Accuracy-Related Penalty

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[IA-78-93]

RIN 1545-AS58

Accuracy-Related Penalty

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: These proposed regulations amend the accuracy-related penalty

regulations under chapter 1 of the Internal Revenue Code. These

amendments are necessary to effect changes to the accuracy-related

penalty made by the Omnibus Budget Reconciliation Act of 1993. This

document also provides notice of a public hearing on the proposed

amendments.

DATES: Written comments must be received by June 21, 1994. The IRS

intends to hold a public hearing on these proposed regulations on July

12, 1994, beginning at 10 a.m. Persons wishing to speak at the hearing

must submit outlines of their comments by June 21, 1994.

ADDRESSES: Send submissions to: Internal Revenue Service, Attn:

CC:DOM:CORP:T:R (IA-78-93), room 5228, POB 7604, Ben Franklin Station,

Washington, DC 20044. The public hearing will be held in the IRS

Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW.,

Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, David L.

Meyer, 202-622-6232; concerning submissions, Michael Slaughter, 202-

622-7180. (These are not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Temporary Regulations and 26 U.S.C. 7805(e)(1)

In the Rules and Regulations section of this issue of the Federal

Register, the IRS is issuing temporary regulations (Treasury Decision

8533) to implement certain changes made to the accuracy-related penalty

in section 6662 of the Internal Revenue Code (Code) by section 13251 of

the Omnibus Budget Reconciliation Act of 1993 (OBRA 1993). Section

7805(e)(1) of the Code (26 U.S.C. 7805(e)(1)) requires the publication

of a notice of proposed rulemaking whenever the Secretary issues

temporary regulations to allow an opportunity for public comment. The

substance of T.D. 8533 is reflected in the proposed amendments to

sections 1.6662-1 through 1.6662-4. The Internal Revenue Service

presently intends to revise Secs. 1.6662-1 through 1.6662-4 in response

to taxpayers' comments on the proposed regulations and does not

presently intend to finalize Sec. 1.6662-7T.

Background

These proposed regulations set forth certain changes made to the

accuracy-related penalty in section 6662 of the Code by section 13251

of OBRA 1993. These changes eliminated the disclosure exception for the

negligence penalty (section 6662(b)(1) of the Code) and raised the

disclosure standard for purposes of the penalties for disregarding

rules or regulations (section 6662(b)(1) of the Code) and a substantial

understatement of income tax (section 6662(b)(2) of the Code) from

``not frivolous'' to ``reasonable basis.'' See section 13251 of OBRA

1993 and H. Rep. No. 213, 103rd Cong., 1st Sess. 669 (1993) (the

Conference Report).

The legislative history to OBRA 1993 indicates that this

``reasonable basis'' standard is a relatively high standard of tax

reporting that is significantly higher than the ``not frivolous''

disclosure standard previously applicable to taxpayers under section

6662 of the Code and currently applicable to preparers under section

6694 of the Code. See Conference Report, at p. 669. A position is not

frivolous if it is not ``patently improper.'' See Sec. 1.6694-2(c)(2)

of the Income Tax Regulations and current Sec. 1.6662-3(b)(3). The

legislative history to OBRA 1993 also provides that the reasonable

basis standard is not satisfied by a position that is merely arguable

or merely a colorable claim. See Conference Report, at p.669.

In addition to adopting the new reasonable basis standard as the

standard that a disclosed return position must satisfy to avoid the

disregard and substantial understatement penalties, Congress adopted

the new reasonable basis standard as the standard that a return

position must satisfy to avoid the negligence penalty. See Conference

Report at p.669.

Treasury requests comments on how the new reasonable basis standard

should be defined for purposes of the negligence, disregard, and

substantial understatement penalties.

Explanation of Changes

Section 1.6662-3(a) of the regulations generally provides that if

any portion of an underpayment, as defined in section 6664(a) of the

Code and Sec. 1.6664-2, of any income tax imposed under subtitle A of

the Code that is required to be shown on a return is attributable to

negligence or disregard of rules or regulations, there is added to the

tax an amount equal to 20 percent of such portion. Section 1.6662-

3(b)(1) defines ``negligence'' to include any failure to make a

reasonable attempt to comply with the provisions of the internal

revenue laws or to exercise ordinary and reasonable care in the

preparation of a tax return. Currently, Sec. 1.6662-3(c) generally

provides that no penalty under section 6662(b)(1) may be imposed on any

portion of any underpayment that is attributable to negligence or a

position contrary to a rule or regulation if the position is adequately

disclosed and is not frivolous, if the requirements of that section are

met.

Section 1.6662-4(a) of the regulations generally provides that if

any portion of an underpayment of any income tax imposed under subtitle

A of the Code that is required to be shown on a return is attributable

to a substantial understatement of such income tax, there is added to

the tax an amount equal to 20 percent of such portion. Section 1.6662-

4(a) further provides that, except in the case of any item attributable

to a tax shelter, an understatement is reduced by the portion of the

understatement that is attributable to positions for which there was

substantial authority or adequate disclosure. Currently, under

Sec. 1.6662-4(e)(2), this adequate disclosure exception will not apply

if the position on the return is frivolous.

