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Tom Talks Taxes - May 30, 2023
More on reliance on a tax professional for penalty relief
This article is one in a series on how taxpayers can rely on a tax professional to escape federal tax penalties.
A previous edition laid the foundation for relying on the advice of a tax professional to avoid federal tax penalties, specifically the §6662 accuracy-related penalty. Can reliance be used as reasonable cause for failure-to-file penalties, such as §6651(a)(1)?
Supreme Court precedent makes it very difficult. In United States v. Boyle, 469 U.S. 241 (1985), a taxpayer hired an attorney to file an estate tax return. The attorney missed the filing deadline; he filed no extension and filed the taxpayer’s return three months late. The taxpayer routinely inquired as to the status of the return.
The Court ruled that a taxpayer cannot delegate their duty to file a tax return or a tax return extension to a representative or agent:
…one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due. In short, tax returns imply deadlines. Reliance by a lay person on a lawyer is of course common; but that reliance cannot function as a substitute for compliance with an unambiguous statute.
However, the Court left the door open if the failure to file the return was due to the advice of a tax professional:
This case is not one in which a taxpayer has relied on the erroneous advice of counsel concerning a question of law. Courts have frequently held that "reasonable cause" is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return, even when such advice turned out to have been mistaken… This Court also has implied that, in such a situation, reliance on the opinion of a tax adviser may constitute reasonable cause for failure to file a return.
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In Estate of Hake v. United States, 234 F. Supp. 3d 626 (M.D. Pa. 2017), a district court held that the executors demonstrated reasonable cause for a failure-to-file penalty against the estate when the attorneys that the estate hired provided incorrect advice as to the filing date of the estate’s Form 706 tax return:
In order to give them time to resolve these ancillary issues, France advised the executors to seek extensions of time in which to file the return and pay the taxes owed… Pursuant to the executors' direction, France filed a Form 4768 on June 12, 2012, seeking extensions of time to file the return and pay the taxes… France advised the executors to seek the longest extension possible, in part because he did not know what the limits on such an extension were, as he had never before filed for such an extension… Galloway prepared and filed the Form 4768 and, upon approval, informed France that the deadline to pay the taxes and return had been extended for one year… France, in turn, informed the executors that they had been granted a one-year extension of the deadlines…
France and Galloway's advice was wrong, as Treasury Regulation 26 C.F.R. 20.6081–1 generally limits any extension to file the Form 706 return to six months for executors in the United States. Indeed, the Form 4768 that Galloway prepared and filed on June 21, 2012, specifically provided for a six-month automatic filing extension and a one-year discretionary payment extension, with the cover letter that accompanied the Form 4768 expressly requesting "an automatic 6 month extension of time to file a Form 706…” Pursuant to this request, the estate's deadline for filing its return was extended until January 2, 2013… However, the deadline for payment of taxes had been extended to July 2013.
The executors were helped by favorable case law in the Third Circuit, which narrowly construed the scope of Boyle to clerical errors by the tax professional. The court in Estate of Hake noted that the average taxpayer has no general knowledge of the complex Form 706 filing and payment deadlines:
This case aptly illustrates how such reliance upon expert advice can be objectively reasonable. As we have noted, there was nothing immediately intuitive about the determination of these deadlines. Instead, in order to ascertain when taxes needed to be paid and returns needed to be filed, the executors would have had first to identify the initial filing and payment deadlines and then navigated a series of extension rules, some of which are automatic and others of which are discretionary. The executors would then have had to recognize that the interplay of these automatic and discretionary extension rules would lead to material differences in payment and filing deadlines. The executors would also have to have been mindful of the fact that the application of some extension rules varies, depending upon their residency status. Given the complexity of these rules it is hardly surprising that even experienced counsel may sometimes become confused.
In Grecian Magnesite Mining v. Comm., 149 T.C. No. 3 (2017), a Greek corporation asserted reliance on its tax professional in an attempt to avoid the assertion of §6662(a) accuracy-related penalties for tax year 2008 and §6651(a)(1) failure-to-file and §6651(a)(2) failure-to-pay penalties for tax year 2009. The tax issues in the case are related to the taxation of partnership liquidation payments; the corporation would have had no U.S. filing requirement absent their ownership of the partnership.
The IRS asserted the corporation did not act in good faith because it did not investigate the advisor’s background and the corporation did not hire an expert who specialized in international tax law or an attorney with an LL.M. degree.
The Tax Court did not agree with the IRS’s position and found the taxpayer not liable for all the penalties in question:
It is true that Mr. Rose does not hold an LL.M. degree in taxation, nor did he claim to be an international tax law expert. But this is not the standard for the reasonable cause defense. To determine whether a taxpayer can avoid liability for a penalty on the basis of his reliance on the advice of a tax professional, we look to see that “[t]he adviser was a competent professional who had sufficient expertise to justify reliance". Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99. Mr. Rose was a licensed attorney and certified public accountant who had spent nearly 40 years preparing income tax returns, and he had accurately prepared GMM's returns for 4 years before the years here in issue. We find that Mr. Rose had sufficient credentials to justify GMM's reliance.
In closing, when a taxpayer is assessed a penalty for failing to file a tax return, and the preparer failed to file an extension as expected, or electronically transmit a return that the taxpayer authorized, there currently is no case law supporting relief using reliance on a tax professional. However, other relief options may be available, such as:
First Time Abate for individuals, C corporations, partnerships, and S corporations (see Internal Revenue Manual 184.108.40.206.3.2.1 (03-29-2023) for relief criteria), or
Rev. Proc. 84-35 for partnerships (see Internal Revenue Manual 220.127.116.11.3.1 (03-09-2022) for relief criteria).
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