Tax Protester (United States) - Penalties - Treatment By Internal Revenue Service

Treatment By Internal Revenue Service

Prior to the Internal Revenue Service Restructuring and Reform Act of 1998 (the "1998 Act"), the Internal Revenue Service had defined a tax-protester scheme as "any scheme without basis in law or fact for the ostensible purpose of expressing dissatisfaction with the substance, form, or administration of the tax laws be either interfering with tax administration or attempting to illegally avoid or reduce tax liabilities."

The IRS has not released records indicating whom the agency defined as "illegal tax protesters" (coded as TC-148). In testimony before Congress in 1997, former IRS historian Shelley L. Davis contended that the IRS kept lists of citizens "for no reason other than that their political activities might have offended someone at the IRS " and she charged that "anyone who offers even legitimate criticism of the tax collector is a tax protester "

After the 1997 congressional hearings, Congress responded with the 1998 Act. Subsection (a) of section 3707 of the 1998 Act now prohibits "officers and employees of the Internal Revenue Service" from designating a taxpayer as an “illegal tax protester” or using any similar designation for a taxpayer. By contrast, subsection (b) of section 3707 provides: "An officer or employee of the Internal Revenue Service may designate any appropriate taxpayer as a nonfiler, but shall remove such designation once the taxpayer has filed income tax returns for 2 consecutive taxable years and paid all taxes shown on such returns."

The IRS has prescribed procedures for its personnel to handle frivolous returns (whether considered valid returns or not) in the "Frivolous Return Program" section of the Internal Revenue Manual. The IRS has concluded, in Service Center Advice 200107034 dated November 15, 2000, that the statutory prohibition on the use of the term "illegal tax protester" by IRS personnel does not prohibit the IRS from maintaining a database of frivolous tax return filers as part of its Frivolous Return Program. IRS Advice 200107034 states (in part):

The Frivolous Return Program in Examination has the specific assignment of processing assessments of frivolous return penalties pursuant to section 6702. The employees of that unit receive documents from throughout the country that IRS employees believe may qualify as frivolous returns under section 6702. The employees reviews the documents and determines how to proceed.

When the documents come into the Frivolous Return Program, employees enter initial data into a computerized inventory database. Initial data includes name, social security number, and tax examiner assigned the case. Later, a tax examiner reviews the documents to see if they qualify as frivolous. If the documents meet the frivolous test, the tax examiner does a compliance check to see if the taxpayer is properly filing returns. If the taxpayer is properly filing returns and is not potentially subject to a frivolous return penalty, then the tax examiner deletes the individual from the database

According to the IRS:

Congress enacted section 3707 because of its concern that taxpayers may be stigmatized by a designation as an "illegal tax protester." Under section 3707(a)(2), the IRS is required to remove illegal tax-protester designations from its individual master file and disregard any illegal tax-protester designation in a place other than the individual master file in the case of any illegal tax-protesters designation made on or before July 22, 1998, the date of the enactment of section 3707. Although section 3707 prohibits the IRS from designating taxpayers as illegal tax protesters, it does provide that the IRS may designated any appropriate taxpayer as a nonfiler. However, the nonfiler designation must be removed once the taxpayer has filed income tax returns for two consecutive years and paid all taxes shown on the returns. Section 3707(b).

We conclude that Congress was concerned that innocent taxpayers may have been mislabeled as illegal tax protesters. However, Congress did not intend to limit the IRS's ability to maintain records and to make designations, other than the illegal tax-protesters designation, where such designations are appropriate.

As a result of the enactment of sections 3707 and 6702, the IRS has tried to balance these competing obligations by focusing on the conduct of the taxpayers and specifically identifying those frivolous arguments asserted rather than applying a general label of tax protester.

The Criminal Investigation (CI) division of the Internal Revenue Service investigates reports of violations of the federal criminal tax statutes, including tax evasion under 26 U.S.C. § 7201, willful failure to file tax returns or pay tax under 26 U.S.C. § 7203, willful filing of false returns under 26 U.S.C. § 7206, and violations of other statutes, and refers tax cases to the Tax Division of the U.S. Department of Justice for prosecution.

In July 2008, the office of the Treasury Department's Inspector General for Tax Administration reported that the number of federal criminal tax investigations referred by the Internal Revenue Service to the Justice Department is at an eight-year high. According to the report, the fiscal year 2007 ended with 4,600 investigations. The increase is nearly 50 percent from fiscal year 2002 to year 2007. The report also concluded that federal criminal tax convictions increased by 6.7% from fiscal year 2006 to fiscal year 2007. The number of persons convicted in fiscal year 2007 was 2,155.