DEFINITIONS

DISCRETIONARY PENALTIES

The Revenue Act contains the penalty provisions applicable to the taxes administered under the act. The discretionary penalties of negligence, intentional disregard, and fraud are found in section 23 of the Revenue Act, MCL 205.23(3), (4), and (5), respectively.

How Discretionary Penalties Are Applied

Every case involving a tax deficiency must be reviewed as to whether discretionary penalties apply based on the specific facts, circumstances and taxpayer intent based on the best information available. If the examination reveals that a discretionary penalty applies, then a determination is made as to which type of discretionary penalty applies. This determination is made in descending order of the severity of the penalty.

First - Fraud 100% (no minimum)

Second - Intentional Disregard 25% (minimum of $25.00)

Third - Negligence 10% (minimum of $10.00)

Once it is determined that a discretionary penalty applies and which type of discretionary penalty will be applied, it must be determined on what amount the penalty will apply. The Revenue Act allows for the imposition of discretionary penalties based on the amount of "deficiency."²  A “deficiency” is a tax liability determined by the Department. A deficiency may result from an underpayment of tax or an excessive claim for refund. Generally, adjustments reducing the amount of a refund are not subject to these penalties because there is no additional tax due the State in this situation.

If any part of the deficiency for a taxable year is subject to a discretionary penalty the penalty is generally applied to the entire deficiency for that taxable year. If more than one discretionary penalty is applicable to a deficiency the higher percentage penalty applies.

Types of Discretionary Penalties

Civil Tax Fraud

Recommendation of the fraud penalty will be made when it is supported by facts leading to the conclusion that the taxpayer's intent was to evade payment of tax. Fraud involves deception: a purposeful act of a taxpayer to disguise, present and/or omit facts in such a way as to put forward a false situation. The fraud penalty may be applied when it is evident that the taxpayer knowingly and willfully acted in a manner to evade payment of all or a portion of a tax.

As a general rule, all factors taken together will set forth a course of conduct revealing an intent to defraud. However, the mere failure to file a tax return is insufficient to sustain a charge of fraud without the presence of some overt act showing intention to defraud. The Department must prove that a tax is due, that the taxpayer filed a false return or failed to file a return, and that the taxpayer intended to evade payment of a tax.

Factors that indicate an intent to defraud include, but are not limited to, the following:

1. Understated, omitted, undisclosed, hidden, or disguised sales, purchases or income resulting in a substantial tax liability.
2. Having a double set of books and records.
3. False, altered, distorted or missing records.
4. Unlicensed or unregistered business operations, both legitimate and illegal.
5. Unexplained differences between related items from different tax returns (e.g., gross receipts for single business tax vs. income tax vs. annual sales tax returns).
6. Concealing assets in secret accounts or registering assets or accounts in false names or the names of others.
7. Consistent pattern of failure to file or pay.
8. False, inflated, or disguised deductions or expenses resulting in a substantial tax liability.
9. Any action or conduct by the taxpayer having the effect of concealing or misleading.

Examples of fraud:

1. Taxpayer buys a car from another individual and substantially understates the purchase price to the Secretary of State.
2. Taxpayer buys a car from another individual who is not a relative but claims the purchase is exempt from use tax because it was purchased from a relative (father, mother, brother, sister, etc.).
3. Taxpayer's cost of goods sold, less cost of non-taxable merchandise, substantially exceeds reported taxable sales.
4. Taxpayer falsely claims a deduction where no deduction exists.
5. Taxpayer claims false exemptions.
6. Taxpayer supplies a false Withholding Tax Schedule (Schedule W) or W-2 form showing withholding tax in excess of what was actually withheld by the employer.
7. Taxpayer supplies a false or altered property tax bill or false rent receipts to support a false claim for tax credit.
8. Taxpayer claims false Schedule C business losses on a non-existent business.
9. Taxpayer, as part of a scheme, files an excessive number of false credit claims.

