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Lines from Lance - Newsletter
November 2009

Business Owners, Accountants, and Others Fined
$200,000 by IRS and Don’t Know Why
By Lance Wallach

If you are a small business owner, accountant or insurance professional you may be
in big trouble and not know it.  IRS has been fining people like you $200,000.  Most
people that have received the fines were not aware that they had done anything
wrong.  What is even worse is that the fines are not appeal-able.  This is not an
isolated situation.  This has been happening to a lot of people.

Currently, the Internal Revenue Service (“IRS”) has the discretion to assess
hundreds of thousands of dollars in penalties under §6707A of the Internal Revenue
Code (“Code”) in an attempt to curb tax avoidance shelters. This discretion can be
applied regardless of the innocence of the taxpayer and was granted by Congress.  
It works so that if the IRS determines you have engaged in a listed transaction and
failed to properly disclose it, you will be subject to a potentially draconian penalty
regardless of any other facts and circumstances concerning the transaction. For
some, this penalty has been assessed at almost a million dollars and for many it is
the beginning of a long nightmare.

The following is an example:  Pursuant to a settlement with the IRS, the 412(i) plan
was converted into a traditional defined benefit plan.  All of the contributions to the
412(i) plan would have been allowable if they had initially adopted a traditional
defined benefit plan.  Based on negotiations with the IRS agent, the audit of the
plan resulted in no income and minimal excise taxes due.   This is because as a
traditional defined benefit plan, the taxpayers could have contributed and deducted
the same amount as a 412(i) plan.
Towards the end of the audit the business owner received a notice from the IRS.  
The IRS assessed the client penalties under the §6707A of the Code in the amount
of $900,000.00.  This penalty was assessed because the client allegedly participated
in a listed transaction and allegedly failed to file the form 8886 in a timely

The IRS may call you a material advisor and fine you $200,000.00. The IRS may fine
your clients over a million dollars for being in a retirement plan, 419 plan, etc. As
you read this article, hundreds of unfortunate people are having their lives ruined
by these fines. You may need to take action immediately. The Internal Revenue
Service said it will extend until the end of 2009 a grace period granted to small
business owners for collection of certain tax-shelter penalties.

But with that deadline approaching, Congress has not yet acted on the tax shelter
penalty legislation. IRS Commissioner Doug Shulman said in a letter to the chairmen
and ranking members of tax-writing committees that the IRS will continue to
suspend its collection efforts with regard to the penalties until Dec. 31, 2009.

"Clearly, a number of taxpayers have been caught in a penalty regime that the
legislation did not intend," wrote Shulman. "I understand that Congress is still
considering this issue, and that a bipartisan, bicameral, bill may be in the works."  
The issue relates to penalties for so-called listed transactions, the kinds of tax
shelters the IRS has designated most egregious. A number of small business
owners that bought employee retirement plans so called 419 and 412(i) plans and
others, that were listed by the IRS, and who are now facing hundreds and
thousands in penalties, contend that the penalty amounts are unfair.
Leaders of tax-writing committees in the House and Senate have said they intend to
pass legislation revising the penalty structure.

The IRS has suspended collection efforts in cases where the tax benefit derived
from the listed transaction was less than $100,000 for individuals, or less than
$200,000 for firms.

Senator Ben Nelson (D-Nebraska) has sponsored legislation (S.765) to curtail the
IRS and its nearly unlimited authority and power under Code Section 6707A. The bill
seeks to scale back the scope of the Section 6707A reportable/listed transaction
nondisclosure penalty to a more reasonable level. The current law provides for
penalties that are Draconian by nature and offer no flexibility to the IRS to reduce or
abate the imposition of the 6707A penalty. This has served as a weapon of mass
destruction for the IRS and has hit many small businesses and their owners with
unconscionable results.

Internal Revenue Code 6707A was enacted as part of the American Jobs Creation
Act on October 22, 2004. It imposes a strict liability penalty for any person that failed
to disclose either a listed transaction or reportable transaction per each
occurrence. Reportable transactions usually fall within certain general types of
transactions (e.g. confidential transactions, transactions with tax protection, certain
loss generating transaction and transactions of interest arbitrarily so designated as
by the IRS) that have the potential for tax avoidance. Listed transactions are
specified transactions which have been publicly designated by the IRS, including
anything that is substantially similar to such a transaction (a phrase which is given
very liberal construction by the IRS). There are currently 34 listed transactions,
including certain retirement plans under Code section 412(i) and certain employee
welfare benefit plans funded in part with life insurance under Code sections 419A(f)
(5), 419(f)(6) and 419(e). Many of these plans were implemented by small business
seeking to provide retirement income or health benefits to their employees.

