Tax News & Views Rips IRS Penalty Process Roundup

Joe Kristan
May 22, 2024
Bing Copilot DALL-E 3 image of vanilla pudding

Key Takeaways

  • National Taxpayer Advocate pans IRS international penalty assessments.
  • Taxpayer watchdog says automatic assessment unfair, inefficient.
  • It's not just rich folks that get hit with severe international penalties.
  • Eide Bailly experts weigh in.
  • Disaster relief tax bill workaround faces its own block.
  • Iowa tornado due date relief.
  • Arizona abusive trust preparer pleads to tax crimes.
  • Vanilla Pudding and Goth fetes.

Taxpayer Advocate rips IRS policies on assessing international penalties. In a post on the NTA Blog, National Taxpayer Advocate Erin Collins called on the IRS to overhaul its policies to automatically assess the severe monetary penalties for late-filed foreign information returns:

U.S. persons who receive money from abroad or who have foreign financial interests or cross-border activities are potentially subject to a range of U.S. reporting requirements. But these taxpayers commonly do not know they are subject to international information reporting requirements and if they do, they do not have the resources to hire tax professionals to help navigate the process. Typically, upon learning of their filing obligation, they voluntarily file the missing information returns – albeit late – only to have their compliance rewarded with a harsh penalty. This is because the IRS has decided to systemically assess many of these penalties, meaning its computer system automatically assesses the penalty upon receipt of a late international information reporting return without any review or action from IRS personnel.

These penalties typically start at $10,000 and go up from there, and apply whether or not any taxable income was underreported. The Taxpayer Advocate dismisses arguments that these penalties just affect rich people and therefore we shouldn't worry about them:

International information return penalties are often thought of as primarily affecting rich people or multinational corporations with significant overseas assets. This is not true. Taxpayers – many of whom are lower- and middle-income individuals, small and midsize business owners, and immigrants – face significant and potentially life-changing penalties, even when they voluntarily comply, for failing to meet obscure and complex foreign information reporting requirements.

As I have discussed in prior blogs and my Annual Report to Congressthese penalties overwhelmingly impact lower- and middle-income individuals and small and midsize businesses who voluntarily come forward. For example, the IRS assesses 71 percent of individual IRC § 6038 penalties against lower- and middle-income taxpayers (those reporting under $400,000 in income). Likewise, it assesses 83 percent of systemic business IRC §§ 6038 and 6038A penalties against small and midsize businesses. These penalties can be huge. For instance, in the foreign gift context, the average penalty for 2018-2021 was more than $235,000 for taxpayers who reported $400,000 or less in income. Many of these penalties bear no relation to any underlying taxable income or liability.

The Taxpayer Advocate heads an independent organization within the IRS "to ensure that every taxpayer is treated fairly and that you know and understand your rights." She notes that many of these penalties are waived, but often only after an expensive and stressful engagement with the IRS:

Though the IRS abates so many penalties, taxpayers still experience great financial cost and emotional toll fighting them. Imagine the stress from opening a collection notice from the IRS demanding payment when you believe your reasonable cause statement provided the information necessary to establish that the IRS should not assert the penalty. Imagine the frustration to learn the IRS did not even read your reasonable cause letter, and you are left in limbo wondering whether it will grant relief. 

Elyse Katz and Ben Peeler of the Eide Bailly IRS Dispute Resolution and Collection Services Group regularly work with taxpayers fighting foot-fault international penalties. Ben notes a case "where they asserted a 138,000 penalty on an account where no tax would ever be due."

Elyse says the IRS is getting worse at handling these issues: 

Appeals has been awful with weighing against these penalties. They seemingly don’t have much knowledge regarding the law and are offering a set settlement amount in most cases...  These cases are taking years to settle and causing undue stress and hardship on taxpayers who have sought out professional advice (CPA/Attorneys) and are still getting penalized.

The Taxpayer Advocate advocates important procedural and statutory steps to ease the problem. While those would help, it would be better to automatically waive penalties for taxpayers who self-report late filings in cases where there is little or no resulting tax underpayment.

