8.17.7. Penalties/Additions to Tax in Computations

(1) The Tax Court does not have jurisdiction over certain underpayments of additions to tax or penalties.

(2) When the Tax Court does not have jurisdiction, the additions (penalties) can be assessed directly. This should be done prior to issuance of the notice of deficiency. Penalties that are assessed are not included as part of the deficiency determined in the notice of deficiency.

(3) In general, Tax Court has no jurisdiction over the following penalties.

• IRC 6651: The IRC 6651 penalty (including the fraudulent failure to file penalty under IRC 6651(f)) where the penalty applies to tax shown on a filed return. Tax Court only has jurisdiction if the penalty is applicable to a deficiency.

• IRC 6652(b): The IRC 6652(b) penalty.

• IRC 6654: The IRC 6654 penalty when a tax return has been filed.

• IRC 6655: The IRC 6655 penalty when a tax return has been filed.

• IRC 6656: The IRC 6656 penalty where the penalty relates to the failure to deposit employment taxes withheld. (However, see IRC 7436 and IRM 8.7.16, Appeals Employment Tax Procedures, for information concerning IRC 7436 Notices of Determination).

  Note: Tax Court does have jurisdiction over the IRC 6656 addition to tax when the addition relates to a deficiency due to the failure to withhold and deposit taxes pursuant to IRC 1441 and IRC 1442. (See IRM 20.1.4.11.5, Deficiency Procedures Form 1042, for additional information).

(4) The list in paragraph (3) above is not all inclusive. For more discussion of Tax Court jurisdiction, see the following IRM sections for additional information:

• IRM 8.17.4.3, Adjustments Requested by AO Prior to Issuing Notice of Deficiency

• IRM 8.17.4.17, Including Penalties/Additions to Tax in the Notice of Deficiency

• IRM 8.11.1, Return Related Penalties in Appeals

• IRM 20.1.1.4.2, Introduction and Penalty Relief, Deficiency Procedures

(1) In most cases, penalty provisions of the code sections in effect for the loss year generating the carryback govern penalties applicable to carryback years, for deficiencies due to a carryback recapture.

(2) Net operating loss carrybacks, capital loss carrybacks and all credit carrybacks cannot be used to reduce the underpayment subject to the penalty.

(3) Prepayment credits and frozen refunds may impact the penalty computations:

1. Prepayment credits are payments of tax such as withholding tax, estimated tax payments, etc., made on or before the due date of the return. Prepayment credits also include payments made on or before the due date for an unfiled return.

2. Prepayment credits do not include advance payments, cash bonds, or amounts applied from other tax liabilities subsequent to the due date of the return for which the penalty applies.

3. Payments and credits from a filed return that are neither applied to a tax liability nor refunded to the taxpayer are called "frozen refunds", and may also impact the penalty computations.

(1) If the return is at least 60 days late, including extensions, a minimum FTF penalty applies:

• For returns due (without regard to extensions) after 12/31/2008, the minimum penalty is the lesser of $135 or 100 percent of the tax required to be shown on the return that was not paid on or before the due date.

• For returns due (without regard to extensions) before 1/1/2009, the minimum penalty is the lesser of $100 or 100 percent of the tax required to be shown on the return that was not paid on or before the due date.

(2) In order for the minimum penalty to apply, there must be a net tax due. Withholding and other allowable credits as of the due date of the return must be less than the revised tax liability or tax required to be shown on the return.

(3) The minimum penalty applies only to income tax returns. It does not apply to employment tax, excise tax, gift tax, or estate tax returns.

(4) When both the failure to pay (FTP) penalty and the minimum FTF penalty apply (income tax returns only), the minimum FTF penalty is not reduced by the amount of the FTP penalty.

(5) See IRM 20.1.2.2.7.4, Minimum Penalty, for additional information.

(1) Effective for returns due after December 31, 1989 (determined without regard to extensions), the FTF and the fraud penalties may be asserted for the same tax year and against the same portion of the tax liability.

(2) If the failure to file is due to fraud, the fraudulent failure to file penalty under IRC 6651(f) may be asserted rather than the regular FTF penalty under IRC 6651(a)(1).

(3) See discussion of IRC 6651(f) in IRM 8.17.7.6.

(1) IRC 6651(c)(1) provides that the penalty for filing late under IRC 6651(a)(1) is to be reduced by the amount of any penalty for paying late imposed under IRC 6651(a)(2) for any month or part of a month during which both penalties apply. The penalties are said to be running concurrently.

(2) The above reduction does not reduce the total penalty for filing late below the minimum penalty, if applicable. See IRM 20.1.2.2.7.4, Minimum Penalty.

