Section 6701. Aiding and Abetting Understatements

The IRS has authority to impose substantial monetary penalties upon persons who knowingly aid and abet in the understatement of the tax liability of another person (Code Sec. 6701). Under this authority, the IRS may impose upon that person a $1,000 penalty ($10,000 with respect to corporate tax returns and documents) if the person:

(1) aids, assists, or gives advice in the preparation or presentation (e.g., during an IRS examination) of any portion of a tax return or other document (e.g., affidavit, claim, etc.) (Code Sec. 6701(a)(1));

(2) knows or has reason to believe that the portion of the return or document will be used in connection with any material matter arising under the Code (Code Sec. 6701(a)(2)); and

(3) knows that if the portion of the tax return or other document is used an understatement of the tax liability of another person would result (Code Sec. 6701(a)(3)).

It is not necessary that the taxpayer whose tax is understated either have knowledge of, or give consent to, those actions that result in the tax understatement (Code Sec. 6701(d)). Accordingly, the IRS need not prove collusion between the taxpayer and the person who aids and abets in the understatement of the tax in order to assess a penalty under Code Sec. 6701.

In order to aid and abet in the understatement of another's tax, a person need not actually prepare the tax return or document that leads to the understatement. For example, if a supervisor orders, or causes a subordinate to perform, an act or knows of an act by a subordinate and does not attempt to prevent the act, then the penalty may be assessed against the supervisor for having directed the preparation of the return or document that led to the understatement (Code Sec. 6701(c)). However, the mere furnishing of typing or other mechanical assistance with respect to the tax return or document is not considered to aid and abet the understatement of a tax liability (Code Sec. 6701(e)).

The aiding and abetting penalty is civil in nature and, thus, can be assessed against a person by means of IRS administrative procedures. However, the burden of proof is on the IRS to prove that the penalty is properly imposed (Code Sec. 6703), in contrast with other penalties that can b

Generally, the amount of the penalty that may be imposed upon a person for aiding and abetting in the understatement of tax under Code Sec. 6701(a) is $1,000. However, if the return or document relates to the tax liability of a corporation, the penalty is $10,000 (Code Sec. 6701(b)).

Only one penalty under Code Sec. 6701(a) may be imposed against an individual for a single tax period or event (Code Sec. 6701(b)(3)). In addition, the IRS may not assess against a income tax return preparer both a penalty for aiding and abetting in the understatement of tax under Code Sec. 6701(a) and a penalty under Code Sec. 6694(a) for an understatement attributable to an unrealistic position or Code Sec. 6694(b) for an understatement attributable to willful or reckless conduct (Code Sec. 6701(f)). This provision allows the IRS to choose which penalty to assess if both penalties apply in a particular set of circumstances.

Similarly, a penalty for promoting an abusive tax shelter under Code Sec. 6700 will not be imposed on any person with respect to any documents if a penalty for aiding and abetting in the understatement of tax has been imposed on that person with respect to the same document (Code Sec. 6701(f)). However, both penalties may be imposed with respect to separate documents, such as when a promoter furnishes promotional material at the time of sale and subsequently provides partnership schedules (Forms K-1) to the investors (House Committee Report, Omnibus Budget Reconciliation Act of 1989.

PENALTIES FOR AIDING AND ABETTING UNDERSTATEMENTS OF TAX LIABILITY

IMPOSITION OF PENALTY. --Any person --

6701(a)(1) who aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,

6701(a)(2) who knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and

6701(a)(3) who knows that such portion (if so used) would result in an understatement of the liability for tax of another person,

shall pay a penalty with respect to each such document in the amount determined under subsection (b).

6701(b) AMOUNT OF PENALTY. --

6701(b)(1) IN GENERAL. --Except as provided in paragraph (2), the amount of the penalty imposed by subsection (a) shall be $1,000.

6701(b)(2) CORPORATIONS. --If the return, affidavit, claim, or other document relates to the tax liability of a corporation, the amount of the penalty imposed by subsection (a) shall be $10,000.

