Reprinted with permission from The Tax Lawyer, Fall 2016 (70:1), at 367–402. Copyright © 2016 American Bar Association. All rights reserved. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
This Article addresses the legal consequences a taxpayer should consider when deciding whether to comply with the basic requirements of the federal income tax laws. A taxpayer considering noncompliance should consider the government’s authority to assert criminal liability, impose civil tax penalties, and forcibly collect any unpaid tax. Although there are numerous criminal tax offenses, the potential offenses that may affect a taxpayer’s decision whether to comply are the failure to file and failure to pay misdemeanors, tax perjury felony, and attempted tax evasion felony. Similarly, the civil tax penalties that are intended to deter basic noncompliance are the failure to file addition to tax, failure to pay addition to tax, and civil fraud penalty. The remaining penalties (over 100 of them) target various types of behavior engaged in by people other than the taxpayer or that occur after a taxpayer has already decided to file a tax return. Thus, a taxpayer deciding whether to file a tax return or attempt to defraud the government need only consider these three. A taxpayer must also consider that the government is authorized, after satisfying certain procedural requirements, to forcibly collect the tax the taxpayer owes.
In the study of tax controversy, it is unusual to group these topics—collection, penalties, and criminal liability—together under the umbrella of noncompliance. Prior to this Article, a taxpayer inquiring about these considerations and their impact would not have found these topics presented together with the purpose of responding to the inquiry. The Code disperses these topics throughout its procedural subtitle. Treasury regulations are organized by Code provision, so they are of no help either. Moreover, secondary sources organize tax controversy chronologically based on events that may occur in the process. Although tax controversy events rarely flow chronologically, the decisions and determinations that taxpayers and the government make flow sequentially. The first decision a taxpayer makes is whether to comply with the tax laws. Thus, it makes sense to discuss criminal liability, penalties, and collection before the discussing the decision to file a return or the procedures for determining a deficiency.
The study of tax controversy begins with the taxpayer’s decision on whether to comply with the tax laws.1 In making this decision, a taxpayer must consider the consequences of not complying.2 If a taxpayer engages in basic noncompliance—not filing a required return, not paying a tax due, or committing fraud—the government is authorized to collect the amount owed with interest, impose penalties, and, if warranted, send the noncompliant taxpayer to jail. The negative societal and infrastructure consequences of taxpayer noncompliance, although potentially devastating to society, are beyond the scope of this Article.
It may seem unusual to examine collection actions, penalties, and criminal sanctions before discussing the Service’s return review process.3 These consequences of noncompliance typically flow from an examination of a taxpayer’s books and records. The taxpayer’s consideration, however, occurs in his4 head, before the Service has any books and records to examine.
Another reason to discuss noncompliance consequences first—especially the collection process—is that the procedures set up to provide notice to taxpayers of a Service investigation, determination, and assessment sometimes fail to get the taxpayer’s attention. It is common that the first time the taxpayer becomes aware the Service has determined he owes more tax is when the Service begins to collect it through collection procedures set forth below. Noncompliant taxpayers tend to take note when their paychecks or their bank accounts begin to shrink
Prior to the discussion of the various consequences of noncompliance, this Article describes the importance of assessment to the procedures the Service has for addressing noncompliance in Part I. Next, this Article provides the background for noncompliance topics. Part II details the Service’s collection process, Part III sets forth basic civil tax penalties, and Part IV discusses the government’s procedures for imposing criminal liability. Part V concludes.
Assessment and Noncompliance
Assessment is generally integral to the enforcement mechanisms giving rise to the consequences of noncompliance. In most cases, it begins the collection process. Moreover, it is a prerequisite for the Service to impose certain civil tax penalties.
