Penalty Relief and Premium Tax Credit Reconciliation

Today we welcome back Christine Speidel, an attorney with Vermont Legal Aid who directs the low income taxpayer clinic there. Christine has specialized over the past year in tax issues arising from the Affordable Care Act and co-authored a new chapter in “Effectively Representing Your Client before the IRS” on ACA issues.  Keith

This is the first tax season that people who received advance payments of the Premium Tax Credit (APTC) must reconcile those payments on their federal income tax returns. APTC was paid during 2014 based on a person’s projected 2014 income (and other eligibility criteria), which may have been estimated as early as October 2013. Not surprisingly, many people are discovering that they received too much APTC or do not qualify for a Premium Tax Credit (PTC) at all, and they are having to repay all or a portion of it with their tax return. As of late February, H&R Block announced that fifty-two percent of its clients who received APTC had to repay a portion of the subsidy.

Taxpayers who have a balance due because of APTC reconciliation do get some relief. In Notice 2015-09 (IRB 2015-6, 2/9/15), the IRS announced limited penalty relief for 2014 only, for taxpayers who have a balance due as a result of excess APTC. However, Notice 2015-09 imposes several conditions that must be met for penalty relief to be granted. It also sets out procedural hurdles that will be difficult for some taxpayers to overcome.

The rationale behind the penalty relief for taxpayers with excess APTC is not fully set out in the Notice. However, some exchanges made erroneous APTC determinations in 2014 amid technological and operational difficulties. Also, many consumers did not understand how APTC worked. This issue was described in a recent New York Times article. The penalty relief is provided under the authority of Sections 6651(a)(2) and 6654(e)(3).  Thus, one could say that Notice 2014-09 amounts to a blanket finding of reasonable cause for late payment, and a concession that the imposition of the estimated tax penalty would be against equity and good conscience. (There are also administrative penalty waivers such as First Time Abate.)

This post will describe the penalty relief available under Notice 2015-09 and some of the barriers that may prevent low-income taxpayers from accessing the relief. I will then offer some thoughts on improvements that could be made.

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Relief under Notice 2015-09

 

Notice 2015-09 provides relief from two penalty provisions: the penalty imposed by Section 6651(a)(2) for late payment of a balance due, and the penalty under Section 6654(a) for underpayment of estimated tax. Unfortunately, relief is not automatically applied to qualifying accounts, and relief from both penalties cannot be requested at one go.

The substantive criteria for relief are the same for both penalties. The penalties will be abated if a 2014 balance due was caused by APTC and: (1) the taxpayer filed a timely 2014 return (including by a properly extended due date); (2) the return reports excess APTC; (3) the taxpayer is current in all tax filing and payment obligations; (4) if the 2014 tax return was filed after 4/15/15, the taxpayer paid the balance due by 4/15/16; and (5) the taxpayer has requested relief. (See Notice 2015-09 at pages 4-5, and also Publication 974 (Mar. 2015) at page 8.)

Taxpayers will be considered current in their tax filing obligations if they “have filed, or filed an extension for, all currently required federal tax returns.” (Notice 2015-09 at page 5.) More controversial (in the LITC community at least) is likely to be the Notice’s definition of when a taxpayer is considered current in their payment obligations. If a taxpayer has any outstanding balances, the taxpayer must either have a current installment agreement or have entered into an offer in compromise. A taxpayer will also be considered in compliance if a “genuine dispute” is pending regarding the existence or the amount of a liability, so long as the liability has not been “finally determined.” (Notice 2015-09 at page 5). This definition of compliance will exclude many LITC clients from relief.

There are distinct procedures to request relief from each penalty. For the late payment penalty (known as the Failure to Pay or FTP penalty), relief is not requested with the tax return. Rather, the taxpayer must respond in writing to the IRS notice demanding payment of the balance (and charging penalties and interest). The taxpayer’s letter must request relief under Notice 2015-09 specifically. (See Notice 2015-09 at page 6.) In all cases, it seems the IRS will impose the FTP penalty before abating it.

There is a different procedure for requesting waiver of the estimated tax penalty. According to Notice 2015-09, “taxpayers should check box A in Part II of Form 2210, complete page 1 of the form, and include the form with their return, along with the statement: ‘Received excess advance payment of the premium tax credit.’” (p. 6) Theoretically at least, this penalty should never be assessed against taxpayers who qualify for relief.

