In Chief Counsel Memo 201623010, the IRS addressed whether Section 6702 frivolous return penalty can be abated due to the taxpayer’s mental incapacity. One would think that a mentally incapacitated person would not be liable for a penalty for filing a frivolous tax return.
Mental Incapacity, Generally
The law recognizes that mental incapacity as a defense or exception to various laws. For example, mentally incapacitated persons may not be held criminally liable for most crimes, contracts entered into by mentally incapacitated persons may not be enforceable, and wills and trusts executed by mentally incapacitated persons may not be valid. Mental incapacity can even be a bar to standing trial.
The idea is that mentally incapacitated persons do not have the requisite legal intent to trigger or violate the law. They are not morally culpable and should not be held to the same standard imposed on others by the law.
Tax Penalties, Generally
The policy for penalties is just the opposite. With penalties, the idea is that the person has the requisite intent or acted knowingly. They are to be punished for violating the law.
This same policy applies to tax penalties. According to the IRS, penalties exist to encourage voluntary compliance with our tax laws. So one would think that taxpayers would not be subject to tax penalties if they are mentally incompetent and this caused them to violate the law. The IRS did not reach this conclusion for the specific tax penalty at issue.
The Section 6702 Frivolous Return Penalty
The memo addressed the Section 6702 frivolous return penalty. This penalty applies if:
- the taxpayer files a document that purports to be an income tax return.
- the purported return lacks the information needed to judge the substantial correctness of the self-assessment or contains information indicating the self-assessment is incorrect; and
- the position on the document is frivolous or demonstrates a desire to delay or impede the administration of Federal tax law.
The IRS’s Reasoning
The IRS memo starts by analyzing the Section 6663 fraud penalty. The Section 6663 fraud penalty applies where there is an underpayment of tax due to fraud. The court cases that address mentally incapacitated taxpayers and the Section 6663 fraud penalty have reached different conclusions. These cases turn on whether the taxpayers mental condition established that they had fraudulent intent.
These cases that address the Section 6663 fraud penalty do not apply according to the IRS memo. Like the Section 6663 fraud penalty, the Section 6702 frivolous return penalty accounts for the taxpayer’s intent. Specifically, the third requirement for the Section 6702 frivolous return penalty, that the taxpayer had a desire to delay or impede the administration of Federal tax laws, accounts for the taxpayer’s intent. The IRS memo notes the disjunctive “or” in this third requirement, concluding that the intent requirement does not apply when the document contains a position the IRS has found to be frivolous.
This strict interpretation means that the intent requirement and language in the Code has no meaning. A taxpayer who is being considered for this penalty will no doubt taken a frivolous position, so the second intent part of the requirement will never be applicable.
The IRS’s strict interpretation reaches the odd result that a mentally incompetent taxpayer who commits fraud may not be liable for a tax penalty, but one that files a frivolous return will always be liable for a tax penalty.