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AMBRECHT & BRITTAIN, LLPIncreasing Taxpayer Compliance:
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Paper presented to the Ways & Means Committee of the U. S. House of Representatives in Washington, D.C., in May, 1998; presented on behalf of the Estate and Gift Tax Committee of the Tax Section of the California State Bar. [The comments contained in this paper are the individual views of the authors who prepared them, and do not represent the position of the State Bar of California.] EXECUTIVE SUMMARYThe United States Internal Revenue Service (IRS) has never been a popular government agency. However, it may be disliked even more now than any time in the past. Although many factors have lead to the current unpopularity of the IRS, one of the principal reasons is the zest with which the IRS asserts penalties against taxpayers. A staff report of the congressionally appointed National Commission on Restructuring the IRS concluded that penalties and interest "are often at a level where they actually are a significant disincentive for many taxpayers to reach agreement with the IRS." The IRS Commissioner himself has stated in Congressional hearings that it is time to reexamine the penalty system. [Attached were copies of a Santa Barbara News-Press article dated March 16, 1998, and letter from Ronald L. Wolfe of Santa Barbara, CA, dated March 16, 1998. Many, if not most, taxpayers make an honest attempt to comply with the virtually incomprehensible Internal Revenue Code (IRC). When told by the IRS that they not only misunderstood the IRC, but also are liable for a penalty, the typical result is a feeling of injustice, rage, and a hardened attitude toward the IRS. There are many examples of citizen outrage against the government (not all of it, of course, directed at the IRS). At one extreme, one reads almost daily about groups and individuals who distrust the US government so greatly they are willing to live in armed isolation, refuse to pay all taxes, plot to blow up government buildings, and even murder government employees. While these individuals may act rather like rebellious adolescents, there are many reasons why they feel disenfranchised and helpless. On the other end of the spectrum, one finds highly-educated high-earning individuals who feel anger and resentment about the poor treatment they and others taxpayers receive at the hands of the IRS. They lose respect for the tax system when the IRS, justifiably or not, accuses them of inaccurate reporting, or when it applies an overly punitive sanction. This resentment reduces compliance with the tax system, and certainly has led to support for proposals to eliminate the IRS. This paper suggests one reform that, if implemented by Congress, could help rebuild and maintain trust and respect between taxpayers and the IRS. This reform concerns the manner in which the IRS asserts the negligence penalty. [See section 6662(b)(1) and section 6662(c ) of the Internal Revenue Code of 1986, as amended. The negligence penalty equals 20% of the portion of an underpayment due to negligence.] We focus on the negligence penalty because it is the penalty most often asserted by the IRS, and thus is the penalty causing most of the problems. This paper is essentially divided into in three parts. First, it generally discusses the manner in which the IRS and the courts apply the negligence penalty. Second, it briefly summarizes some of the psychological research that has been done on two fronts—taxpayer responses to the IRS, and individual responses to authority situations similar to those involving the IRS. Third, it suggests some general reforms to encourage taxpayer compliance and offers a specific proposal that may help relieve some of the tension that the negligence penalty causes between the IRS and taxpayers. DISCUSSION1. THE CURRENT APPLICATION OF THE NEGLIGENCE PENALTYIRC Section 6662 provides in part that: "(a) ...If this section applies to any portion of an underpayment of tax required to be shown on a return, there shall be added to the tax an amount equal to 20 percent of the portion of the underpayment to which this section applies .... "(b) ...This section shall apply to the portion of any underpayment which is attributable to one or more of the following: "(1) Negligence or disregard of rules or regulations ... "(c) ...For purposes of this section, the term `Negligence' includes any failure to make a reasonable attempt to comply with the provisions of this title, and the term `disregard' includes any careless, reckless, or intentional disregard." Regulation section 1.6662-3(b)(1) provides in part that: "(2) Negligence. The term NEGLIGENCE includes any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax return... Negligence is strongly indicated where— "(i) A taxpayer fails to include on an income tax return an amount of income shown on an information return, as defined in section 