Barriers to Relief

 

Two substantive restrictions on eligibility for penalty relief will bar deserving taxpayers from accessing relief. First, the narrow definition of compliance excludes many taxpayers, including people who have prior-year IRS debts in Currently Not Collectible status due to disability, unemployment or other hardship. Second, taxpayers who timely file a 2014 return after 4/15/15 are denied relief unless they pay off their balance by 4/15/16. There is no consideration given to the reason why the taxpayer filed under extension.

The complexity of the procedures for requesting relief is also worrisome. Notice 2015-09 was issued after the filing season had started, and well after most tax professionals had completed their annual continuing education courses. People are not likely to request relief from the estimated tax penalty unless prompted to do so by their preparer or software. I question whether the unrepresented low-income taxpayer population will be able to follow the procedures required to obtain relief from the FTP penalty (or even know to look them up). LITC practitioners will need to review future clients for this issue and request penalty relief for taxpayers when appropriate.

Broader context and ideas for improvement

 

Some of Notice 2015-09’s restrictions on eligibility for relief are puzzling given the circumstances that the policy is presumably intended to address. The procedural requirements mean that many people will not benefit from it even though they qualify. Other people will not qualify even though their 2014 circumstances relating to APTC are just as compelling.

Penalties should be administered with the goal of improving tax compliance. The IRS takes this approach in Policy Statement 20-1, found at IRM 1.2.20.1.1 (06-29-2004). Compliance is improved when people believe that the system is fair. (See the National Taxpayer Advocate 2014 Annual Report to Congress, MSP#8, especially pp. 100-101 and n. 47.) One component of fairness is a rational relationship between the problem and the solution.

With all that in mind, there are three things that should be improved about APTC penalty relief.

First, the IRS should not penalize taxpayers who file under extension. There is no rationale given for requiring someone who timely files pursuant to an extension to finish paying the debt by 4/15/16, while imposing no such requirement on someone who timely files on 4/15/15. This requirement will entirely exclude some taxpayers from relief, without good reason.

Some people may not file by 4/15/15 because they still have not received correct 1095-A forms. I have two clients in that situation currently. It is possible that the forms will not arrive before 4/15. Treasury directs taxpayers who know that corrected forms are pending to wait and file their return when the corrected form arrives. (March 20, 2015 press release and accompanying FAQs.) In Notice 2015-30 (scheduled to appear in IRB 2015-17 on April 27), Treasury issued guidance extending penalty relief to taxpayers who are affected by a delayed or incorrect Form 1095-A. (Notice 2015-30 merits its own post and will not be discussed in detail here.) This is a good step, but it does not go far enough. There are other valid reasons for a taxpayer to file on extension. For example, Joe Kristan recently explained why K-1s are often filed as late as September 15.

It makes sense to encourage taxpayers to file timely returns, including by the extended deadline. However, I question whether restricting APTC penalty relief will actually prevent any late filed returns. Also, some of the other restrictions on relief do not seem to have a policy basis other than reluctance to extend any relief to “bad” taxpayers.

Not everyone will be able to repay their APTC promptly. I know of one Vermont taxpayer who must repay over $11,000 in APTC due to a change in circumstances that he did not realize he should report to the exchange. Just because a taxpayer’s 2014 AGI was over 400% of the poverty line, and thus they are ineligible for APTC repayment caps, that does not mean the taxpayer has plenty of cash now. For my clients, AGI is often inflated by cancelled debt. Many of my taxpayers have also taken lump sum retirement distributions that were withdrawn and used for a specific purpose well before tax time.

Second, a prior-year clean slate should not be a necessary condition before one can find that a taxpayer deserves relief from penalties caused by 2014 APTC reconciliation. If this penalty relief policy were permanent rather than applicable only to 2014, it would make more sense to take prior year compliance into account. The government certainly does not want to see taxpayers with significant, unpaid, or late-paid excess APTC year after year. It might slightly encourage taxpayers to gamble or even intentionally try to receive more APTC than they should if penalty relief were available every year. In the first year of this program, however, whether taxpayers have unresolved/unpaid prior-year liabilities does not seem particularly important to the question of whether they deserve relief from APTC-related penalties for 2014.

