eGrove (Univ. of Mississippi)

American Institute of Certified Public Accountants

the tax adviser, Volume 16, Number 12, December 1985

Hira, Labh S.

Rollovers to IRAs and tax planning for IRA distributions after TEFRA

Kennedy, Calvin

Considerations in the determination of tax on unrelated business income

Wassenaar, Richard

Tax Adviser 
Volume 15 Issue 7 Article 5 
1984 
IRS viewpoint: Abusive tax shelters: “too good to be true” 
Richard Wassenaar 
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 Part of the Accounting Commons, and the Taxation Commons 
Recommended Citation 
Wassenaar, Richard (1984) "IRS viewpoint: Abusive tax shelters: “too good to be true”," Tax Adviser: Vol. 
15: Iss. 7, Article 5. 
Available at: https://egrove.olemiss.edu/tax_adviser/vol15/iss7/5 
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IRS viewpoint
RICHARD WASSENAAR, Assistant Commissioner
 
(Criminal Investigation),
Internal Revenue Service, Washington, D.C.
Abusive tax shelters: 
“
too good to be true”
How many times have you, in your position as tax
 
return preparer or financial consultant, muttered the
 words “This seems too good to be true!” as you
 perused a glossy, professional-looking prospectus
 purporting to offer an 8-to-1 tax write-off for a mod
­est investment in oil, cattle or any of 
a
 dozen other  
types of property? Or, what about the great
­sounding offer from the sincere “tax counselor” who
 outlines a simple plan in which you make out a
 check to an offshore corporation, seemingly for a
 business deduction or church contribution, with the
 guarantee that you will receive 90% of your money
 back? Sadly, over the past eight years or 
so,
 promo ­
tions and schemes such as these, involving fraudu
­lent and abusive tax shelters, have become com
­monplace.
The effort being made against abusive tax shel
­
ters is presently one of the most heavily empha
­sized compliance programs in the IRS. In an effort
 to combat these shelters, the Service has devel
­oped a highly coordinated program of criminal and
 civil enforcement. It is also, however, the responsi
­bility of professional tax practitioners to help police
 this problem. By doing so, they can help taxpayers
 who might become involved in abusive shelters
 avoid financial harm; they can also help them
­
selves, by stopping fraudulent promoters who divert
 
significant fee income from legitimate tax advisers.
Definition of an abusive tax shelter
The term “abusive tax shelter” is sometimes a
 
misnomer; some shelters are really nothing more
 than frauds. Abusive and fraudulent shelters take
 various forms; many are similar to legitimate shel
­ters, while others, such as the business deduction
 or contribution scheme mentioned earlier, are more
 blatant. Identifying an abusive tax shelter is difficult,
 and a good definition that will hold true in all or even
 most instances may not be readily available. For the
 purpose of this article, an abusive tax shelter is an
 investment based on a nonexistent or grossly and
 intentionally overvalued asset. The abusive tax
 shelter transaction lacks economic reality; quite
 simply, it is not what it purports to be.
A few examples may be helpful. An abusive shel
­
ter mimicking a legitimate shelter might be an in
­vestment in master recordings. Normally, an inves
­tor will invest in a master recording with the intention
 and hope that the investment will produce an
 economic gain. Benefits from certain research and
 marketing expenses and substantial investment tax
THE TAX ADVISER, JULY 1984 427
1
Wassenaar: IRS viewpoint
Published by eGrove, 1984
credits may also be available. A $100,000 invest
­
ment may return a $100,000 write-off in a very short
 time. In an abusive shelter, the only real purpose of
 the investment is the tax benefit. Though there is the
 possibility of an economic return, the likelihood is
 virtually nonexistent. The asset used, the master
 recording, is grossly overvalued, and a profit is
 never really expected. Investments 
are
 always  
highly leveraged, often through the execution of
 promissory notes, for as much as 10 times the ac
­tual cash investment. There is no real intention to
 ever pay these notes; their only purpose is to create
 a highly inflated investment tax credit. Therefore, for
 an “investment” of $10,000, which in reality is the
 promoter’s fee, an investor can claim tax advan
­tages, through falsified investment tax credits and
 other inflated expenses, of eight to 10 times his
 actual cash outlay.
There are many indicators that stand out in fraud
­
ulent promotions. For instance, a promoter may
 have complete control over the transaction, or can
 lend or arrange the leverage loan and “forecast” 
(or promise) the exact tax advantages. Factors such as
 these indicate that the transaction lacks economic
 reality. If hints or promises are made that the inves
­tor will never have to pay outstanding notes, or if the
 payback period is 10,15 or 20 years from the date of
 execution, the shelter is probably abusive or fraud
­ulent. Similarly, if 
a
 promoter sells a shelter based  
only on the claimed tax advantages, and not as 
a good business investment, a promotion should be
 considered suspect. If an investment is described in
 its prospectus or by its promoter as “high-risk”
 (meaning little likelihood of profit), the real risk
 involved is that the client will lose the amount
in­vested, will not receive expected tax benefits and
 will be subject to substantial penalties and interest.
 And there is always the possibility of criminal
 investigation and prosecution of both the promoter
 and the client.
Blatant abusive shelter schemes do not even at
­
tempt to resemble legitimate shelters. They con
­trive to create or develop false business or personal
 deductions, and may even include false docu
­mentation for the alleged deductions. These trans
­actions often involve the use of offshore tax havens
 to conceal their true nature. Generally speaking,
 such schemes consist of two parts: First, the pro
­moters create a transaction that appears to be a
 bona fide expense, to the point of convincing a
 potential client to send money to an offshore cor
­poration, and then provide false documentation in
 an attempt to represent these payments as consult
­ing or management fees, insurance payments, pur
­chase of materials at an artificially inflated price or a
 myriad of other designations. Again, the sole func
­tion of this transaction is to create what appears to
 be 
a
 legitimate tax deduction, while the promoter
maintains control over the client’s money. Then,
 
