Senate moves to protect small business from unfair penalties

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Small businesses get a break in the form of an extended moratorium on penalties related to tax shelters. Since last summer the Internal Revenue Service, under pressure from Congress, has been extending the moratorium a few months at a time.

The latest extension expires June 1st if no further action is taken. Last month, however, the Senate has passed legislation that is more than a short-term fix to the issue.

The penalties in question are assessed on businesses and individuals that fail to disclose their investment in tax shelters, which the IRS considers potential tax evasion. An example of such transactions would be employer contributions to post-retirement benefit funds. Minimum penalties for individuals are set at $5,000 and can be as high as $100,000. For corporations, the penalties range from $10,000 to $200,000. These penalties can be assessed for each year a transaction is not reported, and both the business and the business owner can be charged.

The problem, said Senator Ben Nelson (D-NE), is that the provision catches taxpayers that it shouldn’t. "The penalty has ended up snagging small businesses that weren’t advised of their responsibility to disclose", Nelson said in a recent statement.

The intent of enacting these fees was to make it harder for big corporations and wealthy individuals to use tax shelters to dodge their tax obligations. But it also has been applied to small business owners who were not aware of the disclosure requirements related to retirement contributions for themselves and their employees.

The U.S. Small Business Administration reported that, in 2008, roughly 30 million small businesses – defined as having fewer than 500 employees – were in operation. Small or not, that means a significant part of the economy is subject to these penalties.  

On December 18, 2009, leaders of the Senate Finance Committee and three other senators introduced S. 2917, the Small Business Penalty Fairness Act. This bill would require the IRS to make penalties proportionate to the benefits received.

"Some of these businesses were assessed tax penalties as high as $300,000 per year, but received a tax benefit for as little as $15,000 from the transaction", said Senator Charles Grassley (R-IA) in a statement on December 23.

Grassley has been working for months to draw attention to this issue. In December, he told the U.S. Department of the Treasury that he would hold up nominees to Treasury posts until the IRS works out fair treatment of small businesses in regard to these penalties. He also scolded the Treasury for giving a new tax break to Citigroup, which has the power to generate billions in tax savings.

"Treasury is quick to help out big banks but slow to act when small businesses need fair treatment", Grassley said. "There seems to be a double standard and a failure to recognize that small businesses are just as critical to the economy as big banks, if not more critical. Small businesses create 70 percent of all net new jobs. If we don’t recognize that, we’re shooting ourselves in the foot."

On February 9, the Senate passed S. 2917.This bill – which revises Section 6707A of the Tax Code – sets the penalty for failure to disclose at 75 percent of the tax benefit received, and should eliminate the need for temporary extensions. The House has not yet passed legislation on this matter, but the issue has bipartisan support and is expected to pass.

While the moratorium has been in effect, the IRS has continued to issue new liens against businesses that fail to disclose reportable transactions, but the tax agency has not moved to collect. In a statement in early March, IRS Commissioner Doug Shulman told Congress the agency will hold off on issuing new liens, pending the passage of legislation.

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