In general, prior-year compliance is not a requirement for reasonable cause penalty relief. Rather, it is one factor that the IRS considers in determining whether the taxpayer exercised ordinary business care and prudence. See IRM 20.1.1.3.5 Requesting Penalty Relief (11-25-2011), #6. And that makes sense. The IRS should consider priory-ear compliance in the same way for APTC penalty relief.

The Service could at least specify some CNC closing codes that would be acceptable for purposes of qualifying for relief under Notice 2015-09. Taxpayers who are uncollectible due to residence in a foreign country need not be treated the same as taxpayers who are uncollectible due to unemployment or disability. (See table of CNC closing codes in IRM 5.16.1.2 Currently Not Collectible Procedures (1-1-15)).

Third, the procedural complexity is worrisome. The NTA and other stakeholders have repeatedly criticized IRS for its tendency to impose penalties automatically and correct them later. See the National Taxpayer Advocate 2014 Annual Report to Congress, MSP#8, especially notes 26-33 and accompanying text on pages 97-98. The National Taxpayer Advocate’s 2014 Annual Report to Congress highlighted the IRS penalty regime as Most Serious Problem #8.

Generally, failure-to-file and failure-to-pay penalty relief may be requested in writing or over the phone. The Internal Revenue Manual (IRM) allows consideration of oral requests under reasonable cause or FTA. See IRM 20.1.1.3.1 (08-05-2014), Unsigned or Oral Requests for Penalty Relief. This section does not currently encompass relief under Notice 2015-09. Relief from estimated tax penalties is not included at all in current oral waiver authority; a signed written request must be submitted. See IRM 20.1.1.3.1, #6 (08-05-2014).

Conclusion

 

When an individual owes tax to the IRS, several different penalty provisions of the Internal Revenue Code (IRC) may come into play. The penalty and interest provisions of the IRC often confound the taxpayers I work with. Many unsophisticated taxpayers are afraid to file a tax return showing a balance due. They frequently fail to understand how important a timely-filed return is.

Penalty relief that must be specifically requested by the taxpayer is less effective than a blanket policy that is automatically applied by the IRS. This is particularly the case for relief that must be requested in writing.

Taxpayers have the right to a fair and just tax system. (IRS Pub. 1) APTC penalty relief should be simplified substantively and procedurally so that it actually reaches the deserving taxpayers for whom it was designed. The penalty relief provided in Notice 2015-09 is a welcome step. But the Notice does not go far enough to help taxpayers confused by a new system. Penalties only promote tax compliance when they are administered in a way that is perceived as fair.

 

ACA and Tax Procedure: Many Unanswered Questions Still Exist

In today’s guest post we welcome Christine Speidel. Ms. Speidel is an attorney with the Vermont Low Income Taxpayer Project and the Office of the Health Care Advocate, both at Vermont Legal Aid. She has a particular interest in health care reform as it affects low-income taxpayers. Christine will co-author, with Tamara Borland of Iowa Legal Aid, a new chapter on the Affordable Care Act in the upcoming 6th Edition of “Effectively Representing Your Client before the IRS.” Les

Two major tax code sections created by the Affordable Care Act took effect this year. First, Section 5000A provides that individuals must either have health insurance that is “minimum essential coverage,” have an exemption from the requirement to have coverage, or make a shared responsibility payment with their income tax return. Second, Section 36B makes an advanceable and refundable credit available to certain taxpayers to offset the cost of individual market health insurance obtained through the ACA’s affordable insurance exchanges. I will outline the procedures for assessment and collection of the 5000A payment. Then I will briefly outline the procedures for assessing and collecting overpayments of the 36B premium tax credit.

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The individual shared responsibility payment is colloquially known as the “ACA penalty.” The Service is restricted from treating the penalty like any other tax debt. Although the penalty is to be “assessed and collected in the same manner as an assessable penalty under subchapter B of chapter 68.” (Section 5000A(g)(1)) the Service may not employ criminal penalties, criminal prosecutions, the Notice of Federal Tax Lien, or levy procedures to collect the penalty. Section 5000A(g)(2). The ban on levy procedures encompasses many programs employed in the general course of tax collection, including the State Income Tax Levy Program and the Federal Payment Levy Program.