Intentional Disregard

The determining factor for intentional disregard is the taxpayer's intent. When applying this penalty, the issue is whether the taxpayer has deliberately and/or purposefully ignored the tax laws, rules or instructions. While the intent of a taxpayer can be difficult to discern, such intent will be presumed when a taxpayer has received specific instructions from the Department as to the proper reporting of an item of income or deduction but fails to comply with the instructions.

Examples of intentional disregard:

1. Taxpayer has been advised of correct reporting by either an office review or audit, but fails to report correctly in a subsequent filing.
2. Taxpayer has been advised of filing requirements for installments of estimated tax under the Income Tax Act by office review or audit but fails to make quarterly estimated tax payments.
3. Taxpayer has knowledge of a tax obligation and willfully decides not to comply with obligation.

Negligence

Taxpayers are expected to read the instructions for filing tax returns before determining a potential tax liability. If the facts and circumstances indicate that a taxpayer did not exercise due care and there is a determined tax liability, a negligence penalty may be imposed. If a taxpayer fails to file an amended return to report a modification to their federal return or has an underpayment of estimated tax, negligence is presumed.

Examples of negligence:

1. The income tax and corporate income tax instructions clearly require the prepayment of the annual tax, but the taxpayer remits estimated tax payments of less than the required amount.
2. A taxpayer fails to file an income tax or corporate income tax amended return within 120 days, as required by law, after a final alteration, modification, recomputation or determination of a deficiency under the provisions of the Internal Revenue Code.
3. The taxpayer has been assessed a tax deficiency and a subsequent audit of the taxpayer results in a similar deficiency for a subsequent tax period resulting from the taxpayer's failure to correct internal controls and reporting procedures.
4. The income tax and corporation income tax instructions clearly require payment of the estimated annual tax at the time of filing an extension request. The taxpayer understates and underpays the annual liability with the extension request.

NON-DISCRETIONARY PENALTIES

In addition to discretionary penalties, the Revenue Act also requires non-discretionary penalties when a taxpayer fails to file a required return and/or remit a tax that is due.³

How Non-Discretionary Penalties Are Applied

Every case involving a return and/or payment filed or remitted after the due date must be reviewed as to whether late penalties apply.

Except for the information returns, these penalties are a percentage of tax due after subtracting credits and prepayments.

The maximum penalty of 25% is a combined maximum for failure to file and/or pay.

The penalties for failure to file/pay are applied at the stated rate per month or fraction of a month.  In other words, the monthly rate is not prorated for periods of less than a month.

Types of Non-Discretionary Penalties

Failure to File

This penalty of 5% for the first 2 months and 5% for each additional month (maximum 25%) is applied to any monthly, quarterly or annual return, or any other tax return required by law that is filed after the prescribed due date for the return or an authorized extended due date. If adjustments are made as a result of a review of the tax return or from an audit of the taxpayer's records and increase the tax due, the additional tax due may be subject to the discretionary penalties.

Failure to Pay

When a taxpayer has filed a return but fails to pay the tax due, the penalty of 5% for the first 2 months and 5% for each additional month (maximum 25%) is added.

For taxpayers meeting the criteria of section 19(2) of the Revenue Act, MCL 205.19(2), requiring payment of withholding taxes according to the federal schedule, failure to make the payment will result in a penalty of 0.167% per day (25% maximum).

Failure to File Information Return

A penalty of $10.00 per day may be added for each separate return for which there is a failure or refusal to file a required information return. The total penalty for each separate return for which there is a failure or refusal to file will not exceed $400.00.

Since no tax is due on an information return, this penalty is the only penalty applied for the failure to file an information return.

Examples of information returns:

1. Annual sales tax reconciliation showing no tax due.
2. Fiduciary income tax return reporting beneficiary information showing no tax due.

NON-NEGOTIABLE REMITTANCE

Any taxpayer who remits a non-negotiable payment with insufficient funds (i.e., insufficient funds check) to satisfy a tax liability, including amounts due on estimated tax returns, is subject to a penalty of up to 25% of the amount of such payment. Assessments for non-negotiable remittances with insufficient funds are $50.00 for each such remittance. This penalty will be imposed in addition to any other applicable penalties.

