Given the rapid proliferation of new tax legislation, the IRS has been relying on issuing so-called Frequently Asked Questions (“FAQs”) to expedite its advice to taxpayers and the tax professional community rather than issuing regulatory guidance, which, by its nature, is a lengthy process. The problem is that tax practitioners know the degree to which they can rely on regulatory and sub-regulatory guidance. FAQs on the other hand, have not generally been considered “authority” for purposes of establishing the “substantial authority” exception to the substantial understatement penalty.
On October 15, 2021, the IRS announced that it is updating its process for significant FAQs on newly enacted tax legislation. These types of FAQs, as well as any later updates or revisions to them, will now be announced in a news release and posted on the IRS website in a separate Fact Sheet. They will be dated to enable taxpayers to confirm the date on which any changes were made. Prior versions will also be maintained on the IRS website to ensure that, if a Fact Sheet FAQ is later changed, taxpayers can locate the version they relied on if and when they need to do so. IRS says it may apply this updated process in other contexts, such as when FAQs address emerging issues.
The IRS also addressed simmering concerns about potential penalties where a taxpayer relies on FAQs that are later determined to be an incorrect statement of the law as applied to the taxpayer’s facts. In that situation, the IRS says that the taxpayer’s reliance on FAQs (including previously issued FAQs) will give rise to a “valid reasonable cause” defense against any negligence penalty or other accuracy-related penalty as long as the taxpayer’s reliance was in good faith and reasonable. The IRS also indicated - in its General Overview of Taxpayer Reliance on Guidance Published in the Internal Revenue Bulletin and FAQs - that FAQs that are published in a Fact Sheet that is linked to an IRS news release are considered authority for purposes of the exception to accuracy-related penalties that applies when there is substantial authority for the treatment of an item on a return.
The ability to locate on the IRS website prior versions of FAQs that had been posted in a separate Fact Sheet will therefore come in handy for taxpayers seeking to mount a substantial authority defense. Taxpayers should, however, print and save such FAQs to prove actual reliance and maintain a reasonable cause defense if the IRS subsequently imposes a negligence or other accuracy-related penalty.
Unclear, however, is whether return preparers will have a reasonable cause defense when relying on these types of FAQs or whether such FAQs are considered authority for purposes of the exceptions to return-preparer penalties that apply when there is reasonable cause or substantial authority for a position that was not adequately disclosed. Perhaps the IRS will subsequently clarify this in favor of return preparers inasmuch as there seems to be no reason to allow taxpayers to rely on Fact Sheet FAQs to establish reasonable cause and substantial authority but not to allow return preparers to do the same.
Feel free to reach out to your Friedman LLP advisor with any questions.