which the taxpayer believed to be owing as distinguished from a mistake, inadvertence, reliance on incorrect technical advice, honest difference of opinion, negligence, or carelessness.

3.       Among the factors to be considered in recommending imposition of the civil fraud penalty are whether:

A.      the circumstances are of a flagrant nature; and

B.      the tax is diminutive.

4.       Recommendations for imposing the civil fraud penalty must receive careful scrutiny to make certain that such penalties are asserted only in appropriate cases. The Service bears the burden of proving civil fraud by clear and convincing evidence in the Tax Court. See IRC section 7454.

4.23.9.6.1  (03-01-2003)
First Indications of Fraud

1.       A first indication of fraud can be described as a mere suspicion of fraud. Examiners are legally permitted and should endeavor to ask the taxpayer, the preparer, the representative, or any other involved party for an explanation of the "discrepancies" which are the basis of the examiner's suspicion of fraud and any other question(s) which will resolve the uncertainty of the taxpayer’s intent.

2.       The examiner's judgement will determine when certain techniques will be used, how far each should be followed, and how far the examination should be extended. At the first indication of possible fraud, the examiner should review the Fraud Handbook, IRM 25.1. Guidelines concerning Employment Tax Fraud are discussed in IRM 25.1.2.6.

3.       To be effective, examination techniques should be designed to disclose not only errors in accounting and application of law, but also irregularities such as backdated or forged documents that indicate the possibility of fraud. It is not suggested that an examiner deliberately set out to make a fraud case out of every assigned return or case file. However, indications of possible fraud should be recognized where they exist.

4.       When first indications of fraud are uncovered, the examiner will discuss the case with his/her manager. If the manager concurs that there is a possibility of fraud, a conference (either in person or over the phone) should be held between the examiner, the manager and the Fraud Referral Specialist ( FRS ). When all three agree that there is a potential for fraud, then the case should be updated to Status Code 17. Status Code 17 identifies the case as having potential fraud issues and exempts it from cycle time consideration on monthly "aging" reports.

5.       At this time a plan of action should be developed to establish and document the affirmative acts or firm indications of fraud. Refer to IRM 25.1.2.1 for information on the minimum plan for case development. The examiner should continue the audit, being alert for other badges of fraud and follow up on initial suspicions of fraud. See IRM 20.1.5.12.1 for a list of common badges of fraud.

6.       The FRS serves as a resource person and liaison to compliance employees to assist in fraud investigations and offer advice on matters concerning tax fraud in all the business organizations. The FRS will be consulted in all cases involving potential criminal fraud, as well as, those cases that have potential for a civil penalty.

4.23.9.6.2  (03-01-2003)
Firm Indications of Fraud

1.       A firm indication of fraud must be distinguished from a first indication of fraud. A firm indication of fraud is a factual determination that can only be made on a case by case basis. An examiner who is in doubt should consult with the manager and the FRS to determine if the indicators of fraud are sufficiently developed. However, under no circumstances shall examiners or managers obtain advice and/or direction from Criminal Investigation for a specific case that is under examination. In addition, if a referral is being considered, an examiner should not solicit an agreement or solicit and receive delinquent returns prior to the submission of a fraud referral.

2.       If an examiner discovers firm indications of fraud, the examination should immediately be suspended without disclosing to the taxpayer the reason for such suspension. Examiners are cautioned not to carry the investigation beyond the point where a valid indication of fraud is adequately supported by the workpapers.

3.       If the case does not meet the guidelines for a criminal referral, then this should be documented in the case file and the examiner should then proceed with the civil examination.

4.       If the case does warrant a criminal referral, the examiner will prepare a referral on Form 2797, Referral Report of Potential Criminal Fraud Cases. See IRM 4.23.6.5 for further instructions. The referral will be forwarded through the manager, to the FRS , to CI's Lead Development Center and then to a Special Agent in Charge in CI.

4.23.9.6.3  (03-01-2003)
Cases Involving Possible Criminal Proceedings

1.       Information about the source or details of evidence relating to a potential criminal case must be safeguarded and withheld to the extent necessary to avoid prejudice to a case. This general rule is applicable not only during the investigation of a case, but also in any action taken with respect to the civil portions of a case having open criminal aspects. When appropriate, examiners are expected to coordinate proposed disclosures of information through established channels.

2.       Full cooperation among all levels of operations in the Internal Revenue Service must be maintained to ensure that there is no duplication in investigations and unnecessary inconvenience to the public is avoided. The examiner should review IDRS to determine if any Z freeze (TC 914) conditions exist and if other functions are assigned to the taxpayer case. Criminal Investigation (CI) or the FRS should be contacted prior to beginning case action whenever an un-reversed TC 914 is present in any module.

3.       In employment tax cases warranting assertion of the Trust Fund Recovery Penalty (TFRP), there will be instances when any appreciable delay in asserting and collecting the tax or penalty would jeopardize the revenue. In all such cases, the area director is authorized to decide whether collection of the tax or penalty might be jeopardized. If the revenue might be jeopardized, the tax or penalty may be assessed and collected by a quick assessment or a jeopardy assessment, as the circumstances warrant. IRC section 6672 does not bar assertion of the TFRP against responsible officers whenever fraud is asserted against the corporation on the underlying employment tax liability.