6701(b)(3) ONLY 1 PENALTY PER PERSON PER PERIOD. --If any person is subject to a penalty under subsection (a) with respect to any document relating to any taxpayer for any taxable period (or where there is no taxable period, any taxable event), such person shall not be subject to a penalty under subsection (a) with respect to any other document relating to such taxpayer for such taxable period (or event).

6701(c) ACTIVITIES OF SUBORDINATES. --

6701(c)(1) IN GENERAL. --For purposes of subsection (a), the term "procures" includes --

6701(c)(1)(A) ordering (or otherwise causing) a subordinate to do an act, and

6701(c)(1)(B) knowing of, and not attempting to prevent, participation by a subordinate in an act.

6701(c)(2) SUBORDINATE. --For purposes of paragraph (1), the term "subordinate" means any other person (whether or not a director, officer, employee, or agent of the taxpayer involved) over whose activities the person has direction, supervision, or control.

6701(d) TAXPAYER NOT REQUIRED TO HAVE KNOWLEDGE. --Subsection (a) shall apply whether or not the understatement is with the knowledge or consent of the persons authorized or required to present the return, affidavit, claim, or other document.

6701(e) CERTAIN ACTIONS NOT TREATED AS AID OR ASSISTANCE. --For purposes of subsection (a)(1), a person furnishing typing, reproducing, or other mechanical assistance with respect to a document shall not be treated as having aided or assisted in the preparation of such document by reason of such assistance.

6701(f) PENALTY IN ADDITION TO OTHER PENALTIES. --

6701(f)(1) IN GENERAL. --Except as provided by paragraphs (2) and (3), the penalty imposed by this section shall be in addition to any other penalty provided by law.

6701(f)(2) COORDINATION WITH RETURN PREPARER PENALTIES. --No penalty shall be assessed under subsection (a) or (b) of section 6694 on any person with respect to any document for which a penalty is assessed on such person under subsection (a).

6701(f)(3) COORDINATION WITH SECTION 6700. --No penalty shall be assessed under section 6700 on any person with respect to any document for which a penalty is assessed on such person under subsection (a).

.01 Added by P.L. 97-248. Amended by P.L. 101-239.

Aiding and Abetting Understatements: Assessment of penalty

Assuming, without deciding, that an accountant's conduct in preparing transmittal letters, which advised investors in an abusive tax shelter of their deductible business expenses on their Schedule C returns, was subject to penalties for aiding and abetting understatements of tax liability under Code Sec. 6701, the court determined that the IRS had correctly based the amount of the penalty assessed against the accountant on the number of Schedule C's sent out to which the accountant's letter was attached. Even though the accountant prepared only three letters, he realized that each letter was to be duplicated and sent to each investor as a cover letter for Schedule C's that were not prepared by him. It was also determined that the penalties were properly assessed for the tax years in which the accountant's allegedly prohibited conduct occurred.

W.T. Kuchan , DC Ill. , 88-1 USTC ¶9377.
.

R.D. Warner, DC Fla., 89-1 USTC ¶9253.

The IRS proved by a preponderance of the evidence that a tax-shelter promoter of hydroelectric plants had actual knowledge that the projects were not placed in service during the years in question. Since he took the deductions and credits pertaining to such projects anyway, the penalties imposed against him under Code Sec. 6701 had been properly assessed.

J.E. Mitchell, BC-DC Wash., 89-2 USTC ¶9494.

A motion for summary judgment filed by a certified public accountant who sought the return of
An individual was subject to penalty for aiding in the preparation of several Form K-1 returns containing information investors incorporated into their tax returns that resulted in tax understatements. The individual supplied the information for completion of the S corporation return and its related Forms K-1. He employed a tax preparer to complete the returns and he reviewed and signed them. A penalty plus interest applied for each of the Forms K-1 since the amount of the penalty was determined by the category of taxpayer whose tax liability was understated, that is, the investors. A corporate penalty was not applicable since the S corporation did not understate its corporate tax liability.