The forms that trigger large penalties include:

  • Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
  • Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner
  • Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations
  • Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business
  • Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships
  • Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs)
  • Form 8398, Statement of Specified Foreign Financial Assets

Related: Eide Bailly International Tax Services.



Congress: hold-up workaround held up?

Wyden Vows to Hold Disaster Tax Relief Bill Passed in House - Doug Sword and Cady Stanton, Tax Notes ($):

The Senate’s top taxwriter said he would block a $4.9 billion tax relief bill for disaster victims that overwhelmingly passed in the House, launching a new chapter in this Congress’s drama over tax legislation.

The bill in question is a disaster relief measure that is included in the House-passed tax relief bill that would restore important business breaks, including research expensing. The Senate has not taken up the bill, which the House passed in January. The new disaster relief-only bill reflects a belief that the original bill is dead in the Senate.

“The only reason this disaster relief didn’t become law soon after the House passed it months ago is because Senate Republican leaders have blocked it,” Wyden said in a statement. “Senate Republicans will have an opportunity to show whether they in fact support disaster relief when the Tax Relief for American Workers and Families Act comes up for a vote soon.”

Wyden said he believes Smith still wants to pass the larger package despite his support of the separate disaster relief legislation in the House and that the two of them still believe the larger package has the votes needed to pass in the Senate.


Presidents’ Tax Returns and Families’ Foreign Payments Targeted by Unlikely Duo - Natalie Andrews, Wall Street Journal:

House Oversight Committee Chairman James Comer (R., Ky.) and Rep. Katie Porter, a California Democrat on the committee, plan to introduce a bill on Wednesday that would force presidents and vice presidents to disclose their tax filings for the two years before entering the White House, for the years while in office, and for two years afterward. 

It would also compel them, along with close family members such as children, siblings and in-laws, to disclose payments from foreign entities as well as large gifts and loans from family members.


Cause, effect?

Millionaires tax revenue reaches $1.8 billion, on pace to double estimates - Chris Lisinski, State House News Service via WGBH. "That's more than $800 million more than what the Legislature and Gov. Maura Healey planned to spend in surtax revenue for all of fiscal year 2024, raising the possibility of a sizable pot that will land in an Education and Transportation Reserve Fund and the Education and Transportation Innovation and Capital Fund, both surtax-specific accounts, once the books close."

Massachusetts Risks $1 Billion in Lost Tax Revenue as Rich Flee - Sri Taylor, Bloomberg ($). "Migration out of Massachusetts to other US states accelerated during the pandemic as the rise of remote work made it more feasible to live farther away from the office. If the current trend continues, more than 96,000 residents making a combined $19.2 billion in adjusted gross income are set to leave the state annually by 2030, according to a study by Boston University ’s Questrom School of Business. That will cost Massachusetts about $961 million in income tax revenue each year, the study estimates."


Reaping the whirlwinds

IRS announces tax relief for taxpayers impacted by severe storms and tornadoes in Iowa - IRS:

Following the disaster declaration issued by the Federal Emergency Management Agency (FEMA), individuals and households that reside or have a business in Clarke, Harrison, Mills, Polk, Pottawattamie, Ringgold, Shelby, and Union counties qualify for tax relief.

The declaration permits the IRS to postpone certain tax-filing and tax-payment deadlines for taxpayers who reside or have a business in the disaster area. For instance, certain deadlines falling on or after April 26, 2024, and before Oct. 15, 2024, are granted additional time to file through Oct. 15, 2024. As a result, affected individuals and businesses will have until Oct. 15, 2024, to file returns and pay any taxes that were originally due during this period.

Expect the declaration to be broadened to cover yesterday's storms.


Blogs and Bits

7 financial gifts for graduates - Kay Bell, Don't Mess With Taxes. "Did your graduate work while in school earlier this year? Or will they soon get a summer job before starting (or resuming) classes? You can help them keep all that hard-earned cash, and plan for their still far-off post-work years, by contributing to (or opening) a custodial IRA account."