4.       If an examiner learns that an assigned case involves a taxpayer who is the subject of a criminal investigation, all activity on the case will be immediately suspended. The examiner’s manager will consult with the Supervisory Special Agent in Criminal Investigation relative to the continuance of employment tax activity on the case. If agreement to either continue the suspension or to resume the employment tax activity on the case cannot be reached at the group or territory level, the issue will be decided at the area level. Where more than one area is involved, the Director of Field Operations having jurisdiction over the criminal investigation will resolve the question.

5.       In income, estate, and gift tax cases in which criminal prosecution has been recommended (except potential jeopardy cases), the Service does not authorize assessment of additional taxes and penalties during the time the recommendation for criminal prosecution is under consideration or during the period such cases may be awaiting trial or pending an appeal. The same procedure will be followed with respect to employment tax cases in which criminal prosecution has been recommended.

6.       Threat of criminal prosecution shall not be made in any case. If a question concerning civil action arises in a case with open criminal aspects, it will be resolved on the basis of whether the criminal case will be prejudiced by the proposed civil action. Policy Statement P–4–84 provides that the consequences of civil enforcement actions on criminal investigations for the same taxable periods and same types of taxes must be carefully weighed. Any discussion or negotiation regarding settlement of civil enforcement actions must be guided by this policy, and input from the FRS .

4.23.9.6.4  (03-01-2003)
Common Fraudulent Devices

1.       Fraud may exist where a taxpayer willfully attempts to illegally underreport taxes, or does not pay taxes. For a taxpayer to be guilty of a crime in which willfulness is an element, that individual must have acted deliberately, knowingly, and with the specific intent to violate the law.

2.       The majority of criminal fraud situations employment tax examiners will encounter result from:

A.      Willful failure to account for, collect, or pay over taxes (IRC section 7202).

B.      Willful failure to file a return (IRC section 7203).

C.      Willful failure to pay taxes owed (IRC section 7203).

D.      Willful submission of a false statement under perjury (IRC section 7206(i)).

E.      Failure to collect and deposit in a special trust fund account (IRC sections 7215 and 7512(b)).

F.      Attempts to obstruct or impede tax administration (IRC section 7212(a)).

3.       The Penalty Handbook notes several elements that may be indicative of fraud. Examiners should remain continually alert for these and other "badges of fraud."

4.23.9.6.5  (03-01-2003)
Referrals to Criminal Investigation Division

1.       Cases are referred to Criminal Investigation Division by using Form 2797 (Referral Report of Potential Criminal Fraud Cases). Form 2797 is not required for Civil Fraud Referrals. Contact the Fraud Referral Specialist ( FRS ) for assistance. (See IRM 25.1.1, Fraud Handbook—Criminal Referrals, for additional instructions).

2.       The referral should be a detailed, factual presentation of those factors that were used to establish firm indications of fraud. The report should include, but not be limited to: affirmative act(s) of fraud, the taxpayer’s explanation of the affirmative act(s) when it will assist in determining intent, and the estimated criminal tax liability, financial statements, public records checks, account transcripts, and a copy of the last filed return. No workpapers or attachments are required with the referral.

3.       There may be instances where at the time the examiner discovers indications of fraud, the information available is insufficient to complete Form 2797 in all respects. Even so, the examiner will not delay preparing the report but will complete it to the extent possible.

4.       A separate Form 2797 should be prepared for each individual, entity and type of tax involved in the suspected fraud. After concurrence and signature by the manager, the referral will be immediately transmitted to the FRS . Supporting documents and a copy of each referral will be retained in the examiner's case file and will not be transmitted with the Form 2797 referral. See IRM 25.1 for further instructions.

5.       When the taxpayer is the only party involved in the fraud, the form is prepared in triplicate and must be approved by the manager. One copy is retained with the case file. The original and one copy are forwarded to the FRS for review and concurrence. The FRS will review the Form 2797 and immediately forward it to their manager for approval.

6.       After the Form 2797 is approved by the FRS 's manager, one copy is forwarded to a Lead Development Center for research. Another copy is transmitted to a Special Agent for evaluation. The Special Agent will contact the examiner to set up an initial meeting. The FRS may also be contacted if feasible.

7.       If a case involving a collateral examination results in a fraud referral, the affected territories will coordinate the referrals.

8.       If the referral is accepted by Criminal Investigation (CI), they will finish completing the original Form 2797 and return it to the FRS who will retain a copy and forward the original to the referring examiner. In most cases, the referring examiner will become the cooperating agent on the case. See IRM 25.1.4.3.1 for the duties of a cooperating agent. Once accepted, the examiner will update the case to Status Code 18 and Project Code 095.