once the money is offshore, the client may invest it
 in the stock market, the international money market,
 CDs, etc. or try to return it to his own use disguised
 as a fictitious loan, a gift or a grant. All of these ploys
 are fraudulent.
Abusive shelter schemes are limited only by the
 
imagination of the promoters and must be judged
 accordingly. Any shelter offered purely for tax pur
­poses, claiming to pay for itself with tax savings or
 involving foreign or tax haven transactions should
 be viewed with  great deal of suspicion.
Abusive shelters—a national dilemma
Why is the IRS emphasizing the abusive tax shel
­
ter area? These shelters cost the Treasury, and
 consequently the taxpaying public, billions of dol
­lars in lost revenue. Although the efforts involved in
 auditing, investigating and subsequently collecting
 these taxes are time-consuming and expensive,
 they are essential.
Several large, well-organized tax shelter promo
­
tion groups reach across the country, often provid
­ing several layers of protection or deception for the
 original promoter. Salespersons market not one or
 two, but many different programs at the same time,
 making it more difficult for the IRS to zero in on
 either the promoter or the salesperson. Tax shelter
 promotions have become, in many cases, complex
 conspiracies and, as such, are subject to numerous
 criminal sanctions.
Promoters have designed new programs, speci
­
fically set up to appeal to those in the 35% to 
50% tax brackets, and they have found 
a
 huge market.  
Promises are made by abusive shelter promoters
 that could not be made with legitimate shelters,
 such as tax refunds exceeding investment outlay, or
 “no-risk” features. Promoters easily develop new
 abusive shelter packages, often reusing appraisals,
 legal opinions and engineering reports, and just
 changing the name of the promotion or the type of
 asset. Some promoters have also moved offshore
 and use bank secrecy laws of tax haven countries to
 conceal the true nature of their transactions.
Fees paid to abusive shelter promoters are gen
­
erally based on the amount of refunds they earn for
 clients. A promoter usually determines the amount
 of tax a client will owe this year and the amounts
 paid for the three prior years as well. He then prom
­ises 
a
 total or near total refund for all tax periods and  
calculates how much shelter the client needs. (Of
­ten, a client will settle for paying a small share of the
 true tax liability in an attempt to avoid detection by
 the IRS.) The promoter will tailor a package to the
 client’s needs and will generally charge about 6% to
 
10%
 of the amount of deductions needed. The pro ­
moter will arrange to produce deductions and/or
428 THE TAX ADVISER, JULY 1984
2
Tax Adviser, Vol. 15 [1984], Iss. 7, Art. 5
https://egrove.olemiss.edu/tax_adviser/vol15/iss7/5
credits that will decrease taxable income to a point
 
at which little or no tax would be due. A taxpayer
 with $60,000 worth of taxable income and a tax
 liability of $16,000 could therefore wipe out all tax
 liability for a fee of $4,000 (a $12,000 net saving).
 While this kind of shelter can just about sell itself, it
 is abusive and will very likely result in an examina
­tion or criminal investigation.
The damage to the collection of revenue by the
 