J.E. Mitchell, CA-9, 92-2 USTC ¶50,512, 977 F2d 1318.

The taxpayer was liable for civil penalties assessed against him for aiding and abetting understatement of tax liability by preparing false S corporation documents. An actual understatement of taxes is not a prerequisite to the imposition of the penalty. In addition, the taxpayer pleaded guilty to criminal charges so he was now collaterally estopped from disputing the facts underlying the crime.

V.H. Golletz , DC Ill. , 91-1 USTC ¶50,233.

An attorney alleged to have played a part in the development of an abusive computer software tax shelter was not liable for penalties for aiding and abetting in the understatement of tax liability. The IRS failed to show that the attorney had actual knowledge of the market value of the software; therefore, it failed to show that he had actual knowledge of any misrepresented, false or fraudulent assertion within the documents in issue. The penalty could not be sustained merely because the attorney should have known the software's value.

S.J. Gard, DC Ga. 92-1 USTC ¶50,159.

A tax return preparer penalty for aiding and abetting the understatement of tax on tax returns was not barred by the federal judiciary five-year statute of limitations on the enforcement of penalties (28 U.S.C. §2462). The absence of an express limitations period, together with the anti-fraud nature of the penalties, indicated that Congress intended an unlimited period of assessment. J.R. Mullikin, Jr. (CA-8, 92-1 USTC ¶50,166) followed.

R. Lamb, CA-8, 92-2 USTC ¶50,538.

A lawyer/certified public accountant who promoted Brazilian research tax shelters was liable for penalties for aiding and abetting other persons in understating tax liability even though he was not the tax return preparer. In addition, the entire liability was properly adjudicated by the trial court under the promoter's petition for refund of 15 percent of the penalty paid; the IRS was not required to make a claim for the 85 percent balance of the penalty.

C.S. Nielsen, CA-5, 92-2 USTC ¶50,618, 976 F2d 951.

A CPA was entitled to recover penalties, assessed by the IRS, plus interest, because the IRS failed to establish that the CPA knowingly understated the tax liability of several of his clients when he prepared their returns. The IRS sent Pre-filing Notification Letters (PFN letters) to the clients at issue, but did not establish that the CPA had seen a copy of the letters. Moreover, because the language of the PFN letters was ambiguous, familiarity with the letters would not have been sufficient to demonstrate that the CPA had actual knowledge that the returns he prepared would have resulted in an understatement of tax liability.

R.J. Rodrigues, DC R.I., 92-2 USTC ¶50,576, 797 FSupp 122.

A partnership was subject to the penalties for promoting abusive tax shelters and for aiding and abetting the understatement of tax liability. Partnerships qualified as "persons" liable for the penalties based on Code Sec. 7701's definition. Although Code Sec. 6671 further amplified the definition, it did not replace or limit the term "persons" to exclude the partnership entity. Although this section required the penalties to be administered in the same manner as taxes, the partnership was liable even though it otherwise was not a taxpaying entity. Additionally, the assessment of the penalties against both the partnership and its partners did not constitute an impermissible double levy; the statutory language did not limit application of the penalties to either a partnership or its partners, and the assessments at issue were punitive in nature and were not taxes. Moreover, the discharge in bankruptcy of the partners' liability for the penalties could not serve to discharge the partnership. Finally, the court could impose both penalties because the partnership did not submit evidence that the Code Secs. 6700 and 6701 penalties were based on the same document.

Bailey Vaught Robertson & Co., DC Tex.,93-2 USTC ¶50,392.