9.       If CI does not accept the referral, Form 2797 and a memorandum of declination will be returned to the examiner. This memorandum should remain in the case file.

10.   After notification that the referral was not accepted, the examination may be resumed. The examiner will continue to be alert for new indications of fraud in declined referral cases. If they develop, the case will again be referred to the FRS in accordance with referral procedures.

4.23.9.6.6  (03-01-2003)
Civil Fraud Penalty Rates

1.       IRC section 6663(a) provides that if any part of the underpayment of tax required to be shown on the return is due to fraud, a penalty equal to 75% of the portion of the underpayment which is attributable to fraud will be added.

2.       IRC section 6663(b) further provides that if the IRS established that any portion of the underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud. However, if the taxpayer establishes by a preponderance of evidence that any portion of the underpayment is not attributable to fraud, such portion will be excepted from the fraud penalty.

3.       IRC section 6664(b) provides that the penalty applies only when a return has been filed. See IRM 4.23.9.9(3) of this section for the fraudulent failure to file penalty.

4.       IRM 20.1.5.12, IRC Section 6663:Civil Fraud Penalty, of the Penalty Handbook provides current rates and specific procedures for assertion of the civil fraud penalty. IRM 20.1.5.2 further describes coordination between the fraud penalties and other penalties.

4.23.9.6.7  (03-01-2003)
Civil Fraud Procedures

1.       A Civil fraud penalty case may be developed on the facts and circumstances of a civil examination or result from the completion of a criminal prosecution.

2.       Civil fraud no longer requires a referral to Criminal Investigation (CI). Determination of this penalty is a shared responsibility of both the examiner and manager. The Fraud Referral Specialist ( FRS ) is also available for assistance.

3.       When a case is being closed in which the civil fraud penalty is being assessed, the examiner should prepare the Form 6809, Civil Fraud Penalty Monitoring Form. The orginal Form 6809 should be placed in the case file and a copy of this form should be sent to the FRS .

4.       Upon concurrence of the manager and FRS , cases being developed for potential fraud should be updated to Status Code 17.

5.       For civil settlement of a prosecution case, the examiner should contact CI to ascertain which criminal statutes the taxpayer was convicted of before attempting to resolve the related civil fraud penalty. The examiner should obtain a copy of the plea agreement or judgement notating the applicable criminal statutes and years.

6.       In cases where fraud was considered and the civil fraud penalty is not being recommended, the examiner will explain in the workpapers why the penalty was not asserted.

7.       On successful criminal prosecution cases returned for civil tax settlement, Area Counsel must provide written approval for non-assertion of the civil fraud penalty.

8.       In statutory notice cases, Area Counsel must approve civil fraud penalties prior to issuance.

9.       Examiners and managers should be aware of collateral estoppel and the important distinction it can have in civil tax fraud penalty cases. Refer to the IRM 25.1.6, Civil Fraud for a more complete explanation.

10.   When closing a fraud case, enter "C" or "F" on the appropriate line of Form 5344 to ensure capture of the penalty on AIMS.

11.   Form 3198 or Form 9231 may be used for routing of civil fraud cases.

4.23.9.7  (03-01-2003)
Negligence Penalty

1.       Examiners should not hesitate in appropriate cases to recommend the assertion of additions to the tax for negligence currently imposed as part of the accuracy-related penalty by IRC section 6662. IRC section 6662(b)(1) applies to negligence or disregard of the rules or regulations.

2.       Negligence, in the generally accepted legal sense, is the omission to do something which a reasonable person guided by those considerations which ordinarily regulate the conduct of human affairs would do, or doing something which a prudent and reasonable person would not do. Negligence includes any failure to make a reasonable attempt to comply with the provisions of tax laws, exercise ordinary and reasonable care in tax return preparation, or keep adequate books and records. The term "disregard" includes careless, reckless, or intentional disregard. Whether or not negligence has occurred in a particular employment tax case requires exercise of sound judgment by the examiner, supervisor, and reviewer.

3.       The negligence penalty should be invoked if there has been negligence or an intentional disregard of published rulings and regulations in the preparation of returns, as distinguished from a mere error or a difference of opinion on some controversial question and a willful intent to evade is not present or cannot be substantiated.

4.       The code sections and applicable dates for the negligence penalty have changed frequently. The Return Related Penalties section of the Penalty Handbook provides pertinent information on these changes. It further describes coordination between the negligence penalty and other penalties.

5.       The Penalty Handbook also discusses negligent conduct and some of the indicators of negligence.

6.       When an underpayment of tax is attributable to the taxpayer’s failure to keep adequate records, the negligence penalty may be asserted if the taxpayer’s records are found to be inadequate upon initial examination or subsequent examination. Whether the penalty is asserted should be determined in view of the facts and circumstances of the particular case.

7.       Even if the return was prepared by an agent or employee of the taxpayer, the penalty may still be applied in appropriate instances. Unlike the fraud penalty, the taxpayer bears the same burden of proof in a negligence case as in a straight deficiency or overassessment case. IRC section 7491(c), however, provides that the Commissioner has the burden of production in any court proceeding with respect to the liability of any individual for any penalty, addition to tax, or additional amount (penalties). Therefore, with regard to section 7491(c), for the Commissioner to meet his burden of production, the Commissioner must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty.