Treasury is obvious. However, a more subtle threat,
 one that is making itself felt more and more, is the
 loss of clients to abusive promoters. No legitimate
 tax adviser or financial consultant can hope to com
­pete against promoters offering a 10-to-1 purported
 tax write-off; the temptations to the public are very
 strong indeed. So tempting, that recently, one
 fraudulent promoter was able to boast that several
 investors had remained his clients, despite the fact
 that they had been warned by their previous ac
­countant that they could go to jail for their partici
­pation in the promoter’s schemes.
The IRS response
To combat the growing abusive shelter problem,
 
the IRS has developed a highly coordinated three
­pronged response. The three areas of concentra
­tion are civil examination, criminal investigations
 and the injunction and penalty provisions of TEFRA.
There are approximately 350,000 tax returns
 
presently under examination for shelter-related 
is­sues. In addition, approximately one-third of the
 60,000 cases on the Tax Court docket involve shel
­ters. The Criminal Investigation Division has looked
 into almost 
1,000
 abusive and fraudulent shelters  
and over 260 are currently under criminal investiga
­tion. Criminal investigations are conducted when
 shelters offer tax advantages based on assets that
 do not exist or are intentionally overvalued, or on
 transactions that simply do not take place. In situa
­tions such as these, substance takes precedence
 over form; that is, just because the paperwork, loan
 documents, canceled checks, correspondence,
 etc., look real, does not mean the transaction is
 legitimate.
Due to the pronounced trend toward the use of
 
offshore tax havens (not only by abusive shelters,
 but also for laundering other illegal profits and con
­cealing other illegal activity, such as narcotic traf
­ficking), the Criminal Investigation Division has
 taken an aggressive stand on investigating shelters
 utilizing the bank secrecy laws of offshore tax ha
­vens. If a shelter is legitimate, it does not need the
 secrecy of offshore havens and can stand the test of
 daylight.
The TEFRA provisions provide that a civil injunc
­
tion can be initiated against a promoter, salesman,
 appraiser or other participant in the marketing of
abusive tax shelters and/or other abusive schemes.
 
TEFRA also provides for penalties of at least $1,000
 per marketing attempt, or 
10%
 of gross revenues  
received (whichever is greater), to be levied against
 promoters and salesmen.
A special group of 16 Department of Justice trial
 
attorneys has been formed to pursue civil injunc
­tions. At this time, this group has recommended
 seeking injunctions in over 60 cases, involving ap
­proximately 250 individuals and businesses, and at
 least 12 injunctions have now been granted. Upon
 being enjoined, a person may not market that, or
 any other, abusive shelter again. Violation of these
 court orders will subject that promoter or salesper
­son to criminal contempt charges. In addition, crim
­inal investigations may follow the civil injunction.
New methods are also being developed to iden
­
tify abusive shelters. One of the most successful
 has been developed at several IRS Service Cen
­ters, in which IRS personnel, through computer
 programs and physical scanning, have reviewed
 millions of returns to detect abusive shelters. There
 is an increasing likelihood that refunds generated
 through reliance on abusive shelters will not be
 issued, and that, instead, these taxpayers 
will
 be  
called upon to justify their deductions. Already, mil
­lions of dollars in refunds have been delayed or
 stopped, in an effort to avoid the expensive and
 time-consuming process of collecting the tax a sec
­ond time.
Conclusion
Certain factors are particularly evident when deal
­
ing
 with abusive or fraudulent shelters: Exorbitant  
write-offs when compared to the cost of shelters
 (anything greater than 2-to-1 is suspect, and 3-to-1
 is highly questionable), the presence of foreign
 transactions, controlled private financing, backdat
­
ing
 and the absence of risk and payment of loans  
based solely on future earnings may all be indica
­tive of improper promotions. An investor should
 consult his regular tax adviser or financial consul
­tant 
if
 approached by a promoter with such pro ­
grams.
The IRS in general, and the Criminal Investiga
­
tion Division in particular, are determined to stop the
 further development of abusive and fraudulent shel
­ters. These programs have no real economic sub
­stance except for the promoters’ profits and can be
 detrimental to the financial interests of any person
 taking a chance with one. Many participants in
 these schemes may understand their abusive na
­ture, but they intentionally look the other way to
 avoid seeing what is really happening. They realize
 that abusive shelters really are “too good to be
 true.”
THE TAX ADVISER, JULY 1984 429
3
Wassenaar: IRS viewpoint
Published by eGrove, 1984


IRS viewpoint: Abusive tax shelters: “too good to be true”

the tax adviser, Volume 15, Number 9, September 1984

Thomas, Kenneth F.

Stromsem, William R.