6724(d)(1); "(ii) A taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return which would seem to a reasonable and prudent person to be `too good to be true' under the circumstance; ..." Although omitted here, the regulations continue by discussing specific situations where the application of the negligence penalty "is strongly indicated" but not automatic. Regulation section 1.6662-3 (b)(2) provides: "(2) DISREGARD OF RULES OR REGULATIONS. The term DISREGARD includes any careless, reckless or intentional disregard of rules or regulations. The term `rules or regulations' includes the provisions of the Internal Revenue Code, temporary or final Treasury regulations issued under the Code, and revenue rulings or notices (other than notices of proposed rulemaking) issued by the Internal Revenue Service and published in the Internal Revenue Bulletin. A disregard of rules or regulations is `careless' if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position that is contrary to the rule or regulation. A disregard is `reckless' if the regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe. A disregard is `intentional' if the taxpayer knows of the rule or regulation that is disregarded. Nevertheless, a taxpayer who takes a position contrary to a revenue ruling or a notice has not disregarded the ruling or notice if the contrary position has a realistic possibility of being sustained on its merits." Many tax professionals believe that the IRS routinely asserts the negligence penalty against taxpayers any time there is an underpayment of taxes, notwithstanding that section 6662 of the IRC and the regulations do not provide any basis for such a blanket assertion of the negligence penalty. [Compare Rev. Rul. 75-330, 1975-2 C.B. 496 wherein the IRS held that, "it is improper to automatically assert the negligence penalty in every case in which the accumulated earnings tax is applicable" since "a determination of negligence depends on the facts and circumstances in each case."] For example, in many cases where the underlying tax law itself is not clear, the IRS still has asserted the negligence penalty only to be overruled in court. [See, for example, Kochnasky v. Commissioner KTC 1996-368 (9th Cir. 1996) and Charley v. Commissioner, KTC 1996-329 (9th Cir. 1996).] It appears that the negligence penalty is often used not only as a penalty for certain behavior, but also as "hidden tax." [See News-Press Article, footnote 3.] Because the IRS uses the penalty as a way of raising tax revenue in addition to the normal means of raising revenue through the tax rates, a special conflict in the taxpayer's mind occurs that will be discussed in greater detail following. The confusion in the taxpayer's mind is further amplified by the courts because they do not appear to offer helpful guidance or reliable interpretation of the standards for applying the negligence penalty. For example, the Tax Court's standard approach to determining whether the Commissioner's assertion of the negligence penalty should be affirmed is illustrated by the language in the Estate of Ralph B. Campbell v. Commissioner: [56 T.C. 1 (1971).] "The Commissioner determined that an addition to tax should be assessed under section 6653(a), IRC 1954, for underpayment of tax in 1963 `due to negligence or intentional disregard of rules and regulations.' The burden of proof on this issue is upon petitioners. (citations omitted). We have found that the burden was not carried." [IRC section 6653(a) is the predecessor to section 6662(a) and (b)(1). For a discussion of the history of section 6662, see, Korshin v. Commissioner, KTC 1996-327 (4th Cir. 1996).] In other cases, the Tax Court may review the facts of the situation in more detail to confirm the appropriateness of the penalty. Although this approach may be more helpful in establishing some uniformity in the application of the negligence penalty, courts may still disagree on the import of the specific facts on negligence. For example, the Tax Court in the Estate of Louise S. Monroe v. Commissioner [104 T. C. 352 (1995)] said that: "Negligence includes a failure to make a reasonable attempt to comply with the provisions of the internal revenue laws. (citations omitted). "The determination of whether a taxpayer acted with reasonable cause and in good faith depends upon the pertinent facts and circumstances. (citations omitted) ... "Reliance on a qualified advisor will constitute reasonable cause only if the taxpayer has acted in good faith and has made full disclosure of all relevant facts to the adviser. (citations omitted). "Petitioner contends that it acted with reasonable cause, because it relied upon the advice of its accountants for an understanding of the requirements for a qualified disclaimer under section 2518. Petitioner argues that it reasonably concluded that Monroe was free to give the disclaimants cash gifts equaling the amounts of their renounced bequests within weeks of the