Sec. 6676 erroneous claim for refund penalty

Sec. 6676 imposes a penalty on a taxpayer who files a claim for refund or credit of income tax in an amount that is determined to be excessive. The penalty, effective for claims filed after May 25, 2007, was intended to close what was commonly considered a procedural loophole. Prior to the enactment of Sec. 6676, a taxpayer could take an aggressive position on a claim for refund (e.g., on Form 1120X, Amended U.S. Corporation Income Tax Return) with little penalty exposure.

That result occurred because the Sec. 6662 accuracy-related penalties — as well as the Sec. 6662A accuracy-related penalty on understatements with respect to reportable transactions and the Sec. 6663 civil fraud penalty — are imposed on underpayments of tax attributable to various types of conduct (e.g., negligence or disregard of rules or regulations). However, the disallowance of a claim for refund or credit does not result in an underpayment; instead, the taxpayer simply does not get back the tax it alleges was overpaid.

The Sec. 6676 penalty is equal to 20% of the excessive amount, the amount by which the claim for refund or credit exceeds the amount allowable for the tax year at issue.

Reasonable basis, reasonable cause

For claims filed before Dec. 18, 2015, the penalty does not apply if the excessive amount has a “reasonable basis.” For claims filed on or after that date, the penalty does not apply if the excessive amount is due to “reasonable cause.” Sec. 6676(c) provides that reasonable cause (or a reasonable basis, for claims filed before Dec. 18, 2015) is deemed not to exist for an excessive amount that is attributable to a transaction that lacks economic substance.

It is difficult to say whether the change from a reasonable-basis to a reasonable-cause standard for penalty relief is taxpayer-favorable or taxpayer-adverse. Sec. 6676 does not define the term “reasonable basis,” and no regulations have been issued under Sec. 6676. However, the term also is used in Sec. 6662(d)(2)(B)(ii)(II), which provides protection from the substantial-understatement component of the accuracy-related penalty for the tax treatment of items that are adequately disclosed and have a reasonable basis, and the regulations under Sec. 6662 define the term “reasonable basis” for purposes of that penalty. Further, in a legal advice memo to program managers (PMTA 2014-015), the IRS Office of Chief Counsel concluded that for Sec. 6676 purposes, “adopting the definition of ‘reasonable basis’ from the section 6662 penalty appears appropriate.”

Penalty relief

Regs. Sec. 1.6662-3(b)(3) provides that “[r]easonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper.” At the same time, the regulation provides a general safe-harbor standard by stating that if a return position is reasonably based on one or more of the authorities listed in Regs. Sec. 1.6662-4(d)(3)(iii) — which are used to determine whether there is substantial authority for the tax treatment of an item — the return position generally will satisfy the reasonable-basis standard.

In PMTA 2010-003, IRS Chief Counsel stated that whether the reasonable-basis standard is satisfied depends on whether the claim is supported by facts and one or more of the relevant authorities, and that this determination “is not dependent on the subjective state of mind of the taxpayer presenting the claim or the actions of the taxpayer in determining the appropriateness of the claim.” Instead, the PMTA states, Sec. 6676 “requires an examination of the claim itself to determine whether it has a reasonable basis.” Therefore, even if a taxpayer took a position on a claim for refund or credit that the IRS may regard as aggressive, this informal IRS guidance indicates that the taxpayer still might not be liable for a Sec. 6676 penalty if the basis for the refund claim is supported by at least one of the authorities listed in the Sec. 6662 regulations.

It should be noted that neither of the two reported cases dealing with Sec. 6676 involved an analysis of whether the reasonable-basis standard had been met. Instead, in Rand, 141 T.C. 376 (2013), the taxpayers claimed improper credits on their original return. The Tax Court discussed the Sec. 6676 penalty as potentially applying to improperly claimed credits that resulted in a refund but, ultimately, concluded that it did not apply in this case because the taxpayers agreed that the Sec. 6662 penalty applied if the court determined a tax underpayment. Thomas, No. 3:14-cv-318 (S.D. Ohio 2/11/15), involved a tax return preparer whose misconduct resulted in his clients’ filing returns that the court said violated Sec. 6676.

Reasonable-cause analysis

Although some have characterized reasonable cause as a relaxed standard for obtaining penalty relief, its subjective nature may be a cause for concern. As noted in PMTA 2010-003, a reasonable-cause analysis typically considers the extent of a taxpayer’s efforts to determine its own proper tax liability (citing Regs. Sec. 1.6664-4(b)), but a taxpayer’s good faith is subjective.

Therefore, for claims made on or after Dec. 18, 2015, instead of being able to rely on an acceptable authority that supports the position it has taken in a claim, under the reasonable-cause standard a taxpayer whose claim has been determined to be excessive must defend against a Sec. 6676 penalty based on its subjective state of mind when it was filed and the actions it took to determine the claim’s propriety. At the same time, because the taxpayer’s awareness of the authorities supporting the position taken in the claim for refund or credit could affect its state of mind, a reasonable-basis analysis still may have some relevance under the new reasonable-cause standard.

Appeal rights, judicial review

A Dec. 30, 2010, IRS memorandum regarding the implementation of the penalty (SBSE-20-0111-001) states that the IRS generally will provide reassessment appeal rights in Sec. 6676 cases but that, if the taxpayer does not agree to extend the period of limitation for assessment, the penalty should be assessed and the taxpayer should be provided post-assessment appeal rights. The memorandum also notes that a taxpayer may seek review of its liability for the Sec. 6676 penalty in a U.S. district court or the Court of Federal Claims, but review by either court requires that the taxpayer first pay the liability in full and file a refund claim with the IRS.