Tax Adviser 
Volume 15 Issue 11 Article 6 
1984 
Washington Report: AICPA testifies on generation-skipping 
transfer tax proposals 
Kenneth F. Thomas 
William R. Stromsem 
Follow this and additional works at: https://egrove.olemiss.edu/tax_adviser 
 Part of the Accounting Commons, and the Taxation Commons 
Recommended Citation 
Thomas, Kenneth F. and Stromsem, William R. (1984) "Washington Report: AICPA testifies on generation-
skipping transfer tax proposals," Tax Adviser: Vol. 15: Iss. 11, Article 6. 
Available at: https://egrove.olemiss.edu/tax_adviser/vol15/iss11/6 
This Article is brought to you for free and open access by eGrove. It has been accepted for inclusion in Tax Adviser 
by an authorized editor of eGrove. For more information, please contact egrove@olemiss.edu. 
Washington report
by KENNETH F. THOMAS, CPA
WILLIAM R. STROMSEM, CPA
AICPA testifies on generation-skipping
 
transfer tax proposals
Since its enactment in 1976, the
 
generation-skipping transfer tax has
 proved troublesome for taxpayers,
 their
 
advisers and the IRS. In an effort  
to apply the
 
law to the many and varied  
generation-skipping transfer situa
­tions, it has become so complex as to
 be ineffective. Both houses of Con
­gress, the Treasury and major profes
­sional groups have sought to correct
 the 1976 legislation, some recom
­mending basic changes and some re
­commending repeal. Recently, the
 House Committee on Ways and
 Means held hearings on the
 generation-skipping transfer tax, con
­centrating on two corrective bills, H.R.
 6260 and H.R. 6261.
H.R. 6260, theTreasury Department
 
Discussion Draft, would provide a
 simplified flat tax on generation
­skipping transfers, rather than the
more complex current system, which
 
determines
 
the additional gift  or estate  
tax that would have been paid if prop
­erty had been transferred directly from
 one generation to another. Transfers
 of up to $1 million per grantor would
 
be  
exempt, and additional exemptions
 would be provided for certain
 
transfers  
not subject to gift tax and for distribu
­tions of up to $10,000 per year to cer
­tain trust beneficiaries. The rate of tax
 on generation-skipping transfers
 would be 80% of the highest gift and
 estate tax
 
rates, or 44% until 1988 and  
40% thereafter.
H.R. 6261, the American Law Insti
­
tute’s Discussion Draft No. 1, would
 provide three flat rates. The three
 taxes would be on
—taxable distributions from gener
­
ation-skipping trusts,
—taxable terminations of genera
­
tion-skipping trusts, and
—generation-skipping transfers.
The tax would be imposed at the
 
highest estate and gift tax rate, and 
a credit of $417,000 per transferor would
 be allowed.
Both bills have been introduced by
 
the chairman and ranking minority
 member of the House Committee on
 Ways and Means for discussion pur
­poses. No action will be taken this
 year, but the bills will probably be ad
­justed and reintroduced early in 1985.
 While there
 is
 no consensus on a solu ­
tion, there appears to be almost
 unanimous agreement that something
 must be done.
Initially, the AICPA favored 
a generation-skipping transfer tax, sup
­porting its enactment in 1976. How
­ever, with changes in the estate and
 gift tax
 
laws and the practical  problems
THE TAX ADVISER, NOVEMBER 1984 693
1
Thomas and Stromsem: Washington Report
Published by eGrove, 1984
For AICPA Members Who  
Have an Interest in
 Federal Taxation
THE TAX DIVISION of theAmerican Institute of Certified
 
Public Accountants has been
 established for AICPA members
 who have an interest in taxes. It
 recognizes the professional
 needs of today’s CPA-tax practi
­tioner and tax executive by
 providing opportunities for these
 CPAs to share their special
 knowledge...expand their com
­petence ... exchange experi
­ences and ideas... and discuss
 commonly-shared technical and
 professional problems.
The AICPA Tax Division is part
 
of the AICPA structure. Member
­ship is voluntary and is available
 only to CPAs who are members
 in good standing of the American
 Institute.
Membership benefits include...
■
 
A subscription to  
The Tax Adviser
■
 
AICPA Tax Division  
Newsletter
■
 
Tax Division position papers  
on proposed tax changes, etc.
■
 
Semi-annual meetings  
■ Agendas, minutes and highlight
 reports on Tax Division execu­tive committee and subcom
­mittee meetings and activities.
Write or phone for
 
additional information and
 membership application.
Promotion Department
 
American Institute of CPAs
 1211 Avenue of the Americas
 New York, NY 10036-8775
 Telephone: (212) 575-6285
in applying the generation-skipping
 
law, the AICPA now favors complete
 repeal. Some other professional
 groups prefer corrective legislation,
 
be ­
lieving that repeal is not a viable politi
­cal option. The AICPA is currently
 studying the merits of these corrective
 proposals.
The AICPA testimony on the
 