8.       If an examiner recommends an addition to the tax on account of negligence, the facts forming the basis for the recommendation will be fully stated. When the negligence penalty is assessed, a copy of the report of examination should accompany the preliminary letter.

9.       Liability for an ad valorem addition to the tax on account of negligence does not remove the bar of the statute of limitations as it does if there is liability for fraud. However, if the Service determines the existence of fraud, there is no bar to the statute of limitations for the entire underpayment, including that portion not attributable to fraud (e.g., negligence or non-negligence).

10.   Examiners will attach Form 3198, Special Handling Notice, or Form 9231, Collections Special Handling Form, to all case files in which the IRC 6662 penalty is to be assessed. Under Special Handling "Other" , annotate "Penalty computation required under IRC section 6662."

4.23.9.8  (03-01-2003)
Assertion of Penalties Involving IRC 3509

1.       IRC section 3509 provides reduced rates for computing the withholding tax under IRC section 3402 and the employee's share of FICA tax under IRC section 3101. The substitute method applies if the employer failed to deduct and withhold those taxes by reason of treating the employee as a nonemployee. When IRC section 3509 applies, the Service cannot compute the applicable penalties on the basis of the higher liability that would have resulted under IRC sections 3402 and 3101.

2.       In computing the failure to deposit taxes penalty under IRC section 6656, the computation should be based only on the employer’s share of the FICA tax liability determined by IRC section 3509. See IRM 4.23.8.5.1, Reduced Tax Rates Under IRC 3509, for more information.

3.       IRC section 3509 does not apply to an erroneous classification of "wages" under IRC section 3121(a), or to an error in interpreting "employment" under IRC section 3121(b). Nor does IRC section 3509 apply if the employer intentionally disregarded the requirement to deduct and withhold the tax.

4.23.9.9  (03-01-2003)
Assertion of Failure to File Penalty

1.       IRC section 6651(a)(1) imposes a penalty for the failure to file a tax return by its required due date. The penalty rate is 5% per month up to a maximum of 25%, computed on the amount of unpaid tax. The penalty is assessed unless the taxpayer can show that the failure to file was due to "reasonable cause" and not due to willful neglect.

2.       See IRM 4.23.9.10(5) below for reduction of the delinquency penalty rate when it is combined with the failure to pay penalty.

3.       IRC section 6651(f) provides that if the failure to file is fraudulent, the penalty increases to 15% per month up to a maximum of 75%.

4.       There is no provision for an extension of time to file an employment tax return under IRC section 6081.

4.23.9.10  (03-01-2003)
Assertion of Failure to Pay Penalty

1.       IRC section 6651(a)(2) provides a penalty for failure to pay tax shown on returns, unless the failure to pay is due to reasonable cause and not due to willful neglect. IRC section 6651(a)(3) provides a similar penalty for failure to pay tax not shown on the return within 21 days from the date of notice and demand for the tax (10 business days if the amount equals or exceeds $100,000).

2.       When a delinquent return is received from a taxpayer during an examination, the examiner will determine whether the failure to pay penalty under IRC section 6651(a)(2) should be asserted. The examiner’s recommendation for the assertion or non-assertion of the penalty will accompany each delinquent return sent to the Campus. If the delinquent return is received from the taxpayer with remittance, the examiner will solicit payment of the penalty when applicable.

3.       The operating division which conducted the examination is solely responsible for determining whether the failure to pay penalty is applicable on delinquent returns secured. This procedure also applies when a "Substitute for Return" is prepared in a case where a delinquent return was due from the taxpayer.

4.       The penalty imposed by IRC section 6651(a)(2) is one-half of 1 percent for each month or fraction thereof during which the failure to pay continues, limited to a maximum of 25 percent, of the tax shown on the return reduced by:

A.      Tax paid on or before the date prescribed for the payment of the tax.

B.      Any credit against the tax which may be claimed on the return.

5.       In cases subject to the delinquency and failure to pay penalties special provisions apply. No taxpayer will be subject to more than 5 percent penalty (both penalties combined) in any one month, limited to a maximum 25 percent. In these cases the delinquency penalty will be computed at 4 ¹/₂ percent per month and the failure to pay penalty at one-half of 1 percent per month.

6.       The failure to pay penalty does not apply to any underpayment of tax against which the 75 percent fraud penalty under IRC section 6663 will be imposed.

7.       See IRC section 6651(d) for certain situations in which the penalty is increased to 1%.

8.       The reasonable causes for failure to pay are the same as the reasonable causes for failure to file a return within the time prescribed by law. These reasonable causes are stated in Policy Statement P–2–7 and in the Penalty Handbook.