While a Notice of Federal Tax Lien (NFTL) may not be filed based on a Section 5000A assessment, the “secret” statutory lien that applies to all tax debts will still arise and attach to all property of the taxpayer under Section 6321. The secret lien could potentially be foreclosed in federal district court pursuant to Section 7403, but the Service will not have the benefit of any priority status that would have been conferred by a NFTL.

Collection of the ACA penalty is expected to occur largely through voluntary payments and refund offsets. Refund offsets are possible, despite the ACA’s prohibition on levies, because the application of an overpayment to a tax liability pursuant to Section 6402(a) is technically not a levy. Perry v. Comm’r, T.C. Memo. 2010-219, and cases cited. See also discussion in the National Taxpayer Advocate’s 2011 Annual Report to Congress, p. 598 (noting that legislation could be helpful to curb inappropriate uses of the Service’s offset authority).

It remains to be seen how the Service will implement the restrictions on its collection powers. For example, the penalty may need to be tracked on its own account transcript. If the penalty is not included on the 1040 account transcript, taxpayers’ representatives will presumably need to identify the penalty as a separate matter on the Power of Attorney (Form 2848).

As an excise tax, the ACA penalty will be subject to the 3 year assessment statute of limitations of Section 6501(a). It is an excise tax because Section 5000A can be understood as imposing an indirect tax on the condition of not having health insurance. Nat’l Fed. Indep. Bus. v. Sebelius, 132 S.Ct. 2566, 2599-2600 (2012). Section 5000A is located in chapter 48, subtitle D of the Internal Revenue Code. Subtitle D is titled Miscellaneous Excise Taxes. If the penalty is underreported by more than 25 percent of the reported penalty, the limitations period is 6 years under Section 6501(e)(3). There is no limitations period at all in the case of fraud or a willful attempt to defeat or evade the penalty, or a failure to file a return. Section 6501(c)(1)(2)&(3).

We do not yet know what the Service’s assessment procedures will be for the ACA penalty. Nothing in the Affordable Care Act or subsequent amendments limits the IRS’s assessment authority with respect to the penalty. Third party information returns filed under Sections 6055 and 6056 will aid the Service in its assessment efforts. Taxpayers have no right to Tax Court deficiency procedures prior to assessment of the ACA penalty. See Section 6211(a), definition of a deficiency. The Service could voluntarily create a pre-assessment administrative review process. This seems advisable as a matter of fairness and political expediency. Many taxpayers will not be able to afford paying the penalty and then filing a refund suit.

In many ways it would make sense, and promote administrative simplicity, for the ACA penalty to be subject to the same assessment procedures as an individual income tax liability. The ACA penalty is to be included on the individual income tax return. Section 5000A(b)(2). More importantly, calculation of the penalty is based on the income, health insurance status, and exemption status of the taxpayer(s) and their dependents.

Automated adjustments, examinations, and Tax Court deficiency litigation frequently involve items of income or whether a person qualifies as the taxpayer’s dependent. Health insurance status could be at issue in a proposed disallowance of the Health Insurance Premium Tax Credit (which is subject to deficiency procedures). The ACA penalty may be implicated by the outcome of these processes. It might be simpler and less confusing for taxpayers if proposed adjustments to the ACA penalty were included with notice of other proposed adjustments to a tax return. However, once a petition is filed in Tax Court, any ACA penalty issues will have to be separated because they are beyond the court’s jurisdiction.

We also do not yet know what procedures the Service will use to collect the ACA penalty. As with the assessment issues just discussed, in some areas the Service has very few restrictions placed on it. For example, because liens and levies may not be used to collect the penalty, the collection due process rights associated with liens and levies do not apply. The Service is not legally obligated to provide the rights conferred by sections 6330 and 6331 when employing its offset authority. Boyd v. Comm’r, 451 F.3d 8 (1st Cir. 2006). As a matter of fair and efficient tax administration, though, it may choose to provide for post-assessment administrative review.