generation-skipping transfer tax was
 delivered to the House Committee on
 Ways and Means on Oct. 2, 1984, by
 Bernard W. Nebenzahl, incoming
 chairman of the Estate Planning Sub
­committee of
 
the AICPA Tax Division.  
A summary of his testimony appears
 below.
The AICPA has supported the
 
enactment of the generation-skipping
 transfer 
tax.
 Tax Policy Statement No.  
4 on Estate and Gift Tax Reform, ap
­proved in 1974, supported the concept
 of a generation-skipping transfer 
tax, and at
 
hearings on the Tax Reform Act  
of 1976 the AICPA testified in favor of
 such a
 
tax  when a  skipped generation  
nevertheless received a benefit. Since
 enactment, however, because of prac
­tical problems in applying the law and
 because subsequent changes in trans-
Abbreviations used in TTA
TTA The Tax Adviser IRB Internal Revenue
AFTR2d American Federal Tax
 
Reports, second series
 (Prentice-Hall)
Regs. Sec.
Bulletin
Treasury Regulation
Revenue ProcedureRev. Proc.
Ann. IRS Announcement
Rev. Rul. Revenue Ruling
BTA Board of Tax Appeals
Sec. Section (refers to the
CB Cumulative Bulletin Internal Revenue Code
Cir. Court of Appeals of 1954 unless otherwise
 
indicated)
Cl. 
Ct.
Claims Court
S. 
Rep.
Senate Finance
Cong. Rec. Congressional Record Committee Report
DC
District Court Sup. Ct.Supreme Court
F2d Federal Reports, second TAM Technical Advice
series Memorandum
F Supp Federal Supplement TC Tax Court (regular
GCM General Counsel’s decision)
Memorandum TC Memo Tax Court
H. Rep. House Ways and Means
(memorandum
 
decision)
Committee Report USTC United States Tax Cases
IR Internal Revenue News
(Commence Clearing
Release House)
fer taxes generally have eliminated the
 
need for such 
a
 tax, the AICPA position  
has changed.
The complexity, difficulty of ad
­
ministration, lack of equity and lack of
 revenue from the generation-skipping
 transfer tax have now been well
 documented. 
Even
 the Treasury, the  
tax’s main proponent, has called for
 significant
 
modifications. The question  
is
 
whether this  tax should be modified,  
and given another chance, or re
­pealed. The AICPA favors repeal
 since, even
 
with corrections, the slight  
increase in perceived equity is not
 worth the
 
accompanying complexity to  
our tax law.
The generation-skipping transfer tax
 
was originally enacted to prevent the
 avoidance of estate and gift taxes, by
 transferring assets beyond the next
 generation while
 
providing for the  next  
generation through the use of trusts.
 These trusts could provide the children
 with income during their lives (and ac
­cess to the trust principal in limited
 situations). To avoid the tax at the
 child’s generation, however, substan
­tial interests would have to
 
bypass him  
and go directly to the
 
grandchild. Such  
a plan would not generally coincide
 with the dispositive wishes of most 
in-
THE TAX ADVISER, NOVEMBER 1984
2
Tax Adviser, Vol. 15 [1984], Iss. 11, Art. 6
https://egrove.olemiss.edu/tax_adviser/vol15/iss11/6
dividuals. In most cases, the 
real
 deter ­
rent to generation skipping was the
 transferor’s natural desire to provide
 for the children he has raised, rather
 than for grandchildren whose abilities
 and values might not be well known.
Current
 
Chapter 13  of the Code  pro ­
vides a complex statutory scheme for
 dealing with generation skipping. The
 Treasury has spent much time and ef
­fort in developing regulations, as have
 taxpayers and their advisers in trying to
 understand the law and
 
regulations. All  
agree that the law does not work. It can
 be circumvented by 
a
 taxpayer with  
sophisticated tax advice, and it is just
 as likely to trap an unsophisticated
 taxpayer trying to solve a nontax es
­tate planning problem. Tax saving op
­portunities should not be available only
 to those with the motivation and means
 to take advantage of them, and those
 who wish to comply with the law should
 not be required to incur heavy expendi
­tures for professional advice. To con
­tinue this unworkable part of
 
the Code  
is bad tax policy, and Chapter 13
 should be repealed immediately.
While the AICPA has not had suffi
­
cient time to completely
 
review the cur ­
rent proposals, the following points
 should be noted. The proposed
 
legisla ­
tion seeks to avoid the generation
­skipping tax on “moderately” wealthy
 families by providing a credit or exemp
­tion. (The Treasury proposal states
 that the tax is geared to hit the
 
wealth ­
iest taxpayers.) But the exemption or
 credit amount 
is
 not large enough to  
prevent it from having a
 
substantial ef ­
fect on those of more modest wealth.
 And, while
 
reducing the number of tax ­
payers affected, use of an exemption
 or credit will not reduce the
 
complexity  
for
 
those still subject  to the tax. It  con ­
tinues the complexity for families that
 may not have
 
sophisticated  tax  advice  
available to them, thus creating traps
 for the unwary. It can
 
create hardships  
if a family business or a
 
family farm is  
being transferred to a lower generation
 on the death of the intervening genera
­tion. The
 