4.23.9.11  (03-01-2003)
Penalty for Failure to Make Timely Deposits

1.       The Campus is primarily responsible for asserting the ad valorem penalty prescribed by IRC section 6656 for failure of taxpayers and collecting agencies to make deposits of certain employment taxes, as required by law. In addition examiners will:

A.      Review transcripts of account to identify previously assessed penalties and if they were paid by the taxpayer or abated by the Campuses.

B.      Review the reasonable cause arguments submitted by the taxpayer and determine if the taxpayer took steps to correct the cause. If not, subsequent penalties may be due.

C.      Review the record of liabilities on the returns to determine its accuracy and that it is in balance with the stated liabilities on the return. An imbalance could mean an overstated/understated return or incomplete record of liabilities and additional penalties may be due.

D.      Consider penalties on delinquent taxable returns obtained as a result of an examination, or an adjustment made for a period for which a "Substitute for Return" was prepared by the examiner in lieu of delinquent returns.

2.       In the above cases, after considering the statement of the taxpayer or collecting agency regarding tardy late payment and without referring the matter to the Campus, the examiner will recommend the assertion or non-assertion of the IRC section 6656 penalty in the examination report, together with any appropriate comments in the report transmittal or workpapers. IRM 20.1.4, Failure to Deposit Penalty, of the Penalty Handbook contains instructions for computing the penalty for Amended or Supplemental Returns and FUTA or CAWR adjustments.

3.       The amount required to be deposited includes the employer's share of all employment taxes plus any amounts withheld from employees that were not deposited. If no tax was withheld from employees, the penalty would be based only on the employer’s share of the tax (see Rev. Rul. 75–191).

4.       A four-tier penalty structure was established to encourage depositors to correct errors in a timely manner. Therefore, the amount of the penalty varies according to the time taken to correct the error. The penalty rates are 2% if 1 to 5 days late, 5% if 6 to 15 days late, and 10% if 16 or more days late. The rate is 15% for taxes still unpaid after the 10th day following notice and demand.

4.23.9.12  (03-01-2003)
Penalties for Failure to File Certain Information Returns or Furnish Certain Statements

1.       The penalties for failure to file certain information returns and for failure to furnish certain statements are subject to the reasonable cause criteria explained in Policy Statement P–2–7 and the Penalty Handbook. The entity must make an affirmative showing of reasonable cause in the form of a written statement, under the penalties of perjury, setting forth all the facts alleged as reasonable cause, Form 4571, Explanation for Filing Return Late or Paying Tax Late, may be used for this purpose.

2.       Penalties may be asserted for both the failure to file and the failure to furnish Forms W–2. Filing the information return under IRC section 6051(d) is not a prerequisite for imposition of the failure to furnish penalty.

3.       By law, the Forms W–2 for back year examinations are delinquent. Only Forms W–2c can be timely filed by February 28 of the following year and not be subject to a penalty. Therefore, if reasonable cause does not exist, the examiner must prepare and enclose a Penalty Case File in addition to the employment tax case file. See IRM 4.23.8.11, Information Return Penalty Package, for instructions.

4.       Under section 6674 of the Internal Revenue Code, an employer who willfully furnishes a false or fraudulent statement, or who willfully fails to furnish a statement in the manner, at the time, and showing the information required under IRC section 6051 or 6053(b) may be subject to a penalty of $50 for each failure, which shall be assessed and collected in the same manner as the tax on employers imposed under IRC section 3111. There is no maximum limit on the amount of penalties under IRC section 6674.

4.23.9.12.1  (03-01-2003)
Information Returns Regarding Payments of Remuneration for Services

1.       IRC section 6041(a) requires taxpayers that are engaged in a trade or business to file an information return if, in a calendar year, a payment of $600 or more is made to an independent contractor. A copy of Form 1099–MISC, Miscellaneous Income, may be used for this purpose. Form 1099–MISC is used by the payor to report these payments.

2.       In addition, IRC section 6041(d) provides that the payor must furnish the payee a written statement setting forth the amount of such payments. A copy of Form 1099–MISC may be used for this purpose. The time for furnishing the statement to the payee is set forth in section 6041(d). The statement must be furnished to the payee on or before January 31st of the year following the calendar year for which the return was made.

3.       The time for filing the statement with the Service, along with Form 1096, Annual Summary and Transmittal of U.S. Information Returns, is discussed in regulation section 1.6041– 6. The statement must be filed on or before February 28 of the following calendar year for which the return was required under IRC section 6041.

4.       For information on the requirements for filing Forms 1099 by magnetic media, see the regulations under IRC section 6011. In general, if the taxpayer is required to file 250 or more information returns (Forms W–2, 1042–S, 1099, 1098, 5498, or W–2G), then magnetic media must be used.

4.23.9.12.2  (03-01-2003)
Wage and Tax Statements

1.       IRC section 6051(a) (Receipts for Employees) and section 31.6051–1(a) and (b) of the Employment Tax Regulations provide that employers must furnish the tax return copy and the employee’s copy of Form W–2, Wage and Tax Statement, to employees for remuneration paid during the calendar year.

