Qualified Amended Returns: How to Avoid Tax Penalties

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Qualified Amended Returns: How to Avoid Tax Penalties

A “qualified amended return” is an amended tax return that, if properly filed before a taxpayer is “on the IRS’s radar,” protects a taxpayer against accuracy-related penalties—in layman’s terms, it is a get-out-of-jail-free card.  The Treasury regulations, in effect, provide a “safe harbor” that allows a taxpayer to avoid tax penalties.  A qualified amended return must, by definition, be filed before the IRS begins an investigation of the taxpayer or the promoter of a transaction in which the taxpayer participated.  Much like the IRS’s voluntary disclosure practice and streamlined filing compliance procedure, the qualified-amended-return provisions are intended to encourage voluntary compliance by giving taxpayers an avenue to proactively fix past mistakes.

A Qualified Amended Return Must Be Timely.

A “qualified amended return” is an amended return that is filed after the due date of the original return and before the earliest of several important events.  In other words, the amended return must be “timely.”

Specifically, a taxpayer can file a qualified amended return (or administrative adjustment under section 6227) if the original tax return was not fraudulent and the amended return is filed before:

  • the date that the IRS contacts the taxpayer about an examination (including a criminal investigation) of the tax return;
  • the date on which a person described in section 6700(a) is first contacted by the IRS about the examination of an activity described in section 6700(a) related to any tax benefit claimed by the taxpayer;
  • for certain pass-through items, the date on which the pass-through entity is first contacted by the IRS in connection with an examination;
  • the date that the IRS serves a John Doe summons under section 7609(f) regarding the taxpayer’s tax liability.

The date that the IRS contacts a promoter, organizer or material advisor concerning a listed transaction for which the taxpayer has claimed a tax benefit.

What Penalties Can Be Avoided Through a Qualified Amended Return?

A qualified amended return allows a taxpayer to avoid accuracy-related penalties that would otherwise be imposed on an “understatement” of tax that is reflected on the taxpayer’s original tax return.

Generally, section 6662 imposes an accuracy-related penalty on an underpayment of tax.  The section 6662 penalty applies to understatements attributable to any of the following items:

(1) Negligence or disregard of rules or regulations.

(2) Any substantial understatement of income tax.

(3) Any substantial valuation misstatement under chapter 1.

(4) Any substantial overstatement of pension liabilities.

(5) Any substantial estate or gift tax valuation understatement.

(6) Any disallowance of claimed tax benefits by reason of a transaction lacking economic substance (within the meaning of section 7701(o)) or failing to meet the requirements of any similar rule of law.

(7) Any undisclosed foreign financial asset understatement.

(8) Any inconsistent estate basis.

(9) Any overstatement of the deduction provided in section 170(p).

Accuracy-related penalties under section 6662 can range from 20% to 40%.

A Qualified Amended Return Does Not Avoid Fraud Penalties.

Notably, a qualified amended return does not protect against fraud penalties.  That is, where an understatement relates to a fraudulent position on the taxpayer’s original return, a qualified amended return will not insulate the taxpayer from fraud penalties.  A taxpayer with a fraudulent tax return may, however, be a candidate for a voluntary disclosure.

What is a John Doe Summons?

The regulations provide that an amended return will not constitute a qualified amended return if the IRS has already served a John Doe summons on a third party with respect to the taxpayer’s tax liability.  A John Doe summons is a summons that does not identify the person with respect to whose liability the summons is issued.  See Release the Kraken?—In re Tax Liability of John Does.  Since Congress codified the IRS’s power to issue John Doe summonses in 1976, courts have increasingly approved the IRS’s use of John Doe summonses.  See Coinbase: The Government Strikes Back, AgainSee also IRS Gets Green Light to Seek Information from Third Parties Regarding Panama Offshore Legal Services.

What is a Listed Transaction?

For taxpayers who have claimed tax benefits from undisclosed listed transactions, an amended return will not be treated as a qualified amended return unless it is filed before the IRS contacts a promoter, organizer, seller, or material advisor concerning the listed transaction.   A listed transaction is defined as a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has determined to be a tax avoidance transaction and identified by notice, regulation, or another form of published guidance as a listed transaction. Tax Shelter Penalties: Listed Transactions and Reportable Transactions.

An undisclosed listed transaction, therefore, is a transaction that: (1) is the same or substantially similar to a listed transaction as defined in Section 1.6011-4(b)(2); and (2) was not previously disclosed by the taxpayer.

A taxpayer is no longer eligible to file a qualified amended return once: (1) the IRS first contacts them regarding an examination of their liability under section 6707(a) with respect to the undisclosed listed transaction; or (2) the IRS issues a request for information relating to the listed transaction.

Notably, under Treasury regulations, a qualified amended return includes an amended return that is filed solely to disclose information pursuant to Section 1.6011-4, provided that the taxpayer also makes the required disclosure to the Office of Tax Shelter Analysis.

Takeaway. 

A qualified amended return can be a formidable defense against IRS accuracy-related penalties.  A qualified amended return, however, must be filed “timely”—that is, before the taxpayer or the issue is already on the IRS’s radar.  Once the IRS begins an examination or criminal investigation, it is too late.  But for some taxpayers, a qualified amended return can serve as a veritable a get-out-of-jail-free card when it comes to civil penalties.