AICPA does not believe that  
the tax system should have more
 onerous rules for those of means
 merely because they are more able
 
to  
pay for professional advice.
By taxing direct transfers, the pro
­
posed legislation makes a dramatic
 change in tax policy. Direct transfers to
 family members should not be inhib
­ited. The AICPA believes that such
 transfers are not abusive and feels that
 they should not be subject to the added
tax. Under
 
the proposals, direct trans ­
fers are taxed at the same rate
 
as  indi ­
rect transfers. Under the Treasury
 proposal, indirect transfers are taxed
 once and may last three or more gen
­erations, while the direct transfer will
 be taxed on the death of the recipient.
 The proposals do not even make an
 exemption for direct transfers when the
 intervening generation has died.
 These proposals favor the super-
 wealthy who can afford and are more
 likely to make indirect transfers.
We also question the imposition of 
a 
tax every 35 years on “non-owned”
 trusts in the American Law Institute’s
 proposal.
 
This seems to be an arbitrary  
cutoff, especially when a person’s life
 expectancy may be substantially
 greater. In addition, any tax such as the
 one proposed should provide for in
­stallment payment of taxes related to
 the transfer of
 
a closely  held business,  
credits for tax on prior transfers and 
a statute of limitations on questions of
 value when a credit is
 
used in payment  
of the tax.
The AICPA realizes that this is an
 
important area of perceived inequity
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and possible abuse; however, the
 
complexity that must be added to the
 law in order to deal
 
with the small seg ­
ment of taxpayers involved is a bad
 precedent for tax policy. We urge you
 to repeal the current generation
­skipping transfer tax now. We under
­stand the reluctance to do so until other
 alternatives have been explored, but
 do not believe 
a
 fair and equitable solu ­
tion will be quickly
 
found. It is unfair to  
taxpayers and their advisers to keep
 them in suspended animation until all
 possible solutions have been
 examined. In fairness, we also believe
 the tax should 
be
 repealed retroac ­
tively.
As indicated earlier from our brief
 
review, the AICPA believes that the
 level of exemption or credit should be
 such that the tax not apply to
 
the mod ­
erately wealthy.
 
Also, it is felt that there  
should be no tax 
on
 those  direct trans ­
fers which truly skip a generation.
The AICPA appreciates this oppor
­
tunity to present its views. It expects to
 continue to study this area and com
­ment further 
on
 future legislative pro ­
posals. ns
THE TAX ADVISER, NOVEMBER 1984 695
3
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Westfall, Larry G.

Tax Adviser 
Volume 14 Issue 5 Article 5 
1983 
Washington Report: Employment taxes and the 100% penalty 
Larry G. Westfall 
Follow this and additional works at: https://egrove.olemiss.edu/tax_adviser 
 Part of the Accounting Commons, and the Taxation Commons 
Recommended Citation 
Westfall, Larry G. (1983) "Washington Report: Employment taxes and the 100% penalty," Tax Adviser: Vol. 
14: Iss. 5, Article 5. 
Available at: https://egrove.olemiss.edu/tax_adviser/vol14/iss5/5 
This Article is brought to you for free and open access by eGrove. It has been accepted for inclusion in Tax Adviser 
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IRS viewpoint
LARRY G. WESTFALL, Assistant Commissioner (Collection),
 
Internal Revenue Service, Washington, D.C.
Employment taxes and the 100% penalty
All too often, corporations in financial trouble use
 
the money withheld for employment taxes for other
 purposes, intending to delay the tax payment for
 only a short period of time. When financial pros
­pects do not improve, however, the corporations
 find themselves in a bad situation. The unpaid taxes
 often have increased dramatically, the IRS is de
­manding 
full
 payment, and the business does not  
have the money to pay. Corporate officers and em
­ployees responsible for the tax payments then dis
­cover, too late, and often to their surprise, that they
 will be held personally liable for the unpaid withheld
 tax, and that the IRS will proceed against their per
­sonal assets to collect it.
Since it began many years ago, the withholding
 
