IRS gives small businesses temporary reprieve from tax shelter penalty

In 2004, Congress imposed tough monetary penalties on taxpayers engaging in abusive tax shelter transactions. Since then, Congress and the IRS have recognized that the penalties may be out of line with the offenses in some cases. The IRS announced in July that it is temporarily suspending collection of these penalties in many small business cases.

Code Sec. 6707A penalty

Code Sec. 6707A imposes a penalty on taxpayers that fail to disclose a reportable transaction. The Tax Code requires that individuals and businesses disclose their involvement in so-called reportable transactions. One type of reportable transaction is a "listed transaction."

A listed transaction is a transaction that is the same as or substantially similar to the types of transactions determined by the IRS to be tax avoidance transactions. The IRS periodically publishes a roster of listed transactions.

Congressional concern

In June, a bipartisan group of lawmakers asked the IRS to suspend the collection of Code Sec. 6707A penalties on small businesses. According to the lawmakers, some small business owners were unaware that the transactions were abusive and the penalties far outweigh any benefits they received. These disproportionate consequences were unexpected at the time the Code Sec. 6707A penalty was enacted, the lawmakers told the IRS.

The IRS acknowledged the lawmakers’ concerns and agreed to suspend the Code Sec. 6707A penalty in cases where the annual tax benefit from the transaction is less than the penalty imposed. The penalty is $100,000 for individuals and $200,000 for other taxpayers, per year.

Temporary suspension

The suspension is temporary. It will expire after September 30, 2009. The IRS also indicated that it continue to examine cases of suspected tax shelter activity.

Pending legislation

Legislation has been introduced in the Senate to reform the Code Sec. 6707A penalty to help small businesses. The Small Business Tax Relief Act of 2009 has been referred to the Senate Finance Committee for action. It is uncertain if the committee will take up the bill this year and if the House will pass similar legislation.

(Letter from IRS Commissioner Douglas Shulman to Congress, June 12, 2009)