CCA 1315017: Information-return penalties are divisible by failure

Plain-English summary

Chief Counsel advice addresses whether penalties under sections 6721 and 6722 are divisible for refund-suit jurisdiction. The advice concludes that both penalties are based on separate underlying failures and are divisible. A taxpayer therefore needs to pay the divisible amount attributable to one failure, or the general $100 amount stated in the memo, before filing a refund claim and suit under section 7422. The annual statutory cap on the total penalty does not turn the underlying transaction-based penalties into one indivisible lump penalty.

Ruling snapshot

• Question: What did the IRS decide under the facts presented?
• Outcome: Advice given, with the conclusion stated in the memorandum.
• Key authorities: IRC § 6721; IRC § 6722; IRC § 6724; IRC § 7422; IRC § 6110.

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201315017
       Release Date: 4/12/2013
       CC:PA:02MABond                                   Third Party Communication: None
       POSTN-147583-12                                  Date of Communication: Not Applicable

UILC: 6721.00-00, 6722.00-00

date: December 20, 2012

 to:                   (Appeals Officer)
       (Internal Revenue Service, Domestic Operations)

from: (Senior Technician Reviewer)
(CC:PA:01)

subject: Divisibility of I.R.C. Section 6721 and Section 6722 Penalties

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.

       LEGEND

       X            =        ---------------------------------------------------------

       Amount 1     =        ------------------

       Amount 2     =        ------------------

       Years 1-5    =        ------- -------

       ISSUES

       Whether penalties assessed pursuant to the current versions of section 6721 and
       section 6722 are divisible for purposes of establishing refund suit jurisdiction.

       CONCLUSIONS

       The current section 6721 and section 6722 penalties are both divisible penalties for the
       purpose of establishing refund suit jurisdiction.

POSTN-147583-12 2

FACTS

Taxpayer, X, is a ---------------------------------------------------------------------------------------------
----------------------------------------------. X operates a large --------------------- facility (-----------
-----) on --------------- contiguous to X’s -------------------------------------. Mainly from funds
derived from this ----------- facility, X made numerous payments which were required to
be reported on Form 1099. These payments included distributions of income to ----------
-------------- and non-employee compensation to service providers. X, however, failed to
report any of the payments to the payees or to the Service. Additionally, X operated a
large check cashing operation but failed to comply with any of the registration and
reporting requirements under Title 31 and failed to file any forms reporting the currency
transactions.

Based on X’s repeated failures to file and furnish appropriate information returns, the
Service imposed penalties under section 6721 in the amount of Amount 1 and section
6722 in the amount of Amount 2 for taxable Years 1-5.1 X has expressed interest in
seeking review of these penalties in federal district court. Thus your office asked
whether a taxpayer must pay the current section 6721 or 6722 penalty amounts in full in
order to establish refund suit jurisdiction. As a general rule, a taxpayer can only institute
a refund suit in a federal district court or the United States Claims Court if the taxpayer
pays the tax liability in full prior to the commencement of the suit. Flora v. United
States, 362 U.S. 145 (1960). Courts have recognized a limited exception to this so-
called “full payment rule” when the taxes are deemed divisible. In that case, the
taxpayer need only pay a divisible portion of the tax to satisfy the payment prerequisite
to jurisdiction. Thus, you have requested guidance from this office concerning whether
the current versions of section 6721 and section 6722 are divisible for the purpose of
establishing refund suit jurisdiction. This memorandum responds to your request.

LAW AND ANALYSIS

To meet the jurisdictional requirements of a refund suit, a taxpayer must generally make
full payment of assessed taxes due before the matter may be adjudicated. See Flora,
362 U.S. at 177. In general, the partial payment of assessed taxes or a proposed
deficiency is insufficient to support refund suit jurisdiction. Id. The majority opinion in
Flora, however, noted that one possible exception to the full payment rule might exist
where certain “tax assessments may be divisible into a tax on each transaction or event,
so that the full-payment rule would probably require no more than payment of a small
amount.” Flora, 362 U.S. at 175-78, n.38. The Court was referring at that time to
excise taxes. The Court’s analysis, however, hinged divisibility on a tax being levied on
each transaction or event.

