| How one taxpayer argued and lost at Tax Court. | | | | does not necessarily, establish reasonable cause and |
| Moral: you really have to take some responsibility for | | | | good faith for the purpose of avoiding a section |
| your taxes. Have you ever wondered if you could | | | | 6662(a) penalty. |
| blame your tax preparer in order to avoid an IRS | | | | Based upon the this, the Taxpayer, of course, tried to |
| penalty of 20%? Come up with a new version of "The | | | | fit her case into the Exceptions noted above by |
| Dog Ate My Homework", or "The Devil Made Me Do | | | | pleading special facts and circumstances, as well as |
| It"? If your tax return gets audited, and you "lose", the | | | | reliance on the advice of her tax professional. A |
| IRS is very quick to impose its negligence penalty on | | | | Taxpayer can really not accomplish more than that. |
| top of back taxes, plus interest. The additional tax you | | | | The Tax Court has set forth the following three |
| owe is called a "deficiency" and the penalty is the | | | | requirements in order for a taxpayer to use reliance on |
| "accuracy related penalty", and is imposed at a flat | | | | a tax professional to avoid liability for a section 6662(a) |
| 20% of the deficiency: if you owe $5,000 because | | | | penalty:o (1) the adviser was a competent professional |
| you lost the audit, the penalty is $1,000. | | | | who had sufficient expertise to justify reliance,o (2) the |
| "Hold on!" you may cry. "I gave all my stuff to the | | | | taxpayer provided necessary and accurate |
| preparer. Just because he made errors should not be | | | | information to the adviser, ando (3) the taxpayer |
| a reason to penalize me. I've got enough problems with | | | | actually relied in good faith on the adviser's judgment." |
| coming up with the deficiency. I'm a victim here. Not | | | | See Neonatology Associates, P.A. v. Commissioner, 115 |
| fair. I'm going to Tax Court." Which is precisely what a | | | | T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002). |
| California woman did when faced with a penalty of | | | | These requirements are also known as "prongs", a |
| $1,059.20. Not wanting to pay the big bucks for a tax | | | | Three Prong Test. Unconditional reliance on a preparer |
| lawyer, she represented herself [Pro Se] before the | | | | or adviser does not always, by itself, constitute |
| Tax Court [T.C. Memo 2009-278]. And she lost. | | | | reasonable reliance. The Tax Court has set forth |
| What happened? She asked her long time tax | | | | additional guidelines based upon facts and |
| preparer to prepare her 2005 Form 1040. She gave | | | | circumstances. [Such guidelines are called dicta]o The |
| the preparer financial documents, including a 2005 | | | | taxpayer must also exercise "Diligence and |
| Form SSA-1099 Social Security Benefit Statement, | | | | prudence".Marine v. Commissioner, 92 T.C. 958, |
| indicating that she and her late husband had received | | | | 992-993 (1989), affd. without published opinion 921 F.2d |
| $21,445 of Social Security benefits in 2005. She did not, | | | | 280 (9th Cir. 1991).o "The general rule is that the duty of |
| however, provide the Preparer a 2005 Form 1099-DIV, | | | | filing accurate returns cannot be avoided by placing |
| Dividends and Distributions,indicating that she had | | | | responsibility on an agent." Pritchett v.Commissioner, 63 |
| received $216 of dividend income, or a Form 1099-INT, | | | | T.C. 149, 174 (1974).o Taxpayers have a duty to read |
| Interest Income, indicating that she had also received | | | | their returns to ensure that all income items are |
| $24 of interest income. | | | | included. |
| Now, the Preparer, in the language of the Tax Court, | | | | - Reliance on a preparer with complete information |
| "failed to consider or include" these three taxable items | | | | regarding a taxpayer's business activities does not |
| when he prepared the 2005 Form 1040: Social | | | | constitute reasonable cause if the taxpayer's cursory |
| Security income $21,445, Dividends $216 and Interest | | | | review of the return would have revealed errors. |
| $24. He forgot to put down the $21,445, and of course | | | | Metra Chem Corp. v. Commissioner, 88 T.C. 654, |
| couldn't put down the dividend and interest income, | | | | 662-663 (1987).o "Even if all data is furnished to the |
| because he didn't know about them. The Preparer did, | | | | preparer, the taxpayer still has a duty to read the |
| nonetheless, give the Taxpayer a summary of the | | | | return and make sure all income items are included." |
| items which would be included on the tax return, but no | | | | Magill v.Commissioner, 70 T.C. 465, 479-480 (1978), |
| copy of the return was provided to the Taxpayer until | | | | affd. 651 F.2d 1233 (6th Cir. 1981). |
