CCA 200004033: Increased late payment penalty applies to substitute returns after levy notice

Plain-English summary

The Kansas City Service Center asked whether the higher monthly failure to pay penalty rate can apply when the IRS prepares a substitute return for someone who did not file. Chief Counsel advised that a substitute return prepared under § 6020(b) is treated as the taxpayer's return for this penalty, so the rate rises from 0.5% to 1% after the required levy notice. Filing a late individual or joint return for the same year does not reset the higher rate for the taxpayer who received notice. A spouse who later signs the joint return is not liable for the higher rate until that spouse receives the required notice. The memorandum says the IRS need not separate the liability in its computer system unless the spouse asks.

Ruling snapshot

• Question: Does the higher § 6651(a)(2) penalty rate apply to substitute returns and persist after a late return is filed?
• Outcome: Advice given: yes for the notified taxpayer; no for a spouse who has not received the required notice.
• Key authorities: IRC §§ 6020(b), 6651(a)(2), 6651(d), 6651(g), 6331.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
                                I N T E R N AL R E V E N U E S E R V I C E
                                     WASHINGTON, D.C. 20224

Number: 200004033
Release Date: 1/28/1999
CC:DOM:IT&A:4
TL-N-3720-99
                                                              Date:12/01/1999
UILC: 6651.04-00
      6651.11-00
      6651.20-00

INTERNAL REVENUE SERVICE NATIONAL OFFICE SERVICE CENTER ADVICE

MEMORANDUM FOR ASSISTANT DISTRICT COUNSEL, KANSAS-MISSOURI
               DISTRICT, KANSAS CITY
               CC:MSR:KSM:KCY

FROM:                  Acting Assistant Chief Counsel (Income Tax & Accounting)
                       CC:DOM:IT&A

SUBJECT:               Significant Service Center Advice

       This responds to your request for Significant Advice dated July 26, 1999, in
connection with a question posed by the Kansas City Service Center. The Service
Center requested guidance with respect to the increase of the failure to pay penalty
under § 6651(a)(2) of the Internal Revenue Code as provided under § 6651(d) on a
substitute for return (SFR) prepared by the Service.

                                          Issues

        1. Whether the increased rate to the addition to tax under § 6651(a)(2)
(failure to pay tax as shown on the return) as provided under § 6651(d) applies to
assessments made under the SFR program.

      Assuming the increased rate under § 6651(d) applies to the § 6651(a)(2)
penalty for an SFR, the following issues may arise.

       2. Whether the increased rate to the § 6651(a)(2) penalty, currently in effect
for an amount unpaid on an SFR, continues at the increased rate for an amount of
unpaid tax shown on a delinquent return (other than a joint return) filed by the
taxpayer for the same tax year as the SFR.

      3. Whether the answer to issue number two is different if the taxpayer files a
delinquent joint return.

        4. Whether a spouse who files a delinquent joint return with a taxpayer
currently liable for the increased rate to the § 6651(a)(2) penalty on an SFR is also
liable for the increased rate to the § 6651(a)(2) penalty for the unpaid liability on the
delinquent return.

                                      Conclusions

        1. The increased rate to the § 6651(a)(2) penalty under § 6651(d) applies to
all returns prepared by the Service under the SFR program.

       2. The increased rate to the § 6651(a)(2) penalty under § 6651(d) will
continue at the increased rate after a taxpayer files a delinquent return (single,
married filing separate, or head of household) when the increased rate is already in
effect on an SFR for the same tax year.

      3. The increased rate to the § 6651(a)(2) penalty under § 6651(d) will
continue at the increased rate after a taxpayer has filed a delinquent joint return
when the increased rate is already in effect on an SFR for the same tax year.

       4. Because a spouse who files a delinquent joint return with a taxpayer liable
for the increased rate to the § 6651(a)(2) penalty in effect for an SFR for the same
year has not received the required notice under § 6331, the spouse is not liable for
the increased rate for the unpaid liability on the joint return.

                                         Facts

        The Service currently prepares income tax returns for individuals who fail to
file returns or who file fraudulent returns, under the authority of § 6020(b) of the
Code. These returns are prepared using the Substitute for Return (SFR)
procedures. Under the SFR procedures, the Service establishes a taxpayer
account on the computer and simultaneously prepares and mails a thirty-day letter
to the taxpayer. If the taxpayer fails to respond to the thirty-day letter, the Service
mails a statutory notice of deficiency to the taxpayer. Both the thirty-day letter and
the notice of deficiency issued for a return prepared under the SFR procedures
include the § 6651(a)(2) penalty. If the taxpayer does not petition the United States
Tax Court, the Service will assess the tax liability determined in the notice of
deficiency.

      When the taxpayer does not pay the assessed liability, the Service issues the
usual notice and demand letters to the taxpayer for payment of the liability. If
payment is not received by the Service for the liability listed on the notice and
demand letter, the Service issues a notice of intent to levy as provided under
§ 6331. Pursuant to § 6651(d), the failure to pay penalty under § 6651(a)(2) will
increase from 0.5 percent to 1 percent per month after the final notice of intent to

levy is issued. However, the computer program for the SFR procedures does not
compute the increased rate to the § 6651(a)(2) penalty on an SFR; the lower initial
rate is always in effect.