Over time a limited exception to the “full payment rule” of Flora has developed with
respect to divisible tax assessments. A divisible tax is one that may be divided into

1
The penalties imposed were for cases of intentional disregard; as such, the “total amount imposed”
limits of $1,500,000 per penalty per year were not applied. See discussion below.
POSTN-147583-12 3

separate portions or transactions, and only a portion of the tax must be paid before a
claim is filed. See Steele v. United States, 280 F.2d 89, 91 (8th Cir. 1960); Korobkin v.
United States, 988 F.2d 975, 976 (9th Cir. 1993); Univ. of Chicago v. United States, 547
F.3d 773, 785 (7th Cir. 2008).

In Steele v. United States, which involved penalties assessed under section 6672, the
Eighth Circuit, noting Flora, adopted the “partial payment rule” holding that a taxpayer
assessed a penalty under section 6672 need only pay the divisible amount of the
penalty assessment attributable to a single employee’s withholding before instituting a
refund action. The taxpayer, therefore, only has to pay the withholding tax of one
employee for each taxable period in order to establish refund suit jurisdiction. Steele,
280 F.2d at 91. See also Boynton v. United States, 566 F.2d 50, 52 (5th Cir. 1977)
(same); Nordbrock v. United States, 173 F.Supp.2d 959 (D.Ariz. 2000), aff’d 248 F.3d
1172 (9th Cir. 2001) (found section 6695(d) tax preparer list penalties are divisible).

The hallmark of a divisible tax is that the gross tax imposed is composed of the
accumulation of discrete assessments based on separate underlying transactions,
rather than being one assessment flowing from a single underlying event. By way of
example, the Ninth Circuit stated that “[t]he paradigm [of a divisible tax] is excise taxes:
If you’re assessed $100 for each of a thousand widgets, you can pay $100 – the whole
tax on one of the widgets – and then go to court.” Korobkin, 988 F.2d at 976 (citing to
Flora, 362 U.S. at 171, n.37, 176, n.38). In like manner, the Eighth Circuit cited
examples of divisible taxes calculated “with respect to each document” and applied “to
each such failure” in contrast to the non-transactional penalty at issue before it. Gates
v. United States, 874 F.2d 584, 587, n.3 (8th Cir. 1989). In sum, divisible assessments
are those taxes or penalties that are composed of several independent assessments
created by separate transactions. Thus, in order to determine if section 6721 and
section 6722 are divisible penalties, one must determine if the penalties can be divided
into separate transactions.

Section 6721, “Failure to file correct information returns” provides in part that “[i]n the
case of a failure described in paragraph (2) by any person with respect to an information
return, such person shall pay a penalty of $100 for each return with respect to which
such a failure occurs, but the total amount imposed on such person for all such failures
during any calendar year shall not exceed $1,500,000.” I.R.C. § 6721(a)(1). Section
6721(a)(2) provides that for purposes of paragraph (1) the “failures described” are “any
failure to file an information return with the Secretary on or before the required filing
date, and any failure to include all of the information required to be shown on the return
or the inclusion of incorrect information.” Section 6721(b) provides for reduced
penalties in the case of correction within specified periods. For correction within 30
days, the reduced penalty is “$30 in lieu of $100” for each failure, with the “total amount
imposed” reduced to $250,000. I.R.C. § 6721(b)(1). For correction after the 30th day
but “on or before August 1 of the calendar year in which the required filing date occurs”
the amounts are “$60 in lieu of $100” and $500,000. I.R.C. § 6721(b)(2). Section
6721(e) provides for higher penalties in the case of intentional disregard of the filing
POSTN-147583-12 4

requirement. The intentional disregard penalty is $250 or the greater of a percentage
depending on the particular information reporting requirement. I.R.C. § 6721(e).

