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19 February 2021
On January 13, 2021, the US District Court for the Northern District of Texas ruled in favor of Exxon Mobil Corporation ("Exxon") in its battle against the government over tax penalties. Exxon filed amended returns for its 2006-2009 tax years seeking a $1.35 billion tax refund based upon a change of character of certain transactions (from mineral leases to purchase transactions). The government disallowed the refund claims and imposed a $200 million penalty pursuant to Internal Revenue Code (IRC) section 6676. Exxon paid the penalty and filed suit for a refund.
We have written extensively concerning IRC section 6676, warning taxpayers of this potential landmine. See, e.g., "Taxpayers Should Prepare for the Next Penalty Battleground" Roberson, Spencer and Walters, Law360 (May 21, 2019) and "Expect More Civil Tax Penalties—So, Now What?" Roberson and Spencer, Tax Executive (Sept. 27, 2019). To recap, IRC Section 6676 was enacted in 2007 in response to the high number of meritless refund claims being filed at the time. It imposes a 20% penalty to the extent that a claim for refund or credit with respect to income tax is made for an "excessive amount." An "excessive amount" is defined as the difference between the amount of the claim for credit or refund sought and the amount that is actually allowable. For example, if the taxpayer claims a refund of $2 million and the Internal Revenue Service (IRS) allows only $1 million, the taxpayer can still be penalized $200,000.Significantly, IRC section 6676 does not require the IRS to show any fault or culpability on the part of the taxpayer—e.g., negligence, disregard of rules or regulations, etc. IRC section 6676(a) originally provided a "reasonable basis" defense (which is applicable to the Exxon case), but in 2015 Congress amended the statute and now requires a showing of "reasonable cause." Neither the Code nor the regulations provide for any other defense to the IRC section 6676 penalty. Moreover, the penalty is immediately assessable, meaning taxpayers cannot fight the IRS in a pre-payment forum like the US Tax Court but must first pay the penalty and seek redress in a refund form.
In Exxon, the government argued that the court should overlay a subjective element on "reasonable basis," as the US Circuit Court for the Eighth Circuit did in Wells Fargo & Co. v. United States, 957 F.3d 840 (8th Cir. 2020). Our prior coverage of this case can be found here. The Exxon court declined the invitation. Instead, the court explained IRC section 6676 "focuses on whether the claim had a reasonable basis, not on whether the taxpayer had a reasonable basis." The court agreed with Exxon that its position in the refund claim that its transactions were purchases was reasonable based on the relevant authorities. It further found that the company had "colorable support for its legal contention that a change that affects whether, not when, an item comes into income is not an impermissible change in accounting method," and, accordingly, no penalty applied related to an impermissible change in accounting method.
Exxon is helpful in defining "reasonable basis" for purposes of IRC section 6676, as well as for other penalties, like IRC section 6662. However, the case may be of limited impact to taxpayers going forward given the 2015 statutory change to impose the higher "reasonable cause" standard. Taxpayers should be mindful of IRC section 6676 when filing a refund claim. If this penalty could apply to your refund claim, we strongly suggest you prepare for a reasonable cause defense by, for example, obtaining a tax opinion from a learned and fully informed tax professional. Just be cognizant that if you raise the reasonable cause defense you will be waiving any protections of the attorney-client privilege over that advice and all communications related to the subject matter of the advice.
For further information on this topic please contact Kevin Spencer at McDermott Will & Emery by telephone (+1 312 372 2000) or email (email@example.com).The McDermott Will & Emery website can be accessed at www.mwe.com.
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