The assessment of a penalty against an accountant for aiding and abetting in tax understatements was not barred by the statute of limitations or the Double Jeopardy Clause of the Fifth Amendment. No limitations period applied to the initial assessment of the Code Sec. 6701 penalty, and once an assessment was made, the 10-year statute of limitations on collections began to run; that period had not yet expired in the present case. Although the accountant had been convicted in a related criminal proceeding, assessment of the civil penalty did not constitute punishment barred by the Double Jeopardy Clause. The civil penalty, which was remedial in nature rather than punitive, compensated the government for its losses in tax revenue and its investigation and litigation costs. The penalty was not overwhelmingly disproportionate to the damage caused by the accountant.

W.M. Lea, DC Tenn., 95-1 USTC ¶50,157, 882 FSupp 687.

The penalty for aiding and abetting the understatement of income tax was imposed against a certified public accountant who prepared amended personal returns for a couple and amended returns for a closely held corporation in which the couple had an ownership interest. Although the couple's amended return was disallowed by the IRS as untimely, there is no requirement that the return be used in order for the penalty to be imposed for conduct surrounding its preparation. The CPA understated the couple's income on an amended return by incorrectly increasing their ownership interest in the corporation, thus increasing their flow-through losses. Since the CPA knew that he indicated an incorrect ownership interest on his clients' return and that he did not have the required tracking information to forecast the corporation's income, he had knowledge that the tax-related documents he prepared, if used, would result in a tax liability understatement.

D.D. Bailey , DC Ariz. , 96-1 USTC ¶50,270. Aff'd, CA-9 (unpublished opinion), 97-2 USTC ¶50,571.

A penalty for aiding and abetting the understatement of income tax was properly imposed against an accountant. His claim that he should never have been penalized for tax returns that his clients did not actually sign was not articulated in the trial court and was thus considered waived.

D.D. Bailey, CA-9 (unpublished opinion), 2002-2 USTC ¶50,533, 42 FedAppx 79, aff'g DC-Ariz., 2001-1 USTC ¶50,281 and an unreported District Court decision.

A taxpayer was a disqualified person and an organization manager of a Code Sec. 503(c)(3) exempt entity, and received excess benefit transaction income from salary, severance, undocumented loans, value of automobiles, property rents, and insurance payments, among other sources, within the meaning of Code Sec. 4958. The taxpayer was liable for the penalty under Code Sec. 6684 and, because he made false, fraudulent, and other gross valuation misstatements, also was liable for the penalty under Code Sec. 6701.

Technical Advice Memorandum 200243057, July 2, 2002.

A tax preparer was liable for civil penalties assessed against him for aiding and abetting understatement of tax liability by knowingly participating in the preparation of purported trust instruments and related tax returns that underreported income. The preparer and his financial services organization were also permanently enjoined from organizing, promoting and selling "common-law" trust shelters, from acting as tax return preparers and from otherwise interfering with the enforcement of the tax laws. Additional penalties were assessed for failure to maintain taxpayer lists and for understatement of the tax liability based on an unrealistic position.

L.W. Ratfield , DC Fla. , 2005-1 USTC ¶50,187.

Aiding and Abetting Understatements: Taxpayers subject to penalty

An attorney who allegedly assisted in the preparation of backdated Forms 5300, Application for Determination for Employee Benefit Plan, on behalf of his corporate clients who sponsored employee pension plans could be liable for Code Sec. 6701 penalties. The issue was whether the attorney knew or had reason to believe that the Forms 5300 would be used in connection with a material matter arising under the Internal Revenue Code, and knew that, if used, would result in an understatement of tax liability for the sponsors. The forms were falsified so that the sponsors could retain their qualified status under Code Sec. 401. The falsification of the forms directly gave rise to tax liability to the sponsors because the Forms 5300 related to the corporate tax liability of the sponsors, and would result in an understatement of their tax liability. However, since each erroneous Form 5300 could impact upon the tax liability of both plan sponsors and plan beneficiaries, the court did not decide whether separate penalties could be imposed as to each such taxpayer and taxable period. Thus, the lower court erred when it granted the attorney summary judgment in his refund suit.