A tax liability develops by operation of law on the due date of a tax return.5 Before the Service may begin collecting a tax liability, it still must establish the existence and amount of the liability.6 It is the assessment that establishes the liability of the taxpayer.7 The official assessment occurs when the assessment officer signs the assessment record identifying the taxpayer, the amount owed, and the character of the liability.8
There are various types of assessments.9 The first is the summary assessment. This type of assessment can take place without an investigation.10 The Service uses it to assess tax liabilities reported on tax returns as well as to assess additional amounts resulting from clerical errors.11 Under the summary assessment procedures, the Service assesses the liabilities and then sends a notice to the taxpayer if the liability is not fully paid.12 The summary assessment is considered the general rule, while the other types of assessments are exceptions to the Service’s summary assessment authority.13
The second type is the deficiency assessment.14 This type of assessment occurs after the Service has investigated a tax return and determined the taxpayer owes more tax.15 Prior to a deficiency assessment, the taxpayer has the opportunity to dispute the Service’s determination of a deficiency in the Tax Court.16 The Service must first send the taxpayer a statutory notice of deficiency giving the taxpayer 90 days to file a Tax Court petition.17 The Service may not assess until the taxpayer either fails to file a petition in Tax Court or the Tax Court proceeding has come to a final decision.18
The third type of assessment is a penalty assessment. The Service may immediately assess certain penalties without going through its deficiency procedures.19 One example of an immediately assessable penalty is the delinquency penalty under certain circumstances.20 The Code also imposes immediately assessable penalties on taxes held in trust for the Service.21 These are called assessable penalties because the imposition of the penalty constitutes an independent assessment of a taxpayer’s liability for the penalty with no restrictions.22
In general, the Service has three years from the filing of a tax return to assess the tax.23 Where a taxpayer has substantially omitted tax items from a tax return, the Service has a six-year statutory time period to assess the tax.24 If the taxpayer does not file a tax return, the Service has an unlimited amount of time to collect a tax liability because no limitations period has begun.25 In such a case, the amount does not even need to be assessed.26
To establish the liability in the case where the taxpayer did not file a return, the Service may prepare a return for the taxpayer.27 Such a return—substitute for return28—does not start the limitations period on assessment, thus the time-period for the Service to assess remains unbounded.29 Also, there is no time limit for the Service to assess tax reported on a false return filed knowingly with the intent to evade tax.30
1. This Article focuses on taxpayers who have not yet decided whether to comply with the tax laws. Although there are negative consequences for sloppy or negligent reporting, the taxpayer in such a case has already decided to comply with the tax laws. Such consequences are not discussed here because the focus is on rules that apply before making the decision whether to comply.
2. The theoretical literature about the decision whether to comply with the tax laws suggests a number of taxpayer considerations. See Jose A. Noguera, et al., Tax Compliance, Rational Choice, and Social Influence: An Agent-Based Model, 55 Revue Francaise de Sociologie 765 (2014); Donna D. Bobek, et al., Analyzing the Role of Social Norms in Tax Compliance Behavior, 115 J. Bus. Ethics 451 (2013); James Andreoni, et al., Tax Compliance, 36 J. Econ. Lit. 818 (1998). It is not necessary to address such theoretical considerations in this Article because this Article discusses the decision in the larger context of tax controversy.
3. Virtually all casebooks, treatises, and manuals on tax controversy discuss collection, penalties, or criminal liability after discussing examinations and judicial review. See, e.g., Michael I. Saltzman & Leslie Book, IRS Prac. & Proc. (2013) (table of contents showing discussion of criminal investigation and collection after the Service’s examination procedures); Leandra Lederman & Stephen W. Mazza, Tax Controversies: Practice and Procedure ix-xxii (3d ed. 2009) (table of contents showing discussion of penalties and collection after the Service’s examination procedures, and omitting criminal liability altogether); Camilla E. Watson & Brookes D. Billman, Jr., Federal Tax Practice and Procedure—Cases, Materials and Problems viii-xi (2d ed. 2012) (table of contents showing discussion of penalties, collection, and criminal liability after the Service’s examination procedures).