        After an SFR has been prepared and assessed against a taxpayer, the
taxpayer sometimes elects to file a delinquent return in lieu of the SFR. In most
instances the Service accepts the delinquent return as correct and makes the
proper adjustments to the taxpayer’s liability on the computer system. The SFR
usually has a filing status of single or married filing separate. Sometimes the
delinquent return filed by the taxpayer has a different filing status than the SFR
(i.e., married filing jointly).

                                      Discussion

       Section 6020(b) of the Code provides that the Service may execute a return
for a taxpayer who fails to make any return required by any internal revenue law or
regulation at the time prescribed, or who makes, willfully or otherwise, a false or
fraudulent return.

       Section 6651(a)(2) of the Code imposes a penalty for failure to pay the
amount shown as tax on a return on or before the due date prescribed for payment
of such tax (with regard to extensions), unless it is shown that such failure is due to
reasonable cause and not due to willful neglect. The amount of the penalty is 0.5
percent of the amount of unpaid tax if the failure is for not more than one month,
with an additional 0.5 percent for each additional month or fraction thereof during
which the failure continues, not exceeding 25 percent in the aggregate. Except as
provided under § 6651(g), the addition to tax under § 6651(a)(2) only applies if a
return is filed by the taxpayer. Section 6651(g) of the Code provides that for
purposes of § 6651(a)(2), a return prepared by the Service under § 6020(b) is
treated as a return filed by the taxpayer.

       Section 6651(d) of the Code provides, in part, that the additions to tax under
§ 6651(a)(2) will increase from 0.5 percent to 1 percent per month if the notice
under § 6331(a) or § 6331(d) is given. The increased rate under § 6651(d) begins
at the beginning of the month after the earlier of: (1) the day which is 10 days after
the date on which notice is given under § 6331(d); or (2) the day on which notice
and demand for immediate payment is given under the last sentence of § 6331(a).

       Section 6331 of the Code generally provides rules for levy and distraint. The
last sentence of § 6331(a) provides that in a jeopardy situation, notice and demand
for immediate payment may be made and collection by levy is lawful without regard
to the period of days provided under § 6331(d). Section 6331(d) of the Code
provides that 30 days prior to any levy the Service must provide notice to the
taxpayer of the Service’s intent to make such levy.

Issue 1

       The increased rate to the failure to pay penalty under § 6651(a)(2) as
provided under § 6651(d) applies to all returns prepared by the service under the
SFR program. Returns prepared under the SFR program are returns prepared
under the authority of § 6020(b). See Significant Service Center Advice (October
20, 1999) (attached). Thus, because § 6651(g) provides that a § 6020(b) return is
treated the same as a return filed by a taxpayer for purposes of § 6651(a)(2), an
SFR is subject to the same increased rate to the § 6651(a)(2) penalty as a return
filed by the taxpayer.

Issue 2

         The increased rate to the § 6651(a)(2) penalty as provided under § 6651(d)
continues at the increased rate after the taxpayer files a delinquent return (single,
married filing separate, head of household) when the increased rate is already in
effect for an SFR liability on the same year. The legislative history to
§ 6651(d) states that the purpose of the increased rate to the § 6651(a)(2) penalty
is to compensate the Service for the increased cost of collection methods, such as
telephoning or visiting the taxpayer, which generally occur after the notice of intent
to levy under § 6331(d) is issued to the taxpayer. See H.R. Rep. No. 99-426, at
832 (1985). Even though the taxpayer files a delinquent return after an SFR has
been filed, it is most likely in direct response to the more expensive collection
methods that the Service switched to after issuing the notice of intent to levy.
Additionally, because the taxpayer still has a tax liability from the delinquent return,
the Service will remain involved in the more expensive methods of collection for the
liability. In adhering to the purpose of the legislative history and because the Code
does not indicate otherwise, the increased rate to the § 6651(a)(2) penalty that is in
effect for an SFR will continue in effect even after a taxpayer has subsequently filed
a delinquent return.

Issue 3

        The increased rate to the § 6651(a)(2) penalty under § 6651(d) continues at
the increased rate even after the taxpayer files a delinquent return when the
increased rate is already in effect on an SFR for the same tax year. The taxpayer
in this situation is similar to the taxpayer under issue two, except that the taxpayer
has filed a joint return. Although the spouse who files the joint return with the
taxpayer has not received the § 6331(d) notice (as required under § 6651(d) for the
increased rate to be in effect), the taxpayer has received the § 6331(d) notice.
Thus, for the same reasons as provided under issue 2, the increased amount to the
§ 6651(a)(2) penalty remains in effect even after the taxpayer has subsequently
filed a joint return.

Issue 4

       A spouse who files a delinquent joint return with a taxpayer liable for the
increased rate to the § 6651(a)(2) penalty on an SFR is not liable for the increased
rate on the delinquent joint return. In this situation the spouse has not received a
notice under § 6331 as required by § 6651(d). Thus, until a notice under § 6331
has been issued to the spouse, the increased rate to the § 6651(a)(2) penalty can
not be imposed on the spouse. Although the spouse is not legally liable for the
increased rate of the § 6651(a)(2) penalty that has already accrued on the liability,
we see no reason to separate the liability on the computer system unless a specific
request is made by the spouse.

      If you have any questions or concerns regarding this memorandum, please
contact Brad Taylor at (202) 622-4940.

                                                HEATHER C. MALOY

                                              By:
                                                JUDITH M. WALL
                                                Chief, Branch 4

Attachment: Copy of Significant Service Center Advice (October 20,
1999)(199950033).