Chapter 3: Negligence or Disregard of Rules
or Regulations
Negligence
Negligence includes any failure to
make a reasonable attempt to comply with the
provisions of the tax law, exercise ordinary
and reasonable care in tax return
preparation, or keep adequate books and
records. Negligence is strongly suggested
if a taxpayer fails to make a reasonable
attempt to ascertain the correctness of a
reported item "which would seem to a
reasonable and prudent person to be 'too
good to be true' under the circumstances."
Treas. Reg. § 1.6662–3(b)(1)(ii).
For example, the facts may establish that a
taxpayer reported losses from a transaction
that lacked economic substance or reported
losses or deductions from assets with bases
traceable to lease stripping transactions
that would have seemed, to a reasonable and
prudent person, to be "too good to be
true.” The accuracy-related penalty
attributable to negligence may be applicable
if the taxpayer failed to make a reasonable
attempt to ascertain the correctness of the
claimed losses or deductions by thoroughly
investigating the bona fide economic or
other relevant actual aspects of the
transaction. Consultation with a tax
advisor, regardless of the advisor’s
independence, is not, standing alone,
conclusive evidence of a thorough
investigation by the taxpayer. All relevant
facts, including the nature of the tax
investment, the independence of the tax
advisor, the competence of the tax advisor,
the quality of the opinion, and the
sophistication of the taxpayer must be
considered.
The penalty for negligence does not apply if
the taxpayer’s position has a reasonable
basis. If a return position is reasonably
based on one or more of the authorities in
Treas. Reg. § 1.6662-4(d)(3)(iii), the
position will generally satisfy the
reasonable basis standard even though it
does not rise to the level of substantial
authority. The penalty for negligence may,
however, apply if the taxpayer fails to keep
adequate books and records to substantiate
the items properly.
Disregard of Rules or Regulations
Disregard of rules or regulations
relates to the taxpayer’s failure to follow
the appropriate law in completing the
return, and reflects a disregard of the
Code, temporary or final regulations,
revenue rulings or notices (other than
notices of proposed rule making). The term
“disregard” includes careless, reckless, or
intentional disregard. Treas. Reg. §
1.6662–3(b)(2).
Except for a reportable transaction, as
defined in the regulations under IRC § 6011,
entered into on or after January 1, 2003,
and reported on a return filed after
December 31, 2003, there is no penalty for a
position contrary to a revenue ruling or
notice published in the IRB if the position
has a realistic possibility of being
sustained on its merits. Otherwise, a
taxpayer may not avoid a penalty for
disregard of a rule or regulation on the
basis that the position had a realistic
possibility of being sustained on its
merits.
Adequate Disclosure
The penalty for negligence or
disregard of rules or regulations does not
apply if the taxpayer adequately discloses
the position on Form 8275 or 8275-R (as
appropriate). In the case of a transaction
entered into on or after January 1, 2003,
and reported on a return filed after
December 31, 2003, taxpayers also must
disclose reportable transactions on Form
8886, as required under the IRC § 6011
regulations.
The penalty does not apply to a position
that is contrary to a regulation if the
taxpayer discloses the position and the
position represents a good faith challenge
to the regulation. A good faith challenge
to the validity of a regulation generally
requires a showing that the taxpayer
conducted a careful analysis of reasonably
available authorities relating to the issue,
including statutory language, legislative
history, the underlying Treasury decision,
relevant case law (including case law
pertaining to the presumption of validity to
which regulations are entitled), and the
persuasiveness of the rationale supporting
the contrary position.
The adequate disclosure exception does not
apply if the position with respect to a rule
or regulation does not have a reasonable
basis or if the taxpayer fails to keep
adequate books and records or fails to
substantiate records properly.
