Under IRC section 6676, the IRS has the authority to assess penalties against taxpayers for making erroneous claims for refund or credit. In a 2013 report, the Treasury Inspector General for Tax Administration found that the IRS had only imposed the excess refund penalty 84 times in the first six years after its enactment. That same report recommended that the IRS increase assessment of the penalty such that it would apply to over 575,000 taxpayers each year; however, the IRS did not expand enforcement to these levels [“The Law Which Penalizes Erroneous Refund and Credit Claims Was not Properly Implemented,” No. 2013-40-123, pp. 5–6 (Sept. 26, 2013)]. This made the IRS’s attempt to assess a $200 million erroneous refund penalty against Exxon Mobil Corp. especially surprising [43 F.4th 424 (5th Cir. 2022)]. This article first discusses the erroneous refund penalty, followed by a discussion of its application in the Exxon case.

What is the Erroneous Refund Penalty?

Currently, IRC section 6676(b) provides for a penalty of 20% of the “excessive amount” of a claim for refund or credit unless “it is shown that the claim … is due to reasonable cause.” [There is no reasonable cause exception for noneconomic substance transactions as defined in IRC section 6662(b)(6), making this a strict liability penalty for those transactions.] Note that the original version of IRC section 6676 did not apply to disallowed earned income credits, but this was added by the Protecting Americans from Tax Hikes Act of 2015. “Excessive amount” is the amount that “the claim for refund or credit for any taxable year exceeds the amount of such claim allowable … for such taxable year.”

Congress enacted IRC section 6676 because fraudulent refund schemes had “overwhelmed IRS resources to the point where the IRS was unable to prevent the issuance of erroneous refunds.” From 2011 to 2013, the IRS disallowed over $53 billion fraudulent refunds, but paid over $10 billion in fraudulent refunds [Joint Committee on Taxation, JCS-2-07, “Description of Revenue Provisions Contained in the President’s Fiscal Year 2008 Budget Proposal,” pp. 285–286; see also Wright, “Bogus Refunds & Bad Penalties: The Feckless and Fixable Refund Penalty System,” Akron Law Review, vol. 48, no. 33, Oct. 1, 2015]. At the time, because there was no penalty for erroneous refund claims, there was almost nothing preventing people from flooding the IRS with fraudulent claims. Congress thus enacted IRC section 6676 to discourage such claims.

When Congress originally enacted IRC section 6676 in 2007, the statute stated that the penalty applied unless the taxpayer showed that the claim for refund or credit had “reasonable basis.” This had a logic to it, as both substantial understatement penalties and tax preparer penalties require that the taxpayer’s position either be supported by substantial authority or have a reasonable basis and be adequately disclosed [IRC sections 6662(b)(2), (d)(2)(B), 6694(a)(2)(B)]. Because refund claims require an explanation of the basis of the claim, adequate disclosure is not an issue, thus allowing for the lower “reasonable basis” standard for tax positions. The regulations define “reasonable basis” as:

A relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper. The reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim. If a return position is reasonably based on one or more of the authorities set forth in § 1.6662-4(d)(3)(iii) (taking into account the relevance and persuasiveness of the authorities, and subsequent developments), the return position will generally satisfy the reasonable basis standard even though it may not satisfy the substantial authority standard as defined in § 1.6662-4(d)(2). [Treasury Regulations section 1.6662-3(b)(3)]

“Reasonable basis” is an objective tax standard and does not depend upon the taxpayer’s state of mind.


There were concerns that the lack of a reasonable cause defense to this penalty would be overly burdensome to low-income taxpayers. As explained by the Taxpayer Advocate: “The rules for claiming these income-based refundable credits, available to low-income taxpayers who face unique obstacles in understanding and substantiating eligibility, are complex and varied, which raises the likelihood of mistakes.” The Taxpayer Advocate thus recommended eliminating the reasonable basis standard and replacing it with a reasonable cause defense so that the IRS could consider the taxpayer’s individual facts and circumstances before assessing the penalty.

In 2015, Congress took up the Taxpayer Advocate’s recommendation, and amended IRC section 6676 to change the standard to “due to reasonable cause” [PATH Act, section 209(c)(1)]. “Reasonable cause, is a subjective “facts and circumstances” test that looks to taxpayers’ efforts to ascertain the correctness of their returns [Treasury Regulations section 1.6664-4(b)(1)]. As of yet, there are no cases applying the reasonable cause standard in the context of IRC section 6676 penalties.

How Do Taxpayers Challenge Erroneous Refund Penalties?

IRC section 6676 penalties are “assessable” penalties, which means that the IRS assesses them on notice and demand, and does not issue a statutory notice of deficiency [IRC section 6671(a)]. The IRS does offer review with the IRS Independent Office of Appeals after assessment [Internal Revenue Manual]. Section 6676 penalties are not typically subject to review by the U.S. Tax Court [CCA 201607027 (Feb. 12, 2016)].

