REGULATION. If the failure is willful, however, or an attempt is made to defeat or evade the tax, the offender is liable to imprisonment and to a fine of not more than $10,000 and costs. See also the Act of July 5, 1884. In addition to these specific penalties ad valorem penalties are imposed in various cases. An ad valorem penalty is assessed and collected as a part of the tax, while a specific penalty is recoverable only by suit. . ... (Art. 1041.)

Imperfect returns not acceptable.—

REGULATION. . . . . Each taxpayer should carefully prepare his return so as fully and clearly to set forth the data therein called for. Imperfect or incorrect returns will not be accepted as meeting the requirements of the statute. In lack of a prescribed form a statement made by a taxpayer disclosing his gross income and the deductions therefrom may be accepted as a tentative return, and if filed within the prescribed time a return so made will relieve the taxpayer from liability to penalties, provided that without unnecessary delay such a tentative return is replaced by a return made on the proper form. (Art. 407.)

Understatements

Understatements of tax due.-Under the 1918 law, if it appears that an understatement of the amount of tax due has been made in good faith there shall be no penalty because of such understatement, but if due to negligence there shall be a penalty of 5 per cent added to the additional tax, plus interest at the rate of 12 per cent per annum.

LAW. Section 250. ... . (b) As soon as practicable after the return is filed, the Commissioner shall examine it. If it then appears that the correct amount of the tax is greater or less than that shown in the return, the installments shall be recomputed. . . . .

If the amount already paid is less than that which should have been paid, the difference shall, to the extent not covered by any credits then due to the taxpayer under section 252, be paid upon notice and demand by the collector. In such case, if the return is made in good faith and the understatement of the amount in the return is not due to any fault of the taxpayer, there shall be no penalty because of such understatement. If the understatement is due to negligence on the part of the taxpayer, but without intent to defraud, there shall be added as part of the tax 5 per centum of the total amount of the deficiency, plus interest at the rate of 1 per centum per month on the amount of the deficiency of each installment from the time the installment was due. . . . .

It is therefore of importance to taxpayers that, if an additional assessment is made, care be taken to produce evidence that there was no negligence involved, but that on the contrary the return was made in good faith and not due to any fault of the taxpayer.

REGULATION. In general, negligence is attributable to the taxpayer if he computes the tax in disregard of the instructions on the return form or otherwise incorrectly, unless he can show that his error was due to an honest misunderstanding of the facts or the law of which an average reasonable man might be capable. . . . . (Art. 1005.)

Penalty for understated return.-It will be noted that if the mistake is one "of which an average reasonable man might be capable," the 5 per cent penalty will not be imposed. It is obvious that the penalty will not be assessed when arithmetical or other errors have been made, provided only they are such errors as the average man might make. The honest taxpayer can point out in his defense many conflicting regulations.

In view of the complexities and ambiguities of the law which are recognized by the Treasury itself, no reasonably careful person need fear this penalty. Of course, if a mistake which is made results in a very large understatement of the tax, the whole burden of proof will be placed upon the taxpayer to show that he was not on notice that a mistake had probably been made, because there are numerous methods of approximating the amount of tax due upon a given amount of net income.

No penalty when understatement is made in good faith.If claim for abatement is made and denied, interest at the rate of 6 per cent per annum will be charged from the date originally fixed for payment of the additional assessment on such part of the claim as has been denied. The interest charge at the rate of 6 per cent depends upon whether or not the claim for abatement was "bona fide.""

18

"Section 250 (e).

Taxpayers who make claims in good faith may confidently rely upon the Commissioner to accord to them the benefit of the rate mentioned. 19

Notice from collector of alleged understatement.-Section 250 (b) of the 1918 law and the usual procedure which governs the examination of returns by inspectors from the Commissioner's office in Washington2" are supplemented by the provision of the law which gives to local collectors the right to question the accuracy of returns.

LAW. Section 228. That if the collector or deputy collector has reason to believe that the amount of any income returned is understated, he shall give due notice to the taxpayer making the return to show cause why the amount of the return should not be increased, and upon proof of the amount understated, may increase the same accordingly." Such taxpayer may furnish sworn testimony to prove any relevant facts and if dissatisfied with the decision of the collector may appeal to the Commissioner for his decision, under such rules of procedure as may be prescribed by the Commissioner with the approval of the Secretary.

It is confusing to the average taxpayer to have his returns questioned from two different sources. In view of the right to appeal to the Commissioner in any event, if the collector gives notice of intention to increase an assessment, taxpayers

19 [Former Procedure] Prior to the 1918 law the rate was 12 per cent per annum.

