Bogus Refunds & Bad Penalties: The Feckless and Fixable Refund Penalty System
57 Pages Posted: 14 Oct 2015 Last revised: 22 Oct 2015
Date Written: October 1, 2015
Bogus refund schemes, i.e., schemes created to generate undeserved tax refunds, have long plagued the Internal Revenue Service (“IRS”). In 2011-2013, the IRS identified and stopped over $53 billion fraudulent refunds, yet paid over $10 billion in fraudulent refunds during the same period. Those bogus refunds, however, are not a new phenomenon: a 2005 report by the Treasury Inspector General for Tax Administration (“TIGTA”) to Congress noted that in that year, there were approximately 70,000 bogus claims for refund, totaling over $100 million. By 2007, the Joint Committee on Taxation (the “Joint Committee”), echoing TIGTA’s concerns, told Congress that bogus refund claims had created “unnecessary burdens on both taxpayers and the IRS by straining IRS resources and impeding effective tax administration.”
In response to both TIGTA’s and the Joint Committee’s concerns, in 2007, Congress enacted Internal Revenue Code (the “Code”) section 6676, which gives the IRS the power to penalize erroneous and fraudulent refund claims. Section 6676 was later amended by Congress in 2010, extending the section 6676 refund penalty to refund claims based on transactions lacking economic substance.
While well-intentioned, section 6676 has been feckless. For the five years between May 2007 and May 2012, the IRS assessed only 84 section 6676 erroneous refund penalties, collecting roughly $1.9 million. However, TIGTA found that solely for the approximately one-year period between June 3, 2012 and May 25, 2013, “the IRS could have potentially assessed erroneous penalties totaling more than $1.5 billion.” This Article explains why those potential penalties have not been assessed.
Part of the blame for section 6676’s ineffectiveness is the lack of guidance regarding implementation, and that blame falls squarely at the feet of both the IRS and the U.S. Treasury Department (“Treasury”). Since enactment, Treasury has failed to issue implementing regulations for section 6676, relying instead on the IRS to, in effect, make it up as they go along. That has not worked out so well. The IRS, in making it up, has gotten it wrong at least twice, and has left its employees largely in the dark about how the penalty should be implemented.
Keywords: refund, refund schemes, IRS, fraudulent refunds, regulations
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