(3) When both the IRC 6651(a)(1) FTF and IRC 6651(a)(2) FTP penalties apply to an original assessment, see example below of the computation of the FTF penalty that should be assessed by the Campus if the return is filed late:

(4) If the taxpayer has filed a return late and an additional tax liability is determined:

1. Compute the FTF penalty at the total rate of 5% per month allowable under IRC 6651(a)(1).

2. Generally, the FTP penalty under IRC 6651(a)(2) can't be asserted on a subsequently determined tax deficiency when the taxpayer has filed a return.

   Caution: If the Compliance report (RAR) or notice of deficiency has asserted the IRC 6651(a)(2) FTP penalty and the taxpayer filed a return, the AO or Counsel attorney will need to determine whether the FTP penalty should be sustained or eliminated.

3. However, the IRC 6651(a)(2) FTP penalty may be assessed on the tax liability shown on the return when it was filed.

4. If an IRC 6651(a)(2) FTP penalty was assessed by the Campus on the tax per return, then the FTF penalty must be reduced by the amount of the FTP penalty assessed for any month or part of a month during which both penalties apply. See Exhibit 8.17.7-1 for an example.

(5) Taxpayer has filed a return late - Computations for FTF penalty when the IRC 6651(a)(2) FTP penalty has been assessed:

1. Generally the RGS penalty schedules or the TCS Excel penalty spreadsheets on the Technical Support SharePoint site are used for the IRC 6651 penalty computations.
   

2. RGS Penalty Computations:

• Generally the IRC 6651(a)(2) FTP penalty can't be asserted on a subsequently determined tax deficiency when the taxpayer has filed a return. Therefore, the RGS user should not indicate that the IRC 6651(a)(2) FTP penalty applies on the RGS "Return Related Penalty Details" input screen. If an amount is entered on this input screen for the IRC 6651(a)(2) FTP penalty previously assessed, it won't be considered in the computation of the FTF penalty.

• Therefore, the correct amount to enter into RGS for the previously assessed FTF penalty must include both the assessed FTF penalty and the concurrent IRC 6651(a)(2) FTP penalty assessed. This amount must be determined manually.

• For an article that discusses how to compute the FTF penalty for late filed returns using RGS, click on the "Procedures and Resources" link on the TCS web site, and then see the "Penalty Information" folder.

3. Excel Penalty Computation:

• The TCS Excel IRC 6651 penalty spreadsheet on the Technical Support SharePoint will reduce the FTF penalty amount by the amount of the IRC 6651(a)(2) FTP penalty previously assessed for any month or part of a month during which both penalties apply.

(6) If the taxpayer has not filed a return and an additional tax liability is determined, see IRM 8.17.7.5 for SFR procedures for computing the FTF and FTP penalties.

(1) Notices of Levy: IRC 6651(d) increases the FTP penalty rate under IRC 6651(a)(2) or IRC 6651(a)(3) from one-half of one percent (.005) to one percent (.01) of the tax at the start of the month beginning after:

• 10 days after the date of notice of intent to levy [IRC 6331(d)], or

• The day on which notice and demand for immediate payment is given in the case of jeopardy [IRC 6631(a)].

  Note: The 1% penalty rate applies to all subsequent assessments on that module. However, once a module is fully paid, a later tax assessment will begin to accrue at the one-half of one percent rate.

(2) These are the only two conditions (trigger dates) that allow for the FTP penalty rate increase to one percent. See IRM 20.1.2.2.8.1.1, 1 Percent Penalty Rate — IRC 6651(d), for more information.

(1) An individual's FTP penalty will be reduced to one quarter of one percent (.0025) for any month in which an installment payment agreement with the IRS is in effect, provided the individual timely filed (taking extensions into account) the return relating to the liability that is subject to the installment agreement.

(2) This reduction does not apply if the 1% FTP penalty rate under IRC 6651(d) is in effect.

(3) Termination of installment agreement

1. The one quarter of one percent rate ends following the month during which the installment agreement is terminated.

2. When an installment agreement is terminated, the basic penalty rate reverts to the rate in effect prior to the installment agreement beginning with the first penalty month that begins after the installment agreement is terminated.

(4) See IRM 20.1.2.2.8.1.2, 1/4 Percent Penalty Rate — IRC 6651(h), for more detailed information.

(1) Pursuant to IRC 6020(b), the IRS generally prepares a return when it determines that a taxpayer is liable for filing the tax return, but failed to do so after receiving notification from the IRS.

(2) A valid return must have been prepared under IRC 6020(b) in order to assert the IRC 6651(a)(2) penalty on a nonfiler. The requirements of a valid IRC 6020(b) return are discussed in Treas. Reg. section 301.6020-1.

(3) The requirements of a valid IRC 6020(b) return would include the following documents for each nonfiled tax period (known as the 6020(b) Certification package).

