Latest Article: Calculating the Sec 6707A Penalty: When a Return is not THE return--Yari v. Commissioner
David Neufeld today published his latest article in the Leimberg Information Services Inc. Income Tax Newsletter. The article discusses the recent Tax Court decision in Yari v. Commissioner that found that the first filed return is used to calculate the listed transaction penalty even when that return is replaced with a corrected return showing zero tax liability and zero impact from the listed transaction. Accordingly this taxpayer had a $100,000 penalty in a year when he had zero tax liability. The article is reproduced below.
Steve Leimberg's Income Tax Planning Email Newsletter - Archive Message #75
From: Steve Leimberg's Income Tax Planning Newsletter
Subject: David Neufeld on Yari v. Commissioner: When a Return is Not the Return for Purposes of Calculating the Section 6707A Penalty
David Neufeld provides members with his analysis of Yari v. Commissioner. David S. Neufeld is a tax and T&E lawyer in Princeton, NJ. He represents clients throughout the world, doing both planning and controversy work (administrative and Tax Court). David is also an expert witness in civil cases around the country arising from 419 plans. Most notably, David represents the government of the Island of Nevis, for which he has drafted several laws, including the Nevis LLC Ordinance and recent proposed amendments to permit series LLCs and cell captive insurance companies. For more, go to www.DavidNeufeldLaw.com
Now, here is David Neufeld’s commentary:
In Yari v. Commissioner, the Tax Court sided with the Service in upholding a$100,000 penalty under Section 6707A(b)(2)(A) assessed against Yari for failing to report a listed transaction, despite the fact that during the course of the case, Congress passed the Small Business Jobs Act of 2010 that retroactively modified how the penalty should be calculated. Yari is significant for a number of reasons, not the least of which is that is a case of first impression dealing with the proper calculation of penalties under Section 6707A(b). [TO READ MORE CLICK ON "READ MORE" TO THE RIGHT]
There are times when reading a case is so difficult because you can’t stop
shaking your head in disbelief and checking the first page to see if it is April
1st. The Tax Court’s decision in Yari that was reported on September 15,
2014 is such a case.
In Yari the Tax Court, in a case of first impression, determined that, when
calculating the I.R.C. section 6707A penalty for failing to disclose a listed
transaction, the basis of the penalty is the return as originally filed and any
further properly and timely amended returns are to be completely disregarded.
Yes, an amended return is not “the” return for this purpose.
From 2002 to 2007 Mr. Yari engaged in a transaction involving his Roth IRA;
beginning in 2004 this arrangement was designated a listed transaction.
Exactly what he did is irrelevant for our purposes. Suffice it to say that on the
2004 return, which he filed on October 17, 2005 with the information then
available to him, he understated his income as a result of this transaction by
almost $483,000 and therefore underpaid his income tax by over $135,000.
Furthermore Mr. Yari did not disclose his participation in the Roth IRA
scheme when this return was filed (today that would involve the Form 8886).
Audits began for Mr. Yari’s 2002 to 2007 tax years at various times. The Tax
Court petitions were filed for 2002 to 2004 in December 2007; for 2005 in
December 2009; and for 2006 and 2007 in July 2010. All were settled by
stipulation and decisions filed by three different judges during 2011 and 2012.
Focusing on 2004, this means that the audit and appeals process was likely
commenced during 2006 and completed in September, 2007.
According to the opinion Mr. Yari amended his 2004 return during the audit
(in 2006) to correct an error in the return, resulting in negative taxable income.
He then amended it again after the petitions were filed to reflect a net operating
loss carried back from 2008. In both cases he included the $483,000 of income
from the Roth IRA arrangement originally omitted from his return. In other
words, even with the reversal of the position taken on the return as filed his
taxable income was negative in 2004.[i]
Parallel to these audits and Tax Court proceedings the Service assessed
$100,000 as a section 6707A penalty in September, 2008 and sent a Notice of
Levy in February, 2009. The taxpayer, Mr. Yari, then requested a collection
due process (“CDP”) hearing.
In September, 2010, during the pendency of the CDP, Congress, in the Small
Business Jobs Act of 2010, amended section 6707A to change the calculation
of the penalty. While the old version would have resulted in a flat penalty of
$100,000 regardless of the magnitude of attempted tax savings, the amendment
now directs a calculation of the penalty at “75% of the decrease in tax shown
on the return as a result of such transaction,” with a minimum penalty of
$5,000 and a maximum of $100,000.[ii] Thus the penalty had some correlation
to the purported tax savings shown on the return.
None of this is contested; the taxpayer conceded and the Service agreed that
the taxpayer participated in the listed transaction, failed to disclose it and
should be subject to the section 6707A penalty as amended. The problem for
the court was which return to use to calculate the penalty.