As a result of OBRA 1993, the minimum standard that a disclosed

return position must satisfy to avoid either the penalty for

disregarding rules or regulations or for a substantial understatement

of income tax has been raised from ``not frivolous'' to ``reasonable

basis.'' In addition, there is no longer a disclosure exception for the

negligence penalty and, to avoid that penalty, the return position

generally must satisfy the new reasonable basis standard.

These rules generally apply to returns that are due (without regard

to extensions for filing) after December 31, 1993. However, the rules

relating to changes to the penalties for negligence or disregard of

rules or regulations will not apply to returns, including qualified

amended returns, filed on or before March 14, 1994.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It has also been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do

not apply to these regulations, and therefore, a Regulatory Flexibility

Analysis is not required. Pursuant to section 7805(f) of the Internal

Revenue Code, this notice of proposed rulemaking will be submitted to

the Chief Counsel for Advocacy of the Small Business Administration for

comment on its impact on small business.

Comments and Public Hearing

Before the adoption of these proposed regulations, consideration

will be given to any written comments that are submitted timely (a

signed original and eight copies) to the Internal Revenue Service. All

comments will be available for public inspection and copying in their

entirety.

A public hearing will be held on July 12, 1994, in the IRS

Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW.,

Washington, DC. Because of access restrictions, visitors will not be

admitted beyond the building lobby more than 15 minutes before the

hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons who wish to present oral comments at the hearing must

submit written comments, an outline of the topics to be discussed, and

the time to be devoted to each topic by June 21, 1994.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these proposed regulations is David L.

Meyer, Office of Assistant Chief Counsel, Income Tax and Accounting,

Internal Revenue Service. However, other personnel from the IRS and

Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.6662-0 is amended by:

1. Revising the introductory language,

2. Adding entries for Sec. 1.6662-2 (d)(1) and (d)(2),

3. Revising the entry for paragraph (b)(3) under Sec. 1.6662-3, and

4. Adding an entry for Sec. 1.6662-7.

5. The revised and added provisions read as follows:

Sec. 1.6662-0 Table of contents.

This section lists the captions that appear in Secs. 1.6662-1

through 1.6662-7.

* * * * *

Sec. 1.6662-2 Accuracy-related penalty.

* * * * *

(d) * * *

(1) Returns due before January 1, 1994.

(2) Returns due after December 31, 1993.

Sec. 1.6662-3 Negligence or disregard of rules or regulations.

* * * * *

(b) * * *

(3) Reasonable basis.

(i) In general [Reserved].

(ii) Relationship to other standards.

* * * * *

Sec. 1.6662-7 Omnibus Budget Reconciliation Act of 1993 changes

to the accuracy-related penalty.

(a) In general.

(1) Scope.

(2) Effective date.

(b) No disclosure exception for negligence penalty.

(c) Disclosure standard for other penalties is reasonable basis.

(d) Definition of reasonable basis.

(1) In general [Reserved].

(2) Relationship to other standards.

Par. 3. In Sec. 1.6662-1, the second and third sentences of the

concluding text are revised to read as follows:

Sec. 1.6662-1 Overview of the accuracy-related penalty.

* * * * *

* * * The penalties for disregard of rules or regulations and for a

substantial understatement of income tax may be avoided by adequately

disclosing certain information as provided in Sec. 1.6662-3(c) and

Sec. 1.6662-4 (e) and (f), respectively. The penalties for negligence

and for a substantial (or gross) valuation misstatement under chapter 1

may not be avoided by disclosure.* * *

Par. 4. Section 1.6662-2 is amended by:

1. Redesignating the text of paragraph (d) as (d)(1) and adding a

heading,

2. Revising the first and second sentences of newly designated

paragraph (d)(1), and

3. Adding paragraph (d)(2).

4. The revised and added provisions read as follows:

Sec. 1.6662-2 Accuracy-related penalty.

* * * * *

(d) Effective date--(1) Returns due before January 1, 1994. Section

1.6662-3(c) and Sec. 1.6662-4 (e) and (f) (relating to methods of

making adequate disclosure) as codified in 26 CFR revised April 1,

1993, apply to returns the due date of which (determined without regard

to extensions of time for filing) is after December 31, 1991, but

before January 1, 1994. Except as provided in the preceding sentence,

Secs. 1.6662-1 through 1.6662-5 as codified in 26 CFR revised April 1,

1993, apply to returns the due date for which (determined without

regard to extensions of time for filing) is after December 31, 1989,

but before January 1, 1994. * * *

(2) Returns due after December 31, 1993. Except as provided in the

last sentence of this paragraph (d)(2), the provisions of Secs. 1.6662-

1 through 1.6662-4 reflecting the changes made to the accuracy-related

penalty by the Omnibus Budget Reconciliation Act of 1993 apply to

returns the due date for which (determined without regard to extensions

of time for filing) is after December 31, 1993. These changes include

raising the disclosure standard for the penalties for disregarding

rules or regulations and for a substantial understatement of income tax

from not frivolous to reasonable basis, eliminating the disclosure

exception for the negligence penalty, and providing guidance on the

meaning of reasonable basis. The Omnibus Budget Reconciliation Act of

1993 changes relating to the penalties for negligence or disregard of

rules or regulations will not apply to returns (including qualified

amended returns) that are filed on or before March 14, 1994.