| the return had been electronically filed, and the filing | | | | The Court started off with a consideration of the Third |
| had been acknowledged by the IRS. (This is not | | | | Prong, the reliance in good faith on the Preparers |
| considered to be acceptable practice by any tax | | | | judgment. In a display of common sense which is |
| preparer.) | | | | rarely seen in any federal court, the Tax Court |
| The Taxpayer was well aware of the receipt of | | | | delivered its opinion thato "We conclude that petitioners |
| taxable Social Security Benefits in the 2002, 2003 and | | | | did not rely in good faith on [the Preparer] to |
| 2004 tax years. Nonetheless, she did not detect any | | | | accurately prepare their return. We conclude that |
| errors in the summary of income items considered by | | | | petitioners did not rely in good faith on [Preparer's] |
| the Preparer both in preparing the return, nor in the | | | | advice because they did not examine their return |
| return itself when delivered after receipt of electronic | | | | before it was submitted to the IRS. [Emphasis added] |
| filing. | | | | - There you have it! If you don't read the return, you |
| The IRS, using its document matching programs, | | | | are not really relying upon someone, are you? |
| noticed the under-reported income and generated a | | | | - "Thus, petitioners' unconditional reliance on [The |
| letter calculating the deficiency of $5,296, and imposing | | | | Preparer] does not, on these facts, constitute |
| the accuracy related penalty of $1,059.20. A straight | | | | reasonable reliance and does not excuse their failure |
| calculation of 20% multiplied by $5,296. [IRC Sec. | | | | to closely examine their return." |
| 6662(a)]. | | | | What about the Second Prong? That the Taxpayer |
| The legal framework is as follows: | | | | must provide necessary and accurate information to |
| The Penalty | | | | the Preparer.o The Tax Court noted that the "reliance |
| The Internal Revenue Code, subsection (a) of section | | | | defense is also undercut by the fact that [Taxpayer] |
| 6662 imposes an accuracy-related penalty of 20 | | | | did not provide [Tax Preparer] with necessary Form |
| percent of any underpayment that is attributable to | | | | 1099 documentation regarding their dividend and |
| causes specified in subsection (b). | | | | interest income in 2005. |
| Among the causes justifying the imposition of the | | | | - Sure, the amounts are insignificant, $216 in dividend |
| penalty iso any substantial understatement of income | | | | income, and $24 interest income. But the failure to |
| tax as defined in section 6662(d)o a substantial | | | | hand these over shows sloppiness, and causes the |
| understatement occurs where the amount of the | | | | taxpayer to not meet the Second Prong. |
| understatement exceeds the greater of | | | | After considering the Second and Third Prongs, the |
| - [1] 10 percent of the tax required to be shown on the | | | | Tax Court did not even bother with the First Prong, |
| return for the taxable year, or | | | | whether the tax adviser was a competent |
| - [2] $5,000. | | | | professional. It concluded that the Taxpayer had "not |
| - In this case, the deficiency is $5,296 which is greater | | | | demonstrated good faith and reasonable cause for |
| than $5,000 and fulfills the second condition. | | | | their underpayments for 2005. Accordingly, the Court |
| Exceptions to the Penalty | | | | sustains [the IRS] determination that petitioners are |
| The section 6662(a) penalty is not imposed if a | | | | liable for the section 6662(a) accuracy-related penalty |
| taxpayer can demonstrateo (1) reasonable cause for | | | | for substantial understatements of income tax for the |
| the underpayment ando (2) that the taxpayer acted in | | | | 2005 tax year." |
| good faith with respect to the underpayment. Sec. | | | | That's it. The 20% penalty is kept. Obviously, the |
| 6664(c)(1). | | | | Taxpayer was protesting the principle of the penalty, |
| Subjective Considerations | | | | as $1,059.20 is not a lot of money, and not worth the |
| Regulations promulgated under section 6664(c) further | | | | work of filing a Petition to hear the case in Tax Court. |
| provide thato the determination of reasonable cause | | | | We have discussed this particular case because it |
| and good faith "is made on a case-by-case basis, | | | | illustrates rather clearly the principles involved in |
| taking into account all pertinent facts and | | | | protesting the penalty, as well as the burden of proof |
| circumstances." Sec. 1.6664-4(b)(1), Income Tax Regs.o | | | | required by the taxpayer. |
| Reliance on the advice of a tax professional may, but | | | | |