Examples of non-negotiable remittance:

1. An individual files and remits payment by check of the tax due on the annual 2020 MI-1040 on April 10, 2021. The bank did not honor the remitted check. Therefore, an assessment is issued for the amount of tax due, penalty of $50.00, and failure to pay penalty of 5% (25% maximum) from April 15, 2021, until paid, plus interest.
2. A corporation remits a payment by check of its third quarterly estimate on October 31, 2020. The bank does not honor the remitted check. Therefore, an assessment is issued for the amount of payment, penalty of $50.00, failure to pay penalty of 5% for the first two months, then 5% each month thereafter until paid (maximum 25%), plus interest. Credit will be given on the annual return for the tax amount assessed.
3. A gasoline wholesaler-distributor files its July 2020 report late on August 25, 2020, and remits a check in the amount of tax, the 5% penalty for failure to file, plus interest. The bank does not honor the remitted check. Therefore, an assessment is issued on September 10, 2020, for the amount of the payment, penalty of $50.00, plus a failure to pay penalty of 5% for the first two months and then 5% each month thereafter until paid (maximum 25%).

SIMULTANEOUS PENALTIES

The non-discretionary penalties for failure to file/pay and non-negotiable remittance may be simultaneously applied. In addition to these non-discretionary penalties, a discretionary penalty may be applicable.

OBJECTIONS OR DEFENSES TO PENALTIES

If the Department assesses a discretionary penalty against a taxpayer and the taxpayer objects to the penalty, the taxpayer bears the burden of establishing facts which will negate a finding of intent (in the case of a civil fraud or intentional disregard penalty) or a finding of negligence (in the case of a negligence penalty). The taxpayer must file a written petition with the Department, stating in detail the facts relied upon to defeat the penalty assessment.

While individual cases depend upon the circumstances of the particular case, the following examples illustrate the application of these principles:

1. A finding of intent (in the case of a civil fraud penalty) may be negated where the taxpayer establishes that the taxpayer, acting in good faith, accepted a claim for sales tax exemption from an unrelated third party that ultimately proved to be wrong.
2. A finding of intent (in the case of an intentional disregard penalty) may be negated if a business taxpayer establishes and maintains an accounting system which minimizes the likelihood of mathematical errors or posting errors.
3. A finding of negligence (in the case of a negligence penalty) may be refuted if an individual taxpayer makes simple transpositions or mathematical errors.

Waiver for Reasonable Cause

Any taxpayer may request, in writing, a waiver of penalty. The written request must contain all facts and circumstances alleged to constitute reasonable cause and an absence of willful neglect.  The request should be sent to:  Michigan Department of Treasury, Collection Services Bureau, P.O. Box 30199, Lansing, MI 48909.

If the taxpayer establishes that the failure to file or pay was due to reasonable cause and not to willful neglect, the Department will waive the penalty. If a taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return or pay the tax within the prescribed time, then the delay is due to reasonable cause. In determining whether a taxpayer was unable to file a return or pay a tax despite the exercise of ordinary business care and prudence, the Department will consider all facts and circumstances surrounding the taxpayer, the taxpayer’s actions, and the nature of the tax.

If a taxpayer subject to the negligence penalty demonstrates to the Department's satisfaction that the deficiency or excess claim for credit was due to reasonable cause, the department will waive the negligence penalty. If a taxpayer successfully disputes a penalty for intentional disregard of the law, the Department will not impose a negligence penalty on the tax due.

Examples that are illustrative, but not conclusive, in showing reasonable cause include:

1. The failure to file or pay is caused by the death or serious illness of the taxpayer responsible for filing.
2. The failure to file or pay is caused by the destruction by fire or other casualty of the taxpayer's records or the taxpayer's business.
3. The failure to file or pay personal taxes is caused by the prolonged unavoidable absence of the taxpayer responsible for filing and the taxpayer is precluded, due to circumstances beyond the taxpayer's control, from making alternate arrangements for filing or paying.
4. A showing that the completed return or payment was timely mailed; that is, the U.S. postmark stamped on the envelope is dated on or before the due date set for the filing of the return, including extensions.
5. The delay or failure is caused by erroneous written information that has been prepared contemporaneously and given to the taxpayer by an employee of the Department.