A.      The Form W–2 must show, among other information, the total amount of wages paid subject to withholding of income tax, the total amount of wages paid subject to FICA tax, and the total amounts of income tax and FICA tax deducted and withheld.

B.      The time for furnishing the Form W–2 to each employee is on or before January 31 of the succeeding year, or if employment is terminated before the close of such calendar year. If an employee asks for Form W-2, the employer must issue the W-2 within 30 days of the request or within 30 days of the final wage payment, whichever is later.

C.      Section 31.6051–1(c) of the regulations further provides that corrected statements (Forms W–2c) must be furnished to employees whenever the originally issued Form W–2 was incorrect.

2.       The general rule concerning the time for furnishing both original Forms W–2 and corrected statements to the employee is set forth in section 31.6051–1(d) (Time for Furnishing Statements) of the regulations. "Each statement, for a calendar year and each corrected statement required for the year shall be furnished to the employee on or before January 31 of the year succeeding such calendar year."

3.       Section 31.6051–2(a) of the regulations provides that every employer who is required to make and furnish Form W–2 to each employee under section 31.6051–1 of the regulations, must file a copy of each form, along with the transmittal Form W–3, with the Social Security Administration. The general rule concerning the time for filing Forms W–2 (or magnetic tape or other approved media) is set forth in section 31.6071(a)–1(a)(3)(i) of the regulations, which provides that such statements must be filed on or before the last day of February following the calendar year for which they are made. March 31 is the due date for electronically filed returns.

4.       Section 31.6051–2(b) further provides that corrected statements (Forms W–2c) must be submitted to the Social Security Administration on or before the date the information returns for the period that correction is made would be due under section 31.6071(a)–1(a)(3)(ii).

4.23.9.12.3  (03-01-2003)
Penalty for Failure to File Information Returns or Wage and Tax Statements

1.       There is a penalty under IRC section 6721 for failure to file correct (on paper or on magnetic media) information returns (including Forms W–2 and 1099) on the date prescribed when required under IRC sections 6041(a) or 6051(d). The penalty is $50 per return, subject to a maximum of $250,000 for any calendar year.

2.       If the failure to file is due to intentional disregard of the filing requirement, the penalty imposed is either $100 or 10% of the aggregate amount of the items required to be reported, whichever is greater. There is no maximum limit on the amount of penalties for intentional failure to file. There are provisions for a reduction in penalty.

A.      If a correction is made within 30 days after the required filing date (by March 30 if the due date is February 28), then the penalty imposed shall be $15 in lieu of $50 and the total amount imposed shall not exceed $75,000 per year ($25,000 for small businesses) in lieu of $250,000. See IRM 4.23.9.12.3(3).

B.      If the failure is corrected after the 30th day but on or before August 1 of the calendar year in which the required filing date occurs, then the penalty imposed shall be $30 in lieu of $50, and the total amount imposed on the person during the calendar year shall not exceed $150,000 ($50,000 for small businesses) in lieu of $250,000. See IRM 4.23.9.12.12.3(3).

3.       Exception for de minimis failures — In general, IRC section 6721(c) provides that if (a) information returns have been filed but were filed with incomplete or incorrect information, and (b) the failures are corrected on or before August 1 of the calendar year in which the returns were due, then the penalty will not apply to the greater of 10 returns, or one-half of 1 percent of the total number of information returns required to be filed by the filer during the calendar year.

4.       IRC section 6721(d) provides lower limitations for persons with gross receipts of not more than $5 million: The total amount of penalty imposed shall not exceed $100,000 in lieu of $250,000; $25,000 in lieu of $75,000 and $50,000 in lieu of $150,000.

4.23.9.12.4  (03-01-2003)
Penalty for Failure to Furnish Information Returns or Wage and Tax Statements

1.       There is a penalty under IRC section 6722 (IRC section 6678 for returns due prior to 1987) for failure to furnish correct payee statements on the date prescribed to a payee (or employee) when required under IRC section 6041(a) or IRC section 6051(a). The penalty also includes failure to include all of the information required to be shown on a payee statement or the inclusion of incorrect information. The penalty is $50 per statement, but the total amount imposed shall not exceed $100,000 for any calendar year.

2.       Prior to 1987, the penalty imposed by IRC section 6678(a)(1) for failure to furnish a written statement required by IRC section 6041A(e) did not apply to a payor who had not filed an information return required by IRC section 6041A(a). IRC section 6678(a)(1) imposed a penalty for each failure to furnish the statement to a person with respect to whom a return has been made. A literal reading of the statute necessitates the conclusion that where a payor had failed to file Form 1099 and had failed to furnish the statement required under IRC section 6041A(e), only the failure to file penalty under IRC section 6652(a) could be asserted. The Tax Reform Act of 1986 reworded the statute so that both the failure to file and failure to furnish penalties could be asserted concurrently for Forms 1099 due after December 31, 1986 .

4.23.9.12.5  (03-01-2003)
Q & A Regarding Failure to File or Furnish Penalties

1.       The following questions and answers provide guidance for the assertion of penalties for failure to file certain information returns or to furnish certain statements.