The Service insisted that it is the original return, disregarding all amended
returns and, with a decrease in tax shown on that return of $135,000, the
maximum $100,000 penalty applied. The taxpayer’s position was that the last
amended return should be used, which, with negative taxable income and an
overpayment, would result in the minimum $5,000 penalty. The Tax Court
agreed with the Service.
The court discussed its jurisdiction and its standard of review. We’re more
interested in this commentary on how they decided to agree with the Service.
This is, in the end, a case of statutory interpretation: what did Congress mean
by “the return?”
After reciting the usual suspects of statutory interpretation precedent (rely on
the statute’s “plain and ordinary meaning” unless it “would produce absurd or
unreasonable results,” no need to use “other tools of statutory interpretation” if
the statute is “clear and unambiguous” but, if not, then the court can look to
legislative history) the court states unequivocally the “the statute is clear and
unambiguous: The penalty is calculated with reference to the ‘tax shown on the
return’.”[iii] Right. But that is not the answer or even an answer, it just restates
the question: What is the “the return?”
As if repeating the question supplies the answer, the court then seamlessly
concludes without further explanation that “the return” must naturally be the
return as originally filed. It seems that the court gets there by devising a novel
formula that the original return is the document giving rise to the disclosure
obligation and therefore the only one that matters:
When we look to the penalty provision as a whole, it is clear that
Congress has penalized the failure to disclose participation in a listed or
otherwise reportable transaction on the return or other information
statement giving rise to the disclosure obligation. If the taxpayer fails to
report the transaction on that return or information statement, then the
penalty is based on the tax shown on that return or information
statement, not some other, later filed return or some hypothetical tax.
Congress did not say that the penalty should be calculated by reference
to tax shown on a return; it did not say to calculate the penalty using the
tax required to be shown; and it did not say to calculate the penalty using
the decrease in tax resulting from participation in the transaction.
Congress very clearly linked the penalty to the tax shown on a particular
return—the return giving rise to the reporting obligation.[iv]
Sure, it is clear and unambiguous that the penalty is to be derived to some
extent from the tax shown on the return. But the problem with the court’s
reasoning is that the phrase “tax shown on the return” is not clear and
unambiguous when it comes to the question of which return to use.
There is nothing inherent in that language or the context of that language that
says an amended return is to be disregarded. What if the amended return was
filed before the audit was commenced? This ruling would have the Service dig
up the original return for purposes of computing this penalty as if it were never
amended. The language could be used to support that.
What if the facts were reversed, with the original return showing a putative tax
savings much smaller than shown on the amended return? The Service can be
counted on making the reverse argument, claiming that the clear language of
the statute is to use the last filed return. The language could be used to support
that too. If the same legislative language can serve opposite conclusions then
it is not clear and unambiguous.
Furthermore, to assert a $100,000 penalty in a year where there is zero tax
savings from the offensive transaction is an absurd and unreasonable result, the
very result courts normally strive to avoid. While that is true generally, that is
particularly on target in this case: the original return was wrong and the first
amended return simply corrected that error that had nothing to do with the
listed transaction. Had there been no error on the original return that return
would have shown negative taxable income even ignoring the tax shelter and
there would have been no case. Does the result get much more absurd than
penalizing a taxpayer for making an error in the government’s favor?
The court does review the legislative history, sparse as it is, but only to defuse
the taxpayer’s argument that the legislative history supports his position that
the penalty should be somewhat proportionate to the underlying improperly
attempted tax savings. In this regard the court mentioned and dismissed as
irrelevant the legislative history for the House Bill that was supplanted by the
final Bill as well as the Joint Committee’s General Explanation (the “Blue
Book”). While this may be accurate as a matter of strict statutory
interpretation, it is pedantic.
The author observed the development and process of these amendments all
when it happened; many did. There is no question that Congress’ actions to
amend section 6707A were to correlate and make proportional the penalty to
the offense measured by the attempted tax savings. Nowhere did Congress
consider how these tax savings were attempted, whether by a first or amended
Through section 6707A as amended Congress asked only if there was an
attempt to game the system with a reportable transaction, whether it was
disclosed and how much was at stake. If nothing is at stake then pay $5,000 as
a strict liability penalty.
But the fact that taxpayers before the amendment were being assessed upwards
of $300,000 per year with little or no tax due was the whole motivation for the
amendment, its raison d'être. This disproportion was viewed by Congress as
unreasonable. We know that because the House Ways & Means Committee
and Joint Committee said as much even if the court refuses to listen: the House
Committee viewed the new provision to ensure “a penalty amount that will be
proportionate to the misconduct;”[v] the Joint Committee described the
problem under the original law as an “unconscionable hardship . . . as a result
of the magnitude of the penalty [that] exceeds the tax savings claimed.”[vi] If
none of this matters to the court, how about answering the question, “why was
the law changed if not to avoid results such as this?”