system has been the standard means of income tax
 payment for the vast majority of individual tax
­payers. Taxpayers receive credit for amounts with
­held from their income, regardless of whether the
 funds 
are
 actually paid over to the government. To  
encourage prompt payment and ensure ultimate
 collection of the taxes from a secondary source,
 Congress enacted 
Sec.
 6672, which states:
Any person required to collect, truthfully account for, and
 
pay over any tax imposed by this title who willfully fails to
 
coll
ect such tax, or truthfully account for and pay over such
tax, 
or
 willfully attempts in any manner to evade or defeat  
any such tax or the 
payment
 thereof, shall, in addition to  
other penalties provided by law, be liable to a penalty equal
 to the total amount of the tax evaded, or not collected, or not
 accounted for and paid over. No penalty shall be imposed
 under section 6653 for any offense to which this section is
 applicable.
The amount of the penalty is equal to 100% of the
 
tax required to be collected and 
paid
 over; hence,  
the provision is commonly referred to as the “100%
 penalty.” In the case of employment taxes, the pen
­alty is computed based on 
both
 the withheld income  
tax and the employees’ (but 
not
 the employer’s)  
portion of the social security tax.
The IRS views prompt collection of withheld taxes
 
as one of its highest priorities. Businesses that 
fail
 to  
pay their taxes 
are
 financing their operation with  
government funds and gain an unfair competitive
 advantage over businesses that comply with the
 law. The 
100%
 penalty is one of the tools used by  
the IRS to correct this situation.
The 
100%
 penalty is most frequently used with  
bankrupt and defunct corporations that have failed
 to pay withheld employment taxes. The IRS, how
­ever, is increasingly asserting the penalty in cases
 where a business is operating but collection is in
 doubt.
300 THE TAX ADVISER, MAY 1983
1
Westfall: Washington Report
Published by eGrove, 1983
Since, under IRS policy, the 100% penalty will be
 
used not to penalize but to collect, the term “pen
­alty” is a misnomer. The IRS does not collect from
 both the business and the responsible persons; if
 the penalty is assessed against more than one per
­
son,
 the total penalty is only collected once. The  
IRS’s policy of assertion is outlined in Policy State
­ment P-5-60:
The 100-percent penalty (applicable to withheld employ
­
ment taxes or collected excise taxes) will be used only as a
 collection device. If a corporation has willfully failed to collect
 or pay over employment taxes, or has willfully failed to pay
 over collected excise taxes, the 100-percent penalty will be
 asserted against responsible officers and employees of the
 corporation only if such taxes cannot be collected from the
 corporation itself. . . . When the person responsible for
 withholding, collecting and paying over taxes cannot other
­wise be determined, the Service will look to the President,
 Secretary and the Treasurer of the Corporation as respon
­sible officers.
Before asserting the 100% penalty, the IRS must
 
verify that the statutory period for assessment is still
 open. This period is the same as the assessment
 period for the underlying corporate liability. With
 respect to any taxable period within a calendar year,
 the statute is open for three years from the succeed
­ing April 15, or from the date the return was filed,
 whichever is later. For example, if a Form 941 for
 the first quarter of 1983 was timely filed, the period
 for asserting the 100% penalty is three years from
 April 15,1984. However, until the return 
is
 actually  
filed, or if the IRS prepares a return under Sec.
 6020(b), the statutory period does not begin to run.
 This period can also be extended through a written
 agreement with the responsible person or persons.
 If they refuse to enter into such an agreement, the
 IRS will make sure that an assessment is made
 before the statute expires, even if 
it
 has inadequate  
time to conduct a complete investigation. Once the
 
100
% penalty is assessed, the IRS has the normal  
statutory collection period of six years to collect the
 penalty.
Two elements must be established before the
 
