Penalties For Frivolous Tax Claims Killer Explanation and Guidelines
Those who act on frivolous positions risk a variety of civil and criminal penalties.Those who adopt these positions may face harsher consequences than those who merely promote them. As the Seventh Circuit Court of Appeals noted in United States v. Sloan, 939 F.2d 499, 499-500 (7th Cir. 1991), cert. denied, 502 U.S. 1060 (1992), reh’g denied, 503 U.S. 953 (1992), “Like moths to a flame, some people find themselves irresistibly drawn to the tax protester movement’s illusory claim that there is no legal requirement to pay federal income tax. And, like moths, these people sometimes get burned.”Taxpayers filing returns with frivolous positions may be subject to the accuracy related penalty under section 6662 (twenty percent of the underpayment attributable to negligence or disregard of rules or regulations) or the civil fraud penalty under section 6663 (seventy-five percent of the underpayment attributable to fraud) or the erroneous claim for refund penalty under section 6676 (twenty percent of the excessive amount).Additionally, late filed returns setting forth frivolous positions may be subject to an addition to tax under section 6651(f) for fraudulent failure to timely file an income tax return (triple the amount of the standard failure to file addition to tax under section 6651(a)(1)). See Mason v. Commissioner, T.C. Memo. 2004-247, 88 T.C.M. (CCH) 398 (2004) (frivolous arguments may be indicative of fraud if made in conjunction with affirmative acts designed to evade paying federal income tax).The Tax Relief Health Care Act of 2006 amended section 6702 to allow imposition of a $5,000 penalty for frivolous tax returns and for specified frivolous submissions other than returns, if the purported returns or specified submissions are either based upon a position identified as frivolous by the IRS in a published list or reflect a desire to delay or impede tax administration. Pub. L. No. 109-432, 407(a), 120 Stat. 2922 (2006). The term specified submission means: a request for a hearing under section 6320 (relating to notice and opportunity for hearing on filing of a notice of lien), a request for hearing under section 6330 (relating to notice and opportunity for hearing before levy), an application under section 6159 (relating to agreements for payment of tax liability in installments), an application under section 7122 (relating to compromises), or an application under section 7811 (relating to taxpayer assistance orders).This amendment is effective for frivolous returns or specified frivolous submissions made after March 15, 2007, the release date of Notice 2007-30, 2007-1 C.B. 883, identifying the list of frivolous positions. Notice 2008-14, 2008-4, I.R.B. 310, updates the prior list with four additional frivolous positions: (1) the Ninth Amendment to the U.S. Constitution allows a taxpayer to not pay taxes because of objections to military spending; (2) only fiduciaries are taxpayers, or only persons with a fiduciary relationship to the government must pay taxes; (3) a supposed “Mariner’s Tax Deduction” (or the like) allows a taxpayer employed on a ship to deduct the cost of meals provided by the employer at no cost to the taxpayer; and (4) the section 6421 fuels credit may be claimed in patently unlikable amounts without meeting the requirements for the credit.In the 1980s, Congress showed its concern about taxpayers misusing the courts and obstructing the appeal rights of others when it enacted tougher sanctions for bringing frivolous cases before the courts. Section 6673 allows the courts to impose a penalty of up to $25,000 when they come to any of three conclusions:
- Taxpayer instituted a proceeding primarily for delay,
- Position is frivolous or groundless, or
- Taxpayer unreasonably failed to pursue administrative remedies.
An appeals court explained the rationale for the sanctions in Coleman v. Commissioner, 791 F.2d 68, 72 (7th Cir. 1986): “The purpose of 6673 . . . is to induce litigants to conform their behavior to the governing rules regardless of their subjective beliefs. Groundless litigation diverts the time and energies of judges from more serious claims; it imposes needless costs on other litigants.Once the legal system has resolved a claim, judges and lawyers must move on to other things. They cannot endlessly rehear stale arguments . . . . [T]here is no constitutional right to bring frivolous suits . . . . People who wish to express displeasure with taxes must choose other forums, and there are many available.”Taxpayers who rely on frivolous arguments may also face criminal prosecution for:(1) Attempting to evade or defeat tax under section 7201, a felony, for which the penalty is a fine of up to $250,000 and imprisonment for up to 5 years; or(2) Making false statements on a return under section 7206(1), a felony, for which the penalty is a fine of up to $250,000 and imprisonment for up to 3 years.Persons who promote frivolous arguments and those who assist taxpayers in claiming tax benefits based on such arguments may also face various penalties such as:(1) a $250 penalty under section 6694 for each return prepared by an income tax return preparer who knew or should have known that the taxpayer’s argument was frivolous (or $1,000 for each return where the return preparers actions were willful, intentional or reckless);(2) a $1,000 penalty under section 6701 for aiding and abetting an understatement of tax; and(3) criminal felony prosecution under section 7206(2) for which the penalty is up to $250,000 and imprisonment for up to 3 years for assisting or advising about the preparation of a false return or other document under the internal revenue laws.Further, promoters who fail to comply with court orders run the risk of incarceration for contempt of court. A tax scam promoter named James A. Mattatall was arrested for failing to provide list of the names, addresses, phone numbers, and Social Security numbers of his customers to the Justice Department per the court’s order.Also, a taxpayer named Charles D. Saunders was held in civil contempt, incarcerated and fined $250 a day until he complied with the court’s order directing him to fully comply with a summons from the IRS. See 2006 TNT 164- 16 (August 18, 2006).
