On December 8, 2005, the Governor signed into law chapter 163 of the Acts of 2005 (the "Act"). Sections 12 and 14 of the Act add sections 35A through 35E to chapter 62C of the General Laws. These new sections impose penalties that apply in the following circumstances:
1. A taxpayer substantially understates a tax liability or underpays taxes due to negligence or disregard of Massachusetts laws, including public written statements of the Commissioner;
2. A preparer with respect to a tax return or claim for abatement or refund knows or reasonably should know that the return or claim reflects a position or positions unsupported by Massachusetts law, and the position was not disclosed or was frivolous; or a preparer willfully attempts to understate tax liability or demonstrates a careless, reckless or intentional disregard of Massachusetts tax laws or written public statements issued by the Commissioner;
3. A taxpayer takes a tax return reporting position on an issue in Massachusetts that is inconsistent with a position taken in another state and the governing law relating to that issue is the same in all material respects in Massachusetts and the other state, and;
4. A person organizes, assists in the organization of, or sells (or assists in the sale of) any plan or arrangement, and makes or furnishes, or causes another person to make or furnish, a false, fraudulent or deliberately misleading statement with respect to the allowability of any deduction or credit, the excludability of any income, or the securing of any other tax benefit, including the avoidance of a filing requirement.
The purpose of this Technical Information Release is to explain the nature of the new penalties, the conduct and the types of plans or arrangements to which they apply and the manner of their enforcement. These penalty provisions were in substantial part derived from provisions of the federal Internal Revenue Code imposing like penalties with respect to federal returns, and the Department intends to apply and interpret the new penalties in a manner generally consistent with such provisions of the Code and the Treasury Regulations promulgated thereunder, to the extent that such federal law provides pertinent authority.
II. Negligence and Substantial Understatement Penalties
The underpayment penalty found in the new G.L. c. 62C, § 35A adds to the tax due a penalty of twenty percent of an "underpayment" of tax required to be shown on a return. An underpayment is defined as the difference between the amount of tax required to be shown on a return and the amount reported on that return. This penalty applies to the various taxes governed by the administrative provisions set out in G.L. c. 62C including the personal income tax, corporate excise, and sales and use taxes. It applies only in cases where a return is filed. In order for the penalty to apply, the underpayment must be attributable to "negligence or disregard" of the tax laws of the Commonwealth or of public written statements issued by the Commissioner or to a "substantial understatement" of liability. "Negligence" includes a taxpayer's failure to make a reasonable attempt to comply with the laws or the Commissioner's public written statements. "Disregard" includes any careless, reckless, or intentional disregard of the laws or public written statements. An understatement is substantial for any tax period if it exceeds the greater of 10% of the tax required to be shown on the return or $1,000.
The amount of an understatement will be reduced by any portion of the understatement attributable to a position supported by substantial authority or if the relevant facts are adequately disclosed in the return and there is a reasonable basis for the return position. However, these mitigating factors are inapplicable in the case of "listed abusive transactions or strategies." See section VI below.
Submission of a written statement setting out the relevant facts including, without limitation, the basis for the challenge and identifying the tax law or public written statement being challenged will constitute adequate disclosure. This disclosure may, but is not required to be, in the form of a properly completed federal Form 8275 or 8275R. Electronic filers may utilize Schedule TDS (available in most corporate e-file software and personal income Webfile for Income application). A list of all approved software developers for corporate and personal income electronic filing can be found in the Department's website. Please check the software developers website first to make sure their package for the tax year in question includes Schedule TDS.
[ Note added 10/16/09: TIR 06-5 as originally issued referenced an email address for submission of disclosure statements that is no longer active].
The newly enacted G.L. c. 62C, § 35B provides that a § 35A penalty may not be imposed with respect to any portion of an underpayment if it is shown there was reasonable cause for such portion and the taxpayer acted in good faith. Section 35B further authorizes the Commissioner to list by regulation items considered to be "abusive transactions or tax strategies" for purposes of § 35A and to set forth circumstances under which § 35A penalties attributable to such transactions or strategies may be waived.
III. Preparer Penalties
The preparer penalty found in the new G.L. c. 62C, § 35C(a) will subject return preparers to a $1,000 penalty for positions taken on any return or claim for abatement or refund where the position had no realistic possibility of being sustained on its merits and the facts of the item at issue were not disclosed on the return or claim or the position taken was frivolous. This penalty may be assessed within three years after the return or claim is filed. An application for abatement of the penalty may be filed up to three years from the time it is paid. The Commissioner may waive or abate the penalty if the preparer (denominated "taxpayer" in the statute for administrative purposes) can demonstrate reasonable cause and not willful neglect.