·         Q–1. As a result of reclassification of individuals to employee status, would penalties be applicable against the employer for failure to file and failure to furnish Forms 1099?
A–1. No penalty under IRC section 6721 for failure to file Forms 1099 would be applicable, because no returns are required by IRC section 6041(a). The individuals are employees, not independent contractors. Similarly, no failure to furnish penalty under IRC section 6722 would be applicable for failure to furnish Forms 1099.

·         Q–2. Would the payor be liable for penalties for failure to file and failure to furnish Forms W–2 as a result of the reclassification of individuals to employee status if no Forms 1099 were filed or furnished to the payees?
A–2. The payor would be liable for both the failure to file penalty under IRC section 6721 and the failure to furnish penalty under IRC section 6722, absent reasonable cause. If Forms W–2 are secured by the examiner, the failure to file penalty of $50 per failure ($100,000 maximum per year) may be asserted because these returns were not filed on the date prescribed in the regulations. If the Forms W–2 are furnished to employees subsequent to the examination, the IRC section 6722 penalty may be asserted because these returns were not furnished on the date prescribed in the regulations. If the payor refuses to file Forms W–2, assertion of the penalty under IRC section 6721 for intentional disregard of the filing requirement may be considered. If the payor refuses to furnish Forms W–2, the penalty under IRC section 6674 may be considered. There is no maximum limit on the amount imposed under IRC section 6674 or for intentional disregard under IRC section 6721.

·         Q–3. If Forms 1099 were filed and furnished by the payor prior to reclassification to employee status, could civil penalties be asserted for failure to file and failure to furnish Forms W–2?
A–3. Absent reasonable cause, the penalties for failure to file and furnish Forms W–2 would be applicable even though the payor previously filed Forms 1099, because the requirements of IRC section 6051 and the applicable regulations had not been met.

·         Q–4. Does the fact that an employer withheld or failed to withhold income tax have any effect on the assertion of the failure to file and failure to furnish penalties?
A–4. The penalties should be asserted against the employer who fails to file and furnish Forms W–2 regardless of withholding.

·         Q–5. If wage adjustments are determined as part of an employment tax examination, will an employer be required to file and furnish Forms W–2c ?
A–5. Yes. Forms W–2c must be filed and furnished by the employer pursuant to section 31.6051–2 of the regulations. Pursuant to the regulations, Forms W–2c must be furnished to employees on or before January 31 of the year succeeding the calendar year in which the wage adjustment is determined. Forms W–2c must be filed with the Service on or before the last day of February for the year succeeding the calendar year in which the wage adjustment is determined. In an examination situation, the term "in which the wage adjustment is determined" refers to the period in which the taxpayer settled the employment tax case with the Service.

·         Q–6. If Forms W–2c are required to be filed and furnished, should an employer be given a reasonable period of time, such as 30 days, to meet these requirements?
A–6. A "reasonable time" standard is not appropriate in this instance because the time for filing and furnishing Forms W–2c is set forth in the regulations. Refer to A–5 above. The requirements for filing Forms W–2c are provided to the taxpayer via the bottom part of Form 4668. However, the "reasonable time" standard should be applied when attempting to secure Forms W–2 where reclassification adjustments are imposed.

·         Q–7. If an employer fails to file and furnish Forms W–2c at the time required would the penalties for failure to file and failure to furnish information returns be applicable?
A–7. The penalties for failure to file and failure to furnish Forms W–2 at the conclusion of an examination would be equally applicable for failure to file and furnish Forms W–2c at the prescribed time set forth at the bottom of Form 4668 and the employment tax regulations.

4.23.9.12.6  (03-01-2003)
Failure to Include Correct Information

1.       IRC section 6723 provides a penalty for the failure to include all required information or correct information on either the information return or payee statement. A penalty of $50 is imposed for each incorrect information return or statement with a maximum penalty of $100,000 per year. The $100,000 maximum does not apply in cases of intentional disregard.

2.       The information reporting requirements specified for this purpose include any requirement to include a correct taxpayer identification number on a return or statement and any requirement to furnish a correct taxpayer identification to another person.

4.23.9.13  (03-01-2003)
Trust Fund Recovery Penalty

1.       Section 6672 of the Internal Revenue Code, the Trust Fund Recovery Penalty, formerly, the 100 percent penalty, in relevant part, provides:

A.      "General Rule." Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable for a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over. No penalty shall be imposed under IRC section 6653 or part II of Subchapter A of chapter 68 for any offense to which this section is applicable.

2.       The purpose of section 6672 is to encourage the prompt payment of withheld and other collected taxes, and to provide the Service with a secondary source of collection in the event that these taxes are not paid. The withheld taxes are commonly referred to as "trust fund taxes," reflecting the Code’s provision that such withholdings or collections are deemed to be a "special fund in trust for the United States." See IRC section 7501; Slodov v. United States, 436 U.S. 238 (1978). When the trust fund taxes are not paid by the corporation, the Trust Fund Recovery Penalty may be assessed against the responsible officers for willful failure to collect or pay over the taxes. Section 6672 only applies to persons responsible for collection of these trust fund taxes. See Slodov at p243; S.Rep. No. 1622, 83rd Cong., 2d Sess., 586 (1954); H.R. Rep. No. 1337, 83rd Cong., 2d Sess., A420 (1954).