4. Unless otherwise stated, the term “he” is intended to simplify references to “he or she.”
5. See United States v. Dack, 747 F.2d 1172, 1174 (7th Cir. 1984) (“[A] tax deficiency . . . is deemed to arise by operation of law on the date the return is due.”).
6. See I.R.C. § 6502 (“Where the assessment of any tax imposed by this title has been made within the period of limitation properly applicable thereto, such tax may be collected by levy or by a proceeding in court . . . .”); United States v. Galletti, 541 U.S. 114, 122 (2004) (“To be sure, the assessment of a tax triggers certain consequences. After the amount of liability has been established and recorded, the IRS can employ administrative enforcement methods to collect the tax.”).
7. See § 6502; Galletti, 541 U.S. at 122.
8. See I.R.C. § 6203 (“The assessment shall be made by recording the liability of the taxpayer in the office of the Secretary in accordance with rules or regulations prescribed by the Secretary.”); Reg. § 301.6203-1.
9. Two rare types of assessments are the jeopardy assessment and termination assessment. See I.R.C. §§ 6861, 6851. The Service may rely on the authority under these provisions where it suspects the taxpayer may hide himself, his assets, or in some other way substantially decrease his ability to pay a tax due. See §§ 6861, 6851.
10. It is called a summary assessment because it takes place without an investigation. See Bryan T. Camp, The Mysteries of Erroneous Refunds, 114 Tax Notes (TA) 231, 234 (Jan. 15, 2007) (“It is called the summary procedure because the IRS simply and summarily records the taxpayer’s liability, payments, and credits, based on the information before it, and then notifies the taxpayer if there is a balance due.”).
11. See I.R.C. § 6201(a)(1) (“The Secretary is authorized and required to make the . . . assessments of all taxes . . . imposed by this title [including] all taxes determined by the taxpayer or by the Secretary as to which returns or lists are made under this title.”).
12. See Camp, supra note 10, at 234.
13. See Camp, supra note 10, at 234.
14. See I.R.C. § 6213 (describing the assessment of a deficiency).
15. See I.R.C. § 6212 (describing the Service’s deficiency procedures).
16. See § 6213.
17. See § 6213. Note that a taxpayer who is outside the country has 150 days to respond to the notice.
18. See § 6213.
19. See I.R.C. §§ 6672–6720C (Chapter 68, Subchapter B of the Code).
20. See C.C.N. CC-2002-002 (Oct. 17, 2001) (holding that whether a delinquency penalty is immediately assessable “depend[s] upon whether the penalty is based upon a tax liability reflected on the return or upon a deficiency (with or without a filed return)”).
21. See §§ 6672–6720C (Chapter 68, Subchapter B of the Code).
22. See Saltzman & Book, supra note 3, at ¶ 7B.01 (“Assessable penalties are penalties the Service may assess without restrictions applicable in deficiency cases.”).
23. See I.R.C. § 6501(a) (“Except as otherwise provided in this section, the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed.”).
24. See § 6501(e)(1)(A) (“If the taxpayer omits from gross income an amount properly includible therein and . . . such amount is in excess of 25 percent of the amount of gross income stated in the return . . . the tax may be assessed . . . at any time within 6 years after the return was filed.”).
25. See § 6501(c)(3) (“In the case of failure to file a return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time.”).
26. See § 6501(c)(3).
27. See I.R.C. § 6020(b) (“If any person fails to make any [required] return . . . the Secretary shall make such return from his own knowledge and from such information as he can obtain. . . .”).
28. See § 6020(b); I.R.M. 126.96.36.199.2.1.1(B) (referring to section 6020(b) and providing, “This is an SFR.”).
29. See § 6501(b)(3) (“[T]he execution of a return by the Secretary pursuant to the authority conferred by [section 6020(b)] shall not start the running of the period of limitations on assessment and collection.”).
30. See § 6501(c)(1) (“In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.”).