The new G.L. c. 62C, § 35C(b) provides a penalty for return preparers where any part of an understatement on a return or a claim for refund or abatement is due to a willful attempt by the preparer to understate a tax liability or results from the preparer's careless, reckless or intentional disregard of the Commonwealth's tax laws or the Commissioner's public written statements. A return preparer will not be considered to have carelessly, recklessly or intentionally disregarded a tax law or public written statement if the position taken on the return or claim (a) is adequately disclosed; and (b) either (i), in the case of a return, has a realistic possibility of being sustained on the merits, or (ii), in the case of a claim for abatement or refund, is not frivolous. The penalty equals the greater of $1,000 or 10% of the tax attributable to such understatement, provided that where penalties under § 35C(a) and § 35C(b) are applicable to the same return or claim, the penalty under subsection (b) will be reduced by the amount of the penalty imposed under subsection (a).
IV. Inconsistent Filing Position Penalties
The inconsistent filing position penalty found in the new G.L. c. 62C, § 35D applies to corporate excise (G.L. c. 63) and personal income tax (G.L. c. 62) filers that take an inconsistent position in reporting income. Section 35D requires these filers to "disclose the inconsistency" when filing their Massachusetts returns. If such inconsistency is not disclosed, the taxpayer will be subject to a penalty equal to the amount of tax attributable to the inconsistency. This penalty is in addition to any other penalties that may apply.
A taxpayer is deemed to have taken an "inconsistent position" when the taxpayer pays less tax in Massachusetts based upon an interpretation of Massachusetts law that differs from the position taken by the taxpayer in another state where the taxpayer files a return and the governing law in that other state "is the same in all material respects" as the Massachusetts law. The Commissioner may waive or abate the penalty if the inconsistency or failure to disclose was attributable to reasonable cause and not willful neglect.
For example, if a taxpayer files corporate excise returns in Massachusetts and another state with laws that are the same in all material respects with respect to sourcing of sales of tangible property, but does not apportion its sales under the same methodology in both states and does not disclose the inconsistency, such taxpayer would be subject to penalties under G.L. c. 62C, § 35D.
V. Promoter Penalties
The activities triggering application of the new G.L. c. 62C, § 35E are the organization or assisting in the organization of a plan or arrangement or the sale (or assisting in the sale) of a plan or arrangement where a person (hereinafter a "promoter") makes or furnishes or causes another person to make or furnish a statement with respect to the allowability of a deduction or credit, the excludability of income, or the securing of any other tax benefit, including the avoidance of a filing requirement, which tax benefit the promoter knows or has reason to know is false, fraudulent, or deliberately misleading as to any material matter.
The penalty applies for each taxpayer to whom the promoter makes such a statement. For example, if a promoter prepares and distributes literature to clients and/or prospective clients containing false, fraudulent or deliberately misleading statements with respect to entitlement to a deduction, the promoter will be subject to the $5,000 penalty for each client to whom the statement was distributed (or 100% of the gross income derived or to be derived from the offending activity if the promoter can establish that this amount is less than $5,000). The penalty may be assessed within six years after the statement is made, with any claim for abatement allowed up to two years from the time the assessment was made.
A similar provision in the Internal Revenue Code, § 6700 (Promoting abusive tax shelters, etc.), was enacted in 1982. Without limitation, the newly enacted Massachusetts provision may apply to persons subject to penalty under IRC § 6700, whether or not such penalty has been imposed, where such activities affect tax returns required to be filed with the Commonwealth, as well as to persons promoting plans or arrangements with respect to asserted benefits that are specific to state taxes.
VI. Listed Abusive Transactions or Strategies
The Internal Revenue Service ("IRS") publishes notices identifying certain generic tax shelters as "potentially abusive" and warning taxpayers that, among other consequences, the use of such "listed transactions" may lead to an audit and assessment of taxes, interest and penalties.
The Department may apply the relevant new penalty provisions to plans or arrangements including, but not limited to, "listed transactions" as defined by the IRS in Treasury Regulation § 1.6011-4(b)(2) as warranted, whether or not (a) the IRS has identified the transaction as a "listed transaction" at the time the taxpayer enters into the transaction, or (b) the transaction is (or was) required to be disclosed as a "listed transaction" according to the Treasury Regulations. In addition to federally "listed transactions" which will be incorporated by reference in a regulation to be promulgated, the Department reserves the right to apply the relevant penalties to additional abusive transactions or tax strategies as listed by the Commissioner and incorporated by reference in such regulation.
VII. Manner of Assessment/Effective Date
The penalties provided for in these new provisions will be assessed in the manner of a tax pursuant to the provisions of G.L. c. 62C. The provisions of G.L. c. 62C relating to appeal rights and conferences/hearings with the Commissioner or his duly authorized representative are likewise generally applicable. The penalty provisions with respect to taxpayers and preparers apply to returns or claims for abatement or refund filed on or after December 8, 2005 (the date of enactment of G.L. c. 62C, §§ 35A through 35E). The promoter penalties apply to proscribed activities occurring on or after December 8, 2005.
/s/ Alan LeBovidge
Commissioner of Revenue
April 13, 2006