IRS limits adequate disclosure penalty protection in exam

TAX ALERT | November 17, 2022

Authored by RSM US LLP

Executive summary: IRS issues procedures to make adequate disclosure in the context of an exam

On Nov. 16, 2022, the IRS issued Revenue Procedure 2022-39 to prescribe special procedures for a small population of taxpayers to avoid the imposition of accuracy-related penalties under I.R.C. section 6662(b)(1) and (b)(2) through disclosure early on in an IRS examination. This new revenue procedure obsoletes Rev. Proc. 94-69 which had set forth a similar procedure for taxpayers subject to the now discontinued Coordinated Examination Program (CEP) and Coordinated Industry Case Program (CIC). In general, the Rev. Proc. 2022-39 is effective immediately for taxpayers under audit for four of the five taxable years preceding the audit year.

Under the Treasury regulations, there is no accuracy-related penalty imposed under section 6662 on any underpayment attributable to an item or position that is adequately disclosed, has a reasonable basis and for penalties attributable to disregard of a regulation, represents a good faith challenge to the validity of the regulation. Treas. Reg. section 1.6662-3(c). A taxpayer can make an adequate disclosure by attaching a properly completed Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, to an original return or a qualified amended return. Any amounts shown as due on a qualified amended return are also not subject to accuracy-related penalties. Treas. Reg. section 1.6664-2(c)(2). The regulations define a qualified amended return as one filed after the due date of the return for the taxable year and before the earliest of the date the taxpayer is notified of an IRS examination of the return, or in the case of a pass-through item, the date the pass-through entity is notified of an IRS examination of its return. Treas. Reg. section 1.6664-2(c)(3). Therefore, a taxpayer must typically file a qualified amended return, or request for administrative adjustment, prior to an IRS examination.  

Rev. Proc. 94-69 provided that those taxpayers subject to CEP and later CIC could avoid or reduce accuracy-related penalties with respect to positions taken on the return by adequately disclosing the position in a written statement furnished to the IRS within a 15-day window beginning with the IRS’s written request for such statement, which typically occurred at the opening conference. While this procedure was written for taxpayers subject to CEP and CIC, in practice, IRS examining agents often allowed other taxpayers to provide disclosures at the start of examinations and automatically avoid accuracy-related penalties on those issues disclosed. On Aug. 19, 2020, the IRS requested comments concerning obsoleting Rev. Proc. 94-69. Comments received contended the program was beneficial for both taxpayers and the IRS. The IRS determined that for those large taxpayers and partnerships who are subject to near-annual examinations, special procedures are appropriate for disclosure of errors on a return or items that may result in an underpayment but have a reasonable basis. The IRS declined to expand the procedures as urged by the commentators.

The new Rev. Proc. 2022-39 provides that only frequently audited taxpayers can take advantage of this alternative adequate disclosure process. Eligible taxpayers are those selected under the Large Corporate Compliance Program (LCC) if, on the date of the first IRS contact, at least four of the taxpayer’s tax returns for the five taxable years preceding the year at issue are or were under the LCC. Partnerships selected for examination under the Large Partnership Compliance Program (LPC) with the same 4 out of 5 years examination history are also deemed to be eligible taxpayers. These taxpayers may provide adequate disclosure of an error on a return and avoid accuracy-related penalties on such item if they disclose it on a properly completed Form 15307, Post-Filing Disclosure for Specific Large Business Taxpayers and furnish the form to IRS personnel conducting the examination no later than 30 days from the date the IRS requests the form in writing. Eligible taxpayers must include a description of the items that would result in adjustments for the taxable year with enough information that reasonably may be expected to apprise the IRS of the identity of the item, its amount and the nature of the controversy or potential controversy. Any issues so disclosed will be excluded from any calculation of accuracy-related penalties so long as there is a reasonable basis for the tax treatment of the item. 

All other taxpayers can only take advantage of the normal qualified amended return process to avoid accuracy-related penalties by filing a qualified amended return as described in and satisfying the requirements of section 1.6664-2(c)(3) or by adequately disclosing the position on a properly completed Form 8275, 8275-R or Schedule UTP, Uncertain Tax Position Statement, filed with a return and satisfying the requirements of section 1.6662-3(c). These taxpayers cannot wait until their return has been selected for examination to disclose a potentially controversial position and avoid accuracy-related penalties automatically; once a return of any ineligible taxpayer has been selected for examination, the timeframe for disclosure has passed in accordance with section 1.6664-2(c)(3).

The new Rev. Proc. 2022-39 is further evidence of the IRS’s increased enforcement and discouragement of taxpayers who may be tempted to wait to be examined by the IRS before addressing any issues on their returns that require correcting or disclosure. Taxpayers should consider filing qualified amended returns if they can no longer defend a position previously taken on a return to avoid any potential accuracy-related penalties now, prior to being notified of selection for examination. With the increased IRS budget and enforcement activity, now may be a good time for taxpayers to review their most recent returns and identify any areas of risk. If such areas are identified, taxpayers should consider filing a qualified amended return to protect themselves from accuracy-related penalties. This is a penalty free filing. If taxpayers identify an issue that they have support for but believe that the IRS may challenge, Forms 8275 and 8275-R can be filed using the amended tax return to protect against penalties, which are calculated at 20% of the underpayment of tax.