ABA tax meeting reviews IRS FAQs

Taxpayers may be able to use IRS Frequently Asked Questions (FAQs) to reduce or avoid penalties, according to a recent American Bar Association (ABA) meeting. However, taxpayers cannot rely on FAQs when determining tax liability.

A panel at the ABA Tax Section Hybrid 2022 May Tax Meeting reviewed the IRS’s increasing reliance on FAQs. The panel also discussed ethical issues that may arise in relation to FAQs.

FAQs provide quick informal guidance 

FAQs have several advantages over more traditional forms of guidance. Because they are not reviewed as intensively, the IRS can issue FAQs very quickly (but the panelists noted that IRS Chief Counsel does review most FAQS that are not strictly procedural). FAQs also give the IRS more flexibility to add or change information as the situation warrants. 

These features made FAQs especially valuable during the COVID pandemic, when the IRS had to quickly provide information about several new types of tax relief, ranging from Paycheck Protection Plan (PPP) loans, to complex new employer credits, to new and expanded credits and exclusions for individuals.

The IRS continues to use FAQs for new items, such as Schedules K-2 and K-3 for partnerships and S corporations. Many other recent FAQs explain how to report pandemic relief provisions on 2021 tax returns.

But FAQs have some disadvantages

These FAQ advantages can also be disadvantages. Getting FAQs out quickly means the IRS does not have time to solicit or consider input from taxpayers and tax professionals. The IRS can also modify FAQs without any kind of announcement or record. Thus, FAQs may create confusion and undermine public confidence in the IRS. 

For example, FAQ #85 for the 2020 version of the employee retention credit says that the credit simply reduces the employer’s deductible wage expense. However, the Joint Committee on Taxation Bluebook says that the credit first reduces the employer’s OASDI tax liability, with only the remainder reducing deductible wages. Neither the FAQ nor the JCT report is precedential. So which, if either, is “the law”?

Use of FAQs should be limited

The panelists agreed that when the IRS needs to provide information quickly, FAQ positives outweigh FAQ negatives. However, they also expressed frustration with the use of FAQs in non-emergency situations. 

For example, some FAQs, including ones for virtual currency transactions and certain qualified intermediaries in arrangements with foreign partnerships, have been on the IRS website for years. The panelists concluded that the IRS has no excuse for relying on FAQs when it has had time to provide more substantive guidance. 

Similarly, the IRS recently used a Field Memorandum, News Release, and FAQs to announce significant new procedural requirements for filing amended returns that claim the research credit. The panelists agreed that the IRS should use more formal guidance to make such an important change.  

IRS has improved FAQs

The panelists noted that the IRS has taken some effective steps to improve FAQs. 

Most importantly, the IRS now generally publishes FAQs as a Fact Sheet that is issued with an Internal Revenue News Release, rather than just posting the questions and answers on the IRS website. FAQ changes and updates are also generally issued as Fact Sheets, with any changes noted and dated. And these Fact Sheets are archived, so they remain available on the IRS website.

These changes mean that FAQ guidance no longer just disappears into the ether when the IRS changes its mind. Instead, there is a record of what an FAQ said and when it said it.

FAQs may help taxpayers avoid penalties

Given all these factors, what do FAQs mean for taxpayers and their advisors? 

First, the panelists agreed that taxpayers cannot rely on FAQ guidance when they determine their tax liability. For example, if an FAQ leads a taxpayer to believe they may claim a tax credit, the IRS may deny the credit if the FAQ conflicts with more substantive guidance – the Code, regulations, or rulings published in the Internal Revenue Bulletin. 

However, FAQs may help a taxpayer reduce or avoid penalties. The most common penalties for understating tax liability, such as the negligence penalty and other accuracy-related penalties, are not imposed if the taxpayer had reasonable cause for the understatement. Reliance on FAQs may constitute reasonable cause.

But are FAQs substantial authority? 

A penalty may also be waived if the taxpayer had substantial authority for a return position. This is a more objective test that reasonable cause. The substantial authority test requires the taxpayer to point to some independent authority for their position, while the reasonable cause test looks more at the taxpayer’s subjective belief. 

It is not clear if an FAQ or other subregulatory relief can be substantial authority for determining a particular taxpayer’s tax liability. 

FAQs can raise ethical issues

Finally, the ABA panelists reviewed some ethical issues that tax professionals might face with FAQs. Regardless of the particular facts, the panelists agrees on two guiding principles:

1. The professional must fully inform the taxpayer of all options and their possible consequences.
2. The taxpayer, rather than the professional, must be the one who decides what to do.