IRS updates its process for frequently asked questions
The Internal Revenue Service (IRS) recently published a News Release in which it addresses its process for publishing frequently asked questions (FAQs) on tax legislation and taxpayers’ concerns regarding relying on such FAQs.
With the enactment of the CARES Act and other coronavirus-related tax legislation providing taxpayer relief during the pandemic (for example, the Paycheck Protection Program), the IRS was quick to publish FAQs to answer many of the questions presented by the legislation. Throughout the year, however, the FAQs often changed or were expanded upon as the legislation was clarified or as other developments occurred. This caused confusion among many taxpayers and tax-preparers, and concerns as to whether such FAQs could be relied upon when filing returns or taking certain credits and deductions.
As the IRS explains, the Internal Revenue Bulletin (IRB) is the authoritative instrument of the Commissioner of Internal Revenue for announcing official rulings and procedures of the IRS and for publishing Treasury Decisions, Executive Orders, legislation, court decisions, and other items of general interest. It is the IRS’s policy to publish in the IRB all substantive rulings necessary to promote a uniform application of the tax laws, including all rulings that supersede, revoke, modify or amend any of those previously published in the IRB. All published rulings apply retroactively unless otherwise indicated. Rulings and procedures reported in the IRB do not have the force and effect of Treasury Regulations, but they may be used as precedent.
FAQs are an alternative to guidance published in the IRB because they allow the IRS to more quickly communicate information to the public on topics of frequent inquiry and general applicability. FAQs typically provide responses to general inquiries rather than applying the law to taxpayer-specific facts and may not reflect various special rules or exceptions that could apply in any particular case. FAQs may not be used as precedent.
However, given that recently FAQs have provided the only source of explanation of certain coronavirus-related tax legislation, the reliance on FAQs caused many taxpayers and preparers concern and confusion as to whether such reliance could establish a “reasonable cause” or “substantial authority” defense to the imposition of certain penalties when tax is underreported.
Section 6662(a) of the Internal Revenue Code (the “Code”) imposes a penalty for a taxpayer’s underpayment of tax for a taxpayer’s negligence or disregard of rules or regulations, or for any substantial understatement of income tax.[1] “Negligence” includes any failure to make a reasonable attempt to comply with the provisions of the Code, and the term “disregard” includes any careless, reckless or intentional disregard.[2] There is a “substantial understatement” of income tax if the amount of the understatement for the year exceeds the greater of 10% of the tax required to be shown on the return, or $5,000. The penalty can be avoided if either (i) there is a reasonable basis (reasonable cause) for the taxpayer’s tax treatment, and the relevant facts affecting the tax treatment are disclosed on the return,[3] or (ii) there is or was substantial authority for the tax treatment by the taxpayer.[4]
The determination of whether a taxpayer acted with “reasonable cause” and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Generally, the most important factor is the extent of the taxpayer’s effort to assess the taxpayer’s proper tax liability.[5]
For purposes of the “substantial authority” defense, there is substantial authority for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment. All authorities relevant to the tax treatment of an item, including the authorities contrary to the treatment, are taken into account in determining whether substantial authority exists.[6] The weight accorded an authority depends on its relevance and persuasiveness, and the type of document providing the authority.[7]
In the News Release, the IRS states that, to address concerns about the potential application of penalties to taxpayers who rely on an FAQ, any good faith and reasonable reliance on an FAQ will establish a “reasonable cause” defense against any negligence penalty or other accuracy-related penalty if it turns out the FAQ is not a correct statement of the law as applied to the taxpayer’s particular facts. In addition, FAQs that are published in a Fact Sheet that is linked to an IRS news release are considered authority for purposes of the exception to accuracy-related penalties that applies when there is substantial authority for the treatment of an item on a return.
Significant FAQs on newly enacted tax legislation, as well as any later updates or revisions to the FAQs, will be announced in a news release posted on IRS.gov in a separate Fact Sheet. The Fact Sheet FAQs will be dated to enable taxpayers to confirm the date on which any changes to the FAQs were made. Additionally, prior versions of Fact Sheet FAQs will be maintained on IRS.gov to ensure that, if a Fact Sheet FAQ is later changed, taxpayers can locate the version they relied on if they later need to do so. In addition to significant FAQs on new legislation, the IRS may apply this updated process in other contexts, such as when FAQs address emerging issues.
Thus, while FAQs continue to remain non-precedential in nature, a taxpayer’s good faith and reasonable reliance on an FAQ (even one that is subsequently updated or modified) can establish a valid reasonable cause or substantial authority defense for purposes of abating any negligence or accuracy-related penalty to the extent that reliance results in an underpayment of tax. The News Release provides some much-needed clarification and comfort to taxpayers who have been relying on FAQs to determine their tax liabilities and eligibility for certain credits and deductions, especially in light of the rapidly enacted tax legislation during the coronavirus era.
[1] IRC 6662(a)-(b).
[2] IRC 6662(c).
[3] IRC 6662(d)(2)(B). See also 1.6662-4(b).
[4] IRC 6662(d)(2)(B). See also Treas. Reg. 1.6662-4(d).
[5] Treas. Reg. 1.6664-4(b).
[6] Treas. Reg. 1.6662-4(d)(3)(i).
[7] Treas. Reg. 1.6662-4(d)(3)(ii).