United States

Tax Court holds taxpayer not liable for accuracy-related penalties

INSIGHT ARTICLE  | 

The United States Tax Court recently issued an opinion in which the court determined that a taxpayer was not liable for section 6662 accuracy-related penalty assessed against her due to her reliance on a tax professional to accurately prepare her tax returns. 

Summary of the facts of the case1

In 1982, Dr. Carolyn Whitsett, a physician specializing in blood transfusions, purchased 4,000 shares of Immucor, Inc. stock for $11,000. In 2011, TPG Capital acquired Immucor and issued a stock redemption offer for $27 per share. At the time of the offer, Whitsett owned 63,594 shares due to stock splits and other offers. Whitsett accepted the redemption offer and in January 2012, she received a check for $1,717,038. Included with the check, TPG Capital’s agent sent a letter captioned “Corporate Action Advice” showing the payment date as Aug. 19, 2011, and the tax year as 2012. The letter also stated that the stock redemption was processed on Jan. 4, 2012.

On Jan. 11, 2012, Whitsett contacted her longtime tax return preparer, Joe Whittemore, and provided to him the documents she received with regards to the stock redemptions. After speaking to Whitsett and reviewing the documents, Whittemore prepared her 2011 return and made a series of errors, including improperly reporting the stock sale in the 2011 tax year, incorrectly calculating gain by miscalculating the stock’s cost basis, completing the return several months after the extension due date, and ultimately not actually filing her 2011 return. Whittemore did have the taxpayer pay $154,776 as her extension estimate and $5,393 as her balance due. Each time, Whitsett promptly paid the amounts.

In early 2013, the taxpayer received a Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, for the stock sale showing proceeds of $1,717,038 with a Jan. 4, 2012, sale date. Whitsett again provided this information to Whittemore, as she engaged him to complete her 2012 return, unaware of the problems with her 2011 filing. Whittemore filed her 2012 return, although late, and did not properly attribute the stock sale to 2012.

On Dec. 9, 2013, Whitsett received a notice from the IRS stating she had a credit of $165,562 for her 2011 tax year, but no 2011 return was filed. She responded with a letter stating her understanding that Whittemore did file the return and enclosed a copy of the 2011 return he provided to her. She later sent a second payment of $5,393, which the IRS credited to her account. Mr. Whittemore assured the taxpayer there was no need to refile her 2011 return because he already e-filed it. On Sept. 15, 2014, a second IRS notice was sent to Whitsett, which she again responded to by saying that her 2011 return was electronically filed.

On Oct. 27, 2014, Whitsett received a notice that the information reported on her 2012 return did not match the records related to the stock sale sent to it by Immucor’s agent. That notice informed her that she had a balance due of $680,086 for the 2012 tax year. She executed a Power of Attorney to allow Whittemore to communicate with the IRS on her behalf. In February 2015, Whittemore sent Whitsett an email stating she should have reported the Immucor stock sale in 2012 and that he would file amended returns for both 2011 and 2012, although the 2011 return would have been the original return. Whittemore never filed any returns. After receiving no response from the taxpayer, the IRS issued a notice of deficiency for 2012 in the amount of $541,522 and an accuracy-related penalty of $107,995.

At this point, Whitsett sought a new counsel. Whitsett agreed that the stock sale was attributable to the 2012 tax year and her basis in the stock was $11,000. She did not agree that she was liable for the accuracy-related penalty.

Grounds for the decision

While the Tax Court determined that the IRS did indeed meet its burden regarding negligence, Whitsett avoided the accuracy-related penalty by demonstrating that she did in fact act reasonably and in good faith under the circumstances. She showed that she was unsophisticated in her understanding of tax law and therefore relied on the advice of a tax professional. The Tax Court relied on a three-prong test developed by the court in Neonatology Assoc., P.A. v. Commissioner, 115 T.C. 43 (2000), aff’d 299 F.3d 221 (3d Cir. 2002) to conclude that the taxpayer in this case acted in good faith and thus was not liable for accuracy related penalties.

The three prong test in Neonatology is:

  • the advisor was a competent professional who had sufficient expertise to justify reliance;
  • the taxpayer provided necessary and accurate information to the advisor; and
  • the taxpayer actually relied in good faith on the advisor’s judgment.

The court determined that Whittemore was an experienced and well-established return preparer and had prepared the taxpayer’s returns for many years with IRS challenges only related to math errors. And, while Whittemore was not a certified public accountant, Whitsett reasonably assumed he was, due to his membership in several accounting societies. Finally, his errors regarding the taxpayer’s 2011 and 2012 returns cannot apply retroactively against the taxpayer because the taxpayer was completely unaware of them.

Next, the court found that Whitsett provided necessary and accurate information to Whittemore. She timely disclosed all facts she knew or should have reasonably known. Whitsett provided to Whittemore all the documents related to the stock sale she received, and specifically brought up the sale again during preparation of her 2012 tax return.

Finally, the taxpayer actually relied in good faith on the adviser’s judgment, which takes into account the taxpayer’s experience, knowledge and education. While highly educated as a medical doctor, Whitsett had no training regarding tax return preparation, corporate or tax law. She retained Whittemore over the course of several years without a serious IRS challenge. Continuing that trust, she relied on her tax advisor to her financial detriment. Rather than enjoying a financial benefit of the time value of money by rightfully delaying her tax payment into the 2012 tax year, she included it in her 2011 tax payment. She also honestly believed her 2011 return had been filed.

Conclusion and analysis

Section 6662 imposes a 20 percent penalty on any portion of underpayment attributable to negligence or disregard of rules or regulations or any substantial understatement of tax. Negligence includes any failure to make a reasonable attempt to comply with internal revenue laws. An understatement on income tax is substantial if it exceeds the greater of $5,000 or 10 percent of the tax required to be shown on the return. Section 6664(c)(1) provides that an accuracy-related penalty  may be avoided if a taxpayer acted reasonably and in good faith. The taxpayer acted reasonably if it exercised ordinary business care and prudence. Both determinations are made on a case by case basis and take into account all relevant facts. Treas. Reg. section 1.6664-4(c)(1) provides further guidance as to what constitutes reasonable cause and good faith on the part of the taxpayer when relying on advice from a professional tax advisor. The burden of proof is on the taxpayer.

As this case demonstrates, reliance on reasonable cause as a defense against accuracy penalties is entirely dependent on the facts surrounding any given situation. Had the taxpayer not accurately provided information to the best of her ability, or had she an earlier inkling that that her tax advisor erred in his advice, she might not have met her burden.

The taxpayer’s success in this Tax Court case provides a useful example of situations when the taxpayer can successfully argue reasonable cause and good faith for the abatement of accuracy-related penalties. 

http://www.ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=11262

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