The Small Business Penalty Fairness Act, (S. 2917), introduced by a bipartisan group of Senators on December 18, 2009, will require the Internal Revenue Service (IRS) to assess penalties for failure to disclose such investments in proportion to the benefits received and ensure small businesses don’t suffer excessive fines.

The legislation was developed by members of the Senate Finance Committee and the House Ways and Means Committee, both of which have jurisdiction over tax legislation, after it was discovered that some small businesses that unknowingly invested in transactions of listed tax shelters suffered tax penalties as high as USD300,000 per year, but received tax benefits of as little as USD15,000.

The Small Business Penalty Fairness Act revises section 6707A of the IRS code to set the penalty for failure to disclose reportable transactions to the IRS at 75% of the tax benefit received. Reportable transactions are defined as investments in transactions that the IRS has identified as listed tax shelters or that have characteristics of tax shelters, including large losses or confidentiality agreements.

The minimum penalty under the new legislation is USD10,000 for corporations and USD5,000 for individuals, and the maximum penalty is USD200,000 for corporations and USD100,000 for individuals.

The bill also requires the IRS to submit an annual report to the Senate Finance Committee and the House Ways and Means Committee regarding tax shelter penalties assessed during the preceding year.

The Small Business Penalty Fairness Act is paid for by allowing the IRS to apply penalties for insufficient funds to electronic payments along with bad checks. Additionally, the bill will clarify the Department of Treasury’s authority to withhold payments to federal contractors who owe back taxes on amounts paid for property, as well as payments for goods and services. Both of these proposals are included in President Obama’s fiscal year 2011 budget recommendations.

The bill passed by the Senate was an improved version of the “Small Business Penalty Relief Act of 2009,” introduced on November 16, 2009, with the updated bill including the provisions to fully offset the cost of the package.

The companion bill in the House of Representatives (H.R. 4068) was introduced on November 16 and awaits votes by the Ways and Means Committee and then the full House.