Strict liability requires the IRS to impose the 6707A penalty regardless of innocence
of a person (i.e. whether the person knew that the transaction needed to be
reported or not or whether the person made a good faith effort to report) or the
level of the person’s reliance on professional advisors. A Section 6707A penalty is
imposed when the transaction becomes a reportable/listed transaction. Therefore, a
person has the burden to keep up to date on all transactions requiring disclosure
by the IRS into perpetuity for transactions entered into the past.

Additionally, the 6707A penalty strictly penalizes nondisclosure irrespective of taxes
owed. Accordingly, the penalty will be assessed even in legitimate tax planning
situations when no additional tax is due but an IRS required filing was not properly
and timely filed. It is worth noting that a failure to disclose in the view of the IRS
encompasses both a failure to file the proper form as well as a failure to include
sufficient information as to the nature and facts concerning the transaction. Hence,
people may find themselves subject to the 6707A penalty if the IRS determines that
a filing did not contain enough information on the transaction. A penalty is also
imposed when a person does not file the required duplicate copy with a separate
IRS office in addition to filing the required copy with the tax return. Lance Wallach
Commentary. In our numerous talks with IRS, we were also told that improperly
filling out the forms could almost be as bad as not filing the forms. We have
reviewed hundreds of forms for accountants, business owners and others. We
have not yet seen a form that was properly filled in. We have been retained to
correct many of these forms.

For more information see,,
or e-mail us at

The imposition of a 6707A penalty is not subject to judicial review regardless of
whether the penalty is imposed for a listed or reportable transaction. Accordingly,
the IRS’s determination is conclusive, binding and final. The next step from the IRS
is sending your file to collection, where your assets may be forcibly taken, publicly
recorded liens may be placed against your property, and/or garnishment of your
wages or business profits may occur, amongst other measures.

The 6707A penalty amount for each listed transaction is generally $200,000 per year
per each person that is not an individual and $100,000 per year per individual who
failed to properly disclose each listed transaction. The 6707A penalty amount for
each reportable transaction is generally $50,000 per year for each person that is not
an individual and $10,000 per year per each individual who failed to properly
disclose each reportable transaction. The IRS is obligated to impose the listed
transaction penalty by law and cannot remove the penalty by law. The IRS is
obligated to impose the reportable transaction penalty by law, as well, but may
remove the penalty when the IRS determines that removal of the penalty would
promote compliance and support effective tax administration.

The 6707A penalty is particularly harmful in the small business context, where many
business owners operate through an S corporation or limited liability company in
order to provide liability protection to the owner/operators. Numerous cases are
coming to light where the IRS is imposing a $200,000 penalty at the entity level and
them imposing a $100,000 penalty per individual shareholder or member per year.

The individuals are generally left with one of two options:
Declare Bankruptcy
Face a $300,000 penalty per year.

Keep in mind, taxes do not need to be due nor does the transaction have to be
proven illegal or illegitimate for this penalty to apply. The only proof required by the
IRS is that the person did not properly and timely disclose a transaction that the IRS
believes the person should have disclosed. It is important to note in this context
that for non-disclosed listed transactions, the Statue of Limitations does not begin
until a proper disclosure is filed with the IRS.

Many practitioners believe the scope and authority given to the IRS under 6707A,
which allows the IRS to act as judge, jury and executioner, is unconstitutional.
Numerous real life stories abound illustrating the punitive nature of the 6707A
penalty and its application to small businesses and their owners. In one case, the
IRS demanded that the business and its owner pay a 6707A total of $600,000 for his
and his business’ participation in a Code section 412(i) plan. The actual taxes and
interest on the transaction, assuming the IRS was correct in its determination that
the tax benefits were not allowable, was $60,000. Regardless of the IRS’s ultimate
determination as to the legality of the underlying 412(i) transaction, the $600,000
was due as the IRS’s determination was final and absolute with respect to the 6707A
penalty. Another case involved a taxpayer who was a dentist and his wife whom the
IRS determined had engaged in a listed transaction with respect to a limited liability
company. The IRS determined that the couple owed taxes on the transaction of
$6,812, since the tax benefits of the transactions were not allowable. In addition, the
IRS determined that the taxpayers owed a $1,200,000 section 6707A penalty for both
their individual nondisclosure of the transaction along with the nondisclosure by
the limited liability company.