Relevant Case Law:
Deyo v. United States, 102 A.F.T.R.2d (RIA) 6664 (2d Cir. 2008) – the Second Circuit affirmed a district court decision (98 A.F.T.R.2d (RIA) 6864 (D. Conn. 2006)) that upheld an IRS Appeals determination that enforced collection could go forward of penalties assessed against a married couple for filing frivolous income tax returns. The penalties were imposed on the Deyos after they filed Forms 1040X for tax refunds and on which the taxpayers claimed zero adjusted gross income based on the frivolous position that they did not receive any income from sources listed in the regulations under section 861. The taxpayers argued that the penalty assessments were invalid because they were not managerially approved in writing as required by section 6751. The court of appeals rejected the argument and held that the penalty assessments were properly approved irrespective of whether they might also be within the exemption in section 6751(b)(2)(B) for penalties “automatically calculated through electronic means.”Szopa v. United States, 460 F.3d 884 (7th Cir. 2006) – the court found that a frivolous tax appeal warrants a presumptive sanction of $4,000, but that the court would impose an $8,000 sanction against taxpayers who make repeated frivolous appeals as Szopa did.Gass v. United States, 2001-1 U.S.T.C. (CCH) 50,220 (10th Cir. 2001) – the court imposed an $8,000 penalty for contending that taxes on income from real property are unconstitutional. The court had earlier penalized the taxpayers $2,000 for advancing the same arguments in another case.Brashier v. Commissioner, 2001-1 U.S.T.C. (CCH) 50,356 (10th Cir. 2001) – the court imposed $1,000 penalties on taxpayers who argued that filing sworn income tax returns violated their Fifth Amendment privilege against self-incrimination, after the Tax Court had warned them that their argument – rejected consistently for more than seventy years – was frivolous.Baskin v. United States, 738 F.2d 975 (8th Cir. 1984) – the court found that the IRS’s assessment of a frivolous return penalty without a judicial hearing was not a denial of due process, since there was an adequate opportunity for a later judicial determination of legal rights.Holker v. United States, 737 F.2d 751, 752-53 (8th Cir. 1984) – the court upheld the frivolous return penalty even though the taxpayer claimed the documents he filed to claim a refund did not constitute a tax return. Noting that “[t]axpayers may not obtain refunds without first filing returns,” the court then found that A[h]is unexplained designation of his W-2 forms as ‘INCORRECT’ and his attempt to deduct his wages as the cost of labor on Schedule C also establish the frivolousness and incorrectness of his position.”Jones v. Commissioner, 688 F.2d 17 (6th Cir. 1982) – the court found the taxpayer’s claim that his wages were paid in “depreciated bank notes” as clearly without merit and affirmed the Tax Court’s imposition of an addition to tax for negligence or intentional disregard of rules and regulations.McAfee v. United States, 2001-1 U.S.T.C. (CCH) 50,433 (N.D. Ga. 2001) – after losing the argument that his wages were not income and receiving a $500 penalty, the taxpayer returned to court to try to stop the government from collecting that penalty by garnishing his wages. The court stated that “bringing this ill-considered, nonsensical litigation before this court for yet a second time is nothing but contumacious foolishness which wastes the time and energy of the court system,” and imposed a $1,000 penalty.United States v. Rempel, 87 A.F.T.R.2d (RIA) 1810 (D. Ark. 2001) – the court warned the taxpayers of sanctions and stated: “It is apparent to the court from some of the papers filed by the Rempels that they have at least had access to some of the publications of tax protester organizations. The publications of these organizations have a bad habit of giving lots of advice without explaining the consequences which can flow from the assertion of totally discredited legal positions and/or merit less factual positions.”Rowe v. United States, 583 F. Supp. 1516, 1520 (D. Del. 1984), aff’d, 749 F.2d 27 (3d Cir. 1984) – the court upheld the viability of section 6702 against various objections, including that it was unconstitutionally vague because it does not define a “frivolous” return. A Frivolous is commonly understood to mean having no basis in law or fact,” the court stated.