How a taxpayer argued and lost in Tax Court. Takeaway: You really do have to take some responsibility for your taxes. Have you ever wondered if you could blame your tax preparer to avoid a 20% penalty from the IRS? Do you create a new version of “The dog ate my homework” or “The devil made me do it”? If your tax return is audited and you “lose,” the IRS is quick to assess your negligence penalty in addition to back taxes, plus interest. The additional tax you owe is called the “deficiency” and the penalty is the “accuracy-related penalty” and is imposed at a flat 20% of the deficiency: if you owe $5,000 because you missed the audit, the penalty is $1,000.

“Expect!” you can cry “I gave all my stuff to the preparer. The fact that he made mistakes shouldn’t be a reason to penalize me. I already have enough trouble finding the deficiency. I’m a victim here. It’s not fair. I’m going to Tax Court.” Which is precisely what a California woman did when she was faced with a fine of $1,059.20. Because she didn’t want to pay a lot of money for a tax attorney, she represented herself. [Pro Se] before the Tax Court [T.C. Memo 2009-278]. And she lost.

What happened? She had her long-time tax preparer prepare her 2005 Form 1040. She gave the preparer financial documents, including a 2005 Form SSA-1099, Social Security Benefits Statement, indicating that she and her late husband had received $21,445 in Social Security benefits in 2005. However, you did not provide the Preparer with a 2005 Form 1099-DIV, Dividends and Distributions, indicating that you had received $216 of dividend income, or a Form 1099-INT, Income from Interest, indicating that he had also received $24 of interest income. .

Now, the Preparer, in the language of the Tax Court, “did not consider or include” these three taxable items when preparing the 2005 Form 1040: Social Security Income $21,445, Dividends $216, and Interest $24. He forgot to put in the $21,445 and, of course, he couldn’t put in the dividends and interest income, because he didn’t know them. However, the Preparer provided the Taxpayer with a summary of the items to be included on the tax return, but no copy of the return was provided to the Taxpayer until the return was filed electronically and the filing was recognized by the IRS. . (This is not considered acceptable practice for any tax preparer.)

The Taxpayer was fully aware of the receipt of taxable Social Security Benefits in fiscal years 2002, 2003 and 2004. However, he did not detect errors in the summary of income items considered by the Preparer both when preparing the return, nor in the form itself when it was delivered after receiving the electronic filing.

The IRS, using its document matching programs, noted the unreported income and generated a letter calculating the deficiency of $5,296 and assessing the related accuracy penalty of $1,059.20. A direct calculation of 20% multiplied by $5,296. [IRC Sec. 6662(a)].

The legal framework is as follows:

The penalty
Internal Revenue Code subsection (a) of section 6662 imposes an accuracy-related penalty of 20 percent of any underpayment that is attributable to the causes specified in subsection (b).

Among the reasons that justify the imposition of the sentence is

or any material understatement of income tax as defined in section 6662(d)
or a material understatement occurs when the amount of the understatement exceeds the greater of

– [1] 10 percent of the tax that is required to be shown in the return for the taxable year, or
– [2] $5,000.
– In this case, the deficiency is $5,296, which is greater than $5,000 and meets the second condition.

Penalty Exceptions
The section 6662(a) penalty is waived if a taxpayer can demonstrate

or (1) reasonable cause for underpayment and
or (2) that the taxpayer acted in good faith with respect to the underpayment. Dry. 6664(c)(1).

subjective considerations
The regulations promulgated under section 6664(c) further provide that

o The determination of reasonable cause and good faith “is made on a case-by-case basis, taking into account all relevant facts and circumstances.” Dry. 1.6664-4(b)(1), Income Tax Regulations.
o Relying on the advice of a tax professional may, but need not, establish reasonable cause and good faith for the purpose of avoiding a section 6662(a) penalty.

Based on this, the Taxpayer, of course, tried to fit his case into the Exceptions mentioned above by alleging special facts and circumstances, as well as relying on the advice of his tax professional. A taxpayer can’t really accomplish more than that.

The Tax Court has established the following three requirements for a taxpayer to use reliance on a tax professional to avoid liability for a section 6662(a) penalty:

or (1) the adviser was a competent professional who had sufficient experience to justify the reliance,
or (2) the taxpayer provided necessary and accurate information to the assessor, and
or (3) the taxpayer actually relied in good faith on the assessor’s judgment.” See Neonatology Associates, PA v. Commissioner, 115 TC 43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002). .

These requirements are also known as “points”, a three-pronged test. Unconditional trust in a preparer or adviser does not always, by itself, constitute reasonable trust. The Tax Court has established additional guidelines based on facts and circumstances. [Such guidelines are called dicta]

o The taxpayer must also exercise “diligence and prudence”. Marina v. Commissioner, 92 TC 958, 992-993 (1989), affd. no published opinion 921 F.2d 280 (9th Cir. 1991).
o “The general rule is that the duty to file accurate statements cannot be evaded by attributing responsibility to an agent.” Pritchett v. Commissioner, 63 TC 149, 174 (1974).
o Taxpayers have a duty to read their returns to ensure all items of income are included.

– Relying on a preparer with complete information about a taxpayer’s business activities does not constitute reasonable cause if a superficial review of the return by the taxpayer would have revealed errors. Metra Chem Corporation v. Commissioner, 88 TC 654, 662-663 (1987).

or “Even if all data is provided to the preparer, the taxpayer still has a duty to read the return and ensure that all income items are included.” Magill v. Commissioner, 70 TC 465, 479-480 (1978), affd. 651 F.2d 1233 (6th Cir. 1981).

The Tribunal began with a consideration of Point Three, the good faith reliance on the Preparers’ judgment. In a display of common sense rarely seen in any federal court, the Tax Court issued its opinion that

o “We conclude that the petitioners did not rely in good faith on [the Preparer] to accurately prepare your return. We conclude that the petitioners did not rely in good faith on [Preparer’s] advice because they didn’t review your return before sending it to the IRS. [Emphasis added]

– There you go! If you don’t read the statement, you’re not really trusting someone, are you?
– “Thus, the unconditional confidence of the petitioners in [The Preparer] does not constitute reasonable reliance on these facts and does not excuse your failure to closely examine your statement.”

What about the second tip? That the Taxpayer must provide necessary and accurate information to the Preparer.

o The Tax Court noted that the “defense of confidence is also undermined by the fact that [Taxpayer] did not provide [Tax Preparer] with the necessary 1099 documentation regarding your dividend and interest income in 2005.

– Sure, the amounts are insignificant, $216 in dividend income and $24 in interest income. But the fact of not delivering them shows negligence and makes the taxpayer not comply with the Second Tooth.

After considering the Second and Third Points, the Tax Court did not even concern itself with the First Point, if the tax advisor was a competent professional. It concluded that the Taxpayer “had not demonstrated good faith and reasonable cause for its underpayments corresponding to 2005. Consequently, the Court holds [the IRS] determination that petitioners are liable for the section 6662(a) accuracy penalty for material income tax understatements for tax year 2005.”

That is all. The 20% penalty is maintained. Obviously, the Taxpayer was protesting the principle of the penalty, since $1,059.20 is not a lot of money and not worth the trouble of filing a Petition to hear the case in Tax Court. We have discussed this particular case because it illustrates quite clearly the principles involved in protesting the penalty, as well as the burden of proof required by the taxpayer.