Even the IRS personnel continue to question both the legality and the fairness of
the IRS’s imposition of 6707A penalties. An IRS appeals officer in an email to a
senior attorney within the IRS wrote that “…I am both an attorney and CPA and in my
29 years with the IRS I have never {before} worked a case or issue that left me
questioning whether in good conscience I could uphold the Government’s position
even though it is supported by the language of the law.” The Taxpayers Advocate,
an office within the IRS, even went so far as to publicly assert that the 6707A should
be modified as it “raises significant Constitutional concerns, including possible
violations of the Eighth Amendment’s prohibition against excessive government
fines, and due process protection.”

Senate bill 765, the bill sponsored by Senator Nelson, seeks to alleviate some of
above cited concerns. Specifically, the bill makes three major changes to the
current version of Code section 6707A. The bill would allow an IRS imposed 6707A
penalty for nondisclosure of a listed transaction to be rescinded if a taxpayer’s
failure to file was due to reasonable cause and not willful neglect. The bill would
make a 6707A penalty proportional to an understatement of any tax due.

Accordingly, non-tax paying entities such as S corporations and limited liability
companies would not be subject to a 6707A penalty (individuals, C corporations and
certain trusts and estates would remain subject to the 6707A penalty).

There are a number of interesting points to note about this action:
1.     In the letter, the IRS acknowledges that, in certain cases, the penalty imposed
by section 6707A for failure to report participation in a “listed transaction” is
disproportionate to the tax benefits obtained by the transaction.
2.     In the letter, the IRS says that it is taking this action because Congress has
indicated its intention to amend the Code to modify the penalty provision, so that
the penalty for failure to disclose will be more in line with the tax benefits resulting
from a listed transaction.

3.     The IRS will not suspend audits or collection efforts in appropriate cases.  It
cannot suspend imposition of the penalty, because, at least with respect to listed
transactions, it does not have the discretion to not impose the penalty.  It is simply
suspending collection efforts in cases where the tax benefits are below the penalty
threshold in order to give Congress time to amend the penalty provision, as
Congress has indicated to the IRS it intends to do.  
4.          The legislation does not change the penalty provisions for material advisors.
This is taken directly from the IRS website:

“Congress has enacted a series of income tax laws designed to halt the growth of
abusive tax avoidance transactions. These provisions include the disclosure of
reportable transactions. Each taxpayer that has participated in a reportable
transaction and that is required to file a tax return must disclose information for
each reportable transaction in which the taxpayer participates. Use Form 8886 to
disclose information for each reportable transaction in which participation has
occurred. Generally, Form 8886 must be attached to the tax return for each tax year
in which participation in a reportable transaction has occurred. If a transaction is
identified as a listed transaction or transaction of interest after the filing of a tax
return (including amended returns), the transaction must be disclosed either within
90 days of the transaction being identified as a listed transaction or a transaction of
interest or with the next filed return, depending on which version of the regulations
is applicable.”

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Lance Wallach, CLU, ChFC, CIMC, speaks and writes about benefit plans, tax
reductions strategies, and financial plans. He has authored numerous books for the
AICPA, Bisk Total tape, and others. He can be reached at (516) 938-5007 or For more articles on this or other subjects, feel free to visit his
website at         Lance Wallach, the National Society of
Accountants Speaker of the Year, speaks and writes extensively about retirement
plans, Circular 230 problems and tax reduction strategies. He speaks at more than
40 conventions annually, writes for over 50 publications, is quoted regularly in the
press, and has written numerous best-selling AICPA books, including Avoiding
Circular 230 Malpractice Traps and Common Abusive Business Hot Spots. He does
extensive expert witness work and has never lost a case.  Contact him at
516.938.5007 or visit  The information provided herein is not
intended as legal, accounting, financial or any other type of advice for any specific
individual or other entity.  You should contact an appropriate professional for any
such advice.
Business Owners, Accountants, and Others
Fined $200,000 by IRS and Don’t Know Why

The Lance Wallach Network