execution of the disclaimers. "Respondent maintains that petitioner may not rely on the advice of its accountant as a shield against the negligence penalty, because petitioner failed to disclose relevant information to the accountant. In respondent's view, petitioner did not rely on its accountant in good faith, because petitioner did not inform them of Monroe's cash gifts to the disclaimants equaling the renounced bequests." The court continued: "We are not persuaded by petitioners contention that, because the accountants told the nephew that Monroe could continue to make gifts or leave a bequest to the disclaimants, there was no reason to inform the accountants of these cash gifts by Monroe: The accountants should have been informed of these facts. We do not believe that petitioner acted in good faith reliance on the accountants." The court continued: "Furthermore, on brief, petitioner conceded that Monroe and the nephew were ‘entirely dependent upon the accountants for their understanding of the nature and utilization of disclaimers.' Because petitioner failed to disclose the material fact of Monroe's essentially contemporaneous ‘gift-giving' the accountants were unable to provide a fully informed opinion on whether or not the disclaimer satisfied the requirements of section 2518. We hold that petitioner is liable for the addition to tax under section 6662." Despite the Tax Court's extensive factual discussion justifying its application of the negligence penalty, the Fifth Circuit Court of Appeals disagreed and reversed the Tax Court. This reversal is quite significant because of the rule that a Tax Court determination of negligence is a factual finding which an appellate court must review for clear error. [See Reser v. Commissioner, KTC 1997-97 (5th Cir. 1997).] In other words, the Fifth Circuit necessarily found clear error by the Tax Court. Such a "clear error" approach compels the conclusion that reasonable persons can differ in the application of the current standards utilized to determine the appropriateness of the negligence penalty. For example, the appeals court in Monroe said in part: "Although the Commissioner conceded at trial that the fraud penalty was inapplicable, she nonetheless argued for the imposition of a 20% negligence penalty under IRC section 6662(a). The Tax Court, rejecting the estate's arguments, concluded that the estate could not rely on the accountants' advice because Monroe had failed to disclose material facts. In particular, the Tax Court felt that without being told that Monroe intended to make gifts to the legatees shortly after the disclaimers were executed, the accountants could not properly advise him..." The Monroe court continued: "The Tax Court erred... "(N)o negligence penalty should have been or is warranted. Negligence is defined in section 6662(a) as `any failure to make a reasonable attempt to comply with the provisions of this title...' Monroe was advised by Touche Ross that gift giving to the disclaimants was allowed, as long as no promises were made to induce the legatees to renounce. Based on that advice, it was not unreasonable for Monroe, who was 93 years old at the time the disclaimers were made, to decide that the better course was to make any gifts that he wished to make sooner rather than later..." The confusing application of the current standards concerning the negligence penalty in cases such as this as well as many others is of particular concern since the IRS asserts the penalty with such frequency and in such an apparently arbitrary manner. [See, for example, Monroe v. Commissioner, supra, and Durrett v. Commissioner, KTC. 1996-18 (5th Cir. 1996) where both Appellate Courts overruled the Tax Court and allowed the taxpayer to rely on the advice of a tax expert); See also Otis v. Commissioner, 73 T.C. 671 (1980); and Charley v. Commissioner, KTC 1009-329 (9th Cir. 1996).] In addition, given the fact that the negligence penalty is, in fact, a "penalty", the question must be asked, "What impact does the application of the negligence penalty have on taxpayer compliance?" 2. PSYCHOLOGY OF TAXPAYER BEHAVIORIRS overreaching has two effects. First, it eliminates one essential feature of any tax system – fairness. Second, it causes resentment toward the tax system which leads to a decrease in total tax collections. The first of these two effects is well known. The second is less known, but should be of great concern to Congress, since the purpose of penalties is to increase, not reduce, compliance. Here, we will discuss the second of these two effects. Specifically, we will review the psychological aspects of the current tax law and its application to the IRS' apparent uniform application of the negligence penalty. Many factors affect the way in which taxpayers respond to IRS penalties. These factors include the taxpayers' education, socio-economic status, past interactions with the IRS, and personal attributes (such as varying "degrees