The tax penalty for filing a frivolous income tax return has been set so low and its reach so limited that the penalty has not been of much concern to taxpayers. Unfortunately, those days are now gone. The Tax Relief and Health Care Act of 2006 has made sweeping changes to the Section 6702 frivolous return penalty.
The Sec. 6702 Frivolous Return Penalty
Prior to the recent change, Section 6702 provided for a $500 penalty for filing a frivolous “tax return.” It was a very short tax code section.
The new Section 6702 is much longer. Section 6702 now provides a $5,000 penalty for filing a frivolous “tax return” and a $5,000 penalty for filing a frivolous “tax submission.”
What is a Frivolous Return?
New Section 6702(b)(2)(A) defines a “frivolous submission” as any request for a collection due process hearing or application for an installment agreement, offer in compromise, or taxpayer assistance order that the IRS deems to be frivolous and that the IRS sets out in a published list (the new Section 6702 does not take effect until the IRS publishes this magical list).
The new Section 6702 also provides that the “frivolous submission” penalty will not apply to taxpayers if they withdrawal their submission within 30 days after the IRS notifies the taxpayer that their submission was frivolous. This gives the IRS the authority to determine what is and what is not “frivolous.”
There may be instances where the IRS deems a collection due process, installment agreement or offer in compromise frivolous — even though submitted by the taxpayer in good faith. The question is how taxpayers are going to be able to convince the IRS of their good faith intent? This is particularly problematic since there is a wide range for many “submissions” that could easily be acceptable. We will have to wait for the IRS’ frivolous list to see how the IRS addresses this issue.
Reducing the Penalty Amount
The new Section 6702 gives the IRS the authority to reduce the amount of the penalty if the IRS determines that such a reduction would “promote compliance with and administration of the Federal tax laws.”
This is a much different and pro-IRS standard than the “ordinary care” standard (for reasonable cause) that is employed with other IRS tax penalties and it does not include the hardship provisions that are associated with other penalties.