The Tax Court sees the language of section 6651(a)(2) and (c)(2) as bolstering
We note also section 6651(a)(2), which imposes an addition to tax for
failure “to pay the amount shown as tax on any return specified [by parts
of the Code]”. At first glance, this addition to tax would ignore the
correct tax liability, and a taxpayer who reported a tax greater than the
actual tax due would suffer. But section 6651(c)(2) ameliorates this
potentially harsh result by providing: “If the amount required to be
shown as tax on a return is less than the amount shown as tax on such
return, subsections (a)(2) and (b)(2) shall be applied by substituting such
lower amount.” Congress obviously knows how to link a penalty or an
addition to tax to the tax required to be shown on the return and has done
so. Consequently, the fact that it did not do so in section 6707A tends to
bolster our holding that the penalty applies to the amount shown on
petitioner’s first filed return.[vii]
However, while there is a distinction between sections 6707A and 6651, it is
not the distinction identified by the court; it is not the omission of language
such as that in section 6651(c)(2) that matter, it is the very basis of the penalty
itself that differentiates these section and makes any comparison, even a
comparison of legislative craftsmanship, inapposite.
The addition to tax referenced by section 6651(a)(2) is the penalty for
underpaying tax properly due in a timely manner; there is a direct connection
between the tax due and the offending act. Unlike section 6651(a)(2), section
6707A is not truly a penalty for underpaying tax. It is a penalty for an act
unrelated to any tax payment, the act of not properly disclosing participation in
a listed transaction.
Under the original formulation of this penalty, this was intended by Congress
to be a strict liability penalty regardless of tax liability, up to a capped amount.
With input from the IRS Taxpayer Advocate, the bar and others, Congress
recognized the potential for injustice for such a large fine in many cases.
The question then arose as how to reinstate a just solution. The reference to
75% of the reduction in tax shown on the return was the way chosen, although
there remains a $5,000 strict liability amount. Subject to the stated dollar cap
and floor (neither of which exists in section 6651(a)(2)), this penalty is only
derivative from the amount that should have been on the return. It is not a
penalty based on the reduced tax amount; the penalty is only calculated by that
target number. As this is a completely different type of penalty, whatever
Congress did or did not do in section 6651 would seem irrelevant in
interpreting section 6707A.
If section 6651(a)(2) and (c)(2) is instructive at all with regard to section
6707A despite its difference in purpose and scope, it is that Congress was
focused in section 6651(c)(2) on making the penalty just by making it a direct
and precise correlation between tax actually due and the penalty assessed,
without concern for the return that was filed first. To say the absence of
language analogous to section 6651(c)(2) from the 2010 amendment to section
6707A was intentional seems to suggest that Congress intended to ignore
justice in that section while adhering to it elsewhere. As the court says,
“Congress obviously knows how to link a penalty or an addition to tax to the
tax required to be shown on the return. . . .”
That interpretation is unreasonable as is the consequential result, and as such
should have some impact on the court’s legislative interpretation.
It is eminently reasonable to maintain, as Congress intended, the
proportionality between the taxes avoided through participation in a listed tax
shelter and the section 6707A penalty, and that when, in effect, no taxes are
avoided, whether that is determined on an originally filed return or an amended
one, the penalty should reflect that proportionality. But not according to the
Tax Court. I keep checking the Tax Court web site, hoping to find a document
saying “just kidding.”
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE
LISI Income Tax Planning Newsletter #75, (October 8, 2014)
at http://www.LeimbergServices.com Copyright David Neufeld 2014.
Reproduction in Any Form or Forwarding to Any Person Prohibited – Without
Express Written Permission.
[i] It should be noted that due to the 2008 NOL carryback, the taxpayer had an
overpayment for every year involved except 2002.
[ii] Section 6707A(b)(1).
[iii] Yari v. Commissioner, at 14.
[iv] Yari v. Commissioner, at 14-15
[v] H.R. Rept No. 111-447 to H.R. 4849; see also section 2 of H.R. 4068 and
sec. 2041 of H.R. 5297, both from the 111th Congress, which became the Small
Business Jobs Act of 2010 and virtually identical to the contemporaneous sec.
111 in H.R.4849 which was never passed by the Senate but contains the only
report on the subject
[vi] Staff of J. Comm. on Taxation, General Explanation of Tax Legislation
Enacted in the 111th Congress, at 476-480 (J. Comm. Print, 478 (2011).
[vii] Yari v. Commissioner, at p.19, footnote omitted.