IRS will assert the 100% penalty: responsibility and
 willfulness. A responsible person is defined as one
 who had the duty to perform or the power to direct
 the act of collecting, accounting for and paying over
 the taxes. The responsible person may be an officer
 or employee of the corporation, a member or em
­ployee of a partnership, a corporate director or
 shareholder, or another person with sufficient con
­trol over funds to direct their disbursement. In some
 situations, responsible persons are not directly affil
­iated with the delinquent business. For example, 
if
 a  
bank or other financial institution furnishes funds to
 a business and directs how these funds are to be
 distributed, the IRS may find the bank liable for the
 penalty since it directed that the business not pay
 over the employment taxes.
As a general rule, most 100% penalty cases in
­
volve corporate officers. The IRS makes every
 effort to determine just who was obligated to
 see that the taxes were withheld, collected and paid
 over to the government. However, there are situa
­tions where specific responsibility cannot be estab
­lished positively. In such 
a
 situation, the IRS will  
generally recommend assessment against a cor
­poration’s president, treasurer and secretary.
In addition to determining responsibility for pay
­
ing the taxes, the IRS has to determine whether the
 person acted willfully. Willfulness means inten
­tional, deliberate, voluntary and knowing conduct,
 as distinguished from accidental conduct. Willful
­ness 
is
 considered to be the attitude of a person  
who, having a free will or choice, either intentionally
 disregards the law or 
is
 indifferent to its require ­
ments. There is no requirement that evil intent or
 personal gain be established. The courts have held,
 in effect, that the actions of a corporate officer, in
 permitting withheld tax to be used for operating
 expenses of the business (whether at the officer’s
 direction or with his tacit approval) is willfulness to 
a degree sufficient to make that person liable for the
 100% penalty. If payrolls are 
met,
 the inference is  
that sufficient funds were available to pay the tax,
 regardless of whether such funds were actually set
 aside or otherwise specifically identified for tax pur
­poses. As long as a responsible officer of a corpora
­tion knew the taxes were due and payable but failed
 to ensure that they were paid over to the govern
­ment, there is willfulness to the extent contemplated
 by the statute.
When 
it
 is apparent that the employment taxes  
will not be paid or collection is in doubt, the IRS
 begins a detailed investigation to determine the re
­sponsible persons. Records reviewed include cor
­porate articles of incorporation, minute books and
 bylaws. In addition, the IRS examines bank signa
­ture cards to see who 
is
 authorized to sign checks,  
examines checks to determine who actually did sign
 them, and establishes who handled other financial
 affairs, such as loan applications, financial state
­ments, etc. The corporation’s tax returns them
­selves are reviewed to determine who signed them.
 Whenever possible, the IRS also interviews those
 persons who appear to be liable, to establish more
 definitely just who 
is
 responsible for the unpaid tax.  
The IRS does this both to ensure that those who are
 liable are assessed the penalty and to ensure that
 innocent persons not responsible are not subject to
 the penalty.
At the conclusion of the investigation, letters are
 
sent to the responsible persons advising them of
 their liability for the penalty, requesting their agree
­ment and advising them of their appeal 
rights.
 If a  
proposed assessment 
is
 contested, a written pro ­
test 
is
 required for a hearing in any case in which the
THE TAX ADVISER, MAY 1983 301
2
Tax Adviser, Vol. 14 [1983], Iss. 5, Art. 5
https://egrove.olemiss.edu/tax_adviser/vol14/iss5/5
amount is $2,500 or more for any of the tax periods
 
or years involved. If an appeal is submitted, 
it
 must  
specify, among other things, the findings being con
­tested and a statement of facts supporting the tax
­payer’s position on any contested issue. Protests
 are handled by the appeals office, which is totally
 separate from the collection office that proposed the
 penalty.
In the event an assessment is made, the taxpayer
 
has a right to have collection of the penalty stayed
 and the liability reconsidered, if, within 30 days after
 the date of notice and demand for payment of the
 penalty, the taxpayer posts a bond equal to one and
 one-half times the amount of the assessed penalty.
 The taxpayer must also pay an amount sufficient to
 initiate a refund suit and must file a claim for refund.
If the claim 
is
 denied, the taxpayer must begin a 
refund suit within 30 days.
Clearly the 100% penalty can have a substantial
 
and potentially devastating financial impact on the
 person or persons against whom 
it
 is assessed.  
Corporate officers, employees and representatives
 should recognize that any decisions they make
 which result in the nonpayment of employment
 taxes can affect them personally.
The IRS 
is
 well aware of the potential per ­
sonal hardship that can result from enforcement of
 the tax law by assessing the 100% penalty where
 warranted. It is our hope that the possibility of such
 adverse consequences will deter businesses from
 becoming delinquent in their taxes and that the
 hardships of the 100% penalty can be avoided. tta
ATTENTION TAXPAYERS!
A 
new law requiring partial withholding of  
taxes
 
on interest and dividend income will  
take
 
effect July 1,1983.
If you have an interest-earning account
 or
 
receive dividend payments,  this law  
will affect you!
This is not
 
a new tax. Like  withholding on  
salary checks, it merely changes the way
 taxes are collected.
Exemptions
 are  available for older Ameri ­
cans, lower income individuals and those
 with small savings
 
accounts. To see if you  
qualify, contact your bank,
 
financial institu ­
tion 
or
 the Internal Revenue Service  in  your  
area.
A public
 
service  message from  
the Internal Revenue Service
302 THE TAX ADVISER, MAY 1983
3
Westfall: Washington Report
Published by eGrove, 1983


Washington Report: Employment taxes and the 100% penalty

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