3.       The Service’s policy is to collect the full tax only once, from the corporation or from one or more of the responsible officers. Policy Statement P–5–60 provides:

A.      The Trust Fund Recovery Penalty [applicable to withheld income and employment (social security, medicare and railroad retirement) taxes or collected excise taxes] will be used only as a collection device. The withheld income and employment taxes or collected excise taxes will be collected only once, whether from the corporation, from one or more of its responsible persons, or from the corporation and one or more of its responsible persons.

4.       Section 6672 does not prohibit the assertion of the Trust Fund Recovery Penalty against responsible officers where the addition to the tax for fraud is asserted against the corporation. Section 6672 only bars the assertion of the fraud penalty against a responsible officer liable for the Trust Fund Recovery Penalty. The fraud penalty applies to any underpayment of tax and can be asserted against the corporation for any fraudulent acts, including the trust fund liability, of its officers acting on its behalf.

4.23.9.13.1  (03-01-2003)
Trust Fund Recovery Penalty Procedures

1.       Determinations for the assertion or non-assertion of the Trust Fund Recovery Penalty will be made by the Area Office Technical Support Function (TSf) in Collection. See IRM 5.7.4, Trust Fund Compliance Handbook. Information needed by TSf will be transmitted to them by the examiners for those cases where there is a preliminary indication at the examiner level that the Trust Fund Recovery Penalty may apply.

2.       Form 6238 (Referral Report for Potential Trust Fund Recovery Penalty Cases) will be completed according to the instructions provided in IRM 4.23.9.13.2 below, and the original and one copy forwarded to Area Collection TSf. TSf will contact the examiner within 30 days if they initiate a Trust Fund Recovery Penalty investigation. Otherwise, TSf will return one copy of the Form 6238 to examiner indicating that they do not intend to conduct an investigation in which case no further action is necessary.

3.       For all cases where there is an indication that the Trust Fund Recovery Penalty applies, examiners will include appropriate remarks in their workpapers and include a copy of the completed Form 6238 in the case file. Secure Form 2750, Waiver Extending Statutory Period for Assessment of Trust Fund Recovery Penalty, from every responsible party for all tax periods when the Trust Fund Recover Penalty assessment statute will expire within two years for unagreed cases; one year for agreed cases. See IRM 4.23.14.6 for procedures regarding the Form 2750.

4.       For those cases where Form 6238 was not prepared, examiners will comment in the workpapers that referral to Area Collection TSf was considered but not made and include the reason(s) for not making a referral to Area Collection TSf.

4.23.9.13.2  (03-01-2003)
Instructions for Completing Form 6238 (Referral Report for Potential Trust Fund Recovery Penalty Cases)

1.       Items 1 through 9 of Form 6238 will be completed by the examiner. In addition, print the examiner’s name, phone number and the date the form was prepared. Forward the original and one copy of the form to the Area Collection TSf, through the SB/SE Field Territory Manager, the LMSB team manager or the TE/GE manager.

2.       Item completion instructions are as follows:

·         Item 1—Name and Address of Taxpayer—enter name and current address of taxpayer.

·         Item 2—Employer Identification Number—enter employer identification number; if none, enter "None."

·         Item 3—Tax Periods—enter all tax periods for which there is an indication that the Trust Fund Recovery Penalty may apply.

·         Item 4—The statute of limitations for the Trust Fund Recovery Penalty is treated like that of the employment tax returns. However, an extended statute date on Form SS–10 DOES NOT extend the statute for the Trust Fund Recovery Penalty. Form 2750, Waiver Extending Statutory Period for Assessment of Trust Fund Recovery Penalty, must be used for this purpose. List the earliest statute expiration date for multiple year examinations.

·         Item 5—List the employment tax issues for which the trust fund recovery penalty may apply. Enter the total amount of income tax withholding, the total amount of withheld FICA tax, or the total of other withheld taxes (withholding on gambling winnings and withholding at source) that may be subject to the trust fund recovery penalty.

·         Item 6—Pertaining to the issues listed in Item 5, enter the date(s) when the taxpayer received prior notification from the Service of the responsibility to collect, account for, and pay over such taxes.

·         Item 7—Provide names, titles, and SSN ’s of all persons who appear responsible for not collecting, accounting for, and paying over the taxes.

·         Item 8—Provide your best estimate of the projected disposition of the employment tax case.

·         Item 9—List those issues raised in the current examination which had not been proposed for TFRP in previous examinations and for which willfulness is not present.

Exhibit 4.23.9-1  (03-01-2003)
Instructions for Determining Civil Penalty Statute of Limitations