The general collection statute expiration date (CSED) under Section 6502 should apply to collection of the ACA penalty. It has been suggested that there is no CSED with respect to refund offsets under Section 6402(a), because Section 6502(a) only explicitly limits levies and proceedings in court. ((See Ajay Gupta, ACA Penalty: Toothless? Hardly! Corporate Raiders Fare Better, 141 Tax Notes 877 (Nov. 25, 2013)). This is contrary to the Service’s current practice, and would be a fundamental change in collection policy. See IRM 21.4.6.4, Refund Offset Research (10/1/2013), Note following #3 (requiring consideration of the CSED “in all cases.”). Section 6402(a) explicitly refers to “the applicable period of limitations”. Section 6401(a) of the Code also provides that the term ‘overpayment’ includes a payment of any internal revenue tax that is “collected after the expiration of the period of limitation properly applicable thereto.” In Program Management Technical Advice 2011-035, the Service has noted: “Although the phrase any liability in respect of an internal revenue tax is not defined in the statute, it has long been the Service’s position that a tax liability which could be enforced through normal assessment and collection procedures … is a prerequisite for making an offset under section 6402. See Treas. Reg. section 301.6402-1.”

If the ACA penalty is not timely paid, late payment penalties may be imposed under Section 6651(a)(3). Interest may be imposed under Section 6601, although interest will not begin to run until assessment. Section 6601(e)(2)(A). This is a result of Congress having specified that the ACA penalty is to be collected in the same manner as an assessable penalty located in subchapter B of chapter 68 of the Code.

The Service has stated that the 6662 accuracy-related penalty does not apply to the shared responsibility payment. 78 FR at 53655 (Aug. 30, 2013). The Service reasoned, “The section 5000A shared responsibility payment is not taken into consideration in determining whether there is an underpayment of tax under section 6664. Therefore, the shared responsibility payment is not taken into account under section 6662.” It is not clear how this conclusion was reached: the section 6662 penalty applies to underpayments of tax as defined in section 6664, and section 6664 refers to “any tax imposed by this title.” For Constitutional purposes, the ACA penalty is a tax, imposed by Title 26 of the U.S. Code. However, even if the Service changes its interpretation of section 6664, any accuracy-related penalty would at least have to be based on negligence or disregard of the rules. Section 6662(b)(1). The “substantial understatement” penalty under section 6662(b)(2) only applies to income tax.

The Service has not yet released forms, instructions, detailed publications, IRM provisions, or much guidance regarding assessment and collection of the ACA penalty. There are significant uncertainties at this point regarding the practical implementation of section 5000A.

Assessment and collection of Premium Tax Credit overpayments

In contrast to the individual shared responsibility payment, the Health Insurance Premium Tax Credit (PTC) fits readily into the Service’s existing assessment and collection procedures. The PTC is a new refundable credit, and it is treated for assessment and collection purposes like the existing refundable credits. PTC is available in advance or may be claimed on a tax return.

Anyone who receives advance PTC payments (APTC) must file a tax return to reconcile the advance payments with the PTC actually due to the taxpayer. Treas. Reg. § 1.36B-4. Excess advance payments are treated as additional income tax liability. Section 36B(f)(2); Treas. Reg. § 1.36B-4(a)(1)(i). PTC not taken in advance could also be refunded and then subsequently disallowed.

The Service’s determinations related to PTC eligibility are subject to the same deficiency procedures available to other refundable tax credits under Section 6211(b)(4). Thankfully, there is nothing analogous to the Earned Income Credit ban for PTC.

The ACA does not impose any limits on the Service’s collection powers for excess PTC; therefore, collection may take the form of liens, levies and refund offsets. Penalties and interest may be assessed as with any other unpaid income tax liability.

The uncertainty around accuracy-related penalties under section 6662 is relevant to recipients of the Premium Tax Credit, and particularly to taxpayers who take APTC. The accuracy-related penalty is complex, and I will not describe it in detail here (it has been the subject of several previous Procedurally Taxing posts, including just this past week). In brief, the penalty may be imposed when there is an underpayment of tax as defined in section 6664. In Program Manager Technical Advice Memorandum 2012-016, the Service has conceded that the accuracy penalty does not apply if a disallowed refundable credit was frozen and not actually received by the taxpayer. Previously, the Service asserted that the accuracy penalty did apply if the disallowed credit was received by the taxpayer. However, in Rand v. Commissioner the Tax Court held that disallowed refundable credits cannot reduce the amount shown as tax on the return below zero. 141 T.C. No. 12 (2013). The Commissioner initially appealed the decision to the Seventh Circuit. On June 10, 2014, the parties filed a stipulation to dismiss the appeal with prejudice. It remains to be seen whether the Service will attempt to overrule Rand through regulations or other means.