1. A properly completed and signed Form 13496, IRC 6020(b) Certification, dated on or after the date of the 30-day letter.

2. Form 4549 or Form 4549-A, signed by a duly authorized IRS employee.

3. Form 886-A, Explanation of Items.

   Note: See IRM 4.19.17.1.2, Form 13496 Certification Procedures, for more information, including information about the electronic Form 13496.

(4) The AO or Counsel must determine that SFR procedures were followed in order to sustain the FTP penalty asserted by Compliance. See discussion of steps they must take below:

1. Verify that the taxpayer did not file a return, and that there is a SFR TC 150 posting on the transcript.

2. Check the administrative file to see if the case file includes a 6020(b) Certification package.

3. Where no 6020(b) Certification package is included in the administrative file, the AO or Counsel attorney will need to review the file to determine whether there are documents that would meet the requirements of an IRC 6020(b) return, as outlined in Treas. Reg. section 301.6020-1. (Also see CC Notice 2003-019, as modified by CC Notice 2004-009.)

(5) SFR's for employment and excise tax returns:

1. See IRM 8.7.16.16, IRC 6020(b) Substitute for Return Case Processing, for information about SFR returns prepared for employment tax cases.

2. See IRM 8.7.10.5, Preparing an Excise Tax Return under IRC 6020(b), for information about SFR returns prepared for excise tax cases.

(1) Since the IRC 6651(a)(1) failure to file (FTF) and IRC 6651(a)(2) failure to pay (FTP) penalties are asserted concurrently on substitute for returns, the amount of the FTF penalty must be reduced by the amount of the FTP penalty for any month or part of a month during which both penalties apply. See IRM 8.17.7.3.3 for additional information.

1. For simplicity purposes, RGS implements this reduction by reducing the 5 percent FTF penalty rate by the 0.5 percent penalty rate of the FTP penalty for any month during which both penalties apply. This results in an IRC 6651(a)(1) penalty rate of 4.5 percent a month (to a maximum of 22.5 percent) shown on the RGS IRC 6651 penalty computation schedule. The RGS IRC 6651 penalty computation schedule may be included in the settlement computation as long as the computations are accurate.

2. The TCS Excel IRC 6651 penalty spreadsheet on the Technical Support Sharepoint site will correctly reduce the IRC 6651(a)(1) penalty amount by the concurrent IRC 6651(a)(2) penalty amount.

Caution: If the taxpayer made payments after the due date of the return, the RGS IRC 6651 penalty computation schedule and the TCS IRC 6651 penalty Excel spreadsheet won't be accurate for the FTP penalty. This is because these penalty schedules won't consider any late payments in the FTP penalty computation. When there are late payments, these penalty schedules must be corrected or other schedules used.

(2) FTP Penalty is still accruing: If the FTP penalty has not reached the maximum penalty of 25%, see procedures below:

1. Show the FTP penalty amount on Form 3610 (if prepared) or Form 5278, (or Form 4549, etc.) as an asterisk (*). An explanation should also be included to explain that the amount cannot be determined. Suggested sample language that can be used is "Amount to be determined" or "To be computed later."

   Exception: In certain circumstances the FTP penalty may be computed at the maximum rate when the penalty is still accruing. An example is when Counsel or the AO determines that the FTP penalty should be computed at the maximum 25% rate because the maximum FTP penalty rate will be reached soon after the computations are prepared (usually within a month or two).

   
   

2. Also include penalty computations in the settlement computation. The RGS or the TCS Excel IRC 6651 penalty schedules are generally used for this purpose, but other schedules may also be used.

3. Both the RGS and the TCS Excel IRC 6651 penalty schedules will show an amount for the FTP penalty even if the penalty is still accruing. This FTP amount does not need to be deleted from either the RGS or the TCS Excel penalty schedules and an asterisk inserted, because there is a paragraph on the penalty schedules underneath the computation that tells the taxpayer that the FTP penalty is still accruing.

4. If the RGS or TCS Excel schedules aren't used, then a similar paragraph must be included to notify the taxpayer that the FTP penalty is still accruing.

(3) FTP Penalty at the maximum amount: If the IRC 6651(a)(2) penalty applies in a case at the maximum amount, either because the penalty has reached the maximum rate of 25% or because the tax has been paid in full, see procedures below:

1. Compute the IRC 6651(a)(2) penalty and include on the settlement computation.

2. Also include penalty computations in the settlement computation. The RGS or the TCS Excel IRC 6651 penalty schedules are generally used for this purpose, but other schedules may also be used.

(1) IRC 6654 provides for a penalty when individuals underpay any required installment(s) of estimated income tax liabilities reportable on Form 1040.

1. Taxpayers are required to make estimated tax payments if the tax that will be shown on their return (or, if no return is filed, their tax liability), minus tax amounts withheld from wages during the year, is $1,000 or more.

