The Lance Wallach Network


    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

    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)
    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 manner.        

    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

    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

    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

    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 www. or         

    Lance Wallach,  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

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