IRS Issues Final Regulations on Transfers of Energy Credits Under the Inflation Reduction Act - Parker Tax Pro Library. "The regulations describe rules for the election to transfer eligible credits in a taxable year, including definitions and special rules applicable to partnerships and S corporations and regarding excessive credit transfer or recapture events; in addition, the regulations describe rules related to a required IRS pre-filing registration process."

Related: How the Inflation Reduction Act is Boosting Energy Efficiency Incentives alerts 2022/1


How To Avoid Faulty Advice On IRS Form 706 And The Portability Election - Darren Case and Ashley Case, Forbes. "Some tax professionals have been advising their clients that filing the IRS Form 706 Estate (and Generation-Skipping Transfer) Tax Return is not necessary for a surviving spouse. The reality is filing the Form 706 is not only best practice. Failing to do so may be a case of malpractice.

Related: Eide Bailly Wealth Transition Services.


If You Pay Hush Money, You May Not Be Able To Deduct It On Your Taxes - Robert Wood, Forbes. "But what if you are paid hush money, is it income you have to report on your taxes? Yes, the IRS says almost everything is income, and that applies to hush money, whatever the circumstances."

Can Economic Growth Help Solve Our Debt Problem? - Noah Peterson, Tax Policy Blog. "A growing economy brings in more tax revenue, which reduces the relative debt burden. This gives lawmakers some breathing room to address fiscal imbalances (think gradual tweaks, not drastic measures)."


Verify, then trusts.

Arizona tax preparer pleads guilty to filing false tax returns as part of a nationwide abusive-trust tax shelter scheme - IRS (Defendant name omitted, emphasis added):

According to court documents and statements made in court, from 2017 to 2023, Defendant operated... a return preparation business. During that time, Defendant participated in a scheme to defraud the IRS that involved the promotion, sale and implementation of a fraudulent tax shelter. Defendant participated by preparing and filing over 500 false tax returns for approximately 60 clients nationwide who used the tax shelter to conceal income from the IRS and not pay tax. Defendant intentionally caused more than $60 million in income to be fraudulently sheltered from the IRS, which resulted in a tax loss to the IRS of approximately $17 million.

Defendant prepared the false tax returns to further the abusive-trust tax shelter scheme carried out by others. Clients who purchased the tax shelter – most of whom were successful business owners – were directed to assign or “donate” nearly all of their income to sham trusts and a so-called “private family foundation” to create the illusion that the income was not theirs. However, the sham trusts and foundations were nothing more than bank accounts designed to hold funds the clients earned and continued to control.

To carry out the scheme, Defendant was taught how to prepare tax returns utilizing the scheme’s fraudulent methods. He was instructed to report all income assigned to a sham trust as income of the trust and to offset that income by deducting all expenses paid for by the trust, including the clients’ personal living expenses. Defendant was paid fees for preparing the returns by the clients participating in the tax shelter.

I would guess that the clients using this preparer gloated to friends about how creative and aggressive he was, and these friends groused that their own non-scam preparers were too timid. The gloating may have since subsided.


What day is it? 

It's National Vanilla Pudding Day and World Goth Day. Perhaps these will generally be celebrated separately.

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About the Author(s)

Joe Kristan

Joe B. Kristan, CPA

After 38 years centered on tax consulting for closely held businesses and their owners, Joe is joining Eide Bailly's National Tax Office. Joe's responsibilities include communication, process improvement and training. He is a principal contributor to the Eide Bailly Tax News and Views blog, providing daily updates on tax reform and other tax news. Joe is a Certified Public Accountant and a member of the AICPA Tax Section and Iowa Society of Public Accountants.

Any opinions expressed or implied are those of the author and not necessarily those of Eide Bailly. Opinions found in linked items are those of the authors of the linked item, not of your bloggers or of Eide Bailly. “$” means link may be behind a paywall. Items here do not constitute tax advice.