of locus of control"). Other factors include the degree of certainty that taxpayers attribute to sanctions, the severity of the sanctions, the social milieu regarding tax paying, and the experiences of others vis-à-vis the IRS. A review of a few of the aspects of taxpayer response in more detail is appropriate. Locus of Control: Groenland and Van Veldhoven (1983) [Groenland, E. and Van Veldhoven, G., "Tax Evasion Behavior: A Psychological Framework," Journal of Economic Psychology, 3, pp. 129-144] found that "Locus of Control" can predict tax evasion (when education and occupation are controlled). Individuals with an internal locus of control generally feel they are the masters of their own destiny. Individuals with an external locus of control feel at the mercy of others. An individual's locus of control is often thought to be a life-long characteristic, but in fact it can readily change in response to the environment or circumstances surrounding an individual. War time military brain-washing, as well as the hopeless feelings of Nazi concentration camp victims demonstrate how this attitude can profoundly change. When an agency of authority misuses its authority, for example the misuse of punitive sanctions by the IRS, there may develop a shift away from an "internal locus of control," to an "external locus of control." The individual may now perceive the authority as evil, unwarranted, or arbitrary and the individual will feel helpless and powerless. Helplessness and Powerlessness: The psychological literature is well-documented with decades of research that indicates what happens when individuals feel helpless and powerless (Seligman, Learned Helplessness, Univ. of Pennsylvania, 1970-1995.) To some degree, individual responses to feeling thwarted or punished will vary according to the individual's temperament and most importantly, to his or her past experience. When well integrated, instrumental, pro-active individuals feel thwarted or punished, they will initially get angry. These individuals will use past behavior patterns that have been effective, until those behaviors no longer work. At a certain point, these individuals will seek new behavior until they find something that works – in many cases that may involve non-compliance, the fabrication of information, and the withholding of information or tax payments. Further, when individuals feel brutalized or powerless, they may regress to child-like behavior. Individuals who are chronically helpless will often just take whatever is "dished out" to them by authorities. This group will pay negligence penalties. If the penalty is unwarranted, the IRS's demand for a penalty will only confirm these individual's sense of the injustice of life. The result may be a greater and greater depression, ingrained helplessness, hopelessness, and passivity. Certainly, IRS arbitrary behavior which may result in an individual's feelings of helplessness and powerlessness with either type of individuals are not desirable attributes for US citizens or taxpayers. Professor Ronald G. Worsham, Jr. discovered a profound paradox resulting from IRS procedural injustice (unfair or unreasonable penalties, overly lax enforcement for privileged individuals or corporations, etc.). "Procedural injustice which is experienced indirectly through becoming aware of another's unfair treatment increased the level of non-compliance." In other words, as citizens observe others being mistreated by the IRS, the observers become less compliant. Worsham concludes that "unfair tax enforcement procedures experienced vicariously" do lead to adverse taxpayer behavior and greater non-compliance. (See Seligman, supra.) This is of great concern, since the unjust treatment of just one individual is likely to have a cascading non-compliance effect on a multitude of observing taxpayers. Other influences also impact taxpayer compliance. For example, A. Furnham (1983, "The Protestant Work Ethic, Human Values, and Attitudes Towards Taxation," Journal of Economic Psychology, 2, pp. 113-128) found that individuals with a strong Protestant Work Ethic (PWE) "assigned a higher priority to freedom and independence and were significantly more opposed to taxation than low PWE subjects. This leads to the interesting observation that, although the PWE may promote some values that are well regarded in a democratic society, these values do not necessarily include income tax compliance." (Jackson, B.R., and Milliron, V.C, "Tax Compliance Research," Journal of Accounting Literature, 1986, pp. 129-165.) One of a few studies that measured actual tax evasion (in contrast to self-reporting regarding tax evasion), Hessing, Elffers and Weigel(1988) found that the best predictor of actual tax evasion is "Alienation." (Hessing, D, and Elffers, H., and Weigel, R, "Exploring the Limits of Self-Reporting and Reasoned Action: An Investigation of the Psychology of Tax Evasion Behavior," Journal of Personality and