TAXPAYER-INITIATED DISCLOSURE

Taxpayer-Initiated Disclosure is an administrative program that allows a taxpayer to voluntarily disclose a tax deficiency to the Department without imposition of penalties.  Limitations to a lookback period, which are provided under the statutory voluntary disclosure program under section 30c of the Revenue Act, MCL 205.30c, are not allowed under this administrative program – the taxpayer must file returns and pay the full amount of tax and interest owed for all filing periods.  A taxpayer is required to file a written request or statement to be considered for the Taxpayer-Initiated Disclosure exception from penalty; it is not automatic.

Under Taxpayer-Initiated Disclosure, a person (either a non-filer or a current taxpayer) may disclose and pay any prior period tax deficiency without imposition of penalty, provided there has been no previous contact by the Department.  An initial letter of inquiry is not considered a previous contact; however, a person will not qualify for the penalty waiver if a final letter of inquiry has been issued.

Under Taxpayer-Initiated Disclosure:

No penalty will be applied to tax deficiencies on amended returns if all of the following exist:

1. There has been no contact by the department,
2. The taxpayer is not under investigation by the department for the tax period involved, and
3. The taxpayer or agent pays the tax deficiency and interest without further action by the department.

No penalty will be applied to tax deficiencies paid with the filing of a delinquent return if all of the following exist:

1. There has been no contact by the department,
2. The taxpayer is not under investigation by the department,
3. The tax period of the return(s) includes the taxpayer's first filing period for that tax, and
4. The taxpayer or agent pays the tax deficiency and interest without further action by the department.

A taxpayer is required to file a written request or statement to be considered for the Taxpayer-Initiated Disclosure exception from penalty.

FRIVOLOUS PROTEST

A penalty (the greater of $25.00 or 25% of the tax due) may be imposed when a taxpayer attempts to avoid or delay payment of tax for reasons that are either not facially valid or have repeatedly been found to have no merit in prior litigation.

Examples of frivolous protest include, but are not limited to, the following:

1. Fifth Amendment (privilege against self-incrimination) objections where:

   A.     The taxpayer is engaged, or alleged to be engaged, in unlawful activities; or

   B.     The taxpayer failed or refused to file a return with another taxing authority.

2. Assertions of the unconstitutionality of the tax based on grounds that have repeatedly been found to be without merit, which include:

   A.     The invalidity of the tax based on the gold or silver standard.

   B.     The invalidity or nullification of the 16^th Amendment to the U.S. Constitution.

   C.     The taxpayer asserts it is a “sovereign citizen” or not a citizen of Michigan or the United States that is subject to tax.

3. The payment of tax is merely voluntary.
4. Assertions that payment received for labor (salaries and wages) is a return of capital and not income.

Additionally, section 21(2)(c) of the Revenue Act, MCL 205.21(2)(c), states the following:

"If the taxpayer serves written notice upon the department within 30 days after the taxpayer receives a notice of intent to assess, remits the uncontested portion of the liability, and provides a statement of the contested amounts and an explanation of the dispute, the taxpayer is entitled to an informal conference on the question of liability for the assessment." (Emphasis added)

Therefore, a taxpayer is required to remit payment on the uncontested portion of the tax due within 30 days of receiving the billing. If the taxpayer failed to remit payment of the uncontested portion of the tax due and the results of the informal conference indicate that any portion of the unpaid liability is uncontested, the frivolous penalty will apply to that uncontested portion.

¹ Pursuant to MCL 205.6a, a taxpayer may rely on a Revenue Administrative Bulletin issued by the Department of Treasury after September 30, 2006, and shall not be penalized for that reliance until the bulletin is revoked in writing. However, reliance by the taxpayer is limited to issues addressed in the bulletin for tax periods up to the effective date of an amendment to the law upon which the bulletin is based or for tax periods up to the date of a final order of a court of competent jurisdiction for which all rights of appeal have been exhausted or have expired that overrules or modifies the law upon which the bulletin is based.

² MCL 205.23.

³ MCL 205.24.