False withholding credits create an underpayment subject to fraud penalties

Plain-English summary

Chief Counsel advised that overstated withholding credits on a false Form 1099-OID can create an underpayment subject to the section 6663 civil fraud penalty. Treasury Regulation section 1.6664-2 requires the tax shown on the return to be reduced by overstated withholding, which can make that amount negative and increase the underpayment. The Tax Court’s Rand decision did not change that result because Rand concerned disallowed refundable credits, not overstated withholding. The resulting underpayment is governed by the section 6662 or 6663 penalties rather than the section 6676 erroneous-refund-claim penalty.

Ruling snapshot

• Question: Whether Rand prevents application of the civil fraud penalty to false Form 1099-OID withholding claims
• Outcome: No; overstated withholding can create an underpayment subject to sections 6662 or 6663
• Key authorities: I.R.C. §§ 6662, 6663, 6664, 6676; Treas. Reg. § 1.6664-2; Feller v. Commissioner; Rand v. Commissioner

Full text (IRS public release)

ID:       CCA_2015040813532910
UILC:     6663.00-00, 6664.01-00

Number: 201543016
Release Date: 10/23/2015
From:
Sent: Wednesday, April 08, 2015 1:53:29 PM
To:
Cc:
Bcc:
Subject: RE: Application of the civil fraud penalty on OID Scheme cases after Rand -- POSTS-109898-15


Hi -------------,

Nice speaking with you this morning. As I mentioned, the Rand opinion does not affect
the validity of the advice we provided in the 2010 memo that you referenced concerning
the application of the section 6663 civil fraud penalty to taxpayers who overstate
withholding credits on a false Form 1099-OID (attached).

The case I mentioned, Feller v. Commissioner, is also attached here. The taxpayer in
Feller, like the taxpayers you inquired about, overstated withholding credits. Treas.
Reg. 1.6664-2(a) provides the following formula for calculating the amount of an
underpayment: W – (X + Y – Z), where W equals the amount of income tax imposed, X
equals the amount shown as tax due on the return, Y equals amounts not so shown but
previously assessed or collected without assessment, and Z equals the amount of any
rebates made. Treas. Reg. 1.6664-2(c)(1) specifically provides that, in calculating the
amount of an underpayment, the amount of tax shown as tax on a return (X) shall be
decreased by the amount of any overstated withholding. As was the case in Feller, this
decrease may result in a negative amount of tax shown. This decrease in the amount
shown as tax on the return will give rise to or increase an underpayment of tax. See
Treas. Reg. 1.6664-2(g), Example 3. An underpayment of tax is subject to the section
6662 or 6663 penalties, not the section 6676 penalty.

By contrast, the taxpayers in Rand didn’t overstate their withholding; they claimed
refundable credits, like the EITC and additional child credit, that were ultimately
disallowed. The Court in Rand found that the regs provided no specific guidance on
how refundable credits should be taken into account in calculating the amount shown as
tax due on a return. In the Court’s view, this absence of specific guidance mandated
Rand’s result. In fact, Rand discusses Feller at some length (see p. 383), distinguishing
between overstated withholding credits, which the regs do address, and refundable
credits, which the regulations do not specifically address.

                                                         2

Hopefully this answers your question, but if not, please give me a call and I would be
happy to discuss this with you further.

Best,
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Attachments:

PLR 201018002
Feller v. Commissioner 136 T.C. 497 (2010)
Rand v. Commissioner 141 T.C. 376 (2013)