In order to obtain judicial review, the taxpayer must [except for narrow exceptions; see Interior Glass Systems, Inc. v. United States, 927 F.3d 1081, 1087 (9th Cir. 2019)] pay the penalty in full and file a refund claim using Form 843 within two years of payment. If the IRS denies the refund claim, the taxpayer can obtain judicial review filing a refund action either in federal district court or the Court of Federal Claims [IRC sections 6511(a), (b)]. The taxpayer then has two years after the IRS denies the claim (or six months after the claim is filed if the IRS does not respond earlier) to file the court case [IRC sections 6532, 7422(a)].

The Exxon Case

Exxon amended its income tax returns for 2006 through 2009, claiming a $1.5 billion refund. The court described the tax issue as a “almost as old as the oil industry itself: whether a transaction is a mineral lease or a mineral sale.” [Exxon Mobil Corp. v. United States, 43 F.4th 426 (5th Cir. 2022)]

The basic factual background was that Exxon had two similar agreements with the nations of Qatar and Malaysia to extract offshore minerals in those countries. These agreements required Exxon to extract gas and pay royalties to Qatar and Malaysia. Transfers of mineral interest are typically categorized as sales or leases. If the transactions were leases, Exxon would not recognize income from the portion of the income derived from the minerals and would be entitled to depletion deductions to the extent of its interest in the minerals. This was the position that Exxon took on its original returns. If the transactions were sales, however, the income derived from the minerals would be taxable to Exxon. By changing the characterization of the transaction from a lease to a sale, Exxon actually increased its taxable income for the years at issue. Why did Exxon do this? Because, as the court explained, “Exxon’s new math had the downstream effect of clearing the way for it to claim foreign-tax credits. Because Exxon had paid foreign tax on the money that it now included in its U.S. taxable income, Exxon was able to claim credit intended to prevent the double taxation of income. The foreign-tax credits generated its mammoth refund request.” (Exxon, p. 434)

The IRS disallowed Exxon’s refund claim in full, and also assessed a $200 million excessive refund claim penalty, claiming that Exxon’s position did not have a reasonable basis. Exxon paid the penalty and brought a refund claim in district court. The district court ruled against Exxon on the tax issue but reversed the penalty. On appeal, the Fifth Circuit affirmed.

The Fifth Circuit explained that Exxon’s refund claim position was “irreconcilable with decades of cases,” but nonetheless held that it did have a reasonable basis (Exxon, pp. 433–434). The court applied the definition of “reasonable basis” as requiring that the position be supported by one or more authorities, such as case law, statutes, regulations, private letter rulings, or technical advice memoranda [Exxon, p. 434, citing Treasury Regulations sections 1.6662-4(b)(3), (d)(3)]. The court noted that there was no case law supporting Exxon’s position, but that “the lease/sale issues is a notoriously complex area of tax law,” citing numerous cases that presented complex factual and legal analyses (Exxon, p. 434). In the end, the court explained that although it was a close call, the district court correctly granted Exxon’s claim for refund of the penalty.

As noted above, in 2015, IRC section 6676 was amended to change the defense to penalties from the subjective “reasonable basis” standard, to “reasonable cause.” Because Exxon’s refund claims were for years prior to this amendment, the court applied the original reasonable basis standard. The outcome may have been the same had the reasonable cause standard applied. It is likely that Exxon was advised by competent and well-qualified tax advisors in filing its refund claim, and good faith reliance on a tax professional generally will establish reasonable cause [Treasury Regulations section 1.664-4(b)(1)].

Beware Unwanted Surprises

The takeaway from Exxon is that, despite the origin of IRC section 6676 as a potential weapon against refund fraud, rather than taxpayers making refund claims in good faith, the IRS now appears willing to assess significant penalties when it disallows a refund claim, even one filed by sophisticated taxpayers advised by counsel. Because the IRS may increase enforcement of this penalty, it is important to keep it in mind when advising clients on refund claims (e.g., in February 2022, the IRS updated its Large Business & International “Process Unit,” outlining the criteria from IRC section 6676 penalties and directing examiners to consider whether they apply; https://bit.ly/3x2F69B). Previously, taxpayers may have perceived that there is no downside to taking a longshot at refund claim. Tax professionals should advise clients that this is now a riskier proposition, as the IRS may not only disallow the refund, but charge a penalty of 20% of the rejected claim [see SSTS 1(6); Circular 230, 10.34(c)]. To most taxpayers, this would be a very unpleasant surprise indeed.

Megan L. Brackney, JD, LLM (Tax) is a partner at the law firm of Kostelanetz LLP in New York City.