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If a taxpayer submits an amended return at the start of an IRS audit, can they avoid penalties for doing so?  The rules allow large case taxpayers to make post-audit disclosures and avoid penalties. But what about smaller taxpayers?  Should they make disclosures to IRS auditors at the start of the audit process?  The Beigalski v. Commissioner, T.C. Summary Opinion 2019-35, case provides an opportunity to consider these rules.

Facts & Procedural History

The taxpayer was an independent contractor and then an employee.  The taxpayer deducted 80% of her cell phone expenses, as she used the phone for her business.

The IRS audited the taxpayer’s returns for 2014 and 2015.  During the taxpayer’s initial meeting, she provided the IRS with amended returns.  The returns reflected balances due of $5,000 or less.

The IRS did not process the amended returns.  It audited the originally-filed returns.  In doing so, the IRS determined there was an understatement each year slightly in excess of $5,000.

The IRS issued its notice of deficiency which included accuracy-related penalties.  The taxpayer commenced tax litigation resulting in this court case.

The dispute focused on whether the taxpayer was liable for accuracy-related penalties.

About Accuracy-Related Penalties

The accuracy-related penalty is imposed if there is a substantial understatement of tax.  The penalty is equal to 20 percent of the portion of an underpayment attributable to the understatement.

The penalty only applies the understatement exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000 (there is also a reasonable cause defense that can be available, but that isn’t part of this article).

So what return is considered if the taxpayer submits an amended return at the opening conference?  Is it the original return or the amended return?

The IRS and court went with the original return as audited by the IRS.  But should’t the taxpayer get some credit for disclosing the issue on their amended return at the start of the IRS audit?

The Qualified Amended Return

Taxpayers are able to avoid penalties by submitting a qualified amended return.  A qualified amended return is one that discloses adjustments to the IRS.  It is to be filed before the IRS contacts the taxpayer about the audit.  The benefit of a qualified amended return is that the taxpayer is not subject to IRS penalties.

The IRS issued Rev. Proc. 94-69, 1994-2 C.B. 804 to for large case taxpayers.  It extends the qualified amended return to allow the taxpayer to avoid penalties by providing information to the IRS within 15 days after the opening the IRS audit.  This benefit is only afforded to large case taxpayers.  This includes the largest businesses who are frequently audited by the IRS.

A Benefit Reserved to Large Case Taxpayers

Of course, Rev. Proc. 94-69 does not apply if the taxpayer doesn’t have substantiation for its position.  The IRS would probably have raised this issue if the revenue procedure was at issue.

The taxpayer in this case was not a large case taxpayer and they didn’t hire a tax attorney.  They probably were not even aware of Rev. Proc. 94-69.  The court case didn’t address Rev. Proc. 94-69, so presumably they did not raise the issue.

But should the large case taxpayers get the benefit of no penalties by submitting tax adjustments after the start of the IRS audit, when small taxpayers do not?

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