2. "Tax shown on the return" is defined in the instructions for Form 2210. It's generally net tax reduced by net refundable credits listed for line 3 of Form 2210.

3. The required annual payment is generally based on the lesser of:
   1) A percentage of the tax shown on the original return or, if no return is filed, on the tax as determined or
   2) A percentage of the prior year’s tax.

   Note: Consult IRM 20.1.3 and/or the Form 2210 Instructions for the applicable percentages.

4. The penalty rate is provided by IRC 6621. The period of underpayment runs from the due date of the installment to the lesser of the due date of the return or the date of payment.

(2) For the purpose of asserting the penalty, tax is defined as income and self-employment tax less all credits allowed by Part IV, Subchapter A, Chapter 1, other than tax withheld from wages. Tax withheld is allowed as a payment of estimated tax.

(3) RGS computations:

1. RGS will not show an amount on Form 5278 (or Form 4549/Form 4549-A) for IRC 6654 if the computed penalty is less than $100.

2. The RGS Form 5278 (or Form 4549/Form 4549-A) that is generated without an IRC 6654 penalty when the penalty is less than $100 can be used in the settlement computation.

3. If the AO or Counsel wants TCS to include the IRC 6654 penalty on the Form 5278 (or Form 4549/Form 4549-A) for amounts under $100, they must specify this requirement in their work request to TCS.

(4) See IRM 20.1.3.2, IRC Section 6654 — Individual Taxpayers & Fiduciaries, for more detailed information about IRC 6654.

(1) IRC 6654 provides for a penalty when estates and trusts (other than charitable trusts) underpay any required installment(s) of estimated income tax liabilities reportable on Form 1041 (U.S. Fiduciary Income Tax Return).

1. All estates and most trusts are required to make estimated tax payments in the same manner as individuals.

2. Generally, an estate or trust is required to pay estimated tax if it expects to owe, after credit for withholding, an amount greater than $1,000.

(2) Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, is used by the taxpayer to figure any penalty.

(3) For information and exceptions when computing the estimated tax penalty for estates and trusts, consult the Code and Regulations. The following resources are also available:

• IRM 20.1.3.2.1.1.6, Determining the Required Annual Payment, Fiduciaries of Estates or Trusts

• Instructions for Form 2210

• Form 1041–ES, Estimated Income Tax for Estates and Trusts

(4) Charitable trusts and any private foundation organized as a trust, will be subject to the corporate estimated tax provisions under IRC 6655, rather than IRC 6654.

(1) IRC 6655 imposes a penalty when a corporation (C or S), private foundation, private foundation organized as a trust, or tax exempt organization underpays estimated tax.

(2) A corporation (or other entity subject to IRC 6655) must make estimated tax payments if its tax shown on the return (income tax minus credits) is $500 or more. If the tax is less than $500, no estimated tax payments are required and a penalty will not be assessed.

(3) Since the law can be complex, it is best to consult the Code and Regulations if computation of this penalty is involved in a case. Also IRM 20.1.3.3. IRC Section 6655 — Corporations & Others Not Covered by IRC Section 6654, has very detailed information about IRC 6655.

(1) IRC 6662A generally imposes an accuracy-related penalty on any reportable transaction understatement for tax years ending after October 22, 2004. The penalty applies to:

1. Any listed transaction (which is one category of reportable transactions); and

2. Any other reportable transaction if a significant purpose of the transaction is the avoidance or evasion of federal income tax.

(2) The computation of the IRC 6662A penalty is:

1. 20 percent of the reportable transaction understatement where the reportable transaction was properly disclosed, and

2. 30 percent of the reportable transaction understatement where the transaction was not properly disclosed. (See IRM 20.1.5.15.1, Adequate Disclosure and Rescission of IRC 6707A Impact on IRC 6662A, for discussion of disclosure requirements.)

(3) Due to the definition of "reportable transaction understatement," the IRC 6662A penalty, unlike the IRC 6662 penalty, can apply even if there is no underpayment of tax on the taxpayer’s return. See IRM 20.1.5.15.2, IRC 6662A, Accuracy-Related Penalty on Understatements with Respect to Reportable Transactions, Penalty Calculation, for discussion of IRC 6662A penalty computations.

(4) Coordination with other penalties:

1. IRC 6662A does not apply to any portion of an understatement on which a penalty is imposed under IRC 6663.

2. IRC 6662A does not apply to any portion of an understatement on which a gross valuation misstatement penalty under IRC 6662(h) is imposed.

3. IRC 6662A does not apply to any portion of an understatement on which an IRC 6662 penalty is imposed at the increased rates determined under IRC 6662(i) for nondisclosed, noneconomic substance transactions.