E.W. Berger, CA-2, 96-2 USTC ¶50,339.

Chief Counsel determined that a frivolous income tax return penalty should be assessed against the taxpayer, rather than the return preparer, where a purported return that was deemed frivolous was signed by both the taxpayer and the return preparer. When a taxpayer's name is signed to a return, statement or other document filed with the Service, the signature is presumed genuine and constitutes prima facie evidence that the document was signed by the taxpayer. Furthermore, by signing a purported return, the taxpayer attests to its correctness and authorizes its filing with the Service. Accordingly, the taxpayer is the individual filing the return for purposes of Code Sec. 6702. The return preparer may in appropriate cases, be penalized under Code Sec. 6701.

Service Ctr Advice 200135027, July 18, 2001.

An attorney who caused substantial harm to the government by advising people not to pay their income taxes, withhold taxes from employees' wages, or file tax returns was permanently enjoined from engaging in the promotion of abusive tax schemes. The government was granted a default judgment because it established that the attorney engaged in conduct subject to penalty under Code Sec. 6700 or 6701 because he sold false and fraudulent tax plans and arrangements and assisted in the preparation of documents designed to result in tax understatements. The injunction was appropriate because there was a likelihood of irreparable injury to the government and there were no adequate remedies at law.

E.M. Rivera , DC Calif. , 2003-2 USTC ¶50,621.

Promoters of transactions involving the transfer of patents or other intellectual property to a charity from which the transferor/donor claims a deduction in excess of the amount allowed under Code Sec. 170, may be subject to penalties under Code Sec. 6701 for aiding and abetting in the understatement of a tax liability. The IRS may disallow all or part of a charitable deduction where the doner's entire interest in the property is not transferred, the donor receives some benefit for the transfer, there is insufficient proof of the transfer, and the property transferred is overvalued.

Notice 2004-7, 2004-1 CB 310.

An individual who promoted tax schemes that established corporations in the guise of churches (corporation sole plans) and the filing of frivolous tax returns or claims for refund (claim of right plans) was permanently enjoined from such activities. Under the claim of right plan, the promoter knew, or should have known, that the tax liability of the participants would be materially understated, therefore, the promoter was subject to penalty under Code Sec. 6701. Since the promoter's plans interfered with the administration and enforcement of the nation's tax laws resulting in irreparable harm to the United States , injunctive relief was appropriate to prevent recurrence of the activities subject to penalty.

R.M. Blackstock , DC Okla. , 2005-1 USTC ¶50,257.

The Office of Chief Counsel has provided guidance on the application of Code Sec. 6701 to appraisers. Pursuant to the guidelines already established in the Internal Revenue Manual (IRM), the penalty may be assessed by agents and office auditors as a result of an examination or in connection with a tax shelter registration examination. Appraisers may challenge the imposition of Code Sec. 6701 penalties by: (1) paying 15 percent of the entire assessed penalty and then filing a claim for a refund; (2) following the refund procedures under Code Sec. 7422; or (3) because the Code Sec. 6701 penalty is divisible, pay 15 percent of one assessed penalty in order to challenge the entire amount. There is no right to review by the Appeals Office prior to assessment of the penalty. However, the IRM provides for appeals procedures once the penalty has been assessed and paid.

CCA Letter Ruling 200512016, February 8, 2005.

A corporation engaged in promoting and marketing abusive tax schemes through seminars, the internet and promotional literature was permanently enjoined, pursuant to Code Sec. 7408, from such and other similar activities. The schemes, which involve the creation and the use of sham entities, such as trusts, charitable foundations and limited liability companies to eliminate or reduce reported federal income and/or self-employment tax liability, were subject to penalty under Code Sec. 6700 and 6701 and led to substantial tax losses to the United States Treasury.

F.J. Anderson, DC Fla., 2005-1 USTC ¶50,306.

