This
section
explains
the
employment
tax
penalty
procedures.
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.
In
1989,
the
Omnibus
Budget
Reconciliation
Act
(OBRA)
consolidated
and
restructured
many
penalty
code
sections
to
address
legislative
inconsistencies.
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.
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
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
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.
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).
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.
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
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
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.
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
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.
The
computation
must
include:
the
formula
for
computing
the
penalty,
the
amount
of
each
of
the
variables
in
that
formula,
the
change
in
each
of
these
variables
since
the
date
of
the
of
the
last
notice,
and
the
bottom
line
amount
of
the
penalty
imposed.
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.
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.
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
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
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.
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.
Among
the
factors
to
be
considered
in
recommending
imposition
of
the
civil
fraud
penalty
are
whether:
the
circumstances
are
of
a
flagrant
nature;
and
the
tax
is
diminutive.
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
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.
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.
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.
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.
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.
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
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.
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.
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.
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
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.
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.
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.
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.
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.
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
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.
The
majority
of
criminal
fraud
situations
employment
tax
examiners
will
encounter
result
from:
Willful
failure
to
account
for,
collect,
or
pay
over
taxes
(IRC
section
7202).
Willful
failure
to
file
a
return
(IRC
section
7203).
Willful
failure
to
pay
taxes
owed
(IRC
section
7203).
Willful
submission
of
a
false
statement
under
perjury
(IRC
section
7206(i)).
Failure
to
collect
and
deposit
in
a
special
trust
fund
account
(IRC
sections
7215
and
7512(b)).
Attempts
to
obstruct
or
impede
tax
administration
(IRC
section
7212(a)).
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
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).
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.
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.
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.
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.
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.
If
a
case
involving
a
collateral
examination
results
in
a
fraud
referral,
the
affected
territories
will
coordinate
the
referrals.
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.
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.
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
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.
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