Par. 5. Section 1.6662-3 is amended by:

1. Revising the second sentence of paragraph (a),

2. Revising paragraph (b)(3), and

3. Revising paragraphs (c) (1) and (2).

4. The revisions read as follows:

Sec. 1.6662-3 Negligence or disregard of rules or regulations.

(a) * * * The penalty for disregarding rules or regulations does

not apply, however, if the requirements of Sec. 1.6662-3(c)(1) are

satisfied and the position in question is adequately disclosed as

provided in Sec. 1.6662-3(c)(2), or to the extent that the reasonable

cause and good faith exception to this penalty set forth in

Sec. 1.6664-4 applies. * * *

(b) * * *

(3) Reasonable basis--(i) In general. [Reserved].

(ii) Relationship to other standards. The reasonable basis standard

is significantly higher than the not frivolous standard applicable to

preparers under section 6694 and defined in Sec. 1.6694-2(c)(2).

* * * * *

(c) * * *

(1) In general. No penalty under section 6662(b)(1) may be imposed

on any portion of an underpayment that is attributable to a position

contrary to a rule or regulation if the position is disclosed in

accordance with the rules of paragraph (c)(2) of this section and, in

case of a position contrary to a regulation, the position represents a

good faith challenge to the validity of the regulation. This disclosure

exception does not apply, however, in the case of a position that does

not have a reasonable basis or where the taxpayer fails to keep

adequate books and records or to substantiate items properly.

(2) Method of disclosure. Disclosure is adequate for purposes of

the penalty for disregarding rules or regulations if made in accordance

with the provisions of Secs. 1.6662-4(f)(1), (3), (4), and (5), which

permit disclosure on a properly completed and filed Form 8275 or 8275-

R, as appropriate. In addition, the statutory or regulatory provision

or ruling in question must be adequately identified on the Form 8275 or

8275-R, as appropriate. The provisions of Sec. 1.6662-4(f)(2), which

permit disclosure in accordance with an annual revenue procedure for

purposes of the substantial understatement penalty, do not apply for

purposes of this section.

Par. 6. Section 1.6662-4 is amended by:

1. Removing the third sentence in paragraph (d)(2), and

2. Revising paragraph (e)(2) to read as follows:

Sec. 1.6662-4 Substantial understatement of income tax.

* * * * *

(e) * * *

(2) Circumstances where disclosure will not have an effect. The

rules of paragraph (e)(1) of this section do not apply where the item

or position on the return--

(i) Does not have a reasonable basis (as defined in Sec. 1.6662-

3(b)(3));

(ii) Is attributable to a tax shelter (as defined in section

6662(d)(2)(C)(ii) and paragraph (g)(2) of this section); or

(iii) Is not properly substantiated, or the taxpayer failed to keep

adequate books and records with respect to the item or position.

Par. 7. Section 1.6662-7 is added to read as follows:

Sec. 1.6662-7 Omnibus Budget Reconciliation Act of 1993 changes to the

accuracy-related penalty.

(a) In general--(1) Scope. The Omnibus Budget Reconciliation Act of

1993 made certain changes to the accuracy-related penalty in section

6662. This section provides rules reflecting those changes.

(2) Effective date. This section applies to returns that are due

(without regard to extensions of time for filing) after December 31,

1993. However, the provisions of these regulations relating to the

penalties for negligence or disregard of rules or regulations will not

apply to returns (including qualified amended returns) that are filed

on or before March 14, 1994.

(b) No disclosure exception for negligence penalty. The penalty for

negligence in section 6662(b)(1) may not be avoided by disclosure of a

return position.

(c) Disclosure standard for other penalties is reasonable basis.

The penalties for disregarding rules or regulations in section

6662(b)(1) and for a substantial understatement of income tax in

section 6662(b)(2) may be avoided by adequate disclosure of a return

position only if the position has at least a reasonable basis. See

Secs. 1.6662-3(c) and 1.6662-4(e) and (f) for other applicable

disclosure rules.

(d) Definition of reasonable basis--(1) In general. [Reserved].

(2) Relationship to other standards. The reasonable basis standard

is significantly higher than the not frivolous standard applicable to

preparers under section 6694 and defined in Sec. 1.6694-2(c)(2).

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 94-6237 Filed 3-14-94; 12:20 pm]

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