20

[Former Procedure] As an indication of former confusion the following extracts from the regulations are of interest:

REGULATIONS. “All claims on forms 46 and 47 are to be stamped with the date of receipt immediately on presentation to the collector or division deputy, and thereafter are to be forwarded, without further recording or certification, immediately to the Commissioner.

"Hereafter, where an abatement claim is acted upon, the collector will receive an original letter addressed to the claimant and a carbon copy for the collector's files. The original is to be mailed the claimant immediately with notice and demand for the payment of any tax shown by the letter and the assessment list to be due.

"The purposes of the modification of the former procedure with regard to claims are to eliminate a duplication of detail in the collector's and the Commissioner's office, and the accommodation of the taxpayer by making it possible for him to secure a much more prompt consideration of his claims than has been possible heretofore." (T. D. 2654, February 19, 1918.)

See page 129.

should appeal at once to the Commissioner and follow the procedure outlined in this chapter.

REGULATION. If a collector suspects that the amount of any income is understated in a return, he may on his own initiative take up the matter with the taxpayer and upon becoming satisfied that the amount was understated may increase it accordingly, subject to the right of the taxpayer to appeal to the Commissioner. The Commissioner, however, without the intervention of the collector may exercise original jurisdiction in cases of understatements or other errors in returns, in which event sections 250 and 1305 of the statute and section 3176 of the Revised Statutes, as amended by section 1317 of the statute, are applicable instead of section 228. . . . . (Art. 451.)

Discretionary power of Commissioner in imposing penalties-"Compromises."-The Commissioner may exercise his discretion in fixing the exact amounts of the fines within the maximum limitations of $1,000 in case of failure to file returns and $10,000 in case of refusal.23 With respect to the foregoing penalties he may "entertain offers in compromise" which are usually accepted.2*

In an opinion dated June 3, 1919, the United States Attorney-General held that claims falling in the following classes may be compromised by the Commissioner whenever, in his judgment, such compromises are for the interest of the United States:

(1) Claims for amounts 50 per cent in addition to amounts of income and excess-profit taxes assessed under authority of section 3176 of Revised Statutes, as amended by section 16 of the act of September 8, 1916, and of section 212 of the act of October 3, 1917, in cases of failure to make and file returns or lists within the time prescribed by law or by the collector;

(2) Claims for amounts 100 per cent in addition to amounts of income and excess-profit taxes assessed under authority of said sections in cases of false or fraudulent returns or lists willfully made;

Reg. 33, 1918, Art. 54.

[Former Procedure] Prior to this opinion it was held by some authorities that the Commissioner had no power to mitigate the 25 and 50 per cent penalties.

When specific penalties will not be subject of suit.-In view of the extraordinary conditions now existing it is believed by some that many taxpayers have subjected themselves to penalties. In the circumstances it may be of interest to reproduce instructions to collectors regarding the imposition of the specific penalties and the attempt to recover them by suit.

RULING. Liability to specific penalty attaches upon all delinquent returns and is recoverable by suit. By Section 3214 R. S. the Commissioner of Internal Revenue may or may not institute suit. It has been decided not to institute suit nor to assert specific penalty in certain cases. The assertion of specific penalty does not depend upon the fact of whether or not the 50 per cent addition to tax has been assessed. In some cases where the 50 per cent addition to tax must be assessed because the return was filed after notice from the collector, the specific penalty will not be asserted. It will not be asserted, regardless of whether the 50 per cent addition to tax has been assessed, in cases falling under any of the following designations:

1. Extension granted. Where a return is filed within the thirtyday period of extension granted by the collector or within a further period of extension granted by the Commissioner of Internal Revenue, as provided by Section 14 (c) of the act of September 8, 1916.

2. Return on time. Specific penalty will not be asserted upon an amended return provided the original return was filed within the prescribed time.

3. Mailed in time. Where an affidavit is filed satisfactorily establishing that the return was placed in the mails in ample time to reach the collector's office in ordinary course of mails before the close of business on the final day for filing.

4. Tentative return. Where an informal return was filed within the time prescribed. The return of a parent company including therein the income of a subsidiary company will be accepted as a tentative return of the subsidiary company, if the fact is stated that the tentative return includes the income of the subsidiary.

5. Filed in wrong district. Where the return was filed in some other collection district within the prescribed time.

6. Net income under $3,000. Where it develops that the net income of an individual for 1913. 1914, 1915 or 1916 was less than $3,000, or under the act of October 3, 1917, for 1917, etc., less than $1,000 or $2,000.

7. Erroneous information. Where the delinquency is alleged to be due to erroneous or misleading information given by officials or employees of the Internal Revenue Service and there is no evidence in conflict therewith.