The IRS will not recognize certain deductions that taxpayers may be claiming with respect to donated vehicles sold at auction. Some charities have been claiming that vehicles were sold to needy individuals at prices significantly below fair market value, thereby triggering the exception to the rule that a donor's deduction is limited to the proceeds from the sale of the vehicle. The IRS is taking the position that vehicles sold at auction are not sold at prices significantly below fair market value and do not qualify for the exception for sales to needy individuals. Charities that sell a donated vehicle at auction and provide the donor with an acknowledgment that indicates anything other than that the deduction may not exceed the gross proceeds from the sale may be subject to penalties under Code Secs. 6701 and 6720.

IRS News Release IR-2005-145, December 20, 2005.

Penalties assessed against an attorney for promoting an abusive tax shelter were not abated as the result of his death and were assessed against his estate because the penalties were not penal in nature. The legislative intent rendered the monetary penalties under Code Secs. 6700 and 6701 as civil. The fact that the penalties served the traditional aims of retribution and deterrence, and the conduct addressed in the statutes might form the basis for a criminal prosecution was not sufficient to render the penalties as criminally punitive.

K.H. Reiserer, CA-9, 2007-1 USTC ¶50,412, 479 F3d 1160.

A preliminary injunction was issued to prevent a certified public accountant (CPA) from acting as an income tax return preparer and promoting his illegal tax schemes for his clients that resulted to substantial understatement of their tax liabilities. The CPA engaged in conduct subject to penalties under Code Secs. 6694, 6700 and 6701. He prepared federal tax returns containing items he knew would result in understatements of clients' tax liabilities. He also prepared tax returns containing understatements of liability based on positions for which there was no reasonable basis or due to a willful attempt to understate such liabilities, and in reckless or intentional disregard of the internal revenue laws.

L. Baisden , DC Calif. , 2007-1 USTC ¶50,432.

The IRS has identified the four components identifying an intermediary transaction tax shelter (ITTS), which is a listed transaction under Reg. §1.6011-4(b)(2), and has modified Notice 2001-16, 2001-1 C.B. 730 with respect to the types of persons considered to be participants in such transaction. Participants in ITTS transactions have disclosure and registration requirements, and may be subject to penalties for failing to satisfy them. Persons involved in ITTS or substantially similar transactions may be liable for the aiding and abetting penalty.

Notice 2008-20, I.R.B. 2008-06, modifying Notice 2001-16, 2001-1 C.B. 730.

Aiding and Abetting Understatements: Knowledge that document will be used in connection with material matters

Genuine issues of material fact remained regarding whether a certified public accountant was liable for civil penalties for aiding and abetting the understatement of tax liability after the audit of his corporate client. There was a material issue of fact as to whether the individual knew or had reason to know that altered documents and a summary document he submitted would be used in connection with a material matter under the internal revenue laws.

T.L. Cheshire, DC Ala., 97-2 USTC ¶50,912.

A permanent injunction was issued against an individual who promoted abusive tax schemes over the internet. The individual violated Code Sec. 6701 by providing his customers with products meant to hinder the collection of taxes.

J. Cohen , DC Wash. , 2005-2 USTC ¶50,456.

A permanent injunction was issued against the promoter of abusive tax shelters based on the substantial evidence provided by the government showing that he promoted zero returns and tax-evasion schemes by creating and selling materials on his website designed to obstruct the administration of the income tax laws. These website materials were determined to be the preparation or assistance in the preparation of any portion of a return or other document that he knew would be used in connection with any material tax matter and would result in an understatement of tax liability.

C. Conces , DC Mich. , 2006-1 USTC ¶50,324.

A permanent injunction was issued against a promoter of abusive tax shelter schemes involving a non-recognized Indian tribe. He had prepared and sold documents claiming an exemption based on his material fraudulent statements and he knew or should have known that the statements were false or fraudulent and that the documents would be used in connection with a material tax matter that would result in an understatement of tax liability.

D.H. Sanders, DC Ga., 2007-2 USTC ¶50,673.