Section 6722, “Failure to furnish correct payee statements” provides in part that “[i]n the
case of each failure described in paragraph (2) by any person with respect to a payee
statement, such person shall pay a penalty of $100 for each statement with respect to
which such a failure occurs, but the total amount imposed on such person for all such
failures during any calendar year shall not exceed $1,500,000.” I.R.C. 6722(a)(1).
Section 6722(a)(2) provides that for purposes of paragraph (1) the “failures described”
are “any failure to furnish a payee statement on or before the date prescribed therefor to
the person to whom such statement is required to be furnished, and any failure to
include all of the information required to be shown on a payee statement or the inclusion
of incorrect information.” Section 6722(b) provides for reduced penalties in the case of
correction within specified periods. For correction within 30 days, the reduced penalty is
“$30 in lieu of $100” for each failure, with the “total amount imposed” reduced to
$250,000. I.R.C. § 6722(b)(1). For correction after the 30th day but “on or before
August 1 of the calendar year in which the required filing date occurs” the amounts are
“$60 in lieu of $100” and $500,000. I.R.C. § 6722(b)(2). Section 6722(e) provides for
higher penalties in the case of intentional disregard of the requirement to furnish correct
payee statements. The intentional disregard penalty is $250 or the greater of a
percentage depending on the particular payee statement requirement. I.R.C. § 6722(e).

There are at least three reasons why penalties imposed under section 6721 and section
6722 can be divided into separate transactions and are thus divisible. First, each
assessment under both 6721 and 6722 is imposed with respect to a distinct failure that
is a separate “transaction” for purposes of the penalty. Under the general rules of both
penalties, a $100 penalty is imposed per failure with respect to the document at issue
(an information return or payee statement, as applicable). I.R.C. §§ 6721(a), 6722(a).
This is precisely the type of transaction-based penalty as those described by the Gates
court as calculated “with respect to each document” and applied “to each such failure.”
Gates, 874 F.2d at 587, n.3. The penalty structure follows the paradigm offered by the
Ninth Circuit, “If you’re assessed $100 for each of a thousand [failures], you can pay
$100 – the whole tax on one of the [failures] – and then go to court.” Korobkin, 988
F.2d at 976.

Second, not only are both penalties applied on a per-failure basis, but the amount of the
penalty applicable to each failure is adjusted based on the circumstances surrounding
the individual failure. Subsection (b) of both 6721 and 6722 provides that the penalty
imposed by subsection (a) of the applicable penalty “shall be $30 in lieu of $100” if “any
failure described in subsection (a)(2) is corrected on or before the day 30 days after the
required filing date.” And subsection (e) of both 6721 and 6722 provides that “[i]f 1 or
more failures…are due to intentional disregard” then “with respect to each such failure”
the penalty shall be $250 or greater. This determination of penalty amount based on
the circumstances of each failure shows that each failure is a separate, distinct
transaction upon which the 6721 and 6722 penalties are based.
POSTN-147583-12 5

Third, the section 6724 reasonable-cause waiver applicable to sections 6721 and 6722
shows that these are transaction-based penalties. The waiver reads in relevant part:
“No penalty shall be imposed under this part with respect to any failure if it is shown that
such failure is due to reasonable cause and not to willful neglect.” I.R.C. § 6724(a)
(emphasis added). Thus, like the penalty amount, penalty waiver is determined on a
per-transaction basis.

In sum, based on the foregoing, the current section 6721 and section 6722 penalties
should be treated as divisible penalties. A taxpayer assessed with a penalty under
either of these sections need only pay the divisible amount of the penalty attributable to
a single failure, or $100 under the general rule, before filing a refund claim and
instituting a refund suit under section 7422.

It should be noted that under both sections 6721 and 6722 the “total amount imposed”
per section on a person “for all such failures during any calendar year shall not exceed
$1,500,000.” I.R.C. §§ 6721(a), 6722(a). This maximum is reduced in the case of
corrected failures, and does not apply to cases of intentional disregard. I.R.C. §§
6721(b), (e); 6722(b), (e). While an argument might be made that the “total amount
imposed” becomes a single lump penalty rather than a penalty based on separate
underlying transactions, this argument is without merit. A cap on the gross penalty
amount actually imposed on a taxpayer does not change the fact that the penalty is
calculated first and foremost by adding up the individual penalties assessed on each
separate underlying failure.

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call ----------------at ---------------------- if you have any further questions.