Although the Government imagined that the taxpayers themselves acted criminally in taking such shelters and reporting their "too good to be true" positions on their tax returns, the IRS offered a settlement initiative for the taxpayers. That initiative was originally reported in IR-2004-54, on May 5, 2004. For complete links to the IRS positions on this initiative see here. The settlement under the initiative was included (i) taxpayer concession of 100 percent of the tax benefit claimed, (2) deduction of out of pocket costs, and a penalty that, although not set forth in the Notice was 10%. if it was the taxpayer's only abusive shelter or 20% if the taxpayer had other abusive shelters. The Notice warned that:
Taxpayers not participating in the settlement will receive a statutory notice of deficiency (90 day letter) disallowing all losses and out of pocket costs and will be assessed maximum applicable penalties.Note the cautionary warning of assessment of maximum applicable penalties. Of course, the maximum potentially applicable civil penalty is the 75% civil fraud penalty in § 6663.
In Bergmann v. Commissioner, T.C. Memo. 2009-289, taxpayers (husband and wife) not participating in the special IRS settlement initiative instead filed an amended return reversing all the tax benefits that the IRS thought was abusive, and paying the tax and interest accordingly. The IRS swooped in and asserted the 40% gross valuation misstatement penalty under § 6662(h). The taxpayers claimed that the amended return was a qualified amended return under Regs. § 1.6664-2(c)(2) and filed a motion for the Tax Court to render summary judgment on that issue.
The Court framed the issue as follows:
A "qualified amended return" is an amended return filed after the due date of the return for the taxable year and before the earlier of certain events. See sec. 1.6664-2(c)(3), Income Tax Regs. At issue here is whether petitioners filed the amended return before respondent contacted "any person described in section 6700(a)" concerning examination of a section 6700(a) activity from which petitioners directly or indirectly claimed a benefit on the original return. See sec. 1.6664-2(c)(3)(ii), Income Tax Regs. If respondent contacted such a person concerning such an activity before petitioners submitted the amended return, then the return would not be a "qualified amended return," and the accuracy-related penalty may still apply. The parties disagree whether KPMG is a "person described in section 6700(a)." We now turn to that issue.The facts showed that the IRS, by 2002, began investigating KPMG, a promoter / enabler for many allegedly abusive shelters and, evidently, including the one in issue in this case, for its tax shelter activity and had served regular IRS summonses (as opposed to John Doe summonses) upon KPMG. The IRS nevertheless had not become aware of the taxpayers' use of the Son-of-Boss shelters before the taxpayers filed their amended return. The issue then was whether, as to these taxpayers, KPMG was a person described in § 6700(a). The Tax Court (Judge Kroupa) said it did not have enough facts to render summary judgment:
We have carefully considered the materials the parties submitted in connection with petitioners' motion for summary judgment. We are unable to conclude, on the facts presented to the Court at this juncture, whether KPMG qualifies as a "person" under section 6700(a) and thus, whether petitioners' amended return is a "qualified amended return." We find genuine issues of material fact remain concerning this issue. See Sala v. United States, 552 F. Supp. 2d 1167, 1204 (D. Colo. 2008) (the relevant inquiry is whether the third party was contacted regarding the taxpayers' particular transactions). These material facts include those respondent noted in his response to petitioners' reply memorandum. Specifically, factual disputes exist whether KPMG is a "person described in section 6700(a)," and if it is, whether and when respondent first contacted KPMG concerning promotion of tax shelter transactions with respect to which petitioners directly or indirectly claimed tax benefits on the original return. These material facts need to be further developed before the Court can determine whether the amended return is a "qualified amended return." Accordingly, petitioners are not entitled to summary judgment on this issue.I present this case in this Federal Tax Crimes Blog to remind practitioners of the qualified amended return opportunity to correct erroneous positions by amended return. A qualified amended return is an amended return filed after the original due date of the return (determined with extensions) but before any of the following events: (i) the date the taxpayer is first contacted for examination of the return; (ii) the date any person is contacted for a tax shelter promoter examination under § 6700; (iii) as to a pass-through entity item, the date the entity is first contacted for examination; (iv) the date a John Doe Summons is issued to identify the name of the taxpayer; and (v) as to certain tax shelter items, the dates of certain IRS initiatives published in the Internal Revenue Bulletin. § 1.6664-2(c)(2). The daily grist of a tax practitioner's mill is the new client who, from conscience or otherwise, wants to get right with the IRS after filing one or more fraudulent or at least incorrect returns. The standard advice (barring some most unusual wrinkles), after determining that the taxpayer is not under investigation, is to have him or her file amended returns for some number of years (that a different blog discussion). Anecdotally from my practice over many years and my discussions with others, the amended returns will almost invariably not draw any penalty because the IRS will have no reason to believe that they are not qualified amended returns. The IRS will have to launch an investigation which, given its allocation of limited resources, it might not do with an amended return in hand that likely corrects all material problems (or at least the ones that the IRS could find on audit). And, even if the IRS were to launch an investigation, in most cases the only way the IRS can avoid the penalty-neutralizing effect of the amended return as a qualified amended return is to allege that the original position on the return is fraudulent. See § 6664(c)(2). The IRS has to prove fraud by clear and convincing evidence and given that burden will often not have any incentive to deploy its investigative resources to build a fraud case in order to assert an accuracy related penalty. In most cases, even in cases where the taxpayer in fact may have committed fraud on the original return, the system will simply pass him by. And, you will note that the IRS does not assert fraud in the Bergmann case as a basis for disqualifying the amended return as a qualified amended return.
As I tell my students, when a client walks in with this profile (one or more fraudulent or potentially fraudulent or just incorrect prior year returns), your job is very limited. Get him to an accountant and get the amended returns filed ASAP.