Social Psychology, 54 (3), 405-413, 1988. "This study of long-term tax evasion used 155 tax payers in the Netherlands. Tax returns were audited. ‘Among 57 individuals whose audited returns resulted in additional taxes levied of 1000 guilders (about $600), 70% denied any misrepresentation.' In this study Alienation was measured using a nine-statement scale drawn from Srole's 1956 Alienation Scale (e.g. ‘life is getting worse for people like me,' ‘you can't count on other people these days') [Srole, L, "Social Integration and Certain Corollaries," American Sociological Review, 21, 709-716].") These researchers stated it "has been argued that a sense of alienation from others together with generalized feelings of dissatisfaction with life and pessimism about the future increases the probability of deviance by minimizing personal concerns regarding the propriety of one's actions." The degree of alienation actually predicts the amount of tax evasion for individuals—greater alienation correlates with greater amounts of tax evasion! These authors also found that independent measures of competitiveness were highly correlated with actual tax evasion, but not self-reports of tax evasion. 3. DOES THE NEGLIGENCE PENALTY INCREASE TAXPAYER COMPLIANCE?Learning theory tells us a great deal about the effect of penalties (called "punishments" by learning theorists.) There are two basic types of learning. The first is associative learning, often called conditioned response learning, or classical conditioning. The learning occurs when two events occur fairly simultaneously. The learning that occurs is an association—when a person experiences one of the stimuli, he or she is "reminded" of the associated event. An example of conditioned response learning occurs when someone is reminded of the good feelings associated with the odor of cooking turkey or chocolate chip cookies baking in the oven. The second type of learning is called operant conditioning. Operant conditioning, often called instrumental learning, is based on giving a reward or punishment following some type of behavior on the part of the individual. B.F. Skinner (Science and Human Behavior, Macmillan, NY 1953) conducted thousands of studies to better understand the parameters of operant conditioning. Punishment, in the case of the IRS the use of penalties and audits, is intended to teach citizens to avoid non-compliant tax behavior, or to teach citizens to become compliant taxpayers. Most behavior modification systems are built on operant conditioning models. Behavioral psychologists have studied the rules that govern behavior modification for many decades in this century. A basic set of learning principles have been discovered. This area of research encompasses thousands of articles, research, journals, etc. Some of the most basic principles are as follows: • Rewards lead to more lasting behavioral change • Rewards lead to more internalized change • Rewards lead to greater cooperativeness and collaboration • Rewards lead to "approach" behavior • Punishment works by creating fear (fear = anticipation of a noxious outcome, which an individual wishes to avoid) • The effects of punishment tend to wear off more quickly than rewards • Punishment leads to anger, resentment, hostility, sabotage and minimal compliance • Punishment leads to "avoidance" behavior Tax penalties are a form of punishment. (May v. Commissioner, 65 T.C. 1114 (1976).) The Government hopes that individuals will want to avoid these punishments, and hopefully modify their tax behavior accordingly. However, as can be seen above, this form of behavior modification is far inferior as a means of shaping the taxpayer's behavior. The old adage, "honey will get you a lot more than vinegar" certainly applies to the positive reinforcements (rewards) and negative reinforcements (punishment, penalties) utilized by the IRS. [Jackson and Milliron suggest conducting research to test whether financial rewards such as special refunds and lottery tickets for honest reporters will impact tax compliant behavior. Jackson, B.R., and Milliron, V.C., "Tax Compliance Research," Journal of Accounting Literature, 1986, pp. 129-165.] In fact, these authors are unaware of any positive reinforcements that are utilized by the IRS to encourage taxpayer compliance. 4. GENERALIZED SOLUTIONS The above research suggests various ways of improving taxpayer compliance with the tax system. Congress may wish to consider the following suggestions as a means of improving taxpayer compliance: Use of Rewards: Congress and the IRS may want to reward "good" taxpayers by offering some form of tax reduction where the taxpayer has complied 100% with the internal revenue laws. For example, if a taxpayer has not had any changes on his or her income tax returns (1040) for say 10 years, then on the 11th year, the taxpayer would be entitled to reduce his or her tax due by 20% (or some maximum dollar amount) as a reward. Moderate Use of Penalties: Ironically, M. Spicer and S. Lundstedt ["Audit Probabilities and the Tax Evasion Decision: An Experimental Approach," Journal of Economic Psychology, 2, p. 303, 1976] in a survey of US taxpayers "... found that experience with tax audits was positively and significantly related (long-term) both to increased tax resistance and to admitted tax evasion." Although tax audits do increase tax payments, this effect wears off by the third year following an audit! (Westat, Inc., Self-Reported Tax Compliance: A Pilot Survey Report, prepared for the IRS, March 21, 1980.) Mild Sanctions: Mild sanctions may be as or more effective than severe sanctions. R. Schwartz and S. Orleans ("On Legal Sanctions," University of Chicago Law Review, Winter, 1967, pp. 274-300) argue that "taxpayers may become alienated if sanctions are perceived as too severe, resulting in general antagonism and disrespect for the law." They cite examples from moonshining during Prohibition, the burning of draft cards during the Vietnam War, and 18th century English law which required the death sentence for certain thefts over a certain magnitude, with the result that juries routinely found the theft to be for one shilling less than the threshold amount. 5. A SPECIFIC PROPOSAL—AN INDEPENDENT PENALTY APPEALS BOARDA Proposal: We have seen that the IRS' ability to assert the negligence penalty with impunity may lead to taxpayer hostility which can reduce rather than increase compliance with the tax system. Therefore, we believe that one step that can be taken by Congress should be to reform the current application of the negligence penalty by empowering taxpayers. Such a reform can be accomplished through the creation of a simple and inexpensive appeal process, which would counterbalance (in the taxpayer's mind) the ease with which the IRS can assert the negligence penalty and would relieve a taxpayer's feelings of helplessness and powerlessness. Specifically, Congress could create a national negligence penalty appeal process that is independent from the IRS. The appeals process could be administered by a "Penalty Appeals Board" ("PAB"). Any time that the IRS asserted the negligence penalty, the taxpayer could immediately appeal the imposition of the penalty to the PAB. This appeal would be independent of the audit process itself, so taxpayers could obtain a hearing on the penalty issue even while the audit was still in progress. [An immediate review of the proposed negligence penalty would allow the penalty issue to be resolved quickly so that the taxpayer would not have to agonize over the penalty during the tax audit itself and over the increased interest associated with the penalty.] Ironically, the IRS has a penalty review procedure already in place albeit not "independent" from the IRS itself. However, this review process is not readily known by taxpayers, or as stated in the Internal Revenue Manual ("I.R.M."), "Taxpayers are often unaware that certain penalties may be waived or abated for reasonable cause." (See I.R.M. (20) 321, et seq.) The I.R.M. sets forth a detailed review of the negligence penalty, abatement procedures, definitions of reasonable cause (I.R.M. (20) 320, et seq.), reasonable cause guidelines (I.R.M. (20) 330, et seq.), and reasonable cause guidance for specific situations, among others (I.R.M. (20) 360, et seq.). The I.R.M. even provides that, "Taxpayers have the right to challenge the assertion or assessment of a penalty, and may do so at any stage in the penalty process" (emphasis added)." Generally, tax practitioners who know of the appeals process for penalty abatement believe that the process is simply a "rubber stamp" and of no real benefit to the taxpayer. The fact that procedures for the approval of a penalty exist in the I.R.M., albeit not generally known by taxpayers, should enable the service to easily implement the PAB process in the following manner: 1. Each time an IRS agent asserted the negligence penalty, the taxpayer would be given a "negligence appeal form" that would be divided into two parts. The first part would list specific and standardized factors that could lead to the imposition of the penalty. (See for example, Publication 1586 (8-97) where the IRS has already established such a procedure for the appeal of a penalty based on reasonable case for missing and incorrect names on tax forms.) 2. The second part of the negligence appeal form would allow the taxpayer to explain on the form why he, she or they believe the penalty does not apply to the case. 3. After completing the form, the taxpayer would send it to a regional or national penalty appeals processing center. 4. The PAB would, in turn, send the taxpayer's appeal form back to the IRS agent who would then be given the opportunity to respond to the taxpayer's concerns. It should be a simple matter for the examining agent to comply with this requirement since the I.R.M. already requires that the agent provide for such an analysis in his or her work papers. (According to I.R.M. (20) 939, "the examining agent is responsible for the assertion of the accuracy penalties.… Consideration for assertion is made on all examinations and appropriate comments as to why the penalty is recommended or not recommended are mandatory on the examiner's workpapers… EMPHASIS IS PLACED ON THE FACT THAT THE EXAMINER MUST GIVE A THOROUGH EXPLANATION FOR ASSERTION OR NON-ASSERTION OF THE PENALTY.") 5. The PAB would then review both the taxpayer's appeal and the IRS agent's response and make any one of three decisions: • the taxpayer's appeal could be denied with the written decision sent back to the taxpayer with an explanation; • the appeal could be granted; • the decision could be delayed until the substantive tax issues are resolved. 6. If the taxpayer desired, he, she or they would be given the opportunity to discuss the matter with a member of the PAB. 7. If the taxpayer disagreed with the decision of the PAB, an appeal to the Tax Court would be made available. A. Benefits of the Penalty Appeals Board The establishment of a Penalty Appeals Board would have many benefits. First, there would be a standard national approach to the imposition of the negligence penalty. This would be an improvement over the current situation, where the IRS typically asserts the negligence penalty on an ad hoc basis, and where even the Tax Court and appeals courts sometimes appear to lack a clear idea of when the negligence penalty should be imposed. Second, taxpayers would have the right to have an immediate, independent hearing (outside the IRS) without having to incur the expense of taking their case through the IRS standard appeals process and Tax Court. This would be fair to the taxpayer, since he, she, or they would not need to wait for a resolution of the negligence penalty over a many year period. Third, and perhaps most important, IRS agents would lose the incentive to assert the negligence penalty arbitrarily. Because the actual imposition of the penalty would be out of their hands, they no longer could use the penalty as a bargaining chip. As a consequence, the IRS most probably would use the penalty more sparingly in the future, applying it only to those situations where its use was clearly justified. Fourth, the Tax Court (and other courts) would not have to spend as much time analyzing the appropriateness of negligence penalties since the issue would more often have been resolved by a prior independent body, PAB. B. Disadvantages of the Penalty Appeals Board Of course, any new tax proposal has potential problems. One problem with this proposal is that it would create yet another layer of bureaucracy in the tax system, the PAB. Another problem is that at times the appropriateness of the negligence penalty is clear only after the underlying tax dispute is resolved—one can determine whether a taxpayer is negligent only after determining whether the taxpayer is liable for tax. Thus, at times the PAB appeals process would be able to commence only after the IRS and the taxpayer agreed upon the underlying tax liability, as above mentioned. This usually should not be a problem, however, as the negligence penalty typically is imposed in a situation where the tax liability is clear. In the rare situation that involves a more complicated tax situation, the PAB appeals process perhaps could not begin or, as mentioned above, would be delayed until the substantive case was at IRS Appeals or at Tax Court. However, few cases go to Appeals or Tax Court. Thus, in most cases the suggested reform would be beneficial. 6. CONCLUSIONThe current use of the negligence penalty by the IRS is presently engendering taxpayer hostility and may be contributing to less compliance by taxpayers. The IRS is perceived as applying the negligence penalty arbitrarily and in an automatic fashion. According to various psychological research data, such arbitrary IRS practice causes taxpayers to feel helpless and powerless, which in turn can lead to taxpayer anger and, in the long run, less compliance with the internal revenue laws. Of even greater concern is the vicarious anger and resentment taxpayers feel when they observe procedural injustice applied to others leading to generalized non-compliant tax behavior. Congress needs to develop a simple and inexpensive way to allow taxpayers to appeal the negligence penalty. It is suggested that Congress consider establishing a Penalty Appeal Board (PAB) for two main purposes. First, the PAB will enable taxpayers to quickly appeal any attempt by the IRS to assert the negligence penalty. In this way, taxpayers would feel empowered to deal with the negligence penalty thereby reducing taxpayers' feelings of helplessness, powerlessness, anger, and resentment. Second, the board will help standardize the